Corporate governance codes
FRC: UK Corporate Governance Code – July 2018
In July 2018, the Financial Reporting Council (FRC) published its new 2018 UK Corporate Governance Code (2018 Code). This follows the FRC’s consultation on proposed amendments to the 2016 UK Corporate Governance Code published in December 2017 and the 2018 Code will apply to accounting periods beginning on or after January 1, 2019. With the 2018 Code, the FRC has also published updated Guidance on Board Effectiveness (Guidance).
In light of feedback received during the consultation process, the FRC has revised some of the Principles and Provisions in the 2018 Code from those consulted on. Key changes to note include the following:
- Provision 5 requires the board, in the annual report, to describe how the interests of key stakeholders and the matters in section 172 Companies Act 2006 have been considered in board discussions and decision-making. In relation to engagement with the workforce, it permits one or more of a combination of the following methods to be used:
- A director appointed from the workforce;
- A formal workforce advisory panel; or
- A designated non-executive director. However, the FRC has introduced flexibility by stating that if the board has not chosen one or more of these methods, then the company must explain the alternative arrangements it has in place and why these are effective. The Guidance describes “workforce” in this context, making it clear that it is not meant to align with legal definitions of workforce, employee, worker or similar and companies will need to be able to explain who they have included in determining their workforce, and why.
- In relation to the independence of the chair, the FRC states that it recognises the “special” role of the chair, their close involvement with the company and close relationship with the executives throughout their tenure and so, as a result, has reverted in Provision 9 to the approach in the 2016 UK Corporate Governance Code (2016 Code) for the chair to be “independent on appointment” rather than throughout their tenure. So far as the chair’s tenure is concerned, Provision 19 states that the chair should not remain in office for more than nine years from their first appointment to the board, and where a non-executive director is appointed as chair, time served in that capacity will count towards the nine year period. However, a limited extension will be permitted if the chair was previously a board member, the appointment supports the company’s succession plan and its diversity policy, and a clear explanation is provided.
- So far as the independence of non-executive directors is concerned, Provision 10 has been amended in light of feedback. Provision 10 only relates to non-executive directors and not also to the chair, as proposed in the consultation, and while it sets out a list of criteria against which independence is to be determined, the board retains the discretion as now, to consider a non-executive director to be independent even if any of those or other relevant circumstances apply, provided that a clear explanation is given.
- Provision 11 requires at least half (excluding the chair), rather than the majority, of the board to be independent non-executive directors, so reflects the wording in the 2016 Code.
- To deal with concerns about over-boarding of directors, Provision 15 requires boards, on making new appointments, to take into account other demands on directors’ time and prior board approval must be obtained before a director takes on additional external appointments. The reasons for permitting significant appointments should be explained in the annual report.
- So far as smaller companies are concerned, they will not be obliged to have an external board evaluation but Provision 21 encourages all chairs to consider using such evaluations.
- So far as membership of the audit and remuneration committees are concerned, the FRC has reverted in the 2018 Code to the requirements in the 2016 Code, namely that companies below the FTSE 350 can have such committees comprising two rather than three independent non-executive directors. However, in a change from the 2016 Code, the board chair of a smaller company can no longer be a member of the audit committee.
- In relation to remuneration, Principle R makes it clear that it is the responsibility of the remuneration committee rather than the board, to exercise discretion over remuneration outcomes. Remuneration committees will be expected annually to consider whether there are circumstances which warrant the exercise of discretion when determining remuneration outcomes.
- Provision 33 clarifies that the remuneration committee only has responsibility for reviewing workforce remuneration and related policies, rather than having oversight of these matters as the FRC originally proposed.
- Total vesting and holding periods of five years or more should apply to share awards granted to executives and remuneration committees should have a formal policy in place relating to post-employment shareholding requirements covering both unvested and vested shares. This is set out in Provision 36.
- Provision 38 makes it clear that executive pension contributions should be in line with those available to the rest of the workforce.
