The Listing Rules of the Irish Stock Exchange (ISE) have for many years required companies on its Main Securities Market (MSM) to "comply or explain" against the UK Combined Code on Corporate Governance. In May 2010, the UK Financial Reporting Council issued a new UK Corporate Governance Code, which imposed several new requirements on UK listed companies with a "premium" listing on the Main Market of the London Stock Exchange (LSE), effective for accounting periods beginning on or after 29 June 2010 (the New Code). On 30 September 2010, the ISE announced that Irish companies listed on the MSM must also adhere from that date to the New Code, on a "comply or explain" basis.
In addition, the ISE has flagged that it intends to implement the recommendations of the Report on Compliance with the Combined Code on Corporate Governance, jointly commissioned by the ISE and the Irish Association of Investment Managers and published in March 2010. These additional requirements are expected to be included in a new Irish Corporate Governance Annex to the Listing Rules due to be published before the end of 2010 and are expected to commence on 1 January 2011.
Which Irish companies are affected by the New Code?
The New Code applies to all companies with shares admitted to trading on the MSM of the ISE (as well as those which have a "premium listing" on the LSE's Main Market). However, certain provisions of the New Code, relating to annual re-election of directors and external evaluation of the Board, will only apply to larger companies listed on the ISE MSM which are not eligible for inclusion in the ISEQ Small Cap Index (equivalent to FTSE 350 companies - the ISE will formalise the interpretive provisions in the Irish Corporate Governance Annex to be published later this year). These provisions are detailed further below.
When are the New Code & Irish Corporate Governance Annex effective?
The New Code will apply to accounting periods beginning on or after 30 September 2010.
As mentioned above, certain additional provisions contained in the Irish Corporate Governance Annex to the Irish Listing Rules are expected to also be effective for all accounting periods beginning on or after 1 January 2011.
What are the key new provisions of the New Code?
The New Code contains the following new key provisions:
Annual Re-election of All Directors (larger companies)
Following consultation with institutional shareholders, and in an attempt to increase the accountability of Directors to shareholders, the New Code provides for annual re-election of all directors, rather than re-election once every three years.
In the UK, this provision only applies to FTSE 350 companies (although smaller companies may voluntarily comply). The ISE has indicated that companies listed in Ireland are to be regarded as equivalent to FTSE 350 companies if they are admitted to trading on its MSM but are not eligible for inclusion on the ISEQ Small Cap Index. This classification is expected to be formalised in the new Irish Corporate Governance Annex, due to be published by the ISE later this year.
Some disquiet has been expressed in the UK over this proposed increase in the frequency of re-election, on the basis that it may give rise to "short-termism" in the decision-making of directors with a view to the next AGM. Concerns have also been raised that annual re-elections could have the potential to destabilise Boards. However, the FRC (and now the ISE) has decided that annual re-election will promote greater engagement between the Board and the company's shareholders, as directors will have an incentive to deal with shareholders' concerns.
However, on 30 September 2010, PIRC (a leading UK independent research and advisory consultancy, providing services to institutional investors on corporate governance) announced that it will give relevant companies a full year to comply with the New Code guidance on annual re-election of directors, in order to give such companies time to get to grips with the new regime. Accordingly, PIRC has stated that it will suspend implementation of across-the-board voting recommendations on annual re-elections until 2012, and in the interim will consider company disclosures on a case-by-case basis.
External Board Evaluation every 3 years (larger companies)
The old Combined Code provided that the performance of the Board should be internally reviewed annually. This requirement is carried over into the New Code. However, under the New Code, where the company is in the FTSE 350 (see above for the Irish equivalent), these reviews will need to be externally and independently facilitated at least once every three years.
The decision to make this a FTSE 350 requirement was made due to the lack of an established board evaluation service industry. For external facilitation to be successful the external evaluators will need to have credibility with the Board and will therefore need to be suitably qualified. Given that this new requirement will increase demand for such services, there may be some difficulty in obtaining suitable facilitators and the FRC has indicated that it will monitor this provision as a result.
Board Balance and Diversity
The New Code provides that appointments to the Board must be based on achieving the appropriate balance of skills, experience, independence and knowledge of the company and ensuring that candidates for Board appointments are drawn from a broad talent pool. The New Code expressly provides that the Board should have regard to the benefits of diversity on the Board including its gender mix. In addition, all directors must have sufficient time available to discharge their responsibilities effectively.
The New Code now includes a clearer statement about the need for performance-related elements of executive directors' pay to be aligned to the long-term success of the company rather than short-term considerations.
The language on remuneration for non-executive directors has also been amended to clarify that all forms of performance-related remuneration are discouraged for non-executives (not just share options).
The New Code also states that companies should consider provisions which enable it to recover variable components of director compensation where there has been misconduct or a mis-statement of results.
Role of Chairman / Senior Non-Executive Director (NED)
The New Code expands on the role of Chairman, to refer to the Chairman's responsibility to ensure a culture of openness and debate, and to ensure that adequate time is available for discussion by the Board of all topics. The Chairman is also now responsible for ensuring that all directors are made aware of shareholders' concerns. The Chairman should also agree and regularly review the training and development requirements of each director on the Board.
The provisions relating to the Senior NED role have been extended to clarify that they should provide a sounding board for the Chairman and should act as intermediary with him/her for the other NEDs where necessary.
The New Code includes explicit references to the need of the Board to monitor risk. It states that it is the Board's responsibility to consider the nature and extent of the significant risks it is willing to take to achieve the company's strategic objectives.
