The Financial Reporting Council (FRC) has published its revised UK Corporate Governance Code. This is a new shorter, sharper UK Corporate Governance Code which hopefully raises the bar for UK businesses who will need to think carefully about how to meet their challenges. The FRC has also published its revised Guidance on Board Effectiveness.
There has been a decline in public trust in business driven by high-profile business failures such as BHS and Carillion, concern over excessive executive pay packages, and the issue of multinational firms being seen as avoiding paying their fair share of tax. This decline in trust has been combined with stagnant real wage growth, and questions over the fairness and implications of the ‘gig’ economy on companies and their workforces. As a result over the past two years, UK corporate governance has been under the spotlight through Prime Ministerial statements, select committee inquiries, public consultations, and a government green paper.
Despite this, UK corporate governance maintains a high reputation internationally and the revised Code is aimed at raising standards further to restore public trust in business. Whilst a high-quality corporate governance framework cannot remove the possibility of business failure, it is an essential contributer to driving good decision making processes, to determining an appropriate business culture, and to maintaining public and investor confidence.
What is new?
The UK’s corporate governance framework is based on a system of shareholder primacy. However, public opinion has shifted over the years to focus on a company’s responsibilities towards other stakeholders including their workforce, their suppliers, and the wider community in which they operate. This was originally encapsulated in section 172 of the Companies Act 2006 and the Government is now introducing secondary legislation to require all companies of a significant size (private as well as public) to explain how their directors comply with the requirements of section 172.
The revised Code reflects this focus on the wider role of the board by asking companies to explain how they have done this. In the case of company staff there is a new provision to enable greater board engagement with the views of the workforce. To address public concern over executive remuneration, the new Code emphasises that remuneration committees should take into account workforce remuneration policies and practices in setting director remuneration and to apply discretion when the resulting outcome is not justified.
The revised Code strengthens the role of the Nomination Committee on succession planning and on establishing a diverse Board. Board effectiveness reviews are fundamental to effective governance, and the requirements, particularly for the use of independently facilitated reviews, are strengthened.
In addition, the revised Code states that companies should explain the actions they intend to take to consult shareholders when more than 20% of votes have been cast against a resolution. This should facilitate a better dialogue, increased transparency and greater understanding between shareholders and the companies they invest in.
How is the structure & reporting changed?
The revised Code is both shorter and sharper in its approach and retains its ‘comply or explain’ approach, which enables it to be applied to the diverse range of listed businesses in the UK while allowing a company’s specific circumstances to be taken into account. However, there is a renewed emphasis on the Principles of the Code and how they have been applied (‘apply and explain’) which is aimed at encouraging more meaningful board engagement and shifting the trend away from a tick box approach to corporate governance.
This renewed focus on the Principles in a manner that can be evaluated is aimed at demonstrating how the governance of the company contributes to its long-term sustainable success and achieves its wider objectives in the context of the particular circumstances of the company. It requires the board to explain how it has set the company’s purpose and strategy, met its objectives and achieved its outcomes through its decisions.
The effective application of the Principles is supported by high-quality reporting on the Provisions of the revised Code. The Provisions establish good practice on a ‘comply or explain’ basis. However, there is an emphasis on avoiding a ‘tick-box approach’. The revised Code emphasises that the alternative to complying with a Provision may be justified in the particular circumstances of a company depending on a range of factors, including the size, complexity, history and ownership structure of a company. Explanations should set out the background, provide a clear rationale for the action the company is taking, and explain the impact that the action has had.
The revised Code also emphasises the responsibilities of investors under the UK Stewardship Code, in engaging constructively and discussing with the company any departures from recommended practice. Investors and their advisors in considering company explanations are urged to pay due regard to a company’s individual circumstances and not to evaluate these mechanistically.
When does it apply?
The revised Code is applicable to all companies with a premium listing, whether incorporated in the UK or elsewhere. The new Code applies to accounting periods beginning on or after 1 January 2019. This timing should give boards time to engage with the letter and the spirit of the revised Code.