Financial Reporting Council - documenting 'principal risks' in Strategic Reports

I had recently spotted that the UK's Financial Reporting Council had issued draft guidance on the compilation of the Strategic Report for listed entities. This segment of a company's Annual Report and Accounts (currently called the 'Business Review') has been a rather ubiquitous and clunky affair regardless of industry, delivering little information to prospective and existing shareholders about how the company's risk profile, appetite, preferences etc. are catered for when executing its strategy.

Strategic reporting for UK companies 
- elimination of flannel?

Insurers have been prominent in efforts to improve this, though driven more by the need to pacify the FSA/PRA than by Parliament - see "risk appetite" break out from its box in  Aviva's AR&A between 2007 and 2012 for example - but the fact that a substantial piece of statutory reporting generally in the hands of executive management can potentially stray from the lexicon and structure of their increasingly professionalised Control Functions (and for banks and insurers, potentially their Internal Models), is clearly one that warrants some focus.

The Strategic Report will be compulsory content for Annual Reports and Accounts from October (Companies Act 2006 414C). The FRC's (non-mandatory) guidance regarding the incorporation of risk-related material into this section is to address the requirement on p2 that the Strategic Report;

...should include a description of the principal risks and uncertainties facing the company

The FRC's specific definition of Principal Risk is found on p35 of the draft guidance as;

A risk or combination of risks that can seriously affect the performance, future prospects or reputation of the entity. These should include those risks that affect the viability of an entity.

The draft guidance (p23) aims to tack on a few definitional aspects of how "risks and uncertainties" are reported in the context of strategy, most pointedly;

• [The risks] should be limited to those considered by the entity’s management to be the most important to the future development, performance or position of the entity. They will generally be matters that the directors regularly monitor and discuss because of their likelihood, the magnitude of their potential effect on the entity, or a combination of the two
• Principal risks or uncertainties with potential effects of such a magnitude that they may threaten the entity’s viability (ie its solvency and/or liquidity) should be explained fully and given due prominence
• Directors should consider the full range of business risks including commercial, operational and financial risks
• The descriptions...should be 
  sufficiently specific that a shareholder can understand why they are important to the 
  entity. This might include a description of the likelihood of the risk, an indication of when 
  the risk might be most relevant to the entity and its possible effects. Significant changes...

  such as a change in likelihood or possible effect, or the inclusion of new 

  risks, should be highlighted and explained. An explanation of how the principal risks and 
  uncertainties are managed or mitigated should also be included.
• 
  

  Where the risk or uncertainty is more generic, the description should make 

  clear how it might affect the entity specifically.

Prudential provide a good example here (from p72) of how this is currently done by an insurer - the fact that it is buried in 75 pages of 'Business Review' underlines why the streamlining of this work has become of statutory interest!

Interestingly, the FRC note that definition for "principal risks" has been developed/derived from previous FRC work, supplemented by work from the Sharman Inquiry - all of that therefore feels well divorced from anything produced by the IRM/Actuarial Profession/EIOPA around risk categorisation, and leads to the same bridging work I have been involved in previously; namely, reconciling how one manages and monitors risk within the business against what one reports externally. Might we have expected to see some kind of compulsory categorisation of "principal risks" in here that favours the financial services industry who arguably carry the largest set? 

Much of the other compulsory material in the Strategic Report (with exemptions) touches on other topical or sensitive matters such as;

• Inclusion of key performance indicators in the report ("...where possible, they should be accepted and widely used")
• Information on environmental matters, staff and social/community/human rights issues
• Information on gender splits at Board, Senior Management and All-company level

I may throw some feedback in to the FRC on this paper- comments welcome until late November. Externally, the main change for insurers will be trimming down some of the fluff and flannel already produced in the space. Internally, aligning the concept of "principal risks" with existing ERM programme/Internal Model lexicon may be a bigger job for anyone operating on a shoestring.

BIS and the future of narrative reporting - two birds, one stone (if you've done your SFCR!)