(FRC, UK Corporate Governance Code, July 2018, 16.07.18)
FRC: Guidance on Board Effectiveness
In July 2018, the Financial Reporting Council (FRC) published its revised Guidance on Board Effectiveness (Guidance) together with the new 2018 UK Corporate Governance Code (2018 Code). The Guidance supplements the 2018 Code by suggesting good practice to assist companies in applying the 2018 Code’s Principles and reporting on that application.
The Guidance was consulted on in December 2017 and in light of feedback a number of changes have been made to the draft previously consulted on. These include the following:
- The language has been made less prescriptive as it was felt that it could be viewed otherwise as a set of requirements.
- Changes have been made to the introduction to emphasise the importance of the Guidance in promoting high standards and to encourage its use alongside the 2018 Code.
- The Principles and Provisions in the 2018 Code related to the content of the Guidance are referenced through footnotes
- A new section on externally facilitated board evaluations has been included in section 3.
- An appendix has been included showing the overlaps between the 2018 Code and the Financial Conduct Authority’s Handbook.
(FRC, Guidance on Board Effectiveness, 16.07.18)
FRC: Feedback Statement – Consulting on a revised UK Corporate Governance Code
In July 2018, the Financial Reporting Council (FRC) published its Feedback Statement following its December 2017 consultation on a revised UK Corporate Governance Code. The Feedback Statement has been published together with the revised 2018 UK Corporate Governance Code (2018 Code) and updated Guidance on Board Effectiveness.
The Feedback Statement summarises the main points raised in relation to the consultation questions and the resulting decisions taken by the FRC. It also includes a table showing how the 2018 Code differs from the 2016 version and in an annex, it tracks the changes from the version consulted on in December 2017 to the 2018 Code.
The FRC notes in the Feedback Statement that it will be monitoring how governance practices and reporting develop in response to the 2018 Code. This will include more in-depth reviews of annual reports to engage with companies on their reporting against the 2018 Code. It expects some companies to adopt the 2018 Code early and states that this will help the FRC determine whether additional guidance or support might be necessary.
The Feedback Statement also includes a summary of the responses to the high-level questions posed on stewardship and the UK Stewardship Code as part of the December 2017 consultation. The FRC is to consult on a revised UK Stewardship Code later in 2018.
(FRC, Feedback Statement – Consulting on a revised UK Corporate Governance Code, 16.07.18)
(FRC, Feedback Statement – Annex: Code changes since the December 2017 consultation 16.07.18)
FRC: Consultation on the Wates Corporate Governance Principles for Large Private Companies
In June 2018, the Financial Reporting Council (FRC) issued a draft of the Wates Corporate Governance Principles for Large Private Companies (the Principles), and supplementary guidance, for public consultation.
In its August 2017 response to its Green Paper on corporate governance reform, the Government stated that it believed that the corporate governance framework for the UK’s largest private companies should be strengthened and, in January 2018, Sir James Wates was appointed to chair a coalition group tasked with developing appropriate corporate governance principles for large private companies.
The Principles have now been published for consultation and are designed to assist companies which, for financial years beginning on or after January 1, 2019, will be required by the Companies (Miscellaneous Reporting) Regulations 2018 to provide a corporate governance statement for the first time. Such companies may adopt the Principles as a framework for the purposes of making the statement of corporate governance arrangements that will be prescribed by the Regulations, assuming they are adopted in their current form. It is further hoped that the Principles will act as guidance to companies of all sizes, not just those subject to the new legislative requirements, in understanding good practice in corporate governance and apply that good practice widely.
It is intended that the Principles be applied on an “apply and explain” basis. A company adopting them will be expected to apply them fully but can provide a supporting statement for each of the six Principles that gives an understanding of how the company’s corporate governance processes operate and achieve the desired outcomes. The Principles are supported by non-exhaustive guidance that helps companies apply them in practice but this is not to be seen as a checklist. Rather, companies adopting the Principles will be encouraged to demonstrate, through a written explanation in their directors’ report and on their website, how the application of the Principles has resulted in improved corporate governance outcomes.
The six Principles and accompanying guidance are as follows:
- Principle One - Purpose: An effective board promotes the purpose of a company and ensures that its values, strategy and culture align with that purpose.
