On January 11, 2017 the Financial Reporting Council (FRC) published its annual report, “Developments in Corporate Governance and Stewardship 2016”, together with an accompanying press release. The purpose of the report is to give an assessment of corporate governance and stewardship in the UK; to report on the quality of compliance with, and reporting against, the UK Corporate Governance Code and the Stewardship Code; to provide findings on the quality of engagement between companies and shareholders; and to indicate to the market where the FRC would like to see changes in corporate governance behaviour or reporting.
UK Corporate Governance Code
In respect of the UK Corporate Governance Code (Code), the FRC highlights the following:
- Overall compliance rates – The number of FTSE 350 companies reporting full compliance with all provisions has increased from 57 per cent to 62 per cent, with 90 per cent reporting full compliance with all but one or two of the Code’s provisions.
- Explanations – The FRC notes that overall too many explanations for non-compliance are of poor quality. Better practice explanations include company-specific context and historical background, and information on what mitigating actions have been taken to address any additional risk. The FRC comments that it is important the company explains how its alternative approach is consistent with the Code provision it is deviating from and whether it is time limited.
- Frequent non-compliance – The Code provision most often not complied with is for at least half the board, excluding the chairman, to be independent non-executive directors – 26 FTSE 350 companies in 2016, compared to 42 in 2015, did not comply with this provision.
- Clawback and malus provisions – The majority of FTSE 350 companies have taken forward the 2014 Code recommendation for companies to put in place arrangements to enable them to recover or withhold variable pay. 91 per cent have now implemented a clawback provision on the annual bonus and 78 per cent on long-term plans.
- Viability statements – Amendments to the Code in 2014 introduced reporting of a longer-term view of a company’s prospects in the form of a viability statement. There is little variation in time horizon between the different business sectors, with two thirds of the sample reviewed choosing three years and the remainder mainly electing five years. The FRC finds the lack of variation between sectors surprising and encourages companies to provide clearer disclosure of why the period of assessment selected is appropriate for the particular circumstances of the company. In addition, the FRC notes that there is room for improvement in explaining what qualifications and assumptions have been made and the quality of reporting of the principal risk linkages.
UK Stewardship Code
In respect of the Stewardship Code, the FRC highlights the following:
- The tiering exercise – The tiering exercise involved consideration of all signatory statements to identify best practice reporting against the Stewardship Code. Initial assessments of statements, sent to signatories in early 2016, indicated whether the FRC considered the signatory to be in Tier 1 or Tier 2 on the basis of their reporting. Many signatories improved their statements in response to this exercise and following feedback from market participants, the FRC decided to introduce a third tier for asset managers. The third tier reflects the greater relevance of the Stewardship Code’s provisions to asset managers, their role as agents and the wide range of quality in the statements in the initial Tier 2.
- Engagement in the 2016 annual general meeting season – The FRC continues to hear from both companies and investors that there is too much focus on remuneration at meetings and while remuneration is inextricably linked to issues such as performance and strategy, both company and investor representatives feel that it can overshadow these important topics. Additionally, some investors have displayed a growing appetite for more disclosure on a broader range of risks, including climate-related matters where these are relevant to the company.
- Compliance with other stewardship codes – After the introduction of stewardship codes in a number of international markets, the FRC states that if signatories meet the reporting requirements of the UK Stewardship Code, the FRC is comfortable for their statements also to address the requirements of other codes and will publish a matrix of the differences between the UK and international codes.
The FRC notes that during 2016 there were two major consultations about corporate governance in the UK, specifically the Department for Business, Energy and Industrial Strategy (BEIS) Select Committee’s inquiry and the Government’s Corporate Governance Reform Green Paper. In response to the issues raised by the BEIS inquiry, the FRC suggested that additional powers may be necessary in order to demonstrate the alignment of business, investor and public interests, including:
- monitoring governance information in annual reports;
- requiring governance reporting by large private companies;
- improving reporting by companies about the elements of section 172 of the Companies Act 2006; and
- taking action against directors who are not members of the professional bodies that the FRC oversees.
The FRC also recommends a wider remit for the remuneration committee and shareholder consultation where there is a significant vote against an AGM resolution.
The FRC will consider how to encourage further improvements in reporting and possible revisions to the Stewardship Code in 2018. It also plans to consult on revisions to the Code, the FRC’s Guidance on Board Effectiveness and the FRC’s Guidance on the Strategic Report, taking account of the FRC’s work on culture and succession planning, the EU Non-Financial Reporting Directive and wider corporate governance changes in light of the Government’s Green Paper. In addition, it is considering guidance for nomination committees as part of wider consultation in light of responses to its October 2015 discussion paper on succession planning.
(FRC, Developments in Corporate Governance and Stewardship 2016, 11.01.17)