Corporate governance review
Government’s Green Paper on corporate governance reform
In November 2016, the Department for Business, Energy & Industrial Strategy (BEIS) published its much heralded Green Paper on corporate governance reform for discussion. A range of options are proposed for strengthening the UK’s corporate governance framework, since “the behaviour of a limited few has damaged the reputation of many”. Section 172 of the Companies Act 2006 enshrines the importance of wider interest groups in corporate governance. Under that section, directors are required to take account of wider interests when seeking to promote the success of a company for the benefit of its shareholders. Therefore, in the Green Paper, the Government is exploring new ways to connect boards to a wider range of interested groups and to build upon existing good governance practices. Options include: increasing shareholder influence over executive pay; strengthening the employee, customer and supplier voice at boardroom level; and extending higher minimum corporate governance and reporting standards to large, privately-held businesses.
Responses to the Green Paper were requested by February 17, 2017.
For more information, please see our briefing on the Green Paper.
FRC’s response to BEIS Select Committee inquiry on corporate governance
In December 2016, the Financial Reporting Council (FRC) published a letter containing its response to the Department for Business, Energy and Industrial Strategy (BEIS) Select Committee’s inquiry on corporate governance which was launched in September 2016. The letter sets out the FRC’s views on how its recommendations on corporate governance could be taken forward and whether additional powers would be needed.
The FRC’s recommendations include:
- Improving the operation of section 172 of the Companies Act 2006 by amending the UK Corporate Governance Code (the Code), providing for disclosure in companies’ annual reports and related changes to the FRC’s Strategic Report Guidance. The FRC states that it can pursue this without requiring powers. However, its application to all companies, including private companies, would require a change to the reporting regulations.
- A review of the Code and associated guidance to develop best practice on delivering board responsibilities to a range of stakeholders.
- A review of the Code to examine whether disclosures relating to board communication might be strengthened to enable appropriate scrutiny and challenge by shareholders and wider stakeholders.
- A code and/or guidance directly applicable to the governance arrangements of large private companies should be developed.
- Monitoring the quality of reporting under the Code, including the option of more direct contact with companies where explanations are not adequate, and publicising good and poor practice.
- A Government review of the enforcement framework in order to establish an effective mechanism for holding directors and others in senior positions to account when they fail in their responsibilities.
- A review of the Code to consider a wider role for remuneration committees, including the pay and conditions of the company’s workforce and reporting on the link between remuneration structure and strategy.
- A Government inquiry into the issues raised by the quantum, growth, disparity and performance-linkage of rewards received by senior executives in a range of corporate forms.
- A review of the Code to explore whether and how, when there are significant shareholder votes against a remuneration report, companies should respond through additional shareholder consultation and reporting.
- A review of the Code and associated guidance against the recommendations proposed by the Hampton-Alexander Review and the Parker Review in order to improve board diversity, including reporting on actions and progress.
QCA and UHY Hacker Young’s Corporate Governance Behaviour Review 2016
In December 2016, the Quoted Companies Alliance (QCA) and UHY Hacker Young published their annual review of corporate governance behaviour, which focuses on the disclosures made by 100 small and mid-size quoted companies taken from the Main List, AIM and ISDX and compares these disclosures against the minimum disclosures set out in the QCA Corporate Governance Code for Small and Mid-Size Quoted Companies (the QCA Code).
The results were discussed with a group of institutional investors at a roundtable discussion and the QCA has used the feedback received to create five recommendations for companies to follow in order to improve the way they address corporate governance disclosures. The recommendations are as follows:
- Demonstrate clear links between strategy, performance and remuneration – Clarity and transparency in matters of remuneration are important foundations upon which trust between companies and shareholders is built. Establishing well-structured remuneration arrangements indicates good governance. However, this can be fully appreciated only if the arrangements are articulated effectively to all shareholders.
- Keep reporting concise and transparent – Each company should demonstrate that it can clearly articulate its business story and the company’s ambition and purpose. This will enhance the quality of engagement with all interested parties, namely, shareholders, other stakeholders and potential investors.
- Demonstrate an understanding of members’ and other stakeholders’ interests – Effective boards do not shy away from addressing the concerns of stakeholders. Instead, they take specific actions or provide clear descriptions and explanations about a particular situation. This enables stakeholders to better understand the company’s approach.
- Publish the results of member votes online – Investors believe strongly that the results of shareholder votes should be disclosed by all companies. Given that AIM Rule 26 requires certain information to be readily available on the company’s website, investors question the reluctance to provide this information, or to be selective in its provision.