A well-defined purpose will help companies of all sizes and structures to articulate their business model, and develop their strategy, operating practices and approach to risk. In large private companies, key shareholders and the board should work together to ensure the company works with a clear sense of purpose. An effective board will promote and develop its collective vision of the company’s purpose and can identify and explain how events or developments affecting the company’s long-term success have been addressed. The board is responsible for ensuring that its strategy is clearly articulated and implemented throughout the organisation and that it, with the company’s values, supports appropriate behaviours and practices within the organisation. Key shareholders, the board and management must own and maintain a commitment to embedding the company’s desired culture throughout the organisation.
- Principle Two - Composition: Effective board composition requires an effective chair and a balance of skills, backgrounds, experience and knowledge, with individual directors having sufficient capacity to make a valuable contribution. The size of the board should be guided by the scale and complexity of the company.
An effective board embraces diversity, promotes accountability and incorporates objective thought that promotes appropriate constructive challenge and effective decision-making. Directors should collectively demonstrate a high level of competence relevant to the company’s business needs and stakeholders, companies should commit to ongoing board professional development and directors should be individually evaluated. Board membership must be broad enough to provide for an appropriate degree of challenge and analysis but agile enough to enable efficient and effective decision making.
- Principle Three - Responsibilities: A board should have a clear understanding of its accountability and terms of reference. Its policies and procedures should support effective decision-making and independent challenge.
Constitutional documents should set out policies and procedures that govern the internal affairs of the company including matters relating to authority, role and conduct of directors. Strong accountable decision-making systems and the delineation of responsibilities ensure the company’s key shareholders, board and senior management have clearly defined roles and decision-making powers, with conflicts of interest appropriately managed. Advisory or board committees could be established with clear terms of reference and independent challenge in board decision-making should be part of effective corporate governance practices. A board should have confidence in the integrity of information used for decision-making and reported by a company. The company should establish internal processes to ensure effective operation of systems and controls and that the quality and integrity of information is reliable, enabling directors to monitor and challenge the performance of the company.
- Principle Four - Opportunity and risk: A board should promote the long-term success of the company by identifying opportunities to create and preserve value, and establishing oversight for the identification and mitigation of risks.
A board has responsibility for an organisation’s overall approach to strategic decision-making and risk management, requiring oversight of risk and how it is managed and appropriate accountability to stakeholders, particularly with regard to conflicts of interest.
- Principle Five - Remuneration: A board should promote executive remuneration structures aligned to the sustainable long-term success of a company, taking into account pay and conditions elsewhere in the company.
Director and senior management remuneration should be developed around principles that align with the company’s culture, values and long-term success including a considered assessment of the company’s response to matters such as its gender pay gap reporting. A clear policy on the transparency of remuneration structures should be established to enable effective accountability to key shareholders. Remuneration including benefits, for directors and senior management, should consider the broader operating context of the company, including the wider workforce’s pay and conditions.
- Principle Six - Stakeholders: A board has a responsibility to oversee meaningful engagement with material stakeholders, including the workforce, and have regard to that discussion when taking decisions. The board has a responsibility to foster good stakeholder relationships based on the company’s purpose.
The board should present a fair, balanced and understandable assessment of the company’s position and prospects and make this available to its material stakeholders on an annual basis. Companies should identify the stakeholder relationships that are integral to its ability to generate and preserve value. The board should demonstrate how the company has undertaken effective engagement with material stakeholders and how such relationships have been taken into account in its decision making. Since the largest material stakeholder may be the workforce, companies should develop methods to engage meaningfully with their workforce and use such forms of engagement when taking decisions.
Responses to the consultation are to be received by September 7, 2018 to allow for the final Principles and guidance to be published in December 2018.
(FRC, Consulation paper: The Wates Corporate Governance Principles for Large Private Companies, 13.06.18)
Quoted Companies Alliance: New QCA Corporate Governance Code
In April 2018, the Quoted Companies Alliance (QCA) published a revised QCA Corporate Governance Code (QCA Code) which replaces the previous version published in May 2013.
