The Financial Reporting Council publishes its proposals for a revised UK Corporate Governance Code.
The Financial Reporting Council (FRC) is consulting on what it has described as a “shorter and sharper” revised UK Corporate Governance Code (Code). The revised Code incorporates recommendations stemming from the government’s recent consultation on corporate governance reform, as well as the FRC’s work on corporate culture, issues raised by the BEIS Commons Select Committee in its report on corporate governance, and recent reviews on gender and ethnic diversity.
The key messages are:
- the overarching importance of good governance in delivering long-term sustainable performance
- the board’s responsibility for establishing a healthy corporate culture
- improved shareholder and wider stakeholder engagement
- diversity in board succession planning
- a reinforcement of the importance of non-executive independence.
Key changes proposed
- The Code has been restructured to provide clarity and refocus emphasis on an updated set of core principles (to address a current tendency to focus on the “comply or explain” provisions in the Code).
- The revised Code will consist of 17 principles, supported by a number of provisions. The concept of supporting principles will be removed; some current supporting principles will become principles or provisions, or be moved to the FRC’s Guide to Board Effectiveness.
- The revised Code will remove the current exemptions/relaxations for companies outside the FTSE 350 – these include provisions relating to externally facilitated board evaluations, annual re-election, proportion of independent non-executives on the board, and the composition of audit and remuneration committees. The FRC believes “even smaller companies should strive for the highest standards of corporate governance”.
Culture and strategy
- New and revised principles emphasise the board’s responsibility to embody and promote the desired corporate culture. The board should establish the company's purpose, strategy and values, and satisfy itself that these and its culture are aligned. Directors must act with integrity and lead by example, and enable the workforce to raise concerns where they consider conduct is not consistent with the company’s values. The importance of a healthy culture in delivering long term sustainable performance and trust in business permeates throughout the revised Code.
- A new provision emphasises the chief executive’s responsibility for proposing strategy to the board and delivering it as agreed.
Shareholder and stakeholder engagement
- A new principle requires the board to ensure effective engagement with, and encourage participation from, shareholders and stakeholders.
- A new provision requires the board to establish a method for gathering views of the workforce, which would normally be one of the following: a director appointed from the workforce; a formal workforce advisory panel; or a designated non-executive director. The term “workforce” is used to capture a wider group than those with formal contracts of employment, including agency workers and self-employed contractors.
- A new provision requires the board to explain in the annual report how it has engaged with the workforce and other stakeholders, and how their interests and the matters set out in section 172 Companies Act 2006 influenced the board’s decision-making. The government is intending to introduce legislation requiring all companies of a certain size (including private companies) to explain how their directors comply with their duties under section 172 with regard to employee interests and fostering relationships with suppliers, customers and others. This new Code provision will be reviewed to ensure it is in line with the new legislative requirement.
- A revised provision dealing with significant shareholder dissent. When more than 20% of votes are cast against a resolution the company should explain, when announcing voting results, what actions it intends to take to consult with shareholders in order to understand the result. In addition, the company must publish an update no later than six months after the vote. The board must then provide a final summary in the next annual report (or in the explanatory notes to the resolutions at the next shareholder meeting) on what impact the feedback has had and any actions or resolutions now proposed. The recently launched public register of shareholder dissent implemented by the Investment Association will record updates on the actions a company is taking.
- A change of emphasis to the application of the independence criteria set out in the Code. The revised Code provision states that non-executive directors “should not be considered independent” if they do not meet the independence criteria (currently the criteria need only be taken into account when considering independence). The FRC believes the change of approach sends a strong message that individuals with a current or previous relationship with the company should not be considered independent.
- The role of the chair is clarified, requiring the chair to demonstrate independent and objective judgment at all times (currently the Code only requires the chair to meet the independence criteria on appointment).
- A new principle to promote diversity in the boardroom and guard against ‘group think’; appointments and succession plans should be based on merit and objective criteria, and promote diversity of gender, social and ethnic backgrounds, cognitive and personal strengths. The nomination committee’s remit will be broadened in this context to oversee the development of a diverse pipeline for succession. The annual report should, among other disclosures, describe the work and progress of the committee in this context, the actions taken by it to increase diversity and inclusion, and include details of the gender balance of those in senior management (the first level of management below board level) and their direct reports.
- All companies should have an externally facilitated board evaluation at least every three years – the current exemption for companies outside the FTSE 350 is removed.
- The remuneration committee will have an expanded remit with responsibility for oversight of company remuneration and wider workforce policies. The annual report should, amongst other disclosures, explain what engagement with the workforce has taken place to explain how executive remuneration aligns with wider company pay policy.
- A recommended minimum vesting and post-vesting holding period for executive share awards of five years (up from the current three years) to encourage focus on longer-term outcomes. Also a new provision requires remuneration schemes and policies to make provision for boards to override formulaic remuneration outcomes.
- A new requirement that the chair of the remuneration committee must have previously served on a remuneration committee for at least 12 months.
- All companies must have a remuneration committee of a minimum of three non-executive directors – currently the Code lowers the minimum to two for companies outside the FTSE 350.
Guidance on Board Effectiveness and UK Stewardship Code
To support the proposed changes to the Code, the FRC has also looked at the Guidance on Board Effectiveness (Guidance) and the UK Stewardship Code.
The revised Guidance follows the structure of the revised Code and should be read alongside it to add clarity and explanation. The FRC says that it is intended to stimulate boards' thinking, including how they can carry out their role most effectively. As the revised Code is subject to consultation, the Guidance may need further refinement to align it with the final wording of the revised Code.
The FRC consultation also includes an initial high-level consultation on the UK Stewardship Code. It asks for views on a series of broad questions which will help form its approach to improving the Stewardship Code and driving best practice in reporting and stewardship activity.
The FRC’s consultation asks for comments on the revised Code and Guidance, and the future direction of the UK Stewardship Code, by 28 February 2018. It intends to then publish a final version of the Code by early Summer 2018, to apply to accounting periods beginning on or after 1 January 2019.