OFR – 6 months on, many companies not yet compliant.

Cometh the new rule, cometh the (non) compliance surveys. 6 months following the initial introduction of the Operating and Financial Review, companies appear to be differing in their views as to how to be compliant with Reporting Standard 1 of the ASB.

Headline stats. A survey from Deloitte’s “Hold the Front Pages” suggests that whilst 82 % of applicable companies produce some form of OFR – either formally or adopting the broad recommendations – significant numbers fall short of the rules applicable from 2006. For example, the survey suggests that 59% disclose no KPI’s, 55% do not disclose the principal risks facing the business, and nearly half do not discuss the business objectives and strategies.

And the length and complexity of the task should not be underestimated, with annual reports now averaging 71 pages – a massive 59% increase since 1996. And according to another survey from Hyperion, whilst many large organisations have invested substantial sums in their transaction systems the same is not universally true of their management reporting systems. Many rely heavily on a hotchpotch of applications and spreadsheets to furnish their monthly board reports and relevant data is scattered widely through the organisation. It is clear that the OFR requires a more co-ordinated and consistent approach underpinned by regular and repeatable processes.

Reminder of the regulations The Companies Act 1985 spells out the objectives and legal requirements of the OFR but detailed guidance on its preparation is contained in Reporting Standard 1 (RS1) prepared by the Accounting Standards Board. The mandatory OFR came into effect for all companies whose year ends commence on or after the 1st April 2005. From 2006, the DTI will impose tough penalties - ultimately, unlimited fines - for directors personally who fail to comply.

Content should include

(a) the development and performance of the business of the company during the financial year,
(b) the position of the company at the end of the year,
(c) the main trends and factors underlying the development, performance and position of the business of the company during the financial year, and
(d) the main trends and factors which are likely to affect the company’s future development, performance and position, prepared so as to assist the members of the company to assess the strategies adopted by the company and the potential for those strategies to succeed.

Key issues facing IRO’s include the requirement to set out strategic plans and prospects in a realistic manner. How can this be done without assisting the company’s competition? Also, as companies can only measure and report on what is actually done - not on where it might wish to be - descriptions of strategy and prospects in the context of market trends and risks will need based on solid ground to satisfy investors and analysts.

Policies and processes to ensure effective and fair treatment of people will need to be in place and measurable.

Socially responsible behaviour - from ethical principles including the supply chain, and community practices - will be high on many agendas. But if accountability and reporting procedures are not in place, there will be little on which to report.

Reputational risk – as with any form of risk – requires measurability across all areas of the business, and few outside the oil industry have made progress. Understanding the reputational impact of the core business is a long list, from levels of compliance through pressure group interest, to stakeholder opinion audits.

And finally, whilst these requirements impact UK listed companies at the moment, the impact and uptake of OFR is being carefully watched on the other side of the Atlantic. A recent NIRI chapter meeting, discussing the “poor quality” – per the SEC – of Management Discussion and Analysis, was told that unless improvements were seen, an OFR style regime would be considered.

More transparency in hedge funds?

The announcement last week at the IOSCO conference of a new investigation by regulators into hedge funds and their transparency – or lack of it, will no doubt be welcomed by investor relations officers. Anything that achieves more insight into the holdings, strategies and practices of these often aggressive super sized investors is to be welcomed. The question remains as to whether this will be achieved, and if it does, won’t it simply drive the hedge funds offshore?.

First, some background. The earliest hedge funds, created more than a half-century ago, were actually formed to hedge against risk. There was a small group of investors with a big pool of money, which was leveraged and then invested in equities in both long and short positions. By shorting stocks, managers could cushion the portfolio if the market dropped, while still reaping gains elsewhere when it rose. Today, an estimated 8,000 hedge funds manage $1 trillion in assets, mostly for wealthy investors and institutions. Hedge funds tend to be more risky than mutual funds, because they bet on falling as well as rising securities.

And they can be more opaque as well. "Hedge funds remain opaque," Roel Campos, one of the SEC's five commissioners, said in an interview. "We need to rationalise what informational needs are necessary before any international coordination on regulation, if regulation is needed."

Current scandals involving the Bayou Group in Connecticut and the KL Group in Florida, in which scores of millions of dollars are unaccounted for, haven't eased concerns.

Traditionally, hedge funds have enjoyed a freedom from regulation, a “can’t touch me” status. That lack of regulation and transparency has been an accepted part of the equation for both investors and federal regulators, but times are changing. An explosion in the number of hedge funds and in the money pouring into them has increased anxiety about their potential risk.

These concerns have led to the announcement last week of a new study to be conducted by International Organisation of Securities Commissions (IOSCO), a global body for financial market regulators. The study will take a different direction from previous work by regulators, in 2 ways. Firstly, other studies have examined the systemic and market risks posed by hedge funds, without examining their internal control procedures. Second, the study is being conducted by a global regulatory body. Working in isolation, national regulators will achieve nothing, because of the global nature of the business.
Whether this new study leads to new regulation – and to new transparency for hedge funds – remains to be seen. However, for IR professionals seeking a greater visibility of beneficial ownership in their share register, it holds light at the end of a long tunnel.

Changing transatlantic practices on soft dollars, making it harder to win analyst coverage?

It is not often that new rules and best practices are set by the UK that other countries are happy to follow. However following the publication of the FSA guidelines on soft dollaring on July 25th, the SEC has followed suit. This has the potential to make it harder for issuers to win analyst coverage, as the business model of equity research changes.

When the FSA issued the guidelines, it noted “We continue to have discussions with SEC staff on issues connected with dealing commissions”. Those discussions have resulted in the SEC’s consultation published last week. It remains open for 30 days.

Soft dollars cover services beyond execution, provided to investment managers by broker-dealers, which are then “paid for” by the investment manager in the form of inflated commissions and guaranteed order flow. In the US, the practice is covered by a safe habour rule 28e of the ’34 Act.

Since plan sponsors (pension funds, corporations etc) foot the bill for investment managers’ use of the research services, acquired with soft dollars, questions have arisen as to whether the clients actually benefit from the research. Commissions are also usually bundled, with no clear divide between the commissions for execution, research and technology.

The SEC proposals will allow fund managers to continue to pay for genuine research services with commissions, but computer hardware, travel and entertainment, rents and salaries would be exclude, potentially raising the costs of sell side research.
And of course, this raises the bar again for foreign listed companies seeking to raise capital in the US, and developing still further the need for broad investor communication.