On December 5, 2017 the FRC published proposals for a revised UK Corporate Governance Code (Code) and updated Guidance on Board Effectiveness (Guidance). The proposals reflect the changing business environment and the revised Code aims to promote the long-term success of companies by achieving the highest standards of corporate governance.
The UK Corporate Governance Code
The revised Code is much shorter and sharper than the current April 2016 Code, reduced from 32 pages to 13 and from around 11000 words to 5000. The FRC has taken findings from its 2016 Culture Report, engaged with stakeholders and incorporated suggestions from the Government’s response to its Green Paper on Corporate Governance Reforms to produce a Code that is fit for purpose.
The FRC has included a revised version of the Code in Appendix A to the consultation document, while Appendix C summarises the changes that have been made to the April 2016 Code.
The revised Code strives to raise standards further and sets out good practice that ought to be adopted by the boards of UK companies. It is now made up of five sections: 1 Leadership and purpose; 2 Division of responsibilities; 3 Composition, succession and evaluation; 4 Audit, risk and internal control; and 5 Remuneration.
Section 1 – Leadership and purpose
Key points for boards to note from this section are:
- Establish a company’s purpose, strategy and values: The revised Code recognises the importance of corporate culture and stresses that the board should satisfy itself that the company’s purpose, strategy, values and culture are aligned.
- Engage with wider stakeholders: The revised Code includes references to the board’s responsibility for considering the needs and views of a wider range of stakeholders to improve trust and achieve mutual benefit, and generally to have regard to wider society.
- Incorporate views of the workforce: To ensure that the workforce voice is heard in the boardroom, a new requirement is included in Provision 3. The revised Code states three ways in way this could be achieved: (i) appoint a director from the workforce; (ii) establish a formal workforce advisory council; (iii) or appoint a designated non-executive director.
- Communicate with shareholders over significant votes against resolutions: The revised Code states that when more than 20 per cent of votes have been cast against a resolution, as under the current Code, the company should explain, when announcing the voting results, what actions it intends to take to consult with shareholders in order to understand the reasons behind the result. However, in addition, no later than six months after the vote, an update should be published before the final summary is provided in the next annual report.
Section 2 – Division of responsibilities
Key points for boards to note from this section are:
- Clarity of roles: This Section considers the separation of duties within the board, with the chair required to demonstrate independent and objective judgement and the chief executive responsible for proposing and delivering the board’s agreed strategy.
- Independent non-executives to constitute a majority: In all companies, including those below the FTSE 350, the independent non-executive directors, including the chair, should comprise a majority of the directors. All current exemptions for companies below the FTSE 350 (including the requirement to have an independent board evaluation every three years) have been removed from the revised Code as the FRC believes even smaller companies should strive for the highest corporate governance standards.
Section 3 – Composition, succession and evaluation
Key points for boards to note from this section are:
- Increase diversity on boards: The revised Code asks boards to intensify their efforts to promote diversity to avoid group think. Diversity includes different gender, social and ethnic backgrounds, cognitive and personal strengths. The FRC reiterates that inclusive and diverse boards will understand their customers and stakeholders more, which in turn, leads to better decision-making.
- Development of diverse pipeline for succession: Responsibility for this is placed on the nomination committee.
- Enhance transparency in respect of progress on diversity: Under Provision 23 of the revised Code, the FRC encourages reporting on actions taken to increase diversity and inclusion, and the outcomes in terms of progress on diversity. This extends to reporting on the gender balance of the senior management (the company’s executive committee or the first layer of management below board level, including the company secretary) and their direct reports.
Section 4 – Audit, risk and internal control
This section remains mostly unchanged, though all companies, including those below the FTSE 350, will require an audit committee of at least three independent non-executive directors.
Section 5 – Remuneration
Key points for boards to note from this section are:
- Give remuneration committees greater responsibility: The remuneration committee is given responsibility for determining the policy for director remuneration and setting remuneration for the board and senior management. The remuneration committee should also oversee remuneration and workforce policies and practices and ensure that these align with company’s strategic objectives.
- Exercise independent judgement and discretion: The revised Code emphasises that the board should establish a remuneration committee of independent non-executive directors with a minimum membership of three. Provision 32 includes a requirement that the remuneration committee chair will have served for at least 12 months on a remuneration committee before taking on this role.
