Financial Services Act 2021: Changes Ahead

The Financial Services Act 2021 has been published, making it the first financial services primary legislation passed by the UK Parliament since the UK left the European single market.

There are some important future changes that issuers need to be aware of.

  • Issuers’ responsibility for notifying the market of transactions by PDMRs and persons closely associated with them

UK MAR requires persons discharging managerial responsibilities (PDMRs, being essentially senior managers) and those persons closely associated with them to notify both the issuer and the Financial Conduct Authority of their transactions in the issuer’s instruments. Currently, this notification must be made by the PDMR and their closely associated persons to the issuer within three business days of the transaction. The issuer must in turn notify the market within three business days of the transaction. This can be a difficult timeline to meet so the Act will require issuers to notify the market within two working days (“working days” will explicitly exclude England and Wales bank holidays) of receiving the notification from the PDMR and persons closely associated with them. This change is due to come into force on 29 June 2021.


  • Responsibility for maintaining insider lists

Currently, under the Market Abuse Regulation as retained in the UK, listed issuers “or any person acting on their behalf or on their account” are required to maintain an insider list. This has created uncertainty as to whether third parties acting on behalf of a listed issuer should be holding their own list or sending it to the issuer to hold. The Act clarifies that both listed issuers and those acting on their behalf or on their account must maintain such lists. This change is due to come into force on 29 June 2021.

  • Criminal penalty for insider dealing increased

Insider dealing is a criminal offence under the Criminal Justice Act 1993 carrying a penalty of up to seven years’ imprisonment on conviction on indictment. This penalty will be increased to a maximum of ten years. The government’s rationale for the increase is that the maximum sentence for fraud, which is considered a comparable economic crime, is currently ten years and that market abuse could be perceived as a lesser crime, increasing the likelihood of market abuse. This change in law will come into force on a date to be specified by HM Treasury.

  • Criminal penalty for market manipulation increased

Market manipulation is a criminal offence under the Financial Services Act 2012, currently carrying a penalty of up to seven years’ imprisonment. For the reason outlined above, this sentence will also be increased to ten years, again on a date yet to be specified by HM Treasury.

Restoring Trust in Audit and Corporate Governance: Consultation

Directors’ reporting and the statutory audit have taken a battering in light of recent corporate catastrophes such as Thomas Cook Group plc, Carillion plc and BHS. In response, the government commissioned three independent reviews in 2018: Sir John Kingman’s Independent Review of the Financial Reporting Council (FRC), the Competition and Market Authority (CMA)’s Statutory Audit Services Market Study and Sir Donald Brydon’s Independent Review of the Quality and Effectiveness of Audit.

  • The FRC Review recommended that the current regulator, the FRC, be replaced.
  • The Brydon Review concluded that statutory audit needs to become more informative and helpful to users.
  • The CMA Market Study called for new measures to increase quality, competition and resilience in audits.

The government has now published a consultation paper, Restoring Trust in Audit and Corporate Governance, that addresses the findings of each review and includes new measures in relation to four areas:

  • Directors
  • Auditors and audit firms
  • Shareholders
  • The audit regulator

This post focuses on the purpose and scope of an audit.

Audits are a well-established part of corporate life and, as the Brydon Review found, the approach to audits has not changed significantly for decades. The traditional audit formula consists of auditors checking the financial statements and directors’ compliance with their legal obligations before signing off that the accounts give a true and fair view of the company. However, this approach misses out on swathes of information that could provide a far more meaningful assessment of the company’s health.

Coupled with this lack of dynamic development in the audit process itself is the domination of the UK audit market by the Big Four – the consultation states that 97% of FTSE 350 audits are undertaken by just four audit firms. This concentration is further compounded by the fact that the Big Four compete to offer large companies a range of other complementary business services.

Given the fundamental purpose of audit is to give investors the comfort of knowing about a company’s state of financial well-being, there is a need to build integrity and resilience in the audit space. The consultation paper proposes to create a new, stand-alone audit profession with a clear public interest focus, backed by new regulations to increase competition and reduce the potential for conflicts of interest. It envisages exciting new opportunities to be opened up for challenger audit firms and for audit firms to separate their audit and non-audit practices.

The government is proposing to introduce a specific statutory duty for auditors to consider relevant director conduct and broader financial and other information in forming their opinions. Whilst the “statutory audit” looks at financial statements, it is proposed that the audit function be expanded to create “corporate auditing”. It is proposed that companies publish an “Audit and Assurance Policy” (AAP) which will set out and define what additional information has been subject to audit. The AAP will be company specific with the directors taking into account the views of shareholders and other stakeholders such as employees, suppliers and lenders. The consultation paper seeks to engage debate around the role the new regulator Audit, Reporting and Governance Authority (ARGA) should play in regulating these wider auditing services and whether its role should extend beyond setting, supervising and enforcing these proposed new standards.

The government is also proposing to introduce new legislation requiring directors of Public Interest Entities (PIEs) to report on the steps they have taken to prevent and detect material fraud. This would be reinforced by further new legislation requiring the auditors of PIEs, as part of their statutory audit, to report on the steps they took to conclude whether the proposed directors’ statement (regarding actions taken to prevent and detect material fraud) is factually accurate. The auditors would also be required to report on the steps they themselves took to detect any material fraud and assess the effectiveness of relevant controls.

The deadline for responses to the consultation is 8 July 2021. The government aims to pass primary legislation to introduce the proposed reforms as soon as parliamentary time allows.

The Investment Association – Shareholder Priorities for 2021

On 18 January 2021, the Investment Association (“IA”) published its shareholder priorities for listed companies in 2021.  The publication:

  1. Assesses the progress made by listed companies on the four areas identified by investors as critical drivers of long-term value at the time of publication of the shareholder priorities for 2020;
  2. Sets outs IA member expectations for 2021; and
  3. Describes the approach which its corporate governance research service, the Institutional Voting Information Service (“IVIS”), will take to analyse these issues for companies with year-ends on or after 31 December 2020. This includes a summary of the IVIS questions and colour top approach for 2021.

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Limit on Corporate Directors: Consultation Opens

The Department for Business, Energy and Industrial Strategy has opened a consultation on the Government’s proposed approach to restricting the use of corporate directors as part of its larger package to enhance corporate transparency, reform Companies House and fight economic crime in the UK.

On the one hand, corporate directors may be seen to weaken corporate governance by preventing individual accountability yet on the other, they may be a useful and legitimate option.

Business meetingThe law as it stands requires that only one director on a company’s board be a “natural” person and any number may be corporate directors. Provision to prohibit the use of corporate directors was made in the Small Business, Enterprise and Employment Act 2015 but this has yet to come into force. Accordingly, the consultation is looking at what exceptions to the prohibition on corporate directors should be introduced so as to achieve an effective balance between their legitimate and “smoke-screen” use.

  • The Government intends to introduce regulations that create a “principles” based exception to the prohibition. The principle is essentially that a company can be appointed as a director if:
    all of its directors are, in turn, natural persons; and
  • those natural person directors are, prior to the corporate director appointment, subject to the Companies House identity verification process.

Responses are due by 03 February 2021.


The Investment Association Publishes Views on 2021 Executive Remuneration

On 16 November 2020, the Investment Association (“IA”) published amendments to its principles of remuneration for 2021 and updated its guidance on COVID-19 and executive pay.

IA Principles

The covering letter to chairs of remuneration committees of FTSE 350 companies highlights the main (minor) changes to the IA principles which essentially seek to clarify investor expectations on the following issues:

  • The use of non-financial performance measures, in particular environmental, social and governance (“ESG”) related measures – on trend with companies increasingly incorporating material ESG risks into their incentive plans, companies will need to ensure ESG performance conditions are clearly linked to the company’s strategy. However, the IA’s view remains that financial targets should comprise the majority of any annual bonus.

  • Deferral of bonuses – where a bonus opportunity is more than 100% of salary, a proportion should always be deferred into shares, not given as cash.

  • Post-employment shareholding requirements – companies should explain what mechanisms are in place to enforce shareholding policies once a director has left the company.

Approach to Pensions in 2021

The theme remains strongly one of alignment between pension contributions for the executive directors and those available to the majority of the company’s workforce. A credible action plan will be required to align the pension contributions of incumbent directors to the majority of the workforce rate by the end of 2022. Alignment with new directors’ remuneration will also be required. Non-alignment may result in a Red Top on both the remuneration policy and remuneration report in 2021.

Executive Pay and COVID-19

The IA has updated its April 2020 guidance on executive pay in the midst of the pandemic. The main thrust is to strike a balance between significant demands on executives during these testing times but to be mindful not to isolate executives from the impact of COVID-19 in a manner that is inconsistent with the approach taken to the general workforce.

Coins and pen over chart

The resounding message is again one of alignment between executive remuneration and the overall experience of the company, its shareholders, employees and other stakeholders. So, where a company has raised additional capital from shareholders, or has taken government support through the Job Retention Scheme, government loans or similar financial support, shareholders expect this to be reflected in executive pay and generally would not expect the payment of any annual bonuses for FY2020 or FY2020/21, unless there are truly exceptional circumstances.

As a result of COVID-19, many employees were furloughed, asked to take pay-cuts or made
redundant. Remuneration Committees need to be ever more mindful of this wider employee context and the impact that it has on pay for the executive directors. In this context, shareholders expect greater transparency about the impact of government measures on remuneration outcomes. Companies should confirm in their Remuneration Committee Chair’s statement that they have not adjusted performance targets during the year and should not be compensating executives with higher variable remuneration opportunity in 2021 for lower remuneration received in 2020 due to the pandemic. And, as regards long term incentive plans,  Remuneration Committees will be expected to use their discretion to reduce vesting outcomes where performance outcomes are not consistent with overall company performance or windfall gains have been received.

The Future of Annual Reporting?

The FRC have published a discussion paper in which they question whether the traditional concept of the annual report remains fit for purpose. Arguably, annual reports are too long, impenetrable and fragmented. In looking at the future of corporate reporting, the challenge is how to balance the need for more concise reporting against demands for more transparency.

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Stewardship Code 2020: Early Reporting

The Financial Reporting Council’s ambitious UK Stewardship Code 2020, effective 1 January 2020, required a new mandatory annual Stewardship Report to be published. This is challenging for investors as it requires reporting on stewardship activities actually undertaken and the outcomes actually achieved, not just stating intent or policy.

Business meetingSome institutions have already reported early and the FRC has published a report, “Review of Early Reporting“, which scrutinises those reports and concludes that whilst there are some early good examples of reporting, more needs to be done.

Set that in the context of growing societal expectations and regulatory demands that investors be engaged stewards of the assets entrusted to their care, and that environmental, social and governance issues, including climate change, are included in their stewardship and investment decision making. It is clear that in relation to all things ESG (including remuneration) related, investors will increasingly engage more actively when challenging the companies they invest in as they will need to be able to report on specific behaviours with practical examples to evidence their compliance with the Stewardship Code.

FCA Consultation on Climate-Related Financial Disclosures For 2021

The Financial Conduct Authority’s consultation paper (CP 20/3) on climate-related disclosures proposes that a new listing rule will take effect for financial accounting periods beginning on or after 1 January 2021.

There is a growing ground-swell around disclosure of all environmental, social and governance (“ESG”) related matters as issuers and investors become increasingly engaged with these issues. The FCA is not proposing to mandate disclosure at this point given that issuers’ reporting practices are still evolving, however this is an area of disclosure that will predictably only expand over time. Indeed, the FCA anticipates that all listed issuers will be disclosing in accordance with the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (“TCFD”) recommendations by 2022.

The proposed new Listing Rule will require premium listed companies to include a statement in their annual financial report setting out:

  1. whether they have made disclosures consistent with the recommendations of the TCFD and recommended disclosures in their annual financial report
  2. where they have:
    • not made disclosures consistent with some or all of the TCFD’s recommendations and/or recommended disclosures; or
    • included some or all of the disclosures in a document other than their annual financial report,
    • an explanation of why;
  3. where in their annual financial report (or other relevant document) the various disclosures can be found.

Guidance on the proposed new disclosure requirements (through a draft new Technical Note) is also set out in the consultation paper.

UK IPO Trendwatch – the Outlook for Autumn 2020

Deal volumes over the past 18 months

Looking back at IPO volumes in 2019 compared to 2018, we saw a 51% decrease in the aggregate number of IPOs across both the Main Market and AIM which is perhaps unsurprising given the uncertainty surrounding Brexit and concern stemming from global trade tensions.

IPO activity levels since 2015

IPO activity levels since 2015

During the first quarter of 2020, as COVID-19 began to impact, we saw a handful of publicly announced postponements in relation to IPO transactions. No doubt behind closed doors a multitude of similar decisions have been made.

Whilst the financial markets grappled with economic lockdown, the second quarter of 2020 has seen IPO activity nearly reach freezing point with IPO volumes down 81% compared to the second quarter of 2019.  During this time, AIM did not see any new issuers on-board. The Main Market saw the listing of two VCTs (Blackfinch Spring VCT plc and Puma Alpha VCT plc) together with China Pacific Insurance (Group) Co., Ltd., operating in the Chinese insurance sector with its shares already listed on the Hong Kong and Shanghai Stock Exchanges. Now we are at the mid-way point of the third quarter of 2020 and we have gradually seen the easing of global lockdown restrictions, AIM has welcomed Elixirr International plc (a management consultancy) and AEX Gold Inc (a special purpose vehicle focusing on the exploration and development of gold in Greenland) to its market.

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