- Describe and explain how board performance is evaluated – Disclosures on board evaluation provide a good opportunity to convey a sense of the operational culture within the business. They help to demonstrate how that culture influences the behaviours of all those involved with the company.
Letter to the Prime Minister urging her to strengthen corporate governance
In January 2017, the International Corporate Governance Network (ICGN), the Institute of Directors (IoD), Institute of Chartered Secretaries and Administrators (ICSA) and the Trades Union Congress (TUC) published a letter sent by them to the Prime Minister regarding corporate governance issues in the Green Paper published in November 2016.
While the signatories will be responding individually to the Green Paper setting out their own particular priorities, they all recognise the importance of section 172 Companies Act 2006. Section 172 requires directors to promote the success of the company for the benefit of shareholders, and in so doing to have regard for the interests of workers, consumers and other stakeholders. The letter notes that there is no effective mechanism for policing this law, which means that if companies, particularly private companies where there is little or no institutional shareholder oversight, do abuse the law, they are not always held to account. The letter suggests that establishing a regulator for companies would deliver economic benefits and greater fairness.
In addition, the letter notes that one of the most contentious governance issues is that of executive remuneration. While the letter acknowledges it is not likely that one single measure will remedy the problem, it states that perhaps what is most important is the Government’s voice in demanding that companies, their remuneration committees, advisers and shareholders, recognise the problem, and resolve a better, and perhaps a simpler, regime for corporate pay which can command broad support.
Finally the signatories urge the Prime Minister to do the following, at a minimum:
- create a complaint and appropriate remedy mechanism for those whose interests should be protected by the law;
- ensure investors and stakeholders are involved in the governance of the complaint mechanism;
- strongly encourage, or mandate larger private companies to apply the principles of independence and transparency which have worked for public companies; and
- help encourage more broadly acceptable frameworks for executive pay, and recognise that executive pay will require a long-term focus by directors, investors, stakeholders and government.
FRC’s review of the UK Corporate Governance Code
On February 16, 2017 the Financial Reporting Council (FRC) announced that it will be undertaking a fundamental review of the UK Corporate Governance Code (the Code). The review will take account of work done by the FRC on corporate culture and succession planning, and the issues raised in the Government’s Green Paper on corporate governance reform and the BEIS Select Committee inquiry.
The FRC will commence a consultation on its proposals later in 2017, based on the outcome of the review and the Government’s response to its Green Paper.
ICSA’s The future of governance – Untangling corporate governance
In February 2017, the Institute of Chartered Secretaries and Administrators (ICSA) published the first in a series of reports on the future of UK corporate governance, which will look at some of the principal issues in the governance environment and seek to identify solutions to them.
This report, “Untangling corporate governance”, argues that the different components of corporate governance require untangling, in order for each of them to be addressed effectively. While the “comply or explain” framework remains appropriate for its original purpose, it is not well suited for delivering some of the other expected objectives of corporate governance. In particular, it is not capable of preventing or effectively sanctioning bad behaviour by boards or directors or of delivering public policy objectives that are relevant to the UK economy or society as a whole. Encouraging good business practices, punishing bad business behaviour and promoting the public interest are interrelated objectives, but they are not the same and cannot all be achieved through the same mechanisms. As a result, the report argues that the different components of corporate governance need to be untangled in order to address each of them effectively.
The report identifies actions that should be considered, in addition to those set out in the Government’s Green Paper on corporate governance reform, including:
- a rethink in policy approach to issues such as income inequality, tackling them across the economy as a whole using tools better suited to the purpose;
- promoting good governance standards across all sectors, and in other investment asset classes that receive a significant amount of money from UK investors;
- improving the effectiveness of the various mechanisms by which listed companies are held to account; and
- introducing effective legal sanctions to punish bad business behaviour.
Developments in institutional investor/proxy advisor guidelines
ISS’ UK and Ireland Proxy Voting Guidelines 2017
On November 21, 2016 Institutional Shareholder Services (ISS) updated its benchmark policy recommendations which, for the most part, take effect for shareholder meetings held on or after February 1, 2017.