- Further reporting requirements: The Code includes a reporting requirement for companies to explain what workforce engagement has taken place to explain how executive remuneration aligns with wider company pay policy.
Guidance on Board Effectiveness
The FRC has also published new proposed Guidance on Board Effectiveness (Guidance) which is set out in Appendix B to the consultation paper.
The Guidance has been amended to support the proposed changes to the revised Code and it follows the structure of the revised Code. Some of the more procedural aspects of the current April 2016 Code have been moved to the Guidance as these are still important but are now common place in many businesses.
The Guidance includes possible questions for boards, management and remuneration committees and the FRC proposes that boards should use the questions posed in the Guidance to consider how they report on their application of the Code’s Principles.
The proposed Guidance includes:
- more information about how the views of a wider range of stakeholders might be heard in the boardroom; and
- provisions supporting the remuneration committee with its new wider role and its new responsibility for wider workforce pay and policies.
The FRC notes that the Guidance will need further updating once the outcome of the consultation on the revised Code is known.
Proposed amendments to the UK Stewardship Code
The consultation also includes questions to help shape the future direction of the UK Stewardship Code, which will be published for consultation in mid-2018. The FRC consults on two ways in which the UK Stewardship Code could be improved:
Format
- Relevance to different signatory categories: Should the Stewardship Code be more explicit about the expectations of those investing directly or indirectly and those advising them? Would separate codes or enhanced separate guidance for different categories of the investment chain help drive best practice?
- Whether to adopt a best practice format: Should the Stewardship Code focus on best practice expectations using a more traditional "comply or explain" format? If so, are there any areas in which this would not be appropriate? How might the FRC go about determining what best practice is?
- Shareholder Rights Directive: Consider how the measures introduced in the 2017 amended Shareholder Rights Directive could be best transposed.
Content
- Consider the amendments to the UK Corporate Governance Code: Are there elements of the revised UK Corporate Governance Code that the FRC should mirror in the Stewardship Code?
- Long-term factors and other issues relating to investment: How could an investor’s role in building a company’s long-term success be further encouraged through the Stewardship Code? Would it be appropriate to incorporate "wider stakeholders" into the areas of suggested focus for monitoring and engagement by investors? Should the Stewardship Code more explicitly refer to ESG factors and broader social impact? If so, how should these be integrated and are there any specific areas of focus that should be addressed?
- Best practice content elements: How can the Stewardship Code encourage reporting on the way in which stewardship activities have been carried out? Are there ways in which the FRC or others could encourage this reporting, even if the encouragement falls outside of the Stewardship Code?
- Asset classes: How could the Stewardship Code take account of some investors’ wider view of responsible investment?
- Content elements of other codes: Are there elements of international stewardship codes that should be included in the Stewardship Code?
- The role of independent assurance: What role should independent assurance play in revisions to the Stewardship Code? Are there ways in which independent assurance could be made more useful and effective?
- Voting in pooled funds: Would it be appropriate for the Stewardship Code to support disclosure of the approach to directed voting in pooled funds?
- Diversity: Should board and executive pipeline diversity be included as an explicit expectation of investor engagement?
- UK committee on climate change: Should the Stewardship Code explicitly request that investors give consideration to company performance and reporting on adapting to climate change?
- Purpose of stewardship: Should signatories to the Stewardship Code define the purpose of stewardship with respect to the role of their organisation and specific investment or other activities? Should the Stewardship Code require asset managers to disclose a fund’s purpose and its specific approach to stewardship, and report against these approaches at a fund level? How might this best be achieved?
Next steps
Responses to all the proposals should be submitted by February 28, 2018. The FRC plans to publish the final version of the Code by early summer of 2018 and it will apply to accounting periods beginning on or after January 1, 2019. Its 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.
(FRC, Proposed revisions to the UK Corporate Governance Code, 05.12.12)
(FRC, Appendix A - Revised UK Corporate Governance Code, 05.12.12)
(FRC, Appendix B - Revised Guidance on Board Effectiveness, 05.12.12)
(FRC, Appendix C - Summary of changes of the UK Corporate Governance Code, 05.12.12)