Piece of good news for the plc insurers amongst us, if not the other sectors, the BIS put out the results of their consultation on narrative reporting for listed entities. Looks like there will be a requirement for a high-level "Strategic Report", which between ORSA executive summaries, RSRs and SFCRs, are probably already written for the Tier 1 companies! More detail on what respondents wanted in this Strategic report is on pages 6-8.

They also had substantial feedback recommending a section in Annual Report and Accounts documents regarding proportions of women on Boards (just discussed in earlier post), as well as our old friend remuneration disclosure.

Of course, anyone who has had the unbridled joy of reading through the Commission's draft Level 2 text will know that between the SFCR and RSR, these kind of disclosures will be de rigeur from 2014, so it remains to be seen how badly the executives get pilloried once they make it easy to gauge their annual package - Aviva's, Standard Life's and Pru's bosses had a good working over this week, and that's with a convoluted presentation style!

Lloyds of London on Solvency II - Annual Report content

Hot on the heels of their delay in submitting their IMAP pack to the FSA, Lloyds of London pushed out their annual report today - as ever, a riveting read in general (and emphasises the scale of Nat Cat activity last year), but I concentrated more on the Solvency II side. They noted;

• "… we have made excellent progress to ensure that, whatever its final implementation date, the Lloyd’s market will be operating to the standards required of Solvency II by January 2013" (p8) - no mention of the IMAP delay, although this could of course work in their favour when looking to achieve this target.
• "Lloyd’s preparations for Solvency II advanced well in 2011, both within the Corporation and the market, and the entire programme across all relevant parts of the business is on track" (p22) - again, odd when IMAP activity has been postponed 3 months!
• "...Solvency II may have a positive impact on the reinsurance sector by increasing demand for reinsurance products" (p49) - same message put out by Swiss Re.

They also note good progress on the ORSA process and reporting front;

• "Lloyd’s has also further developed its approach to the Own Risk and Solvency Assessment (ORSA) – which aligns all of the activities Lloyd’s uses to manage risks and ensure the right level and type of capital. This alignment improves the quality of management information and the resulting decisions. In 2011, we produced a series of pilot reports to enable senior management to review the ORSA’s proposed structure and content. A live report was finalised and approved by the Franchise Board during the first quarter of 2012. In future, the report will be produced at least annually." (p30)

And finally a nice piece of disclosure on economic capital;

• "The capital provided by every member is assessed according to the Lloyd’s Individual Capital Assessment (ICA) capital setting framework. When agreed, each ICA is then ‘uplifted’ (by 35% for 2011) to provide an extra buffer to support Lloyd’s rating and financial strength. This uplifted ICA, which is the Economic Capital Assessment (ECA), is used to determine members’ capital requirements subject to prescribed minimum levels. The FSA oversees the annual review of syndicate ICAs by the Corporation, which reviews the historical performance, business plans and risk appetite of that syndicate in assessing the adequacy of the capital level proposed." (p69).

Whether all of this is good enough to allow them to achieve their objective of avoiding parallel running ICA and the internal model in 2013 is anyone's guess, but let's wish them good luck.  

FSA - Annual Report and Accounts - Solvency II and other bits

Few noteworty bits from the FSA's Annual Report and Accounts published today;

• Solvency II consultation paper for the UK industry due "later this year" - still can't be specific, I guess for the same reasons that the EU can't be!
• Will  be "assessing the efficiacy of firm's reverse stress testing exercises" over the next year - as per my last post, get started early by going through the Cass Business school paper!
• References both in the paper and in the press here and here. 
• Fines revenue up from £33.5m to £91.2m - a 'fine' achievement, if it means the bad guys are paying an appropriate share
• Over budget by £3.4m on contractors for "project activity" - not certain if Sol II is in that number or not.
• One very sharp piece in the Enforcement Annual Performance Review about "credible deterrence" and their increasing wish to use the threat of custodial sentance.
• Risk department up in headcount from 672 to 880 people in one year - the kind of recruitment numbers the Central Bank of Ireland would be delighted with!
• Cost of the Risk department up from £112m to £155m - at least the fines money is up to cover some of that.
• Solvency II revenue of £16.0m booked, against £5.8m the previous year. Those were the days...