The revised QCA Code is constructed around 10 broad principles, accompanied by an explanation of what those principles entail, together with a set of disclosures. It sets out what the QCA considers to be appropriate arrangements for growing companies and asks companies to provide an explanation about how they are meeting the principles through the prescribed disclosures. The QCA Code operates on a “comply or explain” basis so where a company departs from the principles and their application, it will be expected to provide a well-reasoned explanation for doing so as part of its reporting on corporate governance.
The disclosures set out after each principle indicate the areas that companies need to address in their reporting on corporate governance and these should reflect how the company has applied the principles and be tailored to the company’s circumstances. In addition to these disclosures, the correct application of the QCA Code also requires that the chair provides a clear explanation of how the company applies the QCA Code in a corporate governance statement and it is recommended that this be included both in the annual report and on the company’s website.
The 10 principles are as follows:
- Principle 1 – Establish a strategy and business model which promote long-term value for shareholders.
- Principle 2 – Seek to understand and meet shareholder needs and expectations.
- Principle 3 – Take into account wider stakeholder and social responsibilities and their implications for long-term success.
- Principle 4 – Embed effective risk management, considering both opportunities and threats, throughout the organisation.
- Principle 5 – Maintain the board as a well-functioning, balanced team led by the chair.
- Principle 6 – Ensure that between them the directors have the necessary up-to-date experience, skills and capabilities.
- Principle 7 – Evaluate all performance based on clear and relevant objectives, seeking continuous improvement.
- Principle 8 – Promote a corporate culture that is based on ethical values and behaviours.
- Principle 9 – Maintain governance structures and processes that are fit for purpose and support good decision-making by the board.
- Principle 10 – Communicate how the company is governed and is performing by maintaining a dialogue with shareholders and other relevant stakeholders.
The QCA Code also includes sections on good corporate governance and on the roles and responsibilities of the board, the chair, the senior independent director, the non-executive directors, the executive directors, the audit committee, the remuneration committee, the nomination committee, the company secretary and shareholders.
The QCA Corporate Governance Code can be purchased from the QCA here.
(QCA, New QCA Corporate Governance Code, 25.04.18)
LSE: Confirmation of changes to AIM Rules
London Stock Exchange plc (LSE) published AIM Notice 50 in March 2018. It provides feedback on the consultation the LSE issued in December 2017 pursuant to AIM Notice 49 and confirms the resulting rule changes to the AIM Rules for Companies (AIM Rules).
In relation to the corporate governance requirements for AIM companies, respondents supported the new obligation for an AIM company to disclose on its website details of how it complies or explains against a recognised corporate governance code chosen by the board of directors. The LSE remains of the view that it should not prescribe a list of recognised codes as it believes it is preferable for AIM companies to have a range of options to suit their specific stage of development, sector and size. However, AIM Rule 26 has been amended in light of feedback to provide that an AIM company need only review its corporate governance disclosures on its website annually rather than on an ongoing basis.
While the revised AIM Rules came into effect on March 30, 2018, the implementation of the new corporate governance requirements in AIM Rule 26 will take effect from September 28, 2018 so that AIM companies have adequate time to prepare for the change. All new applicants to AIM from March 30, 2018 have to state which corporate governance code they intend to follow but otherwise will have until September 28, 2018 to fully comply with the new requirements in AIM Rule 26.
In its Feedback Statement, the LSE reminds AIM companies that good corporate governance is supported by a meaningful explanation of the company’s practices against the principles of the chosen code, rather than simply identifying areas of non-compliance.
(LSE, AIM Notice 50 and feedback statement, 08.03.18)
(LSE, Mark-up of AIM Rules for Companies, 08.03.18)
Corporate governance in insolvency situations
BEIS: Insolvency and corporate governance – Consultation paper
In March 2018, the Department for Business, Energy and Industrial Strategy (BEIS) announced a consultation to improve the UK’s corporate governance framework and ensure the highest standards of behaviour in those who lead and control companies in, or approaching, insolvency.
