The OFR: cracking under pressure

Are cracks appearing in the chancellor’s unexpected decision to abolish the
statutory operating and financial review?

This month’s extension of the business review consultation to a wider and
lengthier debate on mandatory narrative business reporting suggests that could
be the case.

Less than three months since the u-turn was announced, it is not entirely
unthinkable that widespread resistance to the decision could force the
chancellor to admit he was wrong and reinstate a statutory OFR.

The case for abolishing the statutory OFR, if based on the costs of
compliance, is relatively weak in comparison to the benefits that the OFR can
bring in terms of increased shareholder value, better information for boards or
management, and a reduced cost of capital.

If the decision can be reversed, it should be done swiftly. It may already be
too late to reinstate the previous timings, which required a statutory OFR for
years beginning April 2005.

Many of the companies in the first tranche for a statutory OFR will have
stopped their preparations in late November. Given that they will now find
themselves in the busy last quarter of their financial year, there may not be
time to make up lost ground.

There is no easy way out of the situation caused by the chancellor. We are
left with a problematic relationship between the mandatory business review and
the voluntary OFR that the government hopes companies will continue to produce.

The uncertainty over future requirements and the sheer demotivation generated
by the decision will mean that fewer companies will produce a voluntary OFR in
future than before.

We could give the chancellor the benefit of the doubt and assume that he had
not foreseen the consequences of his decision. After all, how could he? It
doesn’t seem as if any lengthy analysis was undertaken of the impact of the

There was certainly no consultation with stakeholders. And although they were
too polite to say so, the DTI and the ASB seemed as surprised and aggravated by
the decision as those outside the regulatory loop.

But the chancellor shouldn’t be let off the hook that easily. He should not
have circumvented the due process for formulating policy, and should not have
reversed a decision regarded by the government in 2004 as essential for
improvements in narrative reporting sought from quoted companies.

If thorough analysis or consultation had been undertaken before making the
decision to abolish the statutory OFR, it would have served to correct some of
the chancellor’s mistaken assumptions about the review.

First, the OFR is not an unnecessary ‘goldplating’ of an EU requirement. Its
origins lie in best practice guidance issued by the ASB in 1993 and was first
proposed as a mandatory requirement by the Company Law Steering Group in 2001.

Second, the OFR is not primarily about reporting social and environmental
information. Its role is to disclose information about strategies and risks,
information similar to that used by the board to enable investors to make
informed investment decisions.

Third, a mandatory OFR is not simply an overhead to a company. It undoubtedly
does impose compliance costs, depending on the quality and extent of the
company’s existing reporting systems. But the OFR also generates benefits to the
company and to the economy as a whole. Collecting and reporting information on
strategies and risks may uncover previously unrealised deficiencies in the
information available to management or the board.

Disclosure of comprehensive and balanced information gives a better
understanding of the risks and prospects of the business, which in turn results
in a reduced cost of capital for that organisation, enhanced credibility and
better investor relations. The ability to produce a good OFR gives a company the
confidence that its systems are generating robust and useful management

The UK will regain some lost ground when the management commentary
requirements become an essential component of the IFRS reporting package. This
means there will eventually be EU regulation requiring UK-listed companies to
prepare an OFR-like statement for their consolidated statements.

If it weren’t such an important issue, we might find that vaguely amusing.

Unsuitable solution

The problem with requiring a mandatory business review yet expecting a
voluntary OFR is that preparers will naturally conform first with the
legislative requirements. The most likely outcome is that companies will
relocate information that would otherwise go in their OFR into the business
review so that their compliance with the business review is obvious.

But this will spoil the narrative flow of any voluntary OFRs and destroy the
advantages of having a single, coherent and identifiable place where the
company’s performance, position and prospects are discussed.

There is no obvious solution to this problem. Companies will either repeat
much content in their business review to preserve a coherent voluntary OFR; or
they will weaken and fragment their voluntary OFR by omitting material and
instead cross-referencing to the business review; or they will stop producing a
voluntary OFR. None of these options seems in the interest of effective

Charles Tilley is chief executive of CIMA

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