FRC, FCA and PRA Joint Statement 26 March 2020

I notice the market has just dipped below 5,600 so clearly most people are not very worried by this FRC, FCA and PRA announcement. Nevertheless I would point out the following:

In the Joint statement by the Financial Conduct Authority (FCA), Financial Reporting Council (FRC) and Prudential Regulation Authority (PRA) https://www.frc.org.uk/about-the-frc/covid-19/covid19-joint-statement-26th-march-2020

Successful and sustainable businesses underpin our economy and society by providing employment and creating prosperity. Equity and debt capital markets play a vital role providing finance to these businesses and will aid the recovery.

The Covid-19 pandemic is an unprecedented situation but it is important to recognise that, while the reduction in activity associated with Covid-19 could be sharp and large, it is likely to rebound sharply when social distancing measures are lifted. In addition, in the intervening period, while activity is disrupted, substantial and substantive government and central bank measures have been put in place in the UK and internationally to support businesses and households. These measures, which have been evolving rapidly and could evolve further, are expected to remain in place throughout the period of disruption.

If I understand the doublespeak goobledegook language of these regulators, the next two paras are saying: we are not changing the rules about lenders and covenants, so they can screw their customers as much as they like, whilst we continue to ask them to behave nicely!!! Am I being too cynical? Might this lead to another RBS and Global Restructuring Group all over again??

The FCA, FRC and PRA strongly encourage investors, lenders and other users of financial statements to take into account the unique set of circumstances arising from Covid-19 which might result in uncertainty in companies’ financial positions, potential delays in the provision of financial information, the need for auditors to undertake additional work to support their audit opinions and the increased use of modified audit opinions, including qualifications arising from scope limitations.

UK banking authorities[1] have acted to reduce pressure on banks to restrict the provision of financial services, including the supply of credit and support for market functioning. Noting these actions, the FCA, FRC and PRA strongly encourage lenders and other parties to take into account these circumstances in responding to potential breaches of covenants arising directly from the Covid-19 pandemic and its consequences, given the common goal that the financial system should be a source of strength for the real economy during this challenging period. 

I also notice in the https://www.frc.org.uk/about-the-frc/covid-19/company-guidance-update-march-2020-(covid-19)

Given the systemic uncertainties that currently exist, many boards will be less confident in stating that they have a reasonable expectation that the company will be able to continue in operation and meet its liabilities as they fall due over a period of assessment (“the viability statement” as required for compliance with the UK Corporate Governance Code).
However, the FRC stresses the following points:

• Boards are required to have a “reasonable expectation” of the company’s viability over the period of assessment – during the current emergency and unprecedented pace of change, any reasonable level of expectation would naturally carry a much lower level of confidence;
• Being clear on the company’s specific circumstances and the degree of uncertainty about the future is important information; and
• When presenting a company’s viability statement, its board should draw attention to any qualifications or assumptions as necessary.

In describing any qualifications to the statement, a board should describe the limits of the predictions, the level of confidence with which they have been made and the uncertain future events that could prove critical to viability.

Similarly, the key assumptions made and the future scenarios considered should be explained. Many companies already use scenario and stress testing in developing their statements and this should continue as far as practicable. The use of reverse stress testing, to identify future scenarios that could lead to corporate failures, is also good practice.
At this time, the need for fuller disclosure is paramount.

And also

Given the inherent uncertainties in making predictions, we have stressed above the need to disclose underlying assumptions applied when preparing a viability statement, and any significant judgements made when assessing whether there are material uncertainties to disclose.

Similarly, companies should disclose significant judgements made in applying accounting policies that have the greatest effect on the financial statements. The requirement to do so (IAS 1 paragraph 122) is normally distinguished from the requirement of IAS 1 paragraph 125 regarding sources of estimation uncertainty. However, at this time, we encourage companies to provide as much context as possible for the assumptions and predictions underlying the amounts recognised in the financial statements, irrespective of any narrow interpretation of the requirements. Such information will help users to understand the amounts presented.

Relevant judgements and assumptions might include the:

• availability and extent of support through government support measures that have been announced;
• availability, extent and timing of sources of cash, including compliance with banking covenants or reliance on those covenants being waived;
• duration of social distancing measures and their potential impacts.