Among other things, the consultation sought views on a number of proposed measures, including the following:
- Sales of businesses in distress: the introduction of new measures to enable directors of parent companies to be held to account and suffer penalties (through disqualification and/or the imposition of personal liability) where they make a decision to sell an insolvent subsidiary which enters into administration or liquidation within two years of the sale, in circumstances where the interests of creditors are adversely affected between the sale and administration or liquidation and, at the time of the decision to sell, the directors could not have reasonably believed that the sale would lead to a better outcome for those creditors than placing it in liquidation or administration;
- Reversal of value extraction schemes: the introduction of new powers, in addition to those that already exist, to enable insolvency office-holders to reverse transactions, or a series of transactions, which unfairly strip value from a company (ie transactions that have been structured so as to enable value to be extracted from a company being rescued while, at the same time, value is not being added to the company and other creditors are being disadvantaged more than is commercially reasonable) in the event that the company subsequently enters liquidation or administration; and
- Investigations of directors of dissolved companies: extending the Insolvency Service's existing investigative powers into the conduct of directors to cover directors of dissolved companies.
Following recent company failures, the consultation also sought views on certain aspects of the wider corporate governance framework that have been highlighted where existing processes and rules may need updating. These include the following:
- Group structures: Should steps should be taken to improve governance, accountability and internal controls within complex company group structures?
- Shareholder responsibilities: Are there further opportunities, such as through the Financial Reporting Council’s review of the Stewardship Code, to strengthen the role of shareholders in stewarding the companies in which they have investments?
- Payment of dividends: Could the legal and technical framework within which dividend decisions are made be improved and made more transparent while ensuring that dividend payments should remain for directors to decide, having regard to their legal obligations and guidance?
- Directors’ duties and the role of professional advisers: Are directors commissioning and using professional advice with a proper awareness of their duties as directors and the requirement to apply an independent mind?
- Protection for company supply chains in the event of insolvency: Should supply chain and other creditors be better protected and, if so, how this could be achieved while preserving the primacy of the interests of shareholders?
The consultation sought views from directors of companies, institutional shareholders and the investment community as well as the wider public. Responses were accepted until June 11, 2018.
(BEIS, Insolvency and Corporate Governance, 20.03.18)
BEIS: Committee inquiry launched on executive pay and the gender pay gap in the private sector
In March 2018, the House of Commons Business, Energy & Industrial Strategy Committee (BEIS Committee) announced the launch of an inquiry into executive pay and the gender pay gap in the private sector. The BEIS Committee is looking at these issues in light of concerns about the overall level of executive pay and bonuses and the April 2018 deadline for gender pay gap reporting.
The BEIS Committee has asked for written evidence on a number of specific questions relating to the gender pay gap and executive pay.
(BEIS Committee, Corporate governance: delivering on fair pay inquiry, 23.03.18)
BEIS: FTSE 350 companies urged to step up to meet 2020 women on board targets
In June 2018, the Department for Business Energy and Industrial Strategy (BEIS) and the Government Equalities Office published a press release in relation to progress made to date by FTSE 350 companies in meeting the Hampton-Alexander Review target of having at least 33 per cent of board positions held by women by the end of 2020.
At the half-way point of the Hampton-Alexander Review, 29 per cent of FTSE 100 board positions were held by women (up from 12.5 per cent in 2011) so FTSE 100 companies are on track to meet the 33 per cent target by 2020 but FTSE 350 companies may fall short.
In relation to FTSE 350 companies, while the number of women on boards has increased to 25.5 per cent, around 40 per cent of all appointments will need to go to women over the next two years for the FTSE 350 to meet the 33 per cent target. There are also still 10 FTSE 350 companies with all-male boards.
The press release also announces that the new online portal for FTSE 350 companies to submit their 2018 gender leadership data (the number of men and women on the executive committee and direct reports to the executive committee) is now open and progress made on women in executive and leadership positions will be reported in November 2018 when the 2018 Hampton-Alexander Report will be published.
(BEIS: FTSE 350 companies and 2020 women on board targets – Statement – 27.06.18)
Investment Association: 1 in 10 FTSE 350 companies fall short on gender diversity targets
In April 2018, the Investment Association announced that it and the Hampton-Alexander Review had written to 35 FTSE 350 companies with low female representation at leadership level, calling for change.
