If you would like to discuss any aspect of our response, please contact Matt Chapman on

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1 Tel +44 (0) Audit Fax +44 (0) Canada Square London E14 5GL United Kingdom Deepa Raval Financial Reporting Council 8 th Floor 125 London Wall London EC2Y 5AS By to: narrative@frc.org.uk Your ref Our ref dl/tn/ Dear Deepa Thank you for the opportunity to comment on the Draft Amendments to Guidance on the Strategic Report. We have included our responses to the FRC s consultation questions as an appendix to this letter. Our responses reflect strong overall support for the direction the FRC has taken with this update, and recognition of the significant positive impact the original Guidance has had on the development of narrative reporting in the UK. In our view the emphasis on shareholder materiality, and the continued emphasis on the provision of businessrelevant information over the alternative of subject-matter prescription in the draft amendments should support further improvements in UK narrative reporting practice. If you would like to discuss any aspect of our response, please contact Matt Chapman on Yours sincerely David Littleford Partner KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. Registered in England No OC Registered office: 15 Canada Square, London, E14 5GL For full details of our professional regulation please refer to Regulatory Information under About/About KPMG at

2 Question 1 Do you agree with the approach for updating the Guidance for the changes arising from the implementation of the non-financial reporting Directive? We support the FRC's proposed approach as it maintains the integrity and focus of the strategic report. In our view, the alternative of segregating disclosures covered by the Directive in a separate non-financial reporting statement could undermine the clarity of company reports, and may therefore be particularly detrimental to retail investors. The enhanced emphasis on information that is material to shareholders in 3.13, and the retention of the materiality requirement in 5.2 are particularly welcome. We support the continued focus on the annual report as a medium for shareholder communication, with information provided for other stakeholders located outside of the annual report. We consider that it would be helpful to incorporate relevant text from the introduction (para (x)) into the main text of the Guidance in order to address potential misunderstanding arising from the use of the term 'non-financial information statement': Whilst the Regulations use the term non-financial information statement, the information necessary to meet the requirements in the new Regulations does not need to be presented as a separate statement. The purpose of the strategic report and section 172 Question 2 Do you support the enhancements that have been made to Sections 4 and 7 of the Guidance to strengthen this link? We support the overall approach taken in sections 4 (purpose) and 7 (content elements). However, we are concerned that the introduction of additional proposed content elements relating to the Identification of major stakeholders (7.10); Development of stakeholder relationships (7.18); and Allocation of resources (7.21) may lead to a check-box approach. This approach may disrupt the logical flow of the strategic report and encourage businesses to report on these matters in isolation. In our view, a deeper, better-linked discussion is likely to follow if the description of the business model identifies key stakeholders and the related business dependencies, and the discussion of strategy addresses the management of stakeholder relationships and allocation of resources. Many strategic reports already do this. In addition, whilst we agree with the overall approach taken, we suggest the following clarifications to the proposed changes. dl/tn/ 2

3 In relation to section 4: 4.4: The requirement in 4.4 to consider factors that may affect the entity's success in the long term may result in over-disclosure that obscures the material factors. An emphasis on factors relevant to an assessment of the entity's success in the long term would support a more focused approach. 4.5: We fully support the emphasis in 4.5 on sources of value that are not included in the financial statements. We regard this type of historical non-financial information as pre-financial in nature, as it is key to assessing the future financial performance and position of the business. We highlight that although relevance to future prospects is included in paragraph 2.2, it is omitted in 4.5. In relation to section 7: 7.1: Trends and factors affecting the business have been reclassified in 7.1 to 'business performance' rather than 'business environment', presumably to align with the quantitative nature of many disclosures. Whilst recognising that companies are free to adapt the structure of their report, we believe that the logical flow of the discussion may be better served by providing this component as part of the business environment. We emphasise that quantitative information would support the narrative in all three categories of content element, not just performance. Effective application of the linkage principle should ensure that the business performance discussion addresses the current and potential future impact of trends as well as the business's progress in managing them. 7.11: We support the emphasis in 7.11 on KPIs relevant to an assessment of progress against strategy. We would also add that KPIs relevant to an assessment of the impact of the progress against strategy on current and future prospects should also form a material part of the performance discussion, and suggest this is also emphasised here. 7.23: The amendment to 7.23 requires information on risks and uncertainties material to the impact of the entity's activity. This may be misinterpreted as requiring all impacts to be addressed. We would therefore prefer to see the requirement expressed in terms of information on material risks and uncertainties arising from the impact of the entity's activity. This would be more consistent with the approach to materiality described in section 5 of the guidance. dl/tn/ 3

4 Question 3 Do you have any suggestions for further improvements in this area? We highlight that the historical information specified in 4.2, 4.5, 7.17, and 7.19 is prefinancial in nature i.e. it provides essential context to the financial statements to support an understanding of developments in the year and the future financial performance and position of the entity. Emphasising the role that this pre-financial information plays in providing a broader picture of the company's financial performance, position, and prospects may assist companies in focusing on the completeness and materiality of their strategic report disclosures. Materiality Question 4 Do you agree with the draft amendments to Section 5? We support the overall focus of the draft amendments, and emphasise the importance of the continued focus on materiality in the context of investor decision-making, including stewardship. In our view, further guidance could be considered to support the application of materiality. Confusion over how to apply materiality in the strategic report may result in excessive detail in some areas, and a lack of detail in others. Clearer guidance would help preparers to assess whether a matter needs to be raised in the report, and whether a piece of information relating to a material matter needs to be disclosed. We believe preparers would find it helpful to consider whether the disclosure of an item of information would be reasonably expected to move an assessment of the company's enterprise value or the stewardship of that value. Sometimes described as a can I model it? test, this would align more closely with the fundamental assessments of business value used to support long-term investing strategies. We believe the close relation of this approach to the expected long term future cash flows of the business would also help to support the longer-term emphasis introduced in 5.4 and 5.7 of the Guidance. dl/tn/ 4

