Narrative reporting refers to information included in the front end of a company’s annual report and accounts. It includes the three key areas in measuring the sustainability and societal impact of a business: Environmental, Social, and Governance (ESG).
The significance of narrative reporting, or non-financial reporting as it’s also referred to, is on the rise and has become a central area of focus for business leaders and their stakeholders. This increasing interest has driven many existing legal and regulatory requirements as key stakeholders, including investors, regulators, and consumers, turn their attention to how the entity plans to deliver products and services against the backdrop of ESG strategies.
With climate change now recognised as a ‘global emergency’, the spotlight is on businesses to explain how they impact on and are impacted by environmental, social and governance matters. Narrative reporting enables you to effectively tell the full story of your business and how it is playing its part in tackling today’s challenges for a better future. It can also help to cultivate stakeholder trust, integrity, and confidence at a time when corporate transparency and responsibility are becoming increasingly attractive to consumers and influencing buying behaviours.
Ensuring that your narrative reporting is effective and meets the legal and regulatory requirements can be challenging. When considering your approach, including whether to go beyond the minimum level of compliance, there are five key areas to consider.
1. Understanding what’s requiredThe first step is to understand what is required. Non-financial reporting takes time to prepare so it needs to be proportionate to the size and type of business and who uses the entity’s annual report. The consideration of these and other factors by regulators, has resulted in a variety of different scope criteria and exemptions for boards and management teams to understand and apply.
Gathering data to consider each of the requirements can be time-consuming. Start by identifying which listing rule and/or UK company law requirements may apply, the in-scope criteria and possible exemptions. UK requirements are broadly driven by:
- whether and where an entity issues securities to the public;
- the size of the entity, and/or the group that it heads or is part of;
- the nature of the entity’s business and/or entities within the group that it heads or is part of; and
- whether any exemptions are available.
Having this information can make it easier to work through the requirements which can be based on one or more than one of these factors. For example, in-scope criteria may consider the size of the entity only and/or the nature of its business and may be assessed for the company only and/or the group it is part of, or that it heads.
Key areas for consideration
1. Financial information
Collate turnover, gross assets, UK and global employees for the last three financial periods for the company, and if it is a parent, the group that it heads. Then consider the following:
a. Does the income the business generates meet the definition of turnover in company law?
b. How many employees (if any) work wholly or mainly outside the UK?
c. Group figures are considered for a parent entity even if consolidated accounts are not prepared so can be before or after consolidation adjustments, but are processes in place to collate that information for the same or a closely aligned period?2. Nature of activities
Identify activities that might cause an entity to be in-scope, typically certain types of financial services, insurance or investment activity or if an entities’ securities are traded. Then consider the following:
a. Does the entity itself undertake activities that prevent it from qualifying for an exemption?
b. If the entity is part of a group, whether or not it is the parent, do any entities within the group undertake activities that prevent the entity from qualifying for an exemption?
Exemptions can reduce the burden of non-financial reporting but only if they are taken appropriately.
a. Are there specific exemptions that might apply, such as the 40,000 kWh limit for carbon reporting, and do they apply at a company or group level?
b. Is there anything the directors do not want to disclose as they consider it to be seriously prejudicial to the entity’s interests? and if so, why?
c. If exemptions are available because the entity is included in a group report, does that report meets the conditions for exemption? For example, is it prepared in accordance with the same legal requirements and for the same or a closely aligned period?Please note that disclosures that are only required if an entity undertakes a particular activity, such as the purchase of its own shares, are not covered here.
2. Understanding stakeholder expectations
The extent to which non-financial reporting goes beyond the minimum requirements will ultimately depend upon who the users of the annual report are and what the business wants to convey to them. A balance will need to be struck between content and clarity as excessive content could mask or dilute key messages.
Consideration might be given to where the entity expects to be in the short to medium term. For example, if it is growing rapidly and/or gearing up for a listing, then voluntary disclosure of information that will be required in the near future (provided it is clearly identified as such) can create the opportunity for a ‘soft landing’ and time to develop controls and procedures to meet requirements when they become mandatory.
Whilst disclosures must be entity-specific, benchmarking the level of disclosure against competitors can be a useful exercise to assess whether your annual reporting is delivering at a similar level or, if you are looking to deliver best practice, exceeding that.
On the back of the heightened focus on ESG, the appetite for non-mandatory disclosures appears to be increasing as financiers, customers, employees, and the government are taking a greater interest in an entity’s ESG strategies. Therefore, getting a head start on ESG disclosures can benefit the business.
