Six ways to improve your principal risk reporting

Wednesday, February 09, 2011 | Posted by: Fiona Cullinan
Categories: FRC, Governance, Risk | Tags: governance, risk, FRC, compliance, financial, annual report, disclosure, FRRP, principal risks, business review, reporting, directors' report

Many companies are not being clear enough when reporting the principal risks and uncertainties facing their business, said a concerned Financial Reporting Review Panel last week. What steps can businesses take to improve compliance?

The Companies Act 2006 requires directors’ reports to contain a business review, which must contain a description of the principal risks and uncertainties facing the company. But the lack of clarity is resulting in a number of compliance issues, according to the Panel.

Main areas where companies fail:

• The directors’ report does not clearly identify which risks and uncertainties the directors believe to be the principal ones facing the business.
• A long list of principal risks and uncertainties is given and the list raises a question as to whether all the risks and uncertainties on the list are actually principal ones.
• The description given of a risk or uncertainty is in generic terms and it is not clear how that risk or uncertainty applies to the company’s circumstances.
• The disclosure is of a risk framework rather than of the risks or uncertainties themselves.
• The principal risks and uncertainties disclosed are not consistent with other information given in the report and accounts.
• The directors’ report does not state how the company manages its principal risks and uncertainties. As the purpose of the business review is to inform members of the company and to help them assess how the directors have performed their duty to promote the success of the company, the Panel believes that a board should state how the company manages its principal risks and uncertainties.

Grant Thornton’s recent 2010 FTSE 350 Corporate Governance Code found the quality of principal risk disclosures to be varied, with 75% of FTSE 100 companies providing detailed descriptions of their risks, explanations as to their impact on the company and the mitigating actions being taken. However, only 58% of the midmarket were compliant.

More than a third of companies provide only generic risk descriptions and/or fail to explain how they are managing these risks. Typically companies highlight 11.2 (2009: 10.7) risks, with operational risks assuming a greater profile this year.

So how can boards of directors improve their disclosure of the principal risks and uncertainties? The Panel suggests asking the following questions.

Six ways to improve your principal risk reporting

1. Do the disclosures state clearly which are the principal risks and uncertainties facing the business?
2. Are those principal risks and uncertainties the main risks and uncertainties currently facing the business? For example, have they been the subject of recent discussions at board or audit committee meetings? Are there any risks, which have been the subject of such discussions, that should be considered as principal?
3. Is the description of each principal risk and uncertainty sufficient for shareholders to understand the nature of that risk or uncertainty, and how it might affect the company?
4. Are the principal risks and uncertainties described in a manner consistent with the way in which they are discussed within the company?
5. Are they consistent with the rest of the report and accounts? Are there risks and uncertainties on the list which are not referred to elsewhere – or are there significant risks and uncertainties discussed elsewhere which do not appear on the list?
6. Is there a description in the directors’ report (or elsewhere in the report and accounts and explicitly cross-referenced from the directors’ report) of how the company manages each of the principal risks and uncertainties?

Bill Knight, Chairman of the Panel, which is part the Financial Reporting Council, said:

“Any board should be able to describe in their accounts, simply and clearly, the principal risks and uncertainties facing the company. Many boards do this, but too many do not. Boards who retreat behind boilerplate give the impression that they have not themselves understood the risks they face.”

For further help or information on financial reporting and compliance, contact Simon Lowe at simon.j.lowe@uk.gt.com or read more on our Corporate Governance page.

Image: © Juhan Sonin

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