Since 1 January 2019, all large companies must include a separate statement in their strategic report that explains how the directors have taken the broader interests of their stakeholders into account when performing their duties under Section 172 of the Companies Act 2006, since this requires them to promote the success of the company for the benefit of all its members.
At ESG PRO, we recognise that this requirement carries with it many challenges, and corporations need support to prepare a complaint statement, most especially because this is far from a “tick box” exercise and, as such, it is subject to scrutiny and auditing. It is in this context that we see how the company’s approach to sustainability (ESG) is in the spotlight.
Section 172 reporting is required of all UK incorporated companies other than those that qualify as medium-sized (under sections 465 to 467) or are small companies. Medium-sized companies must have at least two out of three of the following:
Be aware that the qualifying criteria can be complex because certain companies which might be considered as “medium” are in fact required to report.
Over the past few years, there has been debate in the UK on the topic of corporate governance. In part this is due to the lack of trust the public place in companies as a result of high-profile business failures, accusations of high executive pay, unethical tax avoidance by multinational companies, and worsening relationships with employees as evidenced by pay disputes. This has led to select committee enquiries, public consultations, and new laws, stock exchange rules, and corporate governance codes.
Poor board room decisions have impacted employees, pension scheme members, customers, suppliers, and other stakeholders, as well as the shareholders, whose interests the directors are required by law to consider when making decisions. It is in this context that the Section 172 Statement came into force. It must be included in the annual report of all large companies (as defined by the Companies Act of 2006), and it is the most important of the new reporting requirements for large companies.
The Companies Act is quite specific in its demand for “…a statement (a “section 172(1) statement”) which describes how the directors have had regard to the matters set out in section 172(1) (a) to (f) when performing their duty under section 172.” (see Companies Act 2006, s.414CZA).
The caution is simple: a mere confirmation that s.172 has been considered is inadequate. The directors must explain how they have executed their duties in accordance with the Act, and this means they should include details of the process or processes used by the board to ensure s.172 was addressed in their decision making in respect of matters of strategic importance.
Most large companies face ESG reporting within their TCFD and CSRD obligations, and these regulations centre on forward-looking climate modelling scenarios. Beyond strategic M&A discussions, as an example, it is sustainability in all its guises which now dominates boardroom discussions on strategy.
Directors are required to promote the success of the company for the benefit of the members as a whole in accordance with section 172 of the Companies Act. In doing so, they should have regard for (among other things) six specified areas that relate to the interests of wider stakeholder groups, which are as follows:
These six areas, which have been a part of the Companies Act since 2007, as well as the idea of reporting on them, are neither new nor novel because the strategic report’s main objective has always been to inform members of how the directors have carried out their responsibilities under Section 172.
However, instead of focusing specifically on the other facets of the directors’ responsibilities, strategic reports traditionally focused on the company’s performance in the current year, possibly with a brief mention of the following year, and describing principal risk. This is especially true for businesses that are exempt from the stricter “non-financial reporting” regulations that are applicable to quoted companies and large public interest entities.
In order to address the above, the introduction of the Section 172 Statement adds a new, explicit requirement for all large companies to describe how these six areas of broader stakeholder interests—which are listed in section 172(1)(a)–(f)—have been taken into account by the directors throughout the year. The focus on these issues reflects an understanding that the majority of them will directly affect a company’s long-term viability and prospects.
Within a company’s strategic report, the Section 172 Statement is required to be a distinct statement. Additionally, it needs to be posted on company’s website, or on that of its parent company if it does not have its own website, in which case it must identify clearly the name of the company to which it relates.
Because it is anticipated that this will be tailored to the company, the law itself does not specify the information or level of detail that must be included in the statement. However, general guidance from the Financial Reporting Council (FRC) and the Department for Business, Energy, and Industrial Strategy (BEIS) suggests that the Section 172 Statement should typically contain details on the following:
As a result, it is unlikely that a straightforward declaration that the directors have complied with section 172 or a general outline of the governance procedures will be deemed sufficient to satisfy the legal requirement. In particular, the third bullet suggests that the statement should be updated yearly and should make reference to issues that have received board attention throughout the year.
To fulfil their section 172 obligations, directors must understand their stakeholder community. A stakeholder is any individual, group, or organisation that may be affected by or have an impact on a company’s decision, activities, or outcome.
The stakeholders of your organisation can include many diverse groups or individuals. They may influence, use, or benefit, or otherwise be impacted by your undertakings, or those who have special knowledge of the current situation, and those that will use, support, or maintain the final product or service.
By clustering stakeholders according to common needs, your list reduces to a more manageable length, increasing the efficiency and impact of your efforts to meet the right groups’ needs.
Your materiality assessment weighs the topics from a dual materiality standpoint, which recognises the difference between material topics of importance to your stakeholders vs. those of primary importance to the business. In the example materiality assessment published by Fresnillo, one can see the impact.
In this light, you can see that your stakeholders extend far beyond your management, employees, and investors, and extends through to those who:
Conducting an appropriately designed materiality assessment informs your company directors, and satisfies the fundamental requirements of your Section 172 statement that the company is engaging with its stakeholders on matters which will define its strategy over the short and long terms.
To manage this process, we recommend a stakeholder assessment is developed as part of an overall materiality assessment to assess the nature and relevance of each group. Since a quality materiality assessment is intrinsic to ESG and wider TCFD/CSRD reporting, this is a worthwhile step.
Identify the important decisions that were made throughout the year. Which decisions had a significant impact on the company or a key stakeholder group during the year or will have a significant impact going forward? These are the choices we would anticipate the board to have carefully considered, and they are probably recorded in board minutes and papers.
If a strategic report is approved by a company’s board and is later challenged for non-compliance with the Companies Act 2006 “every director who knew it did not comply (or was reckless as to whether it complied); and failed to take reasonable steps to secure compliance or prevent the report from being approved, commits an offence.”
Every officer of the company also commits an offence if the section 172 statement is not published on the website and kept available there for the specified periods, as described within the Companies Act.
As the GC100 state so perfectly, it’s all about driving cultural change:
“as the board seeks to determine or discuss the culture of your company, consider how you propose to embed in the habits and behaviours of board, management and employees a culture which, in its pursuit of success for the benefit of shareholders as a whole, is consistent with the company’s goals in relation to stakeholders, whether employees, customers, suppliers, local communities, the environment or others affected by or engaging with the company’s activities.”
At ESG PRO Limited, we assist you through the application of global frameworks which streamline your approach to Section 172 in such a way that addresses all of these criteria.
Leads the daily operations at ESG PRO, he specialises in matters of corporate governance. Humperdinck hails from Bermuda, has twice sailed the Atlantic solo, and recently devoted a few years to fighting poachers in Kenya. Writing about business matters, he’s a published author, and his articles have been published in The Times, The Telegraph and various business journals.
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