Article

How UK constructors can build investment confidence

Elizabeth Collins Elizabeth Collins

The current state of the construction industry – in both buildings and infrastructure – has many challenges, one of which is the erosion of margins on contracts for the major players.

The ability of the large corporates to make money on contracts is continually squeezed because of the costs commanded lower down the supply chain. This is where the shortage of skills has given them a strong bargaining position. That, in conjunction with delivering to a fixed price contract, can erode those margins even further when issues arise in delivery.  Significant changes to the whole supply chain are needed, specifically investment in the growth of the skills base to ensure the sustainability of the industry.

More than cost

Our focus should not be purely on cost but on how a business is governed from the top down. This in turn will also affect tendering processes for customer contracts as well as engaging with corporate advisers. It is important to tender for the right contracts and ensure they are appropriately managed and are operating in a fair and open playing field. Tendering is not just about the supplier chain, the same principles apply to corporate advisers to ensure that the right parties are engaged and for the right reasons.

With all this in mind, investors are understandably wary about ploughing their money into this area of construction.

Following the collapse of the construction company Carillion, fingers of blame have been pointed in all directions – the CEO, the board, the auditors, the government, ’the system’. Without a clear, consistent opinion of where the fault lies, the industry faces a challenge to prove to investors that the same thing won’t happen again.

One thing recent events has uncovered is a lack of general understanding on the respective responsibilities that auditors and directors have. It’s too early to tell what caused Carillion’s downfall, but it is clear that the transparency of roles and relationships needs to be brought to the fore. This will, contribute to improved confidence in the sector.

Using corporate governance as a building block

There are many good construction companies that already take their corporate governance seriously. Our latest corporate governance review shows a record two-thirds of FTSE 350 companies are fully compliant with the UK’s Corporate Governance Code.

Leaders who will attract confidence from investors in both their business and the wider construction sector are those who put transparency and communication at the core of everything they do. The Financial Reporting Council’s new version of the Code, published at the start of this year, lists leadership and purpose as key principles, requiring boards to incorporate culture, values and shareholder and stakeholder engagement.

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The importance of independence and diversity

Financial and legal advisers to these businesses need to be independent to provide relevant objective advice and support. More importantly, a third party with no prior knowledge looking into the business should not call into question that independence from an event or previous service for example.  

Independence looks at relationships, impact of the work on other areas of the business and who would be placing reliance on it as well as the length of the term of office they have held and whether a relationship is deemed too close to be objective. This independence not only affects corporate advisers, auditors, lawyers, but also the board members. 

Our research finds that the most widespread areas of non-compliance with the Code relate to the requirement that at least half the board should be independent non-executive directors, and the need for chairs to be independent on appointment1.

Read more in our Corporate Governance Review

Support individual companies

Diverse board appointments should support individual companies to meet their strategic objectives, says the Financial Reporting Council (FRC). For instance, the government’s FTSE 350 Cyber Governance Health Check Report found that 54% FTSE 350 companies stated cyber/IT was a key risk to their business, but 68% of their boards had no members with expertise in dealing with cyber incidents2.

Companies can inspire confidence in casting their net wide to ensure a diverse board. There is a clear onus on them to look carefully at where non-exec members are coming from, to scrutinise their backgrounds, to clarify why they are there, and assess the value they bring. Companies could also look at imposing time limits on retaining advisers to prevent the risk of a cosy relationship emerging.

With a lot of help from audit

Our CEO Sacha Romanovitch has called for a review of the whole market to prevent scenarios in which auditors could be marking their own homework. Such a review would certainly boost confidence in the construction sector.

Under EU rules, companies now need to put their audit out to tender every 10 years and change auditors every 20. The FRC demands key audit partners rotate accounts every five years and senior members of the team every seven years. But what happens to the smaller businesses, often family firms, that don’t have investors, where the client is usually the shareholder? There’s no measure of accountability. 

Listed companies now issue extended reports that disclose the key audit matters addressed during the audit, a conclusion on the risks identified at planning. The disclosures include details of the auditors’ approach and how materiality was determined. Unlisted businesses are not required to disclose this level of transparency.

There are other ways to establish and improve transparency – challenging companies’ relationships with advisers, including the tender and appointment process. Shareholders should be able to clearly see that a fair and open process has been followed. It should be very clear not only how, but why decisions have been made by the Board on these appointments so that anyone scrutinising the process would conclude they would have made the same decisions.

Attractive industry despite the risks

Investments in any industry sector bring risk – success comes down to how you assess and manage it. Construction is no exception, and has its own investor risks – lack of return due to a change in the market, supplier chain demands, expensive financing or projects overrunning, or unexpected events such as planning constraints making a project less viable or attractive.

But UK real estate and construction are still very attractive options. The construction sector’s activity index (IHS Markit/CIPS construction PMI) sank to a 20-month low of 47 in March, but rose above 50 (the indicator for growth) for April, May and June3. While some of this flux has been linked to the extreme weather, analysts are hopeful that construction may already be steadying the ship for a brighter investment future.

If you would like to explore any of the issues in the article please contact Elizabeth Collins.

References

  1. Corporate Governance Review, Grant Thornton UK LLP, 2017 [ 3137 kb ]
  2. FTSE 350 Cyber Governance Health Check Report 2017, HM Government, 2017
  3. IHS Markit/CIPS construction PMI for March 2018, but it was 52.5 in April 2018 and May 2018, and then 53.1 in June 2018.