A round-up of the latest developments

Corporate Governance Reform – BEIS publishes draft secondary legislation

As part of its corporate governance reform agenda, the government confirmed its intention to drive greater transparency in reporting by introducing secondary legislation to, amongst other things, (i) require companies of a "significant" size to explain how their directors comply with the requirements of section 172 of the Companies Act 2006 (2006 Act) to have regard to stakeholders; and (ii) to require quoted companies to report annually the ratio of CEO pay to the average pay of their UK workforce. On 10 June, the Department for Business, Energy & Industrial Strategy (BEIS) published draft regulations - The Companies (Miscellaneous Reporting) Regulations 2018 (Regulations) - implementing these and other legislative changes. BEIS has also published accompanying Q&As – while it acknowledges that the Regulations will not become law until approved by Parliament, it wants to give companies and stakeholders as much time as possible to understand the proposed changes.

Key proposals in the Regulations include:

Strategic Report - Large companies to include a "s.172(1) statement"

Under proposed amendments to the 2006 Act, a company that is required to prepare a strategic report must ensure that its report for each financial year beginning on or after 1 January 2019 includes a statement describing how the directors have had regard to the matters set out in section 172of the 2006 Act (Duty to promote the success of the company) when performing their duties under that section. According to the Q&A, this should be a separately identifiable statement within the strategic report but one which may cross refer to other parts of the annual report.

Application: In effect, the requirement applies to all "large" companies on the basis that it will not apply to companies that qualify as medium-sized for the purposes of the 2006 Act. All qualifying companies, including subsidiaries, will need to report; parent companies cannot do so on behalf of their subsidiaries albeit that cross-references to group statements and policies can be made where appropriate.

Mandatory website publication: The effect of the Regulations is that all companies required to produce a s.172(1) statement will need to publish it on their website, whether as part of their annual report or on a stand-alone basis.

Directors' Report – Larger companies to include statements of engagement with employees and others

The Regulations propose to amend the content requirements of the directors' report prepared in accordance with s.415 of the 2006 Act in respect of financial years beginning on or after 1 January 2019. These new directors' report requirements are designed to ensure that reports include information about the "important aspects of the s.172(1) duty even where directors do not judge the information to be of sufficient strategic importance to be included in the strategic report that year".

Employees - The directors' report of a relevant company must include a statement that summarises how the directors have engaged with employees during the year. It must also summarise how the directors have had regard to employee interests and the outcome of that regard, including on key decisions taken by the board (subject to the customary exception for information the disclosure of which may seriously prejudice the interests of the company). The information required is in addition to the current requirement to describe actions taken by the company to foster employee involvement in the business.

Application: The proposal applies to those companies that have employed more than 250 persons on average in the financial year. If the company is a parent company, the average number of UK employees is those in the parent's group. No regard need be had to persons employed to work wholly or mainly outside the UK when calculating the average number of employees.

Suppliers, customers and others - The directors' report of a relevant company must also include a statement that summarises how the directors have had regard to the need to foster the company's business relationships with suppliers, customers and others, and the effect of that regard (including on the principal decisions made by directors subject, as above, to a carve out for the disclosure of information that may prejudice the company's interests).

Application: The amendment effectively applies to larger companieson the basis that it will not apply to those companies that satisfy 2 or more of the requirements for qualification as a medium-sized company.

Directors' Report – Certain larger companies to include a statement of governance arrangements

A company to which the proposed rules apply must ensure that its directors' report for the financial year beginning on or after 1 January 2019 includes a statement that sets out the details of any corporate governance code that the company applied during the year, how the company applied the code and the extent and reasons for any departure from it. If no code was applied, the directors' report must explain reasons for that decision as well as the governance arrangements that werein place. The Regulations do not prescribe any particular code although, unsurprisingly, the Q&A does refer to The Wates Corporate Governance Principles for Large Private Companies (on which more below).

Application: The proposed reporting requirement will apply to those larger companies that during the year either: (i) have more than 2,000 employees; and / or (ii) have a turnover of more than £200m and a balance sheet total of more than £2billion.