The New Code now imposes a requirement on companies that the annual report should include an explanation of the company's business model and strategy.
What will be contained in the Irish Corporate Governance Annex?
The ISE has flagged that it will publish an Irish Corporate Governance Annex to the Listing Rules by the end of 2010. This Annex will implement the recommendations of the Report on Compliance with the Combined Code on Corporate Governance jointly commissioned by the ISE and the Irish Association of Investment Managers and published in March 2010.
These recommendations focus on the quality of disclosures provided by companies and in this regard, the ISE suggests that issuers should provide meaningful, evidence-based descriptions of how they apply the provisions of the New Code. Issuers are encouraged to move away from the practice of "recycling" descriptions that replicate the wording of the New Code's provisions and provide more informative disclosures to provide shareholders with greater insight into the company and the circumstances in which it operates. The specific recommendations from the ISE/IAIM report are as follows:
Issuers should persuade investors that the number of non-executive directors on their Board is sufficient. Where less than half the Board is comprised of non-executive directors, the annual report should contain a "fulsome explanation" for this. In addition, issuers will be encouraged to supplement director's biographies with detailed descriptions of the skills, expertise and experience that each director brings to the Board. Information provided about each director should include their membership of Board committees, their date of appointment and their length of service. Similar information will be required for directors nominated by shareholders or government. There is an emphasis on the New Code's independence criteria and an explanation should be produced where a non-executive director fails to meet this criteria.
There should be a focus on the effectiveness of the Nomination Committee and specifically, their processes regarding selecting and appointing new candidates. Where issuers rely on external search agencies to recruit candidates, this fact should be revealed.
The objective, scope and methodology used in the evaluation process should be set out. A distinction should be made between the evaluation of the Board process, of individual directors and of the collective board strength. Where the Board opts to self-evaluate, an explanation of how objectivity was safeguarded during the evaluation should be included.
The Board's refreshment policy should be clearly set out, including the optimum length of service for directors and the general policies in place for Board renewal. Where a company is proposing the re-election of a non-executive director, issuers should provide a strong justification to shareholders for endorsing the appointment, particularly where directors have been on the Board for more than six years. Issuers are encouraged to set out why the director continues to be the 'right person for the job'. Proposed new appointees' biographies should include details of why the proposed individual's specific skills and experience are critical to the company at that time.
Issuers should include a meaningful description of the work carried out by the audit committee during the financial year. Issuers should not simply "recycle" the committee's terms of reference. Specifically, issuers must include an analysis of how the principal risks facing the company are being addressed and managed by the audit committee.
Issuers should clearly describe their remuneration policy, and not simply recycle the committee's terms of reference year on year. Issuers should follow the disclosure provisions contained in paragraph 5 of Section II (Remuneration Policy) of the EU Commission Recommendation on Remuneration. In short, the EU Commission Recommendation suggests that the company's remuneration statement should be clear and easily understandable. Detailed disclosures about the remuneration policy should be disclosed, including details on performance criteria, termination payments, deferment periods and establishment of the remuneration policy of the company concerned.
Where a company is having difficulty attracting, retaining and motivating key personnel, a meaningful description of these challenges together with an indication of the steps taken to deal with them, should be produced.
What about Enterprise Securities Market (ESM) / Alternative Investment Market (AIM) companies?
Irish companies whose shares are traded on the ISE's Enterprise Securities Market (ESM) are not subject to the New Code. ESM companies currently follow the ESM Rules (dated May 2010) issued by the ISE. The ISE has not indicated that it plans to extend the scope of the new arrangement to ESM companies.
Irish companies whose shares are traded on AIM are also not within the scope of the new Code. AIM companies are required to adhere to the AIM Rules. Neither the ESM Rules nor the AIM Rules include or require companies traded on either exchange to adhere to a corporate governance code, although there is no restriction on them doing so. Having said this, it has been said that the costs of complying with the New Code would, in many cases, probably outweigh the benefits of compliance for the average shareholder of an AIM or ESM listed company. However, two U.K. organisations, the Quoted Companies Alliance (QCA) and the National Association of Pension Funds (NAPF), have produced guidelines to assist AIM companies in achieving compliance with good corporate governance standards.
Practical Implications for Irish Listed Companies
While we will need to see the final form of the proposed Irish Corporate Governance Annex in order to properly assess the implications for Irish plcs which are affected by the new corporate governance regime, a number of practical consequences appear to arise for these companies. These include the following:
- Despite the fact that companies with a "premium listing" on the LSE's Main Market will only have to comply with the annual re-election requirements under the New Code if they are big enough to be on the FTSE 350 Index, the effect of the ISE's decision to require Irish companies traded on its MSM to comply with this rule (unless they are eligible for inclusion on the ISEQ Small Cap Index) is that Irish plcs with a dual primary listing of their shares in Dublin and in London and which are too small to be included in the FTSE 350 will, nevertheless, have to comply with these requirements if they are too big to be included on the ISEQ Small Cap Index;
- A review should be carried out to see if the existing provisions in the Articles providing for retirement of directors by rotation need to be amended in order to facilitate with the new annual re-election requirements;
- In the case of executive directors, failure to gain re-election may give rise to automatic termination of their service agreements, which could have a serious impact on business continuity for the company. Accordingly, it may be appropriate to review these agreements to see if any amendments need to be made;
- Service contracts and letters of appointment for NEDs should be reviewed for compliance with the New Code requirements relating to remuneration; and
- Companies should, in due course, assess any changes which will be required to be made to the format and content of the Annual Report in order to reflect the guidance in the new Irish Corporate Governance Annex, as outlined above.