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The operating and financial review (OFR) has rarely been out of the headlines since the concept was first mooted in the late 1990s as part of the company law review initiated by the UK government. Just a few weeks ago the company law reform bill was published by the Department of Trade and Industry and contained the clauses necessary to create the legal framework for the statutory OFR.
The chancellor's recent announcement of government plans to drop the statutory requirement for listed companies to produce an OFR therefore came as a surprise.
The impact of this decision will be felt not only in the UK, but also around the globe, as this initiative created what was widely regarded as both a progressive and a sensible framework for enhancing corporate transparency.
It is worth remembering where the concept of the OFR came from, why it was thought by many people in the business and investor communities to be such a good idea and what the implications of the decision to remove the statutory obligation are likely to be on corporate reporting.
Investors want precisely the type of contextual and non-financial information offered by OFR-style reporting to help make their investment decisions. To date, our own research has spanned 3,100 investors in 16 industries in 14 countries and the global support for the benefits of contextual and non-financial reporting is unmistakeable.
It is generally recognised that company accounts have become overly long and complex and, as a consequence, increasingly difficult to decipher. As a result many investors have struggled to see warning signs of the risks inherent in a company's strategy and performance.
This has been exacerbated by the move to International Financial Reporting Standards (IFRS) which, temporarily at least, has created a reporting model that is increasingly difficult to understand.
The original intention behind the proposed OFR was to explain to the outside world clearly and concisely just how the directors were running the business and to provide an understanding of its operating environment, particularly the opportunities and threats it faces.
The OFR was never designed to replace the detailed financial statements in a company's annual report, but rather to give a complementary and user-friendly overview of business-critical issues to enable readers to reach a better informed view of the company's performance.
PwC fully supported the proposal that every listed company should produce an annual OFR. However, we have consistently believed that its content should be left, as far as possible, to the best judgment of the directors concerned, with the absolute minimum of statutory underpinning. In our view, the approach originally adopted by the government and the standard issued by the Accounting Standards Board (ASB) provided an appropriate framework for the directors of a company to explain their business strategy and the key factors critical to success.
It is worth remembering that most large listed companies already produce an OFR and see great benefits from the process. They recognise the payback both internally through the sharper focus it brings on the key risks and opportunities, as well as improving the quality of information used internally and communicated externally to the owners of, and other stakeholders in, the business.
While it may be too early to predict the precise implications of the chancellor's announcement or how businesses will respond, we believe many companies will continue to publish an OFR-type report that follows the ASB's standard. Those other companies that should be producing a similar report, and would certainly benefit from so doing, may well not bother.
One factor that may influence their decision will be the reaction of the institutional investors. In the circumstances, it will be critically important that the investor community plays its role in enhancing corporate transparency by demanding the information originally set out in the OFR requirements.
Finally, while the government is rethinking, it should perhaps take the opportunity to resolve a big concern of business about the planned OFR: the prospect of legal action against the directors producing the OFR on the basis that they failed to draw specific attention to a particular risk which, while at the time thought to be remote, eventually turned out to be decisive.
If there was a fear about the OFR among business and investors, it related to the possibility of legal challenge and the inevitable risk that directors might resort to a "boilerplate" OFR, long on legal caveats and short on the sort of insight it was designed to offer. Business has repeatedly asked for a "safe harbour" provision, whereby directors are immune from being sued on the information provided in the OFR if they can show they have acted in good faith.
With some considered thought and with the involvement of those with a serious interest in this agenda, the latest surprise announcement might yet yield the key to delivering the quality of transparent reporting that we all want to see. (David Phillips is head of value reporting and Peter Wyman is head of regulatory policy at PwC.)
Under syndication arrangement with FE
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