The requirement will not apply to those companies that are obliged to publish a corporate governance statement under the Financial Conduct Authority's (FCA) Disclosure Guidance and Transparency Rules but will apply to their subsidiaries – thus a qualifying subsidiary of a premium listed company will also be required to report. The Q&A states that the subsidiary could, in principle, and if the circumstances warranted it, state that it did not apply a code because its parent applied the UK Corporate Governance Code which was applied throughout the group. This might shorten the statement, but the subsidiary would still need to explain how the UK Corporate Governance Code actually applies to governance arrangements in the subsidiary and its directors.

Mandatory website publication: The effect of the Regulations is that all companies required to produce a statement of their governance arrangements will need to publish it on their website.

Directors' Remuneration Report – UK incorporated quoted companies required to make greater disclosures

The Regulations propose to amend the content requirements of the directors' remuneration report prepared by a UK incorporated quoted company in accordance with s.420 of the 2006 Act in respect of financial years beginning on or after 1 January 2019 as follows:

Annual statement

This must additionally include a summary of any discretion which has been exercised in the award of directors' remuneration.

Annual report on remuneration

Single figure table – The notes to the single figure table must additionally include: (i) the amount of the annual basis (or any other amount disclosed in column c) and the amount of the LTIP (or any other amount disclosed in column d) that is attributable to share price appreciation (or an estimate if not ascertainable); and (ii) where discretion has been exercised, particulars of how the discretion was exercised, how the resulting level of award was determined and whether the discretion was exercised as a result of share price appreciation or depreciation.

Pay ratios table – This proposal applies only to those quoted companies that have employed more than 250 persons on average during the financial year. If the company is a parent company, the average number of UK employees is those in the parent's group. No regard need be had to persons employed to work wholly or mainly outside the UK when calculating the average number of employees.

The report must include a pay ratios table in the prescribed format which sets out: (i) CEO remuneration as disclosed in the single figure table; and (ii) the pay and benefits of a UK employee on, respectively, the 25th, 50th and 75th percentiles of pay and benefits of the company's UK employees (or the group's UK employees, in the case of a parent company).

On an ongoing basis, the pay ratios table should show the same figures for each of the financial years from 1 January 2019 until such number of preceding financial years reaches nine years.

There are three different methods set out in the proposals (and explained in the Q&A) for calculating the pay and benefits of a UK employee on the 25th, 50th and 75th percentiles and the company should state in the pay ratios table which method has been used.

Notes to the pay ratios table must include: (i) an explanation of why the particular calculation method was chosen; (ii) if the method has changed from the previous year, an explanation for the change; (iii) depending on the method chosen, further disclosure of the methodology used and any adjustments made; (iv) details of any component of pay and benefits which have been omitted; (v) a description of any methodology used to calculate pay and benefits which was different from that used for the single figure table; and (vi) an explanation of any assumptions or statistical modelling used to determine full-time equivalent remuneration.

In addition, the report must explain: (i) any reduction or increase in the pay ratios from the previous year and whether this change was due to a change in CEO pay or the pay of the company's UK employees as a whole, the company's employment models (including the proportion of the company's employees who work outside the UK and of any increase in the workforce that is not employed by the company under contracts of service) and/or the use of a different method to calculate the relevant percentiles; (ii) any trend in the median pay ratio over the period of financial years covered by the pay ratios table; and (iii) whether, and if so why, the company believes the median pay ratios for the year is consistent with the pay, reward and progression policies for the UK employees as a whole.

Directors' remuneration policy

The policy must set out for all executive directors, in respect of performance targets or measures relating to more than one financial year, an indication of the maximum remuneration receivable on the assumption that the company's share price appreciated by 50% during the performance period. This disclosure must include a short description of the basis on which the amount was calculated.

Q&A content

In addition to clearly setting out those companies in scope relative to each new requirement, the BEIS guidance includes detailed Q&A on the requirements to:

  • publish a s.172(1) statement;
  • report on corporate governance arrangements;
  • report on pay ratios, with an annex illustrating pay ratio methodology options; and
  • report on share price impact.

