Background

The UK Corporate Governance Code (the Code) sets out principles of good governance for premium listed companies in the areas of board composition and development, remuneration, shareholder relations, accountability and audit. On 17 September 2014 the Financial Reporting Council (FRC), which publishes the Code, announced various updates to it which will apply to company accounting periods beginning on or after 1 October 2014. 

The updates to the Code go some way to addressing wider criticisms of executive remuneration, are designed to encourage companies to take a more long-term approach in their overall outlook and encourage the board to set the correct 'tone from the top' to promote good behaviours throughout the organisation.

The main changes to the Code can be summarised as follows:

Going concern, risk management and internal control:

  • The directors must state in the company's annual report and half-yearly financial statements whether they consider it appropriate to adopt the going concern basis of accounting and identify any material uncertainties in the company's ability to continue to do so for at least the 12 months following approval of the financial statements;
  • Boards must also now include a 'viability statement' in their strategic report to investors, which is a broader assessment of the company's viability and should look forward significantly beyond 12 months;
  • There is additional emphasis placed on risk management and internal control procedures. In particular, the board must confirm in the annual report that they have carried out a robust assessment of the principal risks facing the company, and should also outline how risks identified are being managed or mitigated;
  • The directors should state whether they have a reasonable expectation that the company will be able to continue in operation and meet its liabilities as they fall due over the period of their assessment.

Remuneration

  • On the issue of remuneration it is now explicitly stated in the Code that directors' remuneration should be "designed to promote the long-term success of the company";
  • Arrangements should be in place for companies to recover or withhold pay when appropriate to do so.

Shareholder engagement

  • The updates to the Code also make some attempt to address any potential shareholder discontent by stating that, in circumstances where a significant proportion of votes have been cast against a resolution at a general meeting, the company should explain what actions it intends to take to understand the reasons behind the result of that vote.

Comment:

The Code will continue to operate on a 'comply or explain' basis, and it remains to be seen whether there will be any improvement on the 57% of FTSE 350 companies claiming full compliance with the Code (according to figures taken from a study by Grant Thornton at the end of 2013). However, given the additional obligations placed on companies in the new version of the Code, that appears unlikely.

Critics of the changes have taken the view that these updates will lead to company reports becoming more complicated and impenetrable, and largely a box ticking exercise. Supporters of the changes say that the requirement for boards to take a longer term view of strategy is good news for investors, who will also benefit from better assessments of solvency and liquidity. That may be the case, but only time will tell to what extent companies will comply with the new guidelines and whether investors really will benefit from the changes.

Most of the changes to the Code put additional obligations onto companies themselves, largely through their directors. There are likely to be additional demands placed on accountants and other professionals in assisting companies in complying with these new obligations, particularly with the requirement to take a longer term view of the company's viability, however ultimately this is the responsibility of the directors.

Although there are additional obligations now placed on the directors themselves, they remain protected under the 'safe harbour' provisions in section 463 Companies Act 2006, so long as the relevant disclosures are made within the strategic report. This provision ensures that as long as the directors did not know that disclosures were untrue or misleading, and that any omissions were not a dishonest concealment of a material fact, then they will not be liable to the company.