This is the sorry tale of how an attempt to encourage transparency and fuller disclosure from companies was suddenly scrapped by the government without a proper consultation process.
When the UK government announced its decision to bring in a mandatory operating and financial review (OFR) in May 2004, then trade and industry secretary Patricia Hewitt insisted it was an attempt to ‘promote greater transparency by our companies.’ But last November, just months before the first mandatory OFRs were due, Chancellor Gordon Brown revoked the requirement.
Brown’s decision to scrap the OFR was intended to send out a signal that the UK government is business-friendly and anxious to cut down on unnecessary red tape. Instead, the decision prompted a wave of hostile reactions from accountants, asset managers, non-governmental organizations and environmental campaigners.
The most vocal opponent of the decision is London-based environmental organization Friends of the Earth (FoE). In December FoE launched a legal challenge claiming the decision to scrap the OFR was ‘unlawful’ as it was ‘procedurally unfair’.
IR magazine sent a freedom of information request to the Treasury asking for documents related to the decision to do away with the OFR. The request was rejected on the basis that it would compromise the principle of ‘collective cabinet responsibility.’
In February the Treasury agreed to widen an ongoing Department of Trade and Industry (DTI) consultation into narrative reporting and pay FoE’s legal costs. It also agreed to release the documents as a result of FoE’s legal action.
These newly released government documents suggest that, after years of open consultation, the Treasury dumped the OFR following private meetings with Hermes Pensions Management, the Association of British Insurers (ABI) and the London Stock Exchange (LSE). They further show that just days before Brown announced this policy u-turn, neither he nor any other member of the Treasury had seen fit to inform the DTI, which was heading the OFR. Meanwhile, the Treasury had already discussed the move with the Confederation of British Industry (CBI), an influential business lobby group.
So much for collective cabinet responsibility.
Behind closed doors
In a meeting on June 8, 2005, an unnamed Hermes representative commented that the OFR was ‘colossally over-engineered’, the government documents show. A Treasury official then suggested that ‘a radical symbolic stripping-down of the OFR would go down incredibly well [with] big business.’ But with so much work already put into the OFR, the official wondered whether this would be ‘feasible’.
Subsequent memos show that on August 12 an ABI employee told a Treasury official that the OFR was ‘one of those things that gets worse as soon as you put it into law.’ The Treasury official described this meeting as ‘promising’. The government memos then suggest that a meeting with the LSE a week later became the final nail in the coffin of the mandatory OFR.
A Treasury discussion note from September 29 calls for the ‘scaling back’ of OFR requirements. This memo addresses how to handle the decision, but there is little discussion about the consequences of dumping the OFR.
Caught off guard
IR magazine spoke to Hermes, the ABI and the LSE, and all three stress that their position in private meetings with the Treasury was no different from their public statements. But they also emphasize that they were unaware of the Treasury’s intentions and believed these meetings to be informal discussions.
‘There’s always dialogue between stakeholders at the same time as formal consultations,’ says Adam Kinsley, director of regulatory strategy at the LSE. ‘However, nobody was expecting the process to pan out as it did – we didn’t have a sense of an imminent decision being made.’ While Kinsley welcomed the final scrapping of the OFR last November, he doesn’t necessarily agree with the process. ‘We’re not saying that revoking the OFR at the last minute is the right way to do things,’ he comments.
Colin Melvin, Hermes’ director of corporate governance, thinks it ‘unlikely’ that the Treasury’s meeting with Hermes instigated the government’s OFR u-turn. But the Treasury refuses to rule out this version of events. ‘You can see for yourself on our web site the record of our contacts with various groups in which the OFR was raised,’ it says in a statement.
The head of FoE’s corporate accountability campaign, Craig Bennett, believes organizations should be wary of closed-door government meetings as officials can place great importance on what is ‘whispered’. ‘This is why a comment from Hermes got misinterpreted and spiraled into this extraordinary decision to scrap the OFR,’ he says.
Meanwhile, FoE has been criticized for having an axe to grind with the government – but it is not alone in expressing a strong reaction against the demise of the OFR. ‘The strange thing here is that the Treasury put so much weight on such a small number of consultees,’ says Craig Mackenzie, head of investor responsibility at HBOS Group’s Insight Investment, one of the UK’s biggest asset managers with more than £95 bn ($170 bn) under management.
Mackenzie highlights the strong contrast between the seven-year process of formulating the OFR, which involved ‘a massive series of consultations with all investors,’ and the subsequent decision to revoke it. He points out that the latter was based on ‘three informal conversations that the Treasury undertook with who-knows-who from three particular institutions.’
Spin over substance
With Chancellor Brown expected to take over the premiership when Tony Blair steps down, Mackenzie suggests that these government documents offer an ‘interesting window on the way the future prime minister will go about the business of government.’
The UK’s Parliamentary Environmental Audit Committee, which is composed of representatives from both major political parties, has also raised questions about Gordon Brown’s handling of the OFR. In a report released in March, it said it is ‘concerned about the way in which the Treasury took the decision to abolish the OFR,’ stating that the decision suggests ‘an attitude of simply opposing competitiveness and sustainability.’ The committee now wants the government to introduce ‘a new reporting scheme which provides effective incentives for listed companies to act more sustainably.’
Bennett believes the memos released by the government demonstrate a preoccupation with spin rather than substance. ‘Nowhere do they assess whether it’s good or bad for British business to scrap the OFR, except with respect to cost savings,’ he comments. The government estimates that the collective cost of implementing the OFR for UK companies would have come to £33 mn. ‘If 1,300-odd listed companies can’t find £33 mn between them to ensure good corporate governance and basic social and environmental reporting, then we’ve really got problems,’ Bennett continues.
Costs aside, 65 percent of the UK’s largest 350 listed companies plan to produce a voluntary OFR anyway, according to a survey of 124 IROs by financial recruitment consultancy Nigel Lynn. With the outcome of the DTI consultation still unclear, 30 percent of survey respondents say they don’t know what they will do and only 5 percent rule out an OFR altogether.
Given the precipitancy of the government’s actions, it is not surprising that many IROs remain unconvinced. Only 31 percent accept the official line that the OFR was revoked to cut red tape. Forty-six percent say they have ‘no idea’ why it was scrapped, and 23 percent cite other reasons.
Without government regulation, companies are likely to take their lead from investors. ‘Investors will want to see companies producing OFRs, and if those investors make this very clear, companies will have a strong incentive to produce OFRs as opposed to business reviews,’ concludes Mackenzie. ‘Forward-looking statements are missing from the current accounting climate, and there’s pretty widespread consensus in the investment community that the OFR requirements are sensible, well considered and well judged.’