The 2017 updates include the following:
Where directors have multiple board appointments, ISS may recommend a vote against the election/re-election of directors who appear to hold an excessive number of board roles at publicly-listed companies. ISS has amended the definition of overboarding to provide clarification on the precise number of board seats ISS believes can be held. A vote could be recommended against directors who hold more than five non-chair non-executive director positions, as well as against a non-executive chairman who also holds more than three other non-chair non-executive director positions, more than one other non-executive chair position and one non-chair non-executive director position or any executive position. In addition, a vote may be recommended against any executive director who holds more than two non-chair non-executive director positions, any other executive position or any non-executive chair position. The voting policy has also been amended to provide that an adverse vote recommendation in relation to a chairman will not generally be applied at the company where the individual is chairman unless that chairman exclusively holds other chair and/or executive positions or is being elected as chairman for the first time.
- The wording of the remuneration sections has been amended to reflect developments in market practice and investor expectations. As a result, the introduction to the remuneration section includes a direct reference to companies which seek to implement pay structures (for example, non-performance related restricted shares) which sit outside the typical UK model, making it clear that structures which involve a greater level of certainty of reward should be matched by lower levels of award.
- In relation to the voting recommendation on the remuneration policy, one of the factors ISS will now consider is whether the remuneration policy or specific scheme structure has an appropriate long-term focus and has been sufficiently justified in light of the company’s specific circumstances and strategic objectives. Again, in relation to variable pay, it is made clear that any increase in the level of certainty of reward must be accompanied by a material reduction in the size of award.
- The policy now states that where a serious breach of good practice is identified in relation to the company’s remuneration policy, and typically where issues have been raised over a number of years, ISS might make a negative voting recommendation against the chair of the remuneration committee (or, where relevant, another member of the remuneration committee).
- In terms of the general recommendation on the remuneration report, ISS will now, where relevant, take into account its European Pay for Performance methodology (EP4P) and a definition of EP4P has been included.
- One of the factors ISS will consider in relation to the remuneration report will be whether exit payments to good leavers were reasonable, with appropriate pro-rating (if any) applied to the outstanding long-term share awards, and special arrangements for new joiners should be in line with good market practice.
- Again, if a serious breach of good practice is identified in relation to the company’s remuneration report, and typically where issues have been raised over a number of years, ISS might make a negative voting recommendation against the chair of the remuneration committee or, where relevant, another member of that committee.
Approval of new or amended LTIP
Factors ISS will consider when considering a resolution to approve a new or amended long-term incentive plan (LTIP) will include whether it is over-complex, and ISS will want to ensure that any increase in the level of certainty of reward is matched by a material reduction in the size of award.
Committee composition of smaller companies
ISS has now made it clear that for companies listed on AIM, and for other companies which are not a member of the FTSE All Share or FTSE Fledgling Indices, the membership of their audit and remuneration committees should reflect the standard set out in the QCA Corporate Governance Code for Small and Mid-Size Quoted Companies. This requires that audit and remuneration committees should include independent non-executive directors only, with half the membership of the nomination committee being independent directors.
Timing of changes to Guidelines
As mentioned above, these updates apply to shareholder meetings taking place on or after February 1, 2017. However, the policy with respect to committee composition of smaller companies will not apply until February 2018 since ISS recognises that this is a significant change and smaller companies will need time to comply with the new requirements if they wish to do so.
Glass Lewis’ 2017 UK Proxy Paper Guidelines
In January 2017, Glass Lewis published an update to its UK corporate governance policy guidelines. Updates from the 2016 Guidelines include:
- Authority to set general meeting notice period at 14 days – Glass Lewis has revised its policy with respect to companies’ requests for authority to call general meetings (other than AGMs) on 14 days notice to generally support such requests. This change has been made in light of constructive engagement with a significant number of UK companies, a multi-year review of market practice, general shareholder support for such authorities and absence of misuse of the authority. Therefore, from 2017, Glass Lewis will generally support such authorities when, as is best practice in the UK, companies provide assurances that such authority would only be used when merited by exceptional circumstances.
- Remuneration – The Guidelines have been updated to reflect current best practice as advocated by the Investment Association’s Principles of Remuneration, specifically to highlight the role of remuneration committees in selecting “a remuneration structure which is appropriate for the specific business, and efficient and cost-effective in delivering its longer-term strategy.”
- Related party transactions – Glass Lewis’ policy on recommending a vote against directors who face a potential conflict of interest from a related party transaction with the company has been clarified. Generally, Glass Lewis will refrain from recommending a vote against directors with a material business relationship with a company that falls under the normal course of business conducted on reasonable terms for shareholders. Rather, such relationships will be considered in Glass Lewis’ assessment of the independence of the board and key committees. Glass Lewis generally recommends voting against directors with a material professional services relationship with a company, such as consulting or legal services, on that basis alone.
