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Chapter 2. Rules That Companies Must Follow

The European Union tightened its rules in January 2007 with the introduction of its Transparency Directive, so named because it aimed to make quoted companies transparent to shareholders, who would be able to see clearly how well or badly the company was doing. Bad news could not be hidden because investors could, the theory ran, see right through any smokescreens.

The EU, as is its custom, was attempting to harmonise the rules across the continent so that investors could buy shares in companies in any European state confident that the same requirements for openness and fair play were being enforced. This, in the view of the European Commission, would lead to a high level of investor protection throughout the Community.

As is also the way in the EU, it took years to get agreement: the original action plan was published by the European Commission way back in 1999.

To be fair, the outcome was a big improvement on the disparate range of financial reporting requirements previously in existence. The aim was to harmonise the regulations rather than to add to the burden.

Nonetheless, the rules are quite detailed and member states are free to impose additional requirements on companies incorporated in their country. Likewise, individual stock exchanges are able to impose additional requirements on companies whose shares are traded on their markets.

Effect on the UK

Most of the requirements were already pretty much covered on the main market of the London Stock Exchange and, to a lesser extent, on AIM, which is exempt from the directive as it does not, in EU eyes, constitute a proper stock market. Fear not. The LSE imposes strict disclosure requirements on AIM-quoted companies and insists that they appoint an approved nominated adviser to see that they toe the line.

The big change as far as the UK was concerned was to bring in quarterly trading updates rather than the half-yearly pronouncements that typically were issued along with half year and full year results.

The initial proposal was to bring full quarterly reporting, as is the norm in the US. In other words companies would produce accounts every three rather than every six months. There was heavy lobbying against this more onerous requirement on the grounds that it would create an undesirable short term attitude in companies and their shareholders.

Even so, the rules on quarterly statements are still quite detailed, including specifying when they must be published.

The timetable

The Directive says:

  An issuer shall make public a statement by its management during the first six month period of the financial year and another statement by its management during the second six month period.

  Such statement shall be made in a period between ten weeks after the beginning and six weeks before the end of the relevant six month period.

You need to look at a calendar to grasp the timetable. For a company whose financial year matches the calendar year, it means that interim statements must be issued somewhere between March 5th and May 14th and between September 4th and November 13th.

For those following the traditional financial year to March 31st, the relevant dates are June 10th to August 19th and between October 9th and December 18th.

Don’t worry about the precise dates. The idea is that statements should come out a week or two after the end of the first and third quarters, although the 10-week window is very wide for this purpose.

It means that many companies combine their interim management statement with the issuing of half-yearly or annual results.

When to expect updates

One has to say that companies quoted on the London stock market are playing the game and issuing four reasonably equally spaced trading updates per year. So a company using the calendar year will issue a trading update around March 31st, a second immediately before or after the half year end at June 30th, a third around September 30th and a fourth within days of the full year end at December 31st.

This means you know promptly how the business has performed in each complete quarter.

However, some companies do have leeway to time the updates to suit their particular trading pattern. The most obvious example is in retailing, where companies have traditionally provided an update on how the key Christmas trading period has gone.

There is nothing to stop companies issuing more trading updates than the rules demand. We do occasionally see companies issue updates at the end of each quarter, another update with half year and full year figures and one for good measure at the AGM.

Most companies give advance warning when the next trading statement is due. In some cases each trading update includes a line saying when the next one is due. Sometimes an indication is given within the company results announcements. Other companies issue a separate announcement of an impending update.

In any case you can easily discover when a trading update is likely to be issued by checking the dates on which statements were made in the previous financial year. They tend to be repeated at much the same stage each year.

What the statement contains

The Directive says what should go into the statement:

It shall contain information that covers the period between the beginning of the relevant six-month period and the date of publication of the statement.

Such a statement shall provide:

  An explanation of material events and transactions that have taken place during the relevant period and their impact on the financial position of the issuer and its controlled undertakings, and

  A general description of the financial position and performance of the issuer and its controlled undertakings during the relevant period.

It is thus no longer possible to hide behind routine ‘nothing much has happened’ statements that were issued by many companies when quarterly statements started as a fad rather than a legal requirement.

Instead, it is now necessary to provide financial data up to within a few days of the trading update, not only for the main company but for any subsidiaries and joint ventures under its control.

These will not be as detailed as the twice yearly financial results. It would be unreasonable to expect them to be, if they are to be bang up-to-date. Full results take time to compile.

In theory, companies need not produce specific figures. They could include sufficient information in the narrative of the statement. However, that would be difficult to achieve without including key operating statistics such as growth in sales or changes in profit margins.

Recording key events

In addition to any figures, companies are required to record any key events since the previous update and explain the impact. There is wide scope for interpreting what constitutes a material event but the intention is clear: anything that could affect the share price that has not been reported already should be in the quarterly update. Among candidates for inclusion, where relevant, would be:

  changes in the state of the market that the company serves

  large orders received or lost

  refinancing

  acquisitions or disposals

  opening of new premises such as stores, distribution centres or factories

  change in strategy

  progress so far in carrying out a previously announced strategy

  adequacy of finance to fund day-to-day operations or expansion

  new product range

  effects of external events such as foreign exchange rates, energy costs, business rates or wage rates

Bit by bit, quarterly statements have become clearer and more comprehensive so that they now contain much relevant and significant information that the investor ignores at his or her peril.

The downside is that companies are tempted to err on the side of putting an excessive amount of detailed information into the quarterly statements – but that is a price worth paying for being a better informed investor.

Half year results

The Transparency Directive replaced the EU’s existing Interim Reporting Directive as regards half yearly and annual results. It requires:

  A report covering the first six months of the financial year as soon as possible after the end of the relevant period, but at the latest within two months

  The report must remain available to the public for at least five years

  It must contain a condensed set of financial statements and an interim management report

The facts and figures given must comply with minimum and quite extensive standards set out in the EU’s reporting regulation IAS 34. The main points are:

  Information relating to all material acquisitions, disposals, restructurings and discontinued operations

  If results are split into business or geographic segments, revenue and results for each segment

  Balance sheet comparatives for the last full financial year as well as for the previous first half

  Income statement comparatives for the previous first half

  Cash flow and changes in equity, both with comparatives for the previous first half

  Important events that have occurred during the first six months of the financial year and their impact on the half yearly figures

  Principal risks and uncertainties for the remaining six months of the financial year

If the half-yearly financial report has been audited, which is unusual in the UK, the audit report has to be reproduced in full.

The directors have to give an assurance that the figures and statements give a true and fair view of the company and its financial position.

Annual results

Companies have a little more leeway (four months) to produce their annual financial report, which must also remain publicly available for at least five years. It comprises audited financial statements, accompanied by the auditor’s report in full, a management report and an assurance from directors that it is a true and fair record.

The management report must contain (where relevant):

  A fair review of the business and a description of the principal risks and uncertainties that it faces

  A balanced and comprehensive analysis of the development and performance of the business and the position it finds itself in at the end of the year

  Analysis of key financial and other performance indicators including information on matters concerning the environment and employees

  Important events that have occurred since the end of the year

  Likely future development

  Research and development activities

  Information on the acquisition of its own shares

  Details of financial risk management and hedging policies

  Risks involving product prices, credit, liquidity and cash flow

Some items, such as research or hedging, may not be relevant and need not be included.

As with the half yearly statement, directors must guarantee that the financial statement is drawn up to accepted accounting standards and give a true and fair view of the position the business is in.