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Amendments to the laws have passed both Commonwealth Houses of Parliament.
The Financial Reporting Council (FRC) published proposed revisions to the UK Corporate Governance Code (Code) on December 5, 2017. In reducing the Code from 32 to 13 pages, the FRC describes it as “shorter and sharper”, comprising 17 Principles and 41 Provisions. Some supporting principles from the current 2016 Code have been removed or incorporated into the new Principles or Provisions and others have been moved to the FRC’s proposed revised Guidance on Board Effectiveness (Guidance) or deleted. It is anticipated that the new Code will apply to accounting periods beginning on or after January 1, 2019.
This briefing looks at the key revisions to both the Code and Guidance, as well as at the FRC’s initial consultation on the future direction of the UK Stewardship Code.
In conducting its review of the current Code, the FRC considered, among other things, the balance between the Principles and Provisions and the results of its 2016 report on “Corporate culture and the role of boards”. Many of that report’s findings have been included in the revised Code. The FRC was also mindful of the Government’s plans to require companies to explain in their annual report how their directors comply with their duties under section 172 Companies Act 2016 (section 172), as well as certain recommendations in the Government’s August 2017 response to its Green Paper on corporate governance reform, and issues raised in the April 2017 report on corporate governance published by the House of Commons Business, Energy and Industrial Strategy Committee.
As a result, the revised Code comprises five sections, with no schedules and Section E in the current Code (Relations with shareholders) has been integrated within the revised Code as the FRC considers shareholder engagement to be a key aspect of good governance.
The Introduction stresses the importance of culture and dialogue with a wide range of stakeholders in promoting the success of companies in the long-term, as well as the importance of applying the Code’s Principles since they emphasise the value of good corporate governance to long-term success.
The revised Code retains the “comply or explain” approach, but provides more guidance on discussions about how its Provisions have been applied – action taken and resulting outcomes should be described, and signposting and cross–references to those parts of the annual report that describe how the Principles have been applied is encouraged to help investors with their evaluation.
It is also made clear in the Introduction that the corporate governance statement should relate coherently to other parts of the annual report, particularly the strategic report and other complementary information, so that shareholders can effectively assess the quality of the company’s governance arrangements and the board’s activities and contributions.
Section 1 comprises four Principles and eight Provisions and it emphasises the need for boards to consider the culture of their company and wider stakeholder interests in achieving long-term sustainability, as well as the importance of shareholder engagement.
Section 2 comprises four Principles and eight Provisions. It considers the separation of duties within the board and the role of the non-executive directors, as well as defining the independence of non-executive directors.
This section comprises three Principles and seven Provisions and it takes account of the Hampton-Alexander Review and Parker Review reports on diversity to ensure that the revised Code challenges directors to consider the composition of both the board and the management pipeline:
This Section comprises three Principles and eight Provisions and largely replicates the requirements in Section C of the current 2016 Code. The FRC notes that while a number of the requirements duplicate those in the Listing Rules, Disclosure Guidance and Transparency Rules and the Companies Act 2006, it believes retaining rather than deleting those requirements is a better course of action, but it seeks views on this. In addition, Provision 24 requires all companies to have an audit committee of at least three independent non-executive directors, even companies outside the FTSE 350.
This section comprises three Principles and 10 Provisions. It reflects not only the findings of the FRC’s Culture Report, notably the important role that incentives and rewards play in driving behaviours that support the desired culture, but also a number of matters concerning remuneration that the Government, in its Green Paper response, invited the FRC to consider. The FRC notes that the Government is planning to introduce secondary legislation on pay ratios and for clearer reporting on the range of remuneration outcomes from complex, share-based incentive schemes. It states that it will keep abreast of these changes and may make consequential changes to Section 5 of the Code, pending the outcome of that legislation.
The Guidance was last published in 2011 and the FRC has now amended it to support its proposed changes to the revised Code. The structure of the Guidance follows the structure of the revised Code, with some elements of the current Code having been moved to the Guidance. The FRC points out that this does not mean that those elements are no longer important, but that the practices are well embedded in company behaviour, and it states that the aim of the revised Code is to encourage companies to go further.
The Guidance includes questions for boards and questions for boards to raise with management which boards can use to consider how they report on their application of the Code’s Principles.
The FRC notes that further changes and refinements will be needed to the Guidance once the consultation on the revised Code is completed.
The UK Stewardship Code was last reviewed in 2012 and since it sets a framework for responsible engaged investors to work alongside company executives to achieve the long-term success of companies, the FRC is taking the opportunity, as part of the consultation on the revised Code, to ask some high-level questions about the future direction of the Stewardship Code. It plans to consult on specific changes to that in 2018.
It raises questions on both the format and content of the Stewardship Code, including the following:
The FRC has asked for questions on the consultation document by February 28, 2018. The FRC aims to publish the final version of the revised Code by early summer 2018, to apply to accounting periods beginning on or after January 1, 2019.
A detailed consultation on specific changes to the UK Stewardship Code will be published in mid-2018, once the review of the Code has been finalised.
The revised Code has been welcomed by investor bodies and other interested organisations as a step in the right direction, given its emphasis on the importance of corporate culture and diversity, the need for companies to engage with all their stakeholders, including their workforce, and the requirements for executive remuneration and workforce policies to be aligned with the company’s strategy and value. In its shorter and sharper format, the revised Code will require boards to think more holistically about how they apply its Principles and it should force companies to move further away from undertaking a box-ticking exercise when reviewing their compliance with the Code.
Smaller companies below the FTSE 350 may find removal of the exemptions in the current Code tricky to deal with initially but, given the proposed implementation date of the revised Code, those companies should have time to put in place arrangements to ensure that they can meet the new requirements when they are implemented.
Companies will have to consider in good time how they propose to gather the views of their workforce. The revised Code sets out the three options proposed in the Government’s response to its Green Paper but the revised Guidance makes it clear that these are not the only possible methods and that boards should be open to innovative alternatives if they believe these would be as or more effective. The Guidance comments that provided the method chosen delivers meaningful, regular two-way dialogue and a means of listening to the workforce, then the Code requirement will be met.
The proposals generally require greater disclosure by boards around decisions they are required to take. This includes more information in the annual report about the remuneration committee’s activities and its decision making-process, as well as explanations of how the board has engaged with its workforce and other stakeholders and how their interests and the matters in section 172 have influenced the board’s decision-making. Boards need to start thinking about how they record that engagement and influence throughout the year to enable them to meet the new requirements.
Amendments to the laws have passed both Commonwealth Houses of Parliament.