- Director tenure – The policy on evaluating the independence of directors based on board tenure has been updated. Glass Lewis will generally refrain from recommending a vote against any directors on the basis of tenure alone. However, it may recommend voting against certain long-tenured directors when lack of board refreshment may have contributed to poor financial performance, lax risk oversight, misaligned remuneration practices, lack of shareholder responsiveness, diminution of shareholder rights or other concerns. In conducting such analysis, Glass Lewis will consider lengthy average board tenure over nine years, evidence of planned or recent board refreshment, and other concerns with the board’s independence or structure.
PLSA’s Corporate Governance Policy and Voting Guidelines 2017
In January 2017, the Pensions and Lifetime Savings Association (PLSA) published an updated version of its Corporate Governance Policy and Voting Guidelines. The updated Guidelines include the following:
- Pay policies should ensure that maximum pay-outs remain in line with the expectations of shareholders and other stakeholders, including workers and wider society. The pay policy should not permit any pay award larger than that necessary to successfully execute the company’s wider strategy, and to incentivise and reward success.
- Pay policies likely to result in pay awards that could bring the company into public disrepute or foster internal resentment owing to their excessive value and/or the overly-generous incentives and rewards that they offer, justify a vote against the policy.
- If the process of engagement prior to the AGM vote fails to produce a remuneration policy that shareholders can support, this represents a serious failure on part of the chairman of the remuneration committee in the most fundamental aspect of their role. As such, a vote against the remuneration policy should in most circumstances be accompanied by a vote against the chairman of the remuneration committee if they have been in post for more than one year.
- In the event of a vote against a revised remuneration policy, if the revised policy continues to fail to meet the principles outlined in the PLSA guidelines, it may also be appropriate to vote against the chairman of the board.
- The evidence that pay incentives are necessary to motivate or reward executives and to achieve success for companies is questionable. Remuneration committee deliberations should take a critical and challenging approach to pay increases and be prepared to exert downward pressure on executive pay.
- Given that the vote on the remuneration report is advisory and that many companies are too slow to heed the message on remuneration, it is more appropriate for shareholders to vote against any remuneration report that they feel unable to support, rather than abstain.
The progress in recent years towards meeting Lord Davies’ target of 33 per cent of women on FTSE 100 boards has been positive but there is still considerable room for improvement in some cases and shareholders expect this momentum to be maintained.
The 33 per cent target is a useful benchmark for gender diversity, and a failure to move closer to the target is one example of a criterion that could justify a vote against the re-election of the board chairman or chairman of the nomination committee.
The 2016 Parker report proposed an ethnic diversity target of no ‘all white’ boards by 2021 and progress towards this target is another useful measure of whether diversity is being sufficiently considered.
- Corporate reporting should detail the composition, stability, training and skills, and engagement levels of a company’s workforce, explaining how this relates to the underlying business strategy as well as the risks and opportunities that derive from the employment models and practices.
- Disclosure of the business model and strategy which fails to convey how the company intends to generate and preserve value over the longer term may lead to a vote against the report and accounts, or the submission of a shareholder resolution.
- Gathering the data necessary to clearly communicate the composition, stability, skills and engagement levels of a company’s workforce may be a medium to long-term process, but if shareholders do not see better disclosure in this area in coming years, a vote against the annual report would be appropriate.
Hermes Investment Management: Remuneration Principles - Clarifying Expectations
In November 2016, Hermes Investment Management published a paper, “Remuneration Principles: Clarifying Expectations”, which is directed primarily towards large publically listed companies. The proposals in the paper seek to practically improve existing executive director pay practices to better achieve their intended objectives.
The paper identifies issues with the prevailing model of executive pay, including excessive quantum, misalignment to long-term value, excessive complexity, weak accountability and unfairness, and low levels of trust. It then proposes solutions to these issues based on its 2013 Remuneration Principles.
The paper also sets out an illustration of a new type of remuneration structure that companies should consider.
Big Innovation Centre’s “The Purposeful Company – Interim executive remuneration report”
In November 2016, the Big Innovation Centre published an interim report on executive remuneration by the Steering Group of its Purposeful Company Taskforce, which is developing a range of policy recommendations to support the development of UK companies pursuing sustainable growth inspired by purpose.
