RegulationCorporate GovernanceShould the OFR have been axed?

Should the OFR have been axed?

Listed companies have embraced the OFR, so why did the Treasury ditch it? asks Charles Tilley. Because it didn't serve its purpose, says Donald Stewart.

Taking a wrong turn

It took seven years to create through due process and extensive stakeholder
consultation, and just 10 weeks to destroy through consultation by stealth. So,
the mandatory requirement for an operating and financial review (OFR) is to be

In contrast to the widely reported comments made by the chancellor, the DTI’s
consultation is well hidden on page seven of an 18-page document, named the
Draft simplification plan on the DTI’s website.

We still have the disclosure required by the accounts modernisation
directive. So what will we lose if companies choose not to abide by the ASB’s
principles-based guidance? Namely, we will lose the emphasis on strategy, the
forward-looking orientation of the OFR and the transparent definitions of key
performance indicators that facilitate sector comparisons.

Institutional investors rate ‘quality of management’ as a key factor in
investment decisions. The OFR helps individual investors assess management, not
just through the detailed content, but the overall quality and richness of
disclosure that shows whether management understands its business and where it
is going.

A CIMA-commissioned MORI survey of 200 senior finance executives of listed
companies found that two-thirds were fairly prepared and committed to meet the
OFR requirements. Interestingly, two-thirds were still deciding on which KPIs to
report and their definition.

So management information in a significant number of companies could have
improved under the proposed regime. Preparing a high-quality OFR can improve
resource allocation within a company, as well as investors’ resource allocation
between companies.

The benefits are unquestionable, but difficult to estimate. Costs are easier
to estimate and said by the DTI to be £33m per annum. Set against a UK stock
market value of £1.5 trillion it needs only an infinitesimal and very achievable
reduction in the cost of capital to justify the statutory OFR.

Astonishingly, the Treasury is mandating government departments to follow the
ASB’s best practice guidance. Enough said…

Charles Tilley is CIMA chief executive

Finally back on track

The government has struck a blow against goldplating through Gordon Brown’s
announcement that he intends to abolish the operating and financial review.

The idea of clearing away unnecessary red tape is both laudable and obvious.
It seems surprising that the compulsory OFR, which was introduced by the DTI in
March this year, has fallen to the Treasury’s axe, as the first example of
unnecessary red tape. How did the DTI get it so wrong?

The EU accounts modernisation directive (as implemented in the UK) requires
that annual reports for large and medium-sized companies contain at least a fair
review of the development and performance of the company’s business and its
position.In addition, the auditors must express an opinion on the consistency of
the annual report (including that review) with the annual accounts.

Nevertheless, the DTI was keen to have quoted companies that go beyond these
parameters. Much has been made of the OFR’s ‘green’ credentials, in requiring
companiesto express their positions andpolicies in relation to social
andenvironmental matters.

Asking companies to make a public future commentary will be problematic.
Firstly, the board’s knowledge of future prospects is likely to be commercially
sensitive and secondly, directors face personal risks when making predictions
about the future.

While the DTI did consult prior to the introduction of the OFR, the scope of
the consultation was limited to whether medium-sized companies should be covered
by the review. The DTI insisted that ‘the OFR will improve the quality,
usefulness and relevance of information provided by quoted companies, helping
shareholders gain an understanding of a quoted company’s future prospects’.

Clearly, the DTI does not appear to have learned from the US SEC experience,
where the longstanding requirement on directors to produce a written report has
led to the generation of many useless boilerplate statements. It would appear
that where the DTI did not listen, Gordon Brown did.

Donald Stewart is a corporate partner at Faegre & Benson

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