In February 2012, the Financial Reporting Council (FRC) published a report of discussions between companies and investors on 'What constitutes an explanation under "comply-or-explain"?'1

The EC's Green Paper on 'The EU corporate governance framework' published in April last year pointed out that the quality of explanations in corporate governance statements when departing from a corporate governance code recommendation needed to be improved. Although the EC does not intend to alter the fundamentals of the comply-or-explain approach, the Green Paper is considering requiring more detailed explanations for any such departures and a description of the alternative solutions adopted, and making corporate governance statements regulated information within the meaning of the Transparency Directive, thus authorising regulators (rather than shareholders) to decide whether an explanation for a company's departure from a recommendation was sufficient or not.

In response to the Green Paper the FRC entered into discussions with companies and investors with the aim of reducing the incidence of insubstantial explanations and thereby "obviating the need for regulatory interference in the content of explanations".

The result of these discussions is a definition of 'meaningful explanation' which goes beyond the required information currently contemplated by the EC in its Green Paper.  Not only should companies set the context and historical background and give a convincing rationale for any deviation from a particular provision of the UK Corporate Governance Code (the Code), but they should also:

  • describe any mitigating action taken to address any additional risk and to maintain conformity with the Code principles, and
  • indicate whether the deviation from the provisions of the Code is limited in time and when the company intends to return to conformity with the provisions.

The FRC will consult later this year whether to make changes to the Code to reflect the proposed definition of what constitutes a meaningful explanation for a deviation from the Code's provisions. The FRC is hoping that the consensus expressed by the discussion group will strengthen its argument in Brussels that the concern regarding the quality of corporate governance statements can be addressed by improving the existing system rather than by introducing new prescriptive regulation. However, the EC has now shifted its focus somewhat by looking into and consulting on the future of European company law as a whole rather than corporate governance alone. The results of this latest EC consultation will be announced at the same time as any initiatives on corporate governance.