Letters were sent to 14 FTSE 100 companies with all-male executive committees or combined executive committees and direct reports with low proportions of women. These companies were asked to explain their poor gender balance and what steps they are taking to move towards the target of a minimum of 33 per cent womens’ representation across their combined executive committee and direct reports to that committee by 2020, as recommended by the 2016 report of the Hampton-Alexander Review. Letters were also sent to the 11 FTSE 250 companies with an all-male board and the 10 FTSE 250 companies that failed to report their gender diversity data to the Hampton-Alexander Review in 2017.
The announcement notes that a number of key investors have told the Investment Association that they will vote against AGM resolutions at 2018 AGMs on the grounds of gender representation so the Investment Association urges the companies it has written to, to take urgent steps to outline their plans to increase diversity.
(Investment Association, FTSE 350 companies fall short on gender diversity targets, 17.04.18)
Institutional Investor guidelines
PIRC: UK Shareowner Voting Guidelines 2018
In March 2018, Pensions and Investment Research Consultants Ltd (PIRC) published the 25th edition of its UK Shareowner Voting Guidelines.
PIRC has made several key changes in the 2018 Guidelines from those published in 2017, including the following:
- Chairman: PIRC will oppose re-election of a chairman with significant independence issues (excluding tenure length), extending beyond their initial appointment.
- Chief executive becoming chairman: If the CEO or finance director becomes chairman, PIRC will not support the re-election of that chairman.
- Executive chairman: The chairman of the board should act independently from the company’s management team when exercising his or her oversight of the functioning of the board. Holding an executive position is incompatible with this role and so PIRC will recommend a vote against the appointment of an executive chairman.
- Committee independence: PIRC requires the audit, remuneration and nomination committees to be exclusively comprised of independent directors. PIRC will oppose the re-election of any non-independent member to either the audit or remuneration committee to avoid conflicts of interest arising.
- Parker Review: At a minimum PIRC expects companies to acknowledge the recommendations made in the 2017 Parker Review and requires each FTSE 100 company to set a target of one ethnic minority director by 2021 unless the company discloses why the target does not apply.
- Commitment: PIRC considers that a chair of a listed company should not also be a chair of another listed company.
- Meeting attendance: Previously PIRC’s policy was to abstain on a director's re-election where a director misses either two board meetings or one audit committee meeting without adequate justification. Now PIRC will oppose any director who misses any meeting without adequate justification provided, as PIRC considers this is a sign of over-boarding or inability to meet commitments.
- Right to attend meetings in person: PIRC will oppose amendments to company articles which permit virtual-only meetings and will consider withdrawing support for the re-election of the chairman and other directors who propose such amendments.
- Response to “significant” vote: Where a company receives “significant” votes against a resolution, PIRC will consider opposition levels of 10 per cent and above as “significant”.
- Financial motivation: PIRC expects genuine attempts to align with shareowners to exclude long-term incentive plans (LTIPs) altogether to prevent the substantial additional costs associated with removing underperforming chief executives.
- Remuneration report votes: PIRC supports an annual binding vote on the remuneration report by shareholders and other stakeholders.
- Restricted Shares: PIRC notes that the traditional LTIP model has faced criticism and interest groups now favour a restricted shares model which has no performance conditions attached. If a company seeks to adopt this model, PIRC’s analysis will incorporate factors including, but not limited to: the quantum available under variable incentive schemes, the existence or not of an LTIP in addition to such a plan and the company’s overall approach to remuneration within the context of reasonableness.
The PIRC UK Shareowner Voting Guidelines 2018 can be purchased from PIRC - click here.
ICSA: Tools to assist with effective board reporting
The Institute of Chartered Secretaries and Administrators (ICSA) Governance Institute and Board Intelligence have produced three resources to help organisations with the preparation and presentation of their board reporting. This follows on from publication of a summary of their research into how board reporting (the preparation of reports and other papers discussed at board meetings) operates in organisations and this was published in December 2017.
While only available to ICSA members, the three resources produced are as follows: