The Companies (Miscellaneous Reporting) Regulations 2018 came into force on 1 January 2019.
For the first time in the UK, some unquoted companies need to formalise their corporate governance arrangements and make additional disclosures in their annual reports for financial years beginning on or after 1 January 2019. The new voluntary Wates Corporate Governance Principles for Large Private Companies (Wates Principles), published by the UK’s Financial Reporting Council (FRC) in December, are designed as a framework to enable large private companies which are not already voluntarily complying with another corporate governance code to comply with these new statutory reporting requirements.
Which companies are affected?
The requirement to make additional reporting disclosures applies to all ‘large’ companies, with extra requirements being imposed on those companies which are in the ‘very large’ category. UK companies with more than 250 UK employees, regardless of whether they are otherwise ‘large’, have new obligations too. There are additional requirements for quoted companies that are not covered in this note.
A ‘large’ company for this purpose is broadly a UK company that satisfies two or more of the following requirements: (i) turnover of more than £36 million; (ii) balance sheet total of more than £18 million; or (iii) more than 250 employees1.
A ‘very large’ company is a UK company that is not already subject to a corporate governance requirement (and is not a community interest company or charitable company) and has on a standalone basis: (i) more than 2,000 employees (wherever located); and/or (ii) a turnover of more than £200 million globally and a balance sheet total of more than £2 billion globally. 2
The Regulations contain further detail on the criteria for coming within the scope of the new requirements.
The Regulations apply to all companies incorporated in the UK that meet the criteria. Even where a parent company is incorporated outside the UK so that it falls beyond the territorial reach of the Regulations, its UK incorporated subsidiary will still be required to comply if the subsidiary satisfies the thresholds.
A review of the