High risk sectors fear FRRP focus

Finance directors across a wide swathe of British industry received an early and unwanted Christmas present from the Financial Reporting Review Panel (FRRP). The FRRP, part of the Financial Reporting Council (FRC), recently announced which sectors it will be reviewing – those it sees as high-risk amid the prevailing economic conditions.

So if you are an FD in commercial property, insurance, support services or travel, you can expect to see an FRRP letter hitting your desk or your inbox. Within those four sectors the FRRP will give particular attention to companies operating in niche markets and those outside the FTSE-350, because it deems they face more risk in the current climate than larger, more diversified companies. Support services are caught by this project too, because they are seen as being potential victims as government cutbacks start to bite.

Bill Knight, chairman of the FRRP, has warned companies caught in a difficult spot not to try and write a load of blather in their business review in the hope that shareholders will not notice. Transparency and clarity in financial and narrative reporting has to be the starting point and bland statements in the business review do nothing to help the reader get a picture of how your directors and your company has fared. Regrettably, marketing and communications teams have such a tight grip on every sphere of corporate life that the first reaction is always to put the best face on things, rather than give a more credible and balanced account. Finance directors must resist the wiles of their public relations whizzes and start telling it like it is.

Those caught up in the FRRP review should start to think now about the questions they will face. These will centre around the business review and, in particular, the description of principal risk and uncertainties. If financial reports have traditionally contained boilerplate disclosures or long lists of generic risks, they should now be torn up and replaced with the real risks that the directors know the company faces. Or, if you simply do not know what might sink your business, you would be well advised to find out – and pronto. The FRRP is looking for the principal risks and “whether descriptions are sufficiently specific to enable a shareholder to appreciate the threat to the company”. It is hard to believe that significant businesses do not have all this information to hand, but the FRRP, with its privileged access to the working of the boardroom and the accounts department, should know.

The FRRP gives little away about why it has homed in on these particular sectors. But it is worth looking back 12 months to see on which sectors it focused in 2010. In late 2009, it announced a watch list of advertising, recruitment, media, information technology and… commercial property. Any alarm bells ringing? Commercial property values have fallen significantly since the heady heights of 2007 and a wall of refinancing is due in 2011-2012 from banks that are not exactly flush themselves. Travel and leisure has also featured in prior years; it makes you wonder what the FRRP has found in previous inquiries.

In its own annual statement, the FRRP says that it challenges companies over failure to disclose risks which, with hindsight, events strongly suggest must have been known at the balance sheet date. In these circumstances, FDs were asked for confirmation of the facts and circumstances known at the date of signing off the accounts, and why some risks that later arose had not been considered a principal risk at that time. These are key questions — though FDs can take some grim satisfaction in knowing that the FRRP does admit this is a tricky area to get right.

This sector analysis must help to improve corporate reporting, but the FRRP should explain why it chooses the sectors it does and it needs to reveal more of its findings. After all, transparency is a two-way process. ?