5 Linkage Question 5 Do you have any suggestions on how the Guidance could encourage better linking of information in practice, or common types of disclosures that would benefit from being linked? In our view, the linkage concept plays a central role in ensuring that companies disclose information that is material to their specific circumstances. It is most effective when it is applied as a basis for building the strategic report from the bottom up. So, for example, we would expect the description of strategy to address the material features of the company s business model and environment, and we would expect the performance measures to address progress in implementing each feature of the strategy, and provide insight into the consequences of implementing it. This bottom-up approach offers a rigorous basis for determining what to include in the strategic report without falling back on generic checklists of disclosure. This approach is already to some extent embedded in the current version of the Guidance, but we believe it could be drawn out more clearly to assist preparers. For example, if a company identifies know-how as a key source of competitive advantage, the need to report on progress in managing it should follow, but practice suggests this does not occur consistently. Applying this logic to the reporting of performance, we highlight that the current version of the Guidance references seven types of quantitative measure, we think efforts to improve linkage could be based around encouraging a more rigorous approach to determining what to report on for each (progress against strategy and objectives ( 7.10); the development of the business ( 7.38); the performance of the business ( 7.38); the position of the business ( 7.38); monitoring risks and progress in managing them ( 7.44, 7.45); indicators of future financial prospects ( 7.45); trends or factors affecting the business ( 7.21)). Content elements Question 6 Do you agree with how the sources of value have been articulated in the draft amendments to the sections on strategy and business model in Section 7? We agree with the approach to sources of value outlined in paragraph 7.17, and we suggest that the example that follows paragraph 7.17 is more akin to guidance and should therefore be part of the main text. We note that paragraph 7.20 highlights potential challenges in reporting on benefits from investment in resources, and 7.21 suggests an approach of reporting on the dl/tn/ 5

6 economic contribution to different stakeholders (sometimes described as a 'value distribution statement'). Whilst this type of analysis may be relevant for wider stakeholder reporting, we do not believe it addresses the issue raised in In our view, the information described by the Guidance in 7.11 to address progress (and potentially outcomes) in implementing strategy is likely to be of much greater relevance for shareholders looking to understand the company s strategy with respect to each of its key resources. Question 7 Do you consider that disclosures on how value is generated would be helpful? We would expect the description of the business model to deal with how the company generates value. We welcome the Financial Reporting Lab s work on the business model, and also highlight our comments in question 9 as a means to further improve practice in this area. Question 8 Do you consider that the draft amendments relating to reporting of non-financial information give sufficient yet proportionate prominence to the broader matters that may impact performance over the longer term? We agree with the overall approach taken in the Guidance to reporting non-financial information as it provides a basis for reporting the information that is most relevant in the context of the specific circumstances of the entity. In our view, caution is needed in prescribing more specific disclosures as this can result in check-box approaches to disclosure that may address the issue but do not provide useful information to support investor stewardship and decision making. We therefore believe further subject-matter specific prescription would be counter-productive. In our view the factors that our most likely to drive longer-term-relevant disclosures are (i) a clearer focus on information that is material to an assessment of shareholder value (see our comments to question 4), and (ii) better application of the linkage concept to ensure that all key aspects of the business model and strategy are followed through in the strategic report narrative (see our comments to question 5). dl/tn/ 6

7 Other Question 9 Are there any other specific areas of the Guidance that would benefit from improvement? In our view the Guidance has had a significant positive impact on the quality and relevance of UK narrative reporting. However, KPMG s research 1 based on comparison to international practice has highlighted three broad areas where UK strategic reports could be improved: 1) Ensure the strategy discussion strikes the right balance between short-term improvement tweaks and long-term strategy A third of UK reports focused only on short-term matters such as efficiency programmes and incremental revenue initiatives. Addressing underlying competitive strengths, such as the customer experience, and explaining how these are being developed and protected could help companies to provide a longer-term perspective. 2) Close the gaps in business model descriptions UK business model descriptions can lack depth and often focus on only a few aspects of the business. The most common gaps in descriptions related to knowhow and supplier relationships that can represent key areas of competitive advantage and challenge. The gaps in these descriptions can be carried through to the rest of the report, and they can also make it difficult for investors to interpret the implications of external factors and events without further guidance from the company. 3) Make better use of non-financial KPIs The best company reports include a range of relevant measures covering, for example, brand, research, staff, customer base, product base, and efficiency. UK companies typically provide KPIs over two or three of these areas, but German companies, which scored particularly strongly in this area, average four or five. In our view, these improvements in practice are most likely to be achieved by enhanced emphasis on materiality and linkage, rather than detailed prescription as disclosures should always be relevant to the specific circumstances of the business. This approach is reflected in our responses to questions 1-8, and should, in our view, provide the focus for any future more comprehensive updates to the Guidance. We highlight the 1 Room for Improvement: dl/tn/ 7

8 relevance of the Financial Reporting Lab s ongoing work in this area, and also note that there may be lessons to be learned from guidance in other jurisdictions that share equivalent shareholder-focused reporting objectives. Over time, further alignment of narrative reporting guidance (in a similar way to that achieved for IFRS) may be a desirable outcome. dl/tn/ 8