The Taskforce puts forward four proposals to help align executive incentives better with long-term purposeful behaviour and to help rebuild public confidence in executive pay:
- Shareholder guidelines and the UK Corporate Governance Code should enable companies to adopt simpler pay structures for CEOs based on long-term equity and debt holdings to encourage long-term behaviour and to avoid the unintended consequences of over-reliance on performance-based incentives.
- Companies should be required to publish a Fair Pay Charter explaining policy and outcomes for wider employee pay and fairness and to engage with employees on its content, including specified disclosures on pay comparisons.
- The directors’ remuneration reporting regulations should be updated to enable greater stakeholder understanding of a company’s maximum pay and the relationship between pay and performance.
- A binding vote regime should be triggered when companies lose or repeatedly fail to achieve a threshold level of support on the advisory remuneration vote.
PLSA’s AGM Season Report 2016
In December 2016, the Pensions and Lifetime Savings Association (PLSA) published its 2016 AGM report. This focuses on the issue of executive remuneration and includes an analysis of remuneration-related votes at FTSE 350 AGMs between September 2015 and August 2016, as well as the results of a PLSA survey examining the views of pension fund investors on executive pay.
The key findings in the report are as follows:
Overall dissent on remuneration-related votes did not change dramatically in 2016. Average dissent on remuneration reports and remuneration policies put to a vote was slightly under 8 per cent across the FTSE 350, a similar level to that in 2015 and 2014. However, the report notes that there were a number of prominent shareholder revolts at high profile companies and of the five FTSE 100 companies with the highest level of dissent on a remuneration-related vote in 2016, none were prepared to acknowledge that they had got their approach to remuneration wrong in their subsequent statements addressing the votes.
PLSA member survey
The findings from this survey suggest asset owners are concerned by the size of executive pay packets, not just their structure.
From the results, the PLSA has identified four key conclusions and will update its corporate governance policy and voting guidelines in line with the findings.
- Boards must do more to address shareholder concerns over CEO pay.
- Stakeholder anger over pay has become an annual event, without practice changing significantly.
- Asset managers must do more to hold boards to account, and recognise the concerns of stakeholders, particularly asset owners.
- The excessive value of pay packages is as much an issue for stakeholders, including pension funds, as their structure, and reductions need to occur.
CFA’s analysis of CEO pay arrangements and value creation in FTSE 350 companies
In December 2016 the CFA Society of the UK published a study carried out by Steven Young and Weijia Li of the Lancaster University Management School examining chief executive officer (CEO) pay structures and their alignment with corporate value creation for FTSE 350 companies between 2003 and 2014/15.
Specifically, the study analyses:
- the performance metrics FTSE 350 companies use as the basis for determining CEO pay;
- how commonly used performance metrics such as earnings per share (EPS) and total shareholder return (TSR) correlate with established measures of long-term value creation to all capital providers; and
- the strength of the association between realized CEO pay and company performance, where performance is measured using both traditional metrics and established measures of long-term value creation.
The major findings of the study include:
- The total annual realised pay for the median FTSE 350 CEO during the sample period is £1.5 million measured at 2014 prices. Total pay for the median CEO has increased by 82 per cent in real terms over the period, with an otherwise linear trend halted only by the financial crisis in 2008-2009 when pay levels slipped back to 2006 levels.
- The level of value creation over the period analysed has been low in absolute terms and erratic from year to year. The median FTSE 350 company generated little in the way of a meaningful economic profit over the period 2003-2009 and although performance improved from 2010 onwards, the median firm generated less than 1 per cent economic return on invested capital per year. The compound growth in annual mean return on invested capital benchmarked against the cost of capital over the 12 year sample period is less than 8.5 per cent.
- Simplistic metrics of short-term performance such as EPS growth and TSR are the dominant means of measuring performance in CEO remuneration contracts. These metrics correlate poorly with theoretically more robust measures of value creation that relate performance to the cost of capital.
- Pay is correlated with value generation at a primitive level. CEOs generating positive economic profits receive 30 per cent higher median total pay than their counterparts generating negative economic profits. Additionally, pay outcomes distinguish between value creation realized in share prices and value creation that remains unrealized.
- Despite relentless pressure from regulators and governance reformers over the last two decades to ensure closer alignment between executive pay and performance, evidence of more granular distinction between pay outcomes and fundamental value creation remains negligible.
- Firm size, industry, and previous year remuneration remain the primary drivers of CEO remuneration in the UK. These dimensions may correlate with aspects of value-generation, but at best they represent imperfect tools for assessing long-term corporate success. Structural concerns over pay arrangements therefore persist.