Consultation on The Wates Corporate Governance Principles for Large Private Companies

Given the requirement in the Regulations for large private companies to report on their governance arrangements, it is no surprise that the FRC, on behalf of James Wates CBE, has also published a consultation on corporate governance principles for such companies (Principles). The Principles focus on "the fundamental aspects of business leadership and performance" and have been produced by the "Coalition Group", the membership of which includes the FRC, the Institute for Family Business, the IoD, the CBI, the Investment Association, ICSA: the Governance Institute and the BVCA.

The Principles have not been drafted as a prescriptive list of actions, working instead on an "apply and explain" basis. A company which adopts the Principles is expected to apply them in full. The "apply and explain" approach means that, if a company has adopted the Principles, it should provide a supporting statement for each principle that explains how its corporate governance processes operate and achieve the desired outcomes. Each principle is supported by guidance.

The Principles are:

  • Purpose – An effective board promotes the purpose of a company, and ensures that its values, strategy and culture align with that purpose.
  • Composition – Effective board composition requires an effective chair and a balance of skills, backgrounds, experience and knowledge, with individual directors having sufficient capacity to make a valuable contribution. The size of a board should be guided by the scale and complexity of the company.
  • Responsibilities – A board should have a clear understanding of its accountability and terms of reference. Its policies and procedures should support effective decision-making and independent challenge.
  • Opportunity and Risk – A board should promote the long-term success of the company by identifying opportunities to create and preserve value and establish oversight for the identification and mitigation of risk.
  • Remuneration – A board should promote executive remuneration structures aligned to sustainable long-term success of a company, taking into account pay and conditions elsewhere in the company.
  • Stakeholders – A board has a responsibility to oversee meaningful engagement with material stakeholders, including the workforce, and have regard to that discussion when taking decisions. The board has a responsibility to foster good relationships based on the company’s purpose.

The consultation is open until 7 September 2018. The final version of the Principles will be published in December 2018.

Periodic financial information and inside information – legitimate interest to delay

The FCA has published a special edition Primary Market Bulletin comprising a consultation on a proposed update to its existing Technical Note on periodic financial information and inside information (UKLA/TN/506.1), involving the delay in disclosure of inside information under Article 17(4) of the Market Abuse Regulation (EU 596/2014). The consultation follows the publication of ESMA's guidelines which set out a non-exhaustive, indicative list of legitimate interests of issuers which are likely to be prejudiced by immediate disclosure, and of situations in which delay is likely to mislead the public.

The draft Technical Note contemplates that the legitimate interests of an issuer may be prejudiced by immediate disclosure when inside information arises during the process of the issuer preparing a periodic financial report and immediate disclosure would impact on the orderly production and release of the report and could result in the incorrect assessment of the information by the public. Therefore, by its nature, this legitimate interest is limited to the situation in which the inside information emerges as part of the process of preparing a periodic financial report and is to be included in the report and immediate disclosure could result in an incorrect assessment of information by the public. The FCA stresses that it does not believe – and issuers should not assume – that this interest will always be present; issuers should assess the existence or otherwise of a legitimate interest which may be prejudiced bythe immediate disclosure of inside information on an on-going and case-by-case basis.

Issues of note raised in the draft Technical Note include:

  • the requirement to disclose inside information applies during the process of preparing financial reports;
  • during the preparation process, issuers should assess on an on-going and case-by-case basis whether they have inside information, starting with the assumption that information relating to financial results could constitute inside information;
  • issuers should record and be able to submit evidence of the assessment process to the FCA upon request;
  • issuers should not take a blanket approach to the assessment of the status of information – i.e. that information to be included in periodic financial reports will always or never constitute inside information;
  • in the context of the proposed legitimate interest, the FCA believes that, in many cases, an issuer will be able to carefully and appropriately draft an announcement that will enable the correct assessment of the inside information, thereby allowing it to be published without delay. Nevertheless, it evidently accepts that in some cases this will not be practicable other than through the publication of the full financial report; and
  • issuers also need to assess on an on-going and case-by-case basis the extent to which any delay is likely to mislead the public – the entirety of paragraph 2.9 of the ESMA Guidelines being particularly pertinent in this context. The FCA is clear that there is no possibility of delaying disclosure if to do so would mislead.

Feedback is requested by 23 July 2018.