Smaller companies must prepare for changes to their corporate governance framework. We outline the changes which you should focus on when preparing for the new regime.
What’s changing for smaller listed companies?
Smaller listed companies need to plan and prepare for the following changes:
At least half the board, excluding the chair, should be non-executive directors whom the board considers to be independent. The exemption for smaller companies (that is companies below the FTSE 350) which simply required them to have at least two independent non-executive directors has been removed. So all smaller companies, which have previously complied with existing Code Provision B.1.2, will need to consider the composition of their board and whether any changes are required.
All directors should be subject to annual re-election. The list of standard resolutions proposed at the Annual General Meeting will need to change to reflect this requirement. For each director, the AGM notice must set out the specific reasons why their contribution is, and continues to be, important to the company’s long-term sustainable success. Previously only directors of FTSE 350 companies were subject to annual re-election (existing Code Provision B.7.1). When annual re-election was first introduced in 2010, the FRC recognised the concern that smaller companies with a more concentrated shareholder base might be exposed to disagreements between their major shareholders, and therefore limited the new provision on director re-election to FTSE 350 companies. However experience since then has indicated that this caution was perhaps unnecessary. Companies subject to this requirement for the first time should consider whether their articles need to change.
Chair limited to nine year term
The chair should not remain in post beyond nine years from the date of their first appointment to the board. The revised Code does contain some flexibility where this is required to facilitate effective succession planning and the development of a diverse board. In those circumstances, the nine year period can be extended for a limited time, particularly when the chair was an existing non-executive director on appointment.
The board must use one or a combination of the following methods:
- a director appointed from the workforce
- a formal workforce advisory panel
- a designated non-executive director.
If the board does not choose one or more of these methods, it should explain what alternative arrangements are in place and why it considers that they are effective. Until now employee representation on boards of UK listed companies has been rare.
Does the new Code contain any exemptions for smaller listed companies?
Yes. Smaller companies benefit from the following exemptions:
Independent board evaluation
Companies outside the FTSE 350 are not required to have a regular externally facilitated board evaluation. However the revised Guidance on Board Effectiveness notes that chairs of smaller companies are encouraged to consider doing this periodically. The FRC had considered requiring all companies to have an independent board evaluation every three years irrespective of their market capitalisation. The final position means that the status quo continues.
Audit committee membership
The board of a smaller listed company should establish an audit committee of independent non-executive directors, with a minimum membership of two (new Code Provision 24 which reflects existing Code Provision C.3.1.). However in a change to the current Code and in order to reinforce the independence of the audit committee, the company chair cannot be a member of the audit committee. The FRC has explained that if there is a strong case for any company chair to be a member then an explanation can be provided. Alternatively the company chair could attend meetings of the committee as an observer.
Remuneration committee membership
The board of a smaller listed company should establish a remuneration committee of independent non-executive directors, with a minimum membership of two (new Code Provision 32 which reflects existing Code Provision D.2.1.).
For new Code Provisions 24 and 32, a smaller company is one that is below the FTSE 350 throughout the year immediately prior to the reporting year.
The FRC had planned to remove all of the current exemptions for smaller listed companies when it started its consultation. So this represents a compromise position from the FRC although we note that:
- the FRC believes that the Code sets good practice and that even smaller listed companies should strive for the highest standards of corporate governance
- the sign post included in the current Code that 'Smaller listed companies, in particular those new to listing, may judge that some of the provisions are disproportionate or less relevant in their case' has been deleted.
What else is changing in the Code?
The shorter and sharper new Code introduced a number of other changes. These are covered in our general briefing on the new Code.
While the detail is important, the context in which these changes are being introduced is key. The FRC has made it clear that the Code places emphasis on businesses building trust by forging strong relationships with key stakeholders. It calls for companies to establish a corporate culture that is aligned with the company purpose, business strategy, promotes integrity and values diversity.
What are my options?
Smaller listed companies should first review their current corporate governance arrangements against the principles and provisions contained in the new Code. Depending on the results of that analysis, boards will then have the following options:
- Option A: work towards achieving compliance with all Code provisions as soon as possible after 1 January 2019.
- Option B: agree that compliance with all Code provisions will take longer to achieve and prepare a meaningful explanation of how the company is changing its corporate governance arrangements to reflect the new Code.
- Option C: if the board takes the view that some provisions of the new Code are not appropriate for the particular circumstances of that company, then articulate that clearly to shareholders and stakeholders.
The new Code makes it clear that 'An alternative to complying with a Provision may be justified in particular circumstances based 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. Where a departure from a Provision is intended to be limited in time, the explanation should indicate when the company expects to conform to the Provision.'
We anticipate that for the first reporting year after the introduction of the new Code, many smaller listed companies will take advantage of this flexibility and will prepare meaningful explanations instead of seeking to comply with all of the Code provisions. The key objective for those tasked with working through corporate governance reporting will be to avoid a box-ticking approach or superficial explanations.
Is there a transitional period for smaller listed companies?
No. The new Code applies to accounting periods beginning on or after 1 January 2019. There is no transitional period available to smaller listed companies. So the choice is very much between 'comply or explain'.
What happens if we have a standard listing?
Companies with a standard listing are not affected by the introduction of the new Code. This is because LR 9.8.6 (which requires a company to explain how it has applied the Main Principles set out in the UK Corporate Governance Code and whether it has complied throughout the accounting period with all relevant provisions set out in the UK Corporate Governance Code) only applies to a company that has a premium listing.
However a company with a standard listing can adopt the new Code if it feels that is appropriate. Separately a company planning a move from the standard segment to the premium segment will need to consider its approach to corporate governance alongside the other super-equivalent requirements of a premium listing.
What other corporate governance developments should we be aware of?
Smaller listed companies should be aware of the Companies (Miscellaneous Reporting) Regulations 2018. These require directors to explain how they have had regard to various matters in performing their duty to promote the success of the company in section 172 of the Companies Act 2006.