In the absence of any consensus view of the future path of the COVID-19 pandemic and its impact on the economy, users cannot expect all companies to apply consistent assumptions when there is such uncertainty. This lack of consistency makes the need for full disclosure of judgements, assumptions and sensitive estimates significantly more important than usual.

And in the guidance for auditors https://www.frc.org.uk/about-the-frc/covid-19/covid-19-bulletin-march-2020, re Going Concern:

The going concern assessment made by management is a fundamental part of the audit that may be significantly affected by the current circumstances. The FRC issued a revised ISA (UK) 570 in September 2019, which is effective for periods commencing on or after 15 December 2019. It requires a more structured and rigorous auditor risk assessment, greater work effort and expanded reporting. When performing an audit for which the revised standard is not yet effective, auditors may consider using some or all of the requirements in the revised standard to help them to carry out their risk assessment and to undertake their work in this area to the necessary high standard. The requirements over going concern reporting in paragraphs 19-22 of the standard may be particularly helpful.

We expect, given the current uncertainty and volatility, that more companies and auditors may need to consider reporting on material uncertainties. Where they do so, this should draw on the available facts and circumstances. Auditors should not generically report on material uncertainties.

Governments globally have announced the availability of business support packages for affected entities, which to date have focused on providing liquidity to affected entities, with some measures to also cover business costs (e.g. salary costs for furloughed staff) in certain circumstances. Many entities have also imposed measures to control costs and conserve available cash.

We face an unprecedented level of uncertainty about the economy and consequent future earnings of companies over the next 12 months.  It is difficult to make a meaningful base case economic forecast, let alone a plausible downside economic scenario.  In this highly uncertain environment, going concern assessments will be more difficult for entities to make, and more companies will need to report a material uncertainty related to going concern.  Companies and auditors should explain to investors the effect on their business of the current public health restrictions in different countries, sensitivities in different short term scenarios, for example the length and nature of public health restrictions that are in place or may evolve during the period of assessment.

It will be important in making any assessment of going concern to ensure that companies and their auditors evaluate whether the entity both has access to sufficient liquidity and can remain solvent through the period of public health restrictions and beyond. Companies and their auditors will need to take into account the terms of their financing facilities, the terms of any liquidity or other support accessed and whether any such support taken on gives rise to future obligations. Deferral of payments now, or the receipt of grants to offset costs may alleviate liquidity challenges but may affect the entity’s solvency if the liquidity support does not continue long enough for the entity to recoup those losses from future profits.

Liquidity and solvency risks faced by the entity may be inter-related and either or both may affect its going concern status and whether it faces material uncertainties related to going concern. Auditors will need to ensure that their assessment of going concern and the evidence that they need to gather in support of that explicitly considers both liquidity and solvency factors which may affect the ability of the directors to assert that the entity is a going concern and to identify and related material uncertainties.

We anticipate in the current circumstances that the auditor’s going concern work will be more extensive, require more evidence, and will continue to be performed through to the point of signing the auditor’s report. In view of this, more evidence may be required from the entity and the auditor should set a clear expectation with the audited entity of the additional time that will be needed to complete the audit in this area to the high standard that users of the financial statements will expect.

In addition, auditors should exercise professional scepticism where management and TCWG have determined that the current circumstances are not reasonably expected to have any material financial impact on the audited entity and that no material uncertainties related to going concern exist for the entity.

We will continue to watch developments and keep members informed.

Lex, in the FT today 27 March has written about this, see https://www.ft.com/content/933b1eb8-7072-4e51-a433-54ead31c97a0 (you need to subscribe to read the link):

Lex, an old and cynical collective organism, suspects the less detail a company gives, the more likely it is to be facing difficulties. The Financial Conduct Authority should set out guidelines on the information Covid-19 statements should contain. And it should nudge shaky businesses into publishing updates. The market has already worked out they look stretched. The question is this: what are they doing about it?

I agree with Lex. Well run companies who have regular shareholder engagement meetings with shareholders (as do HSBC, BHP, GSK, Vodafone, etc) will receive a sympathetic response to whatever decisions they make. Companies who have not established trust with their shareholders will struggle with these decisions and the idea of limited information flows, closed AGM meetings, etc  will be viewed with great suspicion: such behaviour is liable to provoke big share price swings.

Cliff Weight, ShareSoc Director