OFR needed more than ever

Years ago, I asked a chief executive of a FTSE-100 company why a well-known politician from the Thatcher era was a non-executive board member. The CEO answered that at board meetings the politician was always asking: “How would this look on the front page of the Daily Mail?” The value of the question was that it forced those at the top of the organisation to consider how outsiders might view their behaviour.

At its best, the Operating & Financial Review (OFR) acts in a similar way. It is now coming up for its tenth year and has performed better than many anticipated because it makes directors explain to stakeholders the performance of the business and the factors underlying the results. I was not alone in thinking the Accounting Standards Board was mad in giving such free rein to the board, but had the OFR been handled purely by PR departments it would not have established such a central and permanent place in UK financial reporting.

Part of the success of the OFR has been that it is voluntary – although market pressure has made it all but mandatory – and that while the ASB laid out some guidelines they were general enough that companies have not fallen back on boiler-plate compliance.

A discussion paper from the ASB on the future of the OFR is expected before June. While the ASB can rightly be pleased with the performance of its baby, two unrelated events make a review timely. First, there is no OFR equivalent in international financial reporting and the International Accounting Standards Board has called on the ASB’s expertise in this area, so its work is likely to provide a basis for an international standard.

A more pressing reason for a re-examination is that the Company Law Review recommended the OFR become mandatory for public companies which satisfy two of the following criteria: that their turnover is greater than #50m; their balance sheet totals more than £25m; or they have more than 500 employees. It recommends that private companies should be required to prepare an OFR where they satisfy two of the three criteria above, multiplied ten times (turnover above £500m, balance sheet total greater than £250m, more than 5,000 employees). Various other criteria were considered because some significant entities do not necessarily fit easily into these categories.

Nevertheless, they were considered the only workable criteria. Under Company Law Review proposals, the OFR would consist of mandatory and voluntary elements and there would be a “properly prepare” requirement.

Voluntary elements include stakeholder relationships and social and environmental matters. Auditors would be required to review the OFR for the propriety of the directors’ preparation process, consistency with the audited accounts, and compliance with financial reporting standards. No model OFR would be published to discourage the use of boiler-plate compliance.

Yet the fate of the CLR remains uncertain because the hard work carried out by accountants, lawyers and civil servants that was destined to make the UK a great place to do business in the 21st century now rests on Parliamentary timetables and politics. The ASB refuses to pass comment on the benefits of making the OFR mandatory and there are strong arguments against making it over-prescriptive, although there is a need for greater consistency, not in the language but in the order.

Nevertheless, the ASB has a chance to go further than simply sprucing up the OFR. After the financial reporting failures at Enron, Equitable Life et al, the OFR appears to offer a way in which directors can start to rebuild the trust in corporate governance. And there are areas which a re-vitalised OFR could usefully address, in particular risk management, business valuation and potential liabilities. Directors need to spend more time explaining intellectual assets and how they are employed, while, post-Enron, investors need explicit assurance about the use of clever financing tricks.

In the light of recent criticism of the relationship between auditors and directors, FDs need new ways in which the robust nature of that relationship can be communicated without breaking commercial confidentiality. One way may be to be tell stakeholders more about the the work of the audit committee.

When the OFR was first published it broke new ground – the ASB should ensure that it does so once again.