The Sharman Panel of Inquiry, established at the invitation of the Financial Reporting Council to consider Going Concern and Liquidity Risks: Lessons for companies and auditors, publishes its final report and recommendations today.
The Panel's key recommendations are that:-
- The primary purpose of the going concern assessment and reporting should be to reinforce responsible behaviour in the management of going concern risks; and
- The going concern considerations made by directors and reviewed by auditors should cover both solvency and of liquidity and that these should be considered over the cycle, taking an appropriately prudent view of future prospect
and that the FRC should:
- Seek to clarify and harmonise the differing definitions of going concern and related risks in accounting, auditing and governance requirements, working with the international bodies.
- Review its Guidance for Directors to ensure that the going concern assessment is integrated with business planning and risk management; focusses as appropriate on both solvency and liquidity risks (including risks to the entity’s business model or capital adequacy) that could threaten the entity’s survival through the cycle; and includes stress tests of liquidity and solvency.
- Integrate going concern reporting with its Effective Company Stewardship proposals, to present a fuller picture of the principal risks the entity is taking and facing in pursuit of its business model and strategy rather than only highlighting going concern risks when there are significant doubts about the entity’s survival.
- Enhance the role of the auditor by seeking an explicit statement in the auditor’s report about whether the auditor has anything to add to or emphasise in relation to the narrative disclosures made by the directors about the robustness of the process of assessing going concern and its outcome.
The Panel also recommended that the FRC should take a more systematic approach to learning lessons when significant companies fail or suffer significant financial or economic distress but nonetheless survive.
The Panel also looked at whether a special going concern disclosure regime is required for banks and concluded that this should not be necessary. However, the Panel considers it is critical to that conclusion that, in taking forward the recommendation to clarify and harmonise the differing definitions of going concern and related risks, the FRC should clarify that a conclusion that a bank is or would be reliant, in stressed circumstances, on access to liquidity support from central banks that is reasonably assured does not necessarily mean that the bank is not a going concern or that material uncertainty disclosures or an auditor’s emphasis of matter paragraph are required.
Lord Sharman, Chairman of the Panel, said:
"Our final recommendations aim to refocus the going concern process, in light of lessons learnt from the financial crisis, so as to support better risk decision-taking, ensure that investors and other stakeholders are well-protected and informed about those risks and sustain an environment in which directors recognise, acknowledge and respond to economic and financial distress sooner rather than later.”
“The aim of the directors’ assessment and reporting of going concern is not primarily to inform outsiders of distress. Rather, it is to ensure that the company is managed to avoid such distress while still taking well-judged risks. That judgment must rest with the directors and our aim should be to encourage them to discharge their duties in that regard with skill and in good faith.”
“In reaching our recommendations, and in keeping with the responses we have received, our primary purpose has therefore been to reinforce responsible behaviour in the management of going concern risks for companies.”
“Our report addresses in some detail the special considerations for going concern reporting that flow from the unique business model of banks. A key question which we raised in our preliminary report was whether the public interest objective of financial stability should ever override the public interest objective of transparency in capital markets. We have set out in our report our vision of how these may be reconciled.”
“The success of this vision depends critically on: there being adequate central bank liquidity support to address systemic crises; close dialogue between directors, auditors, supervisors and the Bank of England; directors and auditors each being able to reach their own conclusions about the bank’s ability to withstand anticipated stresses, including whether access to central bank liquidity support would be available where necessary; and acceptance that, where such support is expected to be available and relied upon, market transparency does not demand disclosure of that fact to the markets."
Stephen Haddrill, Chief Executive of the Financial Reporting Council, said:
“The FRC welcomes the Panel’s report and thanks Lord Sharman and his fellow Panel members for their insights and recommendations. We will now embark on a careful consideration of the most effective way to take these forward so as to improve the quality of corporate reporting and dialogue between investors and company boards and to reinforce the effective management of going concern risks for companies. The FRC reform has been designed partly to enable us to respond positively to the Panel’s recommendation that we take a more systematic approach to learning lessons when significant companies fail.”
“The final report has made significant ground in exploring the implications of the Panel’s preliminary recommendations and how these may be taken forward. In doing so, it provides much further analysis of the issues identified and this should assist the FRC in developing these recommendations in the UK and in promoting them on the international stage.”
“We will explore the matters relating to banks with the Government, the Bank of England and other stakeholders.”
A copy of the Final Report and Recommendations may be downloaded from the Sharman Inquiry web site: (http://www.frc.org.uk/about/sharmaninquiry.cfm).