The FRC has issued a number of publications looking at the content of published annual reports and identifying what it expects to see in good non-financial reporting, including TCFD, SECR and Section 172 disclosures. These publications can be useful in assessing whether the entity is avoiding common areas of non-compliance and how ‘good’ or ‘best’ practice can be achieved.
3. Assessing data integrity
Businesses have been developing and enhancing internal controls and governance procedures around financial reporting for many years and are now challenged with how to implement these for non-financial reporting purposes.
How to obtain assurance and comfort over the integrity of your data and disclosures is key. There are important questions that the board and management team should consider that help with this:
- What process has been used to identify applicable non-financial reporting requirements, whether the entity is in-scope and eligible to take an exemption?
- What information is required to meet the non-financial reporting requirements both at a high level and the detailed requirements, such as whether global or UK information is required?
- Is that information already reported to the board? If so, is the format of that reporting consistent with what’s required for non-financial reporting, or could it be made consistent?
- Is information already generated internally or if not, what sources are available to obtain it?
- Are the sources of data reliable? Eg What systems/sources are used to obtain the information? What controls are there over the information gathered to cover its completeness and accuracy? What is the process for recording that information and who is responsible for collating and reviewing it?
- Do specialist skills for the preparation and assurance of the data exist in-house or will external experts be engaged?
- What is the process for identifying and engaging external experts to ensure the scope of the engagement and skills of the expert can deliver the information or assurance required in an appropriate format? Are there any caveats or exclusions in the expert’s report that affect the reliance that can be placed on it?
- Is legal or Nomad advice needed before the information is put in the public domain by including it in the annual report? Eg Is there a risk of greenwashing, or from forward-looking statements?
Subject to ethical requirements our Governance experts can help by advising boards and organisations on effective corporate governance and good decision making and our Environmental team can consider your business’s environmental impact across four areas; Emissions, Natural world, Resource consumption, Waste and recycling.
4. Stakeholder communication
The annual report explains what has happened during the historic financial period up to the date the annual report is approved and sets out the entity’s future plans. The challenge for entities is how to deliver this and ensuring key messages are clearly communicated whilst at the same time ensure applicable legal and regulatory requirements are complied with.It may be useful to start with matters considered by the board, for example:
- how they addressed or changed risks, uncertainties, or opportunities (including ESG factors) faced by the business;
- how and which stakeholders were considered in making decisions and if there were any conflicts between their needs;
- what impact board decisions had or will have on the entity’s financial position, performance and/or cashflows; and
- how forward-looking statements from earlier years and other stakeholder communications during the period have been addressed.
Different forms of visual presentation such as tables and diagrams can help to show linked information in an engaging and cohesive way. The FRC’s publication on What Makes a Good Annual Report and Accounts includes examples of how reports should be connected and consistent and its Guidance on the Strategic Report includes ‘linkage examples’ to illustrate how interdependencies or relationships might be highlighted or presented.Once the annual report has been drafted, it’s always good practice to stand back and consider whether:
- there are areas of repetition that could be removed;
- linkages between sections are specific and clear; and
- information provided in the non-financial reporting is consistent with the accounts, for example, information about acquisitions, the segmental analysis, and whether assets are potentially impaired.
5. Legal and regulatory enforcement
The increased focus of users on non-financial reporting increases the importance and attention given by regulators to this area.
Requirements generally come from two main sources:
- UK company law; and
- Listing rules (where applicable).
Breaches can result in the following sanctions:
- Under UK company law, each director that commits an offence could be liable to fines if they knew the content of the strategic report, the directors report or the directors’ remuneration report did not comply with the legal requirements, or was reckless as to whether it complied, and failed to take reasonable steps to secure compliance.
- Under the Listing Rules, if a listed company’s disclosures do not appear to meet the requirements, the FRC may refer the matter to the FCA to take appropriate action, particularly if information is potentially false or misleading, including the omission of material facts, likely to cause investor harm or breach other relevant FCA rules.
The FRC has heightened its consideration of non-financial reporting demonstrated by the following examples:
- The Annual Review of Corporate Reporting (October 2022) - the FRC raised more questions on the strategic report and other issues relating to the non-financial reporting requirements including energy and carbon reporting and stakeholder engagement.
- Published findings from the FRC’s reviews of companies’ annual reports that did not include a clear statement of whether climate‐related financial disclosures are consistent with TCFD.
- Targeted TCFD Thematic Reviews focussing on metrics and targets disclosures and how adequately companies’ net zero commitments have been addressed in their financial statements.
- An area of focus for the 2023/24 FRC’s audit quality inspections is climate-related risks. This includes the linkage between the financial statements and climate-related disclosures which may result in referrals about potential non-compliances and/or the quality of reporting to the Corporate Reporting Review team for further consideration.