The two key themes emerging from the study are:
- the critical nature of performance measure choice in the debate over CEO pay arrangements; and
- the need for future recommendations on pay to focus more attention on linking incentives and rewards more directly to performance metrics that reflect long-term value creation for capital providers.
BEIS: Review of issues affecting black and minority ethnic groups in the workplace
On February 28, 2017 the Department for Business, Energy and Industrial Strategy (BEIS) published an independent review by Baroness McGregor-Smith considering the issues affecting black and minority ethnic (BME) groups in the workplace. This follows terms of reference published in April 2016 which stated that the review would look at the business and economic case for employers to harness potential from the widest pool of talent in the workforce. It was tasked with identifying the obstacles faced by BME groups in progressing through the labour market, assessing the impact of those obstacles, highlighting best practice and making cost-effective recommendations. The Government response to the review was published alongside the review.
The review sets out a number of changes that can be made by employers in the public, private sector and voluntary and community organisations to improve diversity within their organisations, including:
- Measuring success - Given the impact ethnic diversity can have on organisational success, it should be given the same prominence as other key performance indicators. To do this, organisations need to establish a baseline picture of where they stand today, set aspirational targets for what they expect their organisations to look like in five years’ time, and measure progress against those targets annually. They must also be open with their staff about what they are trying to achieve and how they are performing.
- Changing the culture - Improving diversity across an organisation takes time. Aspirational targets provide an essential catalyst for change, but to achieve lasting results, the culture of an organisation has to change. Those from BME backgrounds need to have confidence that they have access to the same opportunities, and feel able to speak up if they find themselves subject to direct or indirect discrimination or bias.
- Improving processes - From initial recruitment, to the support an individual gets and their progression opportunities, processes need to be transparent and fair. In many organisations, the well-established processes in place can act as a barrier to ethnic minorities and hinder their progress through an organisation.
- Supporting progression - Getting a job is only the first step of the career ladder. For those who have friends or family with experience of particular professions, there can be an advantage that supports them in their development. However, this does not result in a business placing the very best candidates in every role.
- Inclusive workplaces - The greatest benefits for an employer will be experienced when diversity is completely embedded and is ‘business as usual’. This means more than simply reaching set targets and changing the processes. It means that everyone in an organisation sees diverse teams as the norm and celebrates the benefits that a truly inclusive workforce can deliver.
The review includes a list of 26 recommendations, many of them directed at listed companies and all businesses and public bodies with more than 50 employees. The review also includes a number of best practice case studies.
The Government’s response includes the following:
- BEIS will work with businesses to ensure they have the resources they need to improve diversity and inclusion and fully embed change within their organisation.
- It sees a business-led, voluntary approach and not legislation as a way of bringing about lasting change.
- The attention of investment funds will be drawn to the importance of effective diversity and inclusion.
- It hopes employers will do what they can to improve their contracts to encourage greater diversity in their supply chains.
- It encourages all employers to accept the review’s recommendations.
The Government will monitor how things develop over the next 12 months and take the necessary action where required.
UK Government Investments: Launch of Future Board Scheme
On March 8, 2017 UK Government Investments announced that in November 2016 the Government launched the Future Board Scheme, in partnership with 30% Club and Board Apprentice. The scheme gives women from a wide range of backgrounds the opportunity to spend 12 months with boards in a developmental capacity.
The scheme is aimed at FTSE 350 companies, small and medium-sized enterprises, and other major organisations. Each organisation involved hosts a participant on their own board and in return puts forward an employee of their own to be placed on another participating board. Companies such as Aviva and Hammerson have signed up to participate in the scheme.
The Government believes the scheme has the potential to significantly grow the talent pipeline of women executives by giving women 12 months’ experience on a major board.
FRC’s tiering of signatories to the UK Stewardship Code
In November 2016, the Financial Reporting Council (FRC) advised that it has categorised signatories to the UK Stewardship Code (the Code) into tiers based on the quality of their Code statements. The FRC also published the list of asset managers, asset owners and service providers split into the relevant tiers. Asset managers have been categorised in three tiers and other signatories in two tiers.
The FRC first announced this exercise in December 2015 with the intention of improving reporting against the principles of the Code and assisting investors in judging how well their fund manager is delivering on their commitments. The FRC believes that the recent assessment demonstrates much improved reporting against the Code and greater transparency in the UK market.
Signatories to the Code have been tiered according to the quality of the reporting in their statements based on the seven principles of the Code and the supporting guidance:
- Tier 1 – Signatories provide a good quality and transparent description of their approach to stewardship and explanations of an alternative approach where necessary.
- Tier 2 – Signatories meet many of the reporting expectations but report less transparently on their approach to stewardship or do not provide explanations where they depart from provisions of the Code.
- Tier 3 – Significant reporting improvements need to be made to ensure the approach is more transparent. Signatories have not engaged with the process of improving their statements and their statements continue to be generic and provide no, or poor, explanations where they depart from provisions of the Code.
Of the nearly 300 signatures to the Code, more than 120 are in Tier 1 now. Asset managers who have not achieved at least Tier 2 status after six months will be removed from the list of signatories as their reporting does not demonstrate commitment to the objectives of the Code.
Developments in stakeholder engagement
ICSA’s project to help boards take account of employee and other stakeholder views
In January 2017, the Institute of Chartered Secretaries & Administrators (ICSA) announced the launch of a joint project with the Investment Association (the IA) intended to ensure that UK public company boards understand the views of their employees and other stakeholders which should then be factored into their decision-making. ICSA and the IA will identify existing best practice and produce practical guidance to enhance understanding of the interests of employees and other stakeholders, in accordance with board duties under section 172 Companies Act 2006.
The guidance will identify different approaches to stakeholder engagement for companies to consider, summarising the issues to be addressed and the practical steps to be taken. These will include the different approaches identified in the Government’s November 2016 Green Paper on corporate governance reform. Specifically, the guidance will set out:
- the ways in which companies can identify non-executive directors with relevant stakeholder experience;
- the processes by which boards can receive the views of their key stakeholders;
- how training and induction can be used to enhance directors’ understanding of their duties and the interests of, and impact on, different stakeholders; and
- a set of options for companies to appropriately report how they have fulfilled their duties in this area.
The guidance will be published in the second quarter of 2017.
Investor Forum’s review for 2015-2016
In January 2017, the Investor Forum (Forum) published its first review, the first time that its engagements have been disclosed publicly. Launched in October 2014, the Forum aims to facilitate a frank but constructive dialogue between investors and companies that focuses on long-term strategic issues and seeks to build trust and confidence through collective engagement.
The review notes that the underlying source of tension between companies and investors typically centres on one of more of four key issues:
- strategy and capital allocation;
- leadership and succession;
- operational performance; and
- reporting and communication.
In the first two years of operation, investors have asked the Forum to investigate 16 company situations for collective engagement. Most of the Forum’s work has been in situations where investors were seeking to recover value after a series of disappointing developments and six proposed engagements related to some form of corporate action by a company, where investors felt their interests could benefit from collective engagement. In eight cases there was comprehensive collective engagement. Three situations did not result in a full collective engagement, but investor feedback was provided to the company, three situations were narrowly defined or did not achieve critical mass for collective engagement, and two continental European situations did not lead to collective engagement as they are outside the Forum’s current remit. In both these cases, however, there was interest in a collective exchange of views and the Forum identified and connected investors who then engaged directly.
Among other things, the review also considers the following matters:
- developments in stewardship;
- common themes in engagements;
- what companies can expect from the Forum;
- what the Forum expects from companies; and
- the Forum’s other activities.
Audit and tender developments
FRC’s Notes on best practice for audit tenders
In February 2017, the Financial Reporting Council (FRC) published a set of best practice guidelines for audit tenders which highlight how audit committees can approach the audit tender process to get the best outcome. These guidelines are based on experiences of audit tenders since the requirement was first introduced into the UK Corporate Governance Code in 2012. The FRC published a previous note on best practice with regard to audit tenders in July 2013.
The updated guidelines include the following:
- In terms of timing of a tender, it may be beneficial to tender the audit before the last possible date, in order to have a wider choice of audit firms and audit partners. The guidance sets out factors to consider when determining the timing of the tender.
- The audit committees of public interest entities (PIEs) related to PIEs in other member states, should consider co-ordination of the tender timing around the group as different member states will have differing rotation requirements. The audit committees of subsidiary PIEs will need to be involved in the tender process to discharge their responsibilities.
- Companies that use several firms for different advice, should develop a long-term strategy for the procurement of professional services which ensures that at least two firms are able to participate in the audit tender process, and satisfy auditor independence requirements by the time of appointment, without unforeseen impacts on other services received by the company, and all members of the audit committee should be involved throughout the tender process.
- The audit committee of a PIE is required to make a recommendation to the board for appointment of an auditor. The audit committee must validate or approve a report on the tendering and appointment process. That report is to allow the audited entity to demonstrate to the FRC that the process has been carried out independently and fairly, and in accordance with legislative requirements. It is a decision for the board of the audited entity if it wishes to make such a report public. The FRC considers that the legislative requirements can be satisfied by a combination of some or all of: (i) the paper prepared for the audit committee to support its deliberations and recommendation to the board for appointment; (ii) the board paper which sets out the audit committee’s assessment and recommendations; and (iii) material contained in the report of the audit committee in the company’s annual report, as that will set out the main areas of focus of the audit committee during the year being reported upon.
- Audit committees should seek views on audit fees in their engagement with major investors regarding the tender process.
Investment Association’s Guidelines on audit tenders
In February 2017, the Investment Association published guidelines setting out the expectations of its members when companies tender their audit. The guidelines cover planning the tender, tender candidates, the tender process and the tender decision. The guidelines are aimed at companies whose shares are admitted to the Premium and Standard segment of the Official List of the UK Listing Authority, to trading on AIM, and to the High Growth Segment of the London Stock Exchange’s Main Market.
Planning the tender
The guidelines state that the audit committee should direct the planning and oversee the process of the tender, including identifying candidates, setting the criteria for selection and the interviews and that the whole of the audit committee should be involved, not just the chair of the audit committee. The tender process should be planned carefully and well in advance since managing a mix of non-audit services is now more complex and likely to need time and input from a range of stakeholders. A company planning to enter into a tender should issue an RNS announcement so that its investors can, if they wish, engage with it on the process and major shareholders should be engaged on the timetable and process, how the audit committee intends to assess audit quality, the selection criteria and assessment mechanism to be applied and the conclusion reached. In relation to giving advance notice of a tender and the timetable, standardised disclosure should be avoided and the company should explain why it is proposing to tender at that time, particularly if it is re-tendering well within the new statutory limit.
The guidelines point out that audit committees need to consider the range of firms invited to tender, ensure that they are objective and independent and also whether the incumbent is to be included. Depending on each group’s circumstances, the guidelines state that investors believe only the larger multi-national groups may have to restrict their choice to the four largest audit firms. Where the incumbent auditor is being invited to tender, the tender process should address any potential advantage the incumbent firm, or an audit firm with a substantial business relationship with the company, may have and ensure there are appropriate mitigating factors and there should be transparency about how the audit committee decided on the candidates to be invited to tender.
The tender process
The guidelines state that for the tender process to be successful and focused, clear objectives should be set as to what it wants to achieve and what is looked for in an auditor. The guidelines state that investors would appreciate audit committees disclosing the selection criteria used, for example, audit quality, cultural fit, industry expertise and transition experience.
The tender decision
The guidelines state that it is important that the audit committee ensures that in making its recommendation to the board as to the preferred firm, it puts audit quality as its main criterion. While fees should be reasonable, they should not be the main deciding factor, particularly in the early stages of the tender process. Major investors’ views should be sought before the appointment is made, particularly if there are issues they want to discuss and at the time the decision is confirmed, there should be an RNS announcement rather than delaying any announcement until the final annual report and accounts is issued. If investor input is received, then the report of the audit committee in the annual report should consider explaining how it went about that engagement and the outcome.
Human rights developments
Corporate Human Rights Benchmark - Key findings for 2017
In March 2017, the Corporate Human Rights Benchmark for 2017 was published. The Benchmark assesses 98 of the largest publicly traded companies in the world on the implementation of the UN Guiding Principles on Business and Human Rights and other internationally recognised human rights and industry standards. The companies assessed are all from high-risk industries – agricultural products, apparel and extractives.
The Benchmark examines companies’ policies, governance, processes, practices, and transparency, as well as how they respond to serious allegations of human rights abuse. This is done by scoring the companies on 100 indicators across six measurement themes. The analysis found that a small number of companies (including BHP Billiton, Marks & Spencer Group, Rio Tinto, Nestle, Adidas and Unilever) emerged as leaders scoring between 55-69 per cent, but the results skewed significantly to the lower bands. A clear majority, 63 out of 98 companies, scored below 30 per cent.
The Benchmark’s creators hope that investors will use its results in their analysis of companies and investment decision making, including the identification of key human rights risks to discuss with management. The Benchmark creators also believe that the ranking paves the way for governments to use a mix of regulation and incentives to enhance transparency and minimum standards of corporate behaviour to make the business case for the respect of human rights.