With the growth of high profile cases of poor quality governance and the increase in public scrutiny, the Financial Reporting Council (FRC) has decided to undertake a review of the Corporate Governance Code (the Code).
The Consultation proposes that the "Revised Code will retain those elements of the Code which are still relevant today. Those elements no longer relevant will either be moved to the FRC’s proposed revised Guidance on Board Effectiveness, or will be removed entirely. It is most likely that the Revised Code will come into effect in the accounting periods beginning or after July 2019. The primary aim of the Revised Code is to make it more succinct, with 17 Principles and 41 Provisions.
The Consultation drew from a variety of reports and reviews, including the 2016 report on "Corporate culture and the role of boards" (the Culture Report), as well as the Hampton-Alexander Review and the Parker Review. Furthermore, the Green Paper Consultation on Corporate Governance Reform was drawn upon for certain aspects of the Revised Code.
The Revised Code, in the interest of promoting governance policies and practices that benefit shareholders and broader society, has been divided into five sections: Leadership and purpose; Division of responsibilities; Composition, succession and evaluation; Audit, risk and internal control; and Remuneration.
Consultation on the changes to the UK Corporate Governance Code
Several changes have been proposed to the five sections. Each is addressed briefly below:
Section 1 – Leadership and Purpose
The Revised Code includes references to the board's responsibility for considering the needs and views of a wider range of stakeholders (as recommended in the Culture Report, and incorporated into Principle C of the Revised Code). Furthermore, provision 3 of the Revised Code includes the Government's three options for ensuring the employee voice is heard in the board room (encapsulating all those working for the company not just those with formal contracts): a director appointed from the workforce, a formal workforce advisory council, or a designated non-executive director.
Provision 4 refers to s172 of the Companies Act 2006, and requires the board to explain in an annual report to workers and stakeholders how their interests and the matters in s172 have influenced the board's decision-making.
Provision 6 improves the transparency on voting when there is more than 20% of votes cast against a resolution by requiring the company to explain what actions it intends to take in consultation with shareholders to understand the reasons behind the result.
Section 2 – Division of Responsibilities
This section focuses on the separation of duties within the board, and the various roles within it, including non-executive directors. For example, Principle E outlines the role of the chair and highlights the importance of its independence and objective judgement.
Perhaps one of the most significant changes is within Provision 11, which states that independent non-executive directors, including the chair, must constitute a majority of the board. Furthermore, there is no longer an exemption for companies outside of the FTSE 350.
Provision 15 has also strengthened the requirements for independence, meaning non-executive directors or chairs must meet the stated criteria, or else be considered not independent.
Section 3 – Composition, succession and evaluation
This section mostly draws from the Hampton-Alexander Review and Parker Review reports on diversity, calling upon directors to consider the composition of the board and the management pipeline. This is encapsulated in Principle J, which aims to broaden the boards' perceptions of diversity and to ensure appointment and succession planning which promote diversity in gender and ethnic backgrounds.
This is achieved in provisions 17 and 23. The former places responsibility on the nomination committee to ensure a diverse pipeline for succession. The latter encourages reporting on actions taken to increase diversity and inclusion. This includes disclosing gender balance of those in the senior management and their direct reports.
Section 4 – Audit, risk and internal control
This section mostly replicates Section C of the original Code. The FRC is retaining the requirements which are duplicated in the Listing Rules, Disclosure Guidance and Transparency Rules and the Companies Act 2006, but is open to changing their stance as a result of the Consultation.
Section 5 – Remuneration
This section addresses the concerns in rising levels of executive pay, which has contributed to mistrust in business. The changes in the Revised Code are aimed at improving remuneration policies and practices. Principle Q aims to address this by emphasiszing the board's role in exercising independent judgement and discretion when approving remuneration outcomes. The Provisions support this:
- Provision 32: Requires all remuneration committees to be made up of at least three independent non-executive directors and the chair must have served at least twelve months on any other remuneration committee before taking on the role.
- Provision 33 expands the remit of the remuneration committee to have oversight of company remuneration and wider workforce policies.
- Provision 37 requires schemes to allow boards to be able to override remuneration outcomes.
- Provision 40 sets out a range of matters the remuneration committee should address when determining the executive director remuneration policies.
- Provision 41 requires companies to report on how they have engaged with the workforce to explain how executive remuneration aligns with wider company pay policy.
In addition to the consideration of the Revised Code, the consultation also invites opinions on changes to the Guidance on Board Effectiveness (the Guidance) and the UK Stewardship Code. In terms of the former, certain elements have been moved from the Code to the Guidance. These elements have mostly become embedded in company behavior, whereas the aim of the code is to encourage companies to go further than what they are already doing. The Guidance will be revised further once the consultation on the Revised Code is completed.
In terms of the latter, the FRC are asking several questions about the future of the Stewardship Code. However, specific consultations on the Stewardship Code will take place in 2018.