The Government has published draft legislation designed to implement many of the proposed reforms coming out of its recent white paper on corporate governance reform.
If approved by Parliament, the Companies (Miscellaneous Reporting) Regulations 2018 will make certain changes to the information companies must disclose in their annual reports. The changes would apply to financial years beginning on or after 1 January 2019.
The Government has also published guidance on the new regulations.
The proposed changes include the following.
Statement on directors’ duties
Large companies would need to include a "section 172(1) statement" in their strategic report, describing how their directors have considered the factors in section 172(1)(a) to (f) of the Companies Act 2006 when carrying out their duty to promote the company’s success.
These include the likely consequences of decisions in the long term, the interests of employees, the need to foster relations with suppliers and customers and maintain a reputation for high standards of business, impact on the environment and community, and the need to act fairly between shareholders.
This would apply to all large companies, whether publicly traded or private. Unquoted companies (including AIM and NEX Growth companies) would also have to publish the statement on their website, or on a website that identifies the company (such as a holding company’s website).
Corporate governance statement
A significant change is the proposed introduction of a corporate governance statement. A company’s director’s report would need to identify a “corporate governance code” and set out how the company applied or departed from that code.
- a company will “enter” the regime if it has either more than 2,000 employees, or both turnover over £200 million and a balance sheet total over £2 billion, in its first financial year or in two subsequent consecutive financial years; and
- it will “leave” the regime if it no longer satisfies either of those criteria for two consecutive financial years.
Main Market and NEX Main Board companies would be exempt, as they already produce a corporate governance statement under the Financial Conduct Authority’s Transparency Rules (DTR 7.2).
Few (if any) AIM companies and NEX Growth companies will meet the thresholds above for the proposed new statutory reporting requirement, although, following changes to the AIM Rules for Companies, AIM companies of all sizes are now required to identify a “recognised corporate governance code” and (from September 2018) to report on departures from it.
The real effect of the proposed change, therefore, would be to bring the comply-or-explain requirement to the very largest privately owned companies. There is currently no corporate governance code for private companies, but the Financial Reporting Council has convened a Coalition Group to draft one.
Companies that produce a directors’ remuneration report would need to include a ratio of CEO to average employee pay. This would affect Main Market companies and other companies admitted to an EEA regulated market, the NYSE or Nasdaq (so-called “quoted companies”).
- a company will “enter” the regime if it has either more than 250 employees in its first financial year or in two subsequent consecutive financial years; and
- it will “leave” the regime if it no longer satisfies that criterion for two consecutive financial years.
The remuneration report would need to state the ratio of CEO pay against average employee pay on the 25th, 50th and 75th percentiles. Companies would have three options for calculating the ratio:
- Aggregate total workforce pay and benefits
- Use "hourly rate gender pay gap information" and identify "best equivalents" for the three quartiles
- Use other information (instead of or alongside pay gap information) to identify best equivalents for the three quartiles
The report would also need to:
- explain the company’s choice of methodology and why any best equivalents reasonably represent the three quartiles
- explain any changes to the CEO pay ratio year on year, including whether they arise because the CEO's pay, average workforce pay, the company's employment models or the ratio calculation methodology has changed since the previous year
- report on trends in the median (50th) percentile and explain why that ratio is consistent with the company’s employee pay, reward and progression policies
These include the following:
- When reporting on awards to directors, quoted companies would need to state the amount of each award attributable to "share price appreciation", and whether any discretion to make the award resulted from share price appreciation or depreciation.They would also need to set out any executive director performance measures applicable across multiple years and the maximum amount receivable under them on a 50% increase in share price.
- Companies with more than 250 employees in their first financial year or two consecutive financial years would be required to include more detail on engagement with employees, including how the directors engaged with employees and had regard to employees’ interests. This would apply to both quoted and unquoted companies.
- Companies would be required to explain how the directors have had regard to the need to foster business relationships with suppliers, customers and others during the financial year. Again, this would apply to both quoted and unquoted companies, provided they meet certain financial and headcount thresholds during their first financial year or two consecutive financial years.
The regulations apply only to companies, and not to limited liability partnerships (LLPs). The Government’s guidance confirms that this is intentional. This makes sense, as LLPs do not have directors and their members are not subject to duties such as that in section 172 of the Companies Act 2006.