Brexit: Reporting Risk

Reporting on Brexit Risk

The Conservative Party leadership contest continues, with the two candidates – Boris Johnson and Jeremy Hunt – attending hustings across the country for the next week. Voting has opened among the Party’s members, and the new Prime Minister will be announced on 23 July. Both candidates have differing Brexit plans, and business will be playing close attention to the pledges and commitments made during the process. Both have committed to leaving the EU by 31 October 2019.

Absent a general election, whoever becomes UK leader faces the same challenge as Mrs May – the numbers don’t stack up in Parliament to pass any version of Brexit on the table to date. Pro-Remain MPs aren’t leaving a stone unturned in their attempts to block a disorderly no-deal exit, including trying (and so far failing) to add a requirement for an October debate into legislation, but succeeding with a narrowly approved amendment to the Northern Ireland Bill that requires ministers to report on the situation in Northern Ireland on a fortnightly basis.

Meanwhile, the Labour Party has fundamentally changed its stance and now supports a second referendum - and if the question put to voters were a choice between Remain and the Conservative Prime Minister’s deal then the Labour Party would campaign for Remain.

Business sentiment

For business, Brexit remains a concern. Our latest survey of UK Chief Financial Officers, out last week, reveals that CFOs continue to rank Brexit as the biggest risk facing their businesses. 83% of CFOs now expect Brexit to lead to a worsening of the business environment in the long term - the highest level since the referendum. Recruitment forecasts, often seen as a bellwether for corporate health, are also sharply down.

Reporting Brexit risk

With this context in mind, we’ve just entered into the 2019 interim reporting season – or for June year-ends, the annual reporting season – and the UK’s Financial Reporting Council is calling for clearer reporting on the potential risks arising from Brexit. It’s likely that businesses won’t know the outcome of the Brexit process before signing June interim reports, so how should such an uncertain impact be reported?

I asked William Touche, leader of Deloitte’s UK Centre of Corporate Governance, for his thoughts on what business should consider when preparing interim reports.

“In its Annual Review of Corporate Reporting, published in October, the FRC called for companies to provide disclosure which distinguishes between the specific and direct challenges Brexit poses to their business model and operations from the broader economic uncertainties.

“Companies may be preparing their last stock exchange announcement before the UK leaves the EU. Brexit should therefore be seen as a “hot topic” for the half year reporting season.

“Half year reports should summarise the principal risks disclosed in the previous full year and where there are developments should update the risk narrative to reflect what has changed.

“As well as looking at disclosures, we also recommend updating your assessment of the potential impacts of Brexit on the group’s business model and operations.”

There are key areas that are worth considering when it comes to Brexit reporting:

• Assumptions: Companies should be looking to address Brexit in their interim reports and explain what assumptions have been built into their forecasts, especially regarding liquidity and cash flows.
• Context: Assumptions need to be made to allow Brexit scenario risks to be quantified, and considered in combination with the other principal risks. How does Brexit compare in terms of exposures and mitigations?
• Scenarios modelled: Due to the uncertainty, business planning will likely involve management running several scenarios which can be refined and finalised as critical milestones change or pass.
• Going concern: Where sensitised forecasts show a short term impact on liquidity and cash flows, going concern should be examined with rigour, as should the carrying values of assets.

To see how Brexit fits within our wider view on areas for board focus at the half year, see our latest ‘On the board agenda’ report.

How much to say

We analysed the reports of 100 FTSE UK listed companies here. In the 2018 reporting season, 3 in 5 companies identified Brexit as a principal risk. Surprisingly, only one company drew out an assumption related to Brexit, although a handful of others described the outcomes against which they prepared.

The range of reporting styles adopted by business so far is striking. Businesses in the same industries with high profile comparable brands, without obvious differences in complexity and supply chain, have reported anywhere from a bland “Brexit is a risk that has been considered” to reporting results of scenario analysis, with associated financial impact. Some businesses have gone significantly further in their reporting detail, particularly in the retail sector. Marks & Spencer Group plc, for example, explained how it models principal risks and described potential mitigations. The interim report for NEXT plc, ran for 10 pages on Brexit and was considered by some as setting the standard in terms of both transparency and reassuring shareholders.

Our expectation is that more boards will need to consider, discuss and report the potential impact of unfavourable Brexit outcomes in more depth in the 2019 reporting season and audit committees will undoubtedly be asking more and deeper questions about Brexit readiness.

Other stakeholders

Of course, many UK companies don’t need to have statutory audits or have foreign parents that deal with audit committees, shareholders and the like. But reporting Brexit risk is taking many forms, and is not just in the sights of UK regulators.

US businesses, which have generally only nodded to Brexit risk in their 10-K filings, for instance, may likewise need to say more in the future. US and international businesses that are registered with the Securities and Exchange Commission (SEC) are likely to be under increased scrutiny with the chairman, Jay Clayton, reported as saying “my personal view is that the impact of Brexit has been understated” and that the SEC will be “sharpening its focus about the risks posed”.

We also hear anecdotally that UK lenders are taking an increasing interest in Brexit and what it might mean for lending terms, rates and covenants, so understanding the detail and being ready to explain your plans whether you are listed, private, large or small remains key.

If you would like further insight on Brexit contact our team at brexitsupport@deloitte.co.uk; or you can contact our UK Centre for Corporate Governance at corporategovernance@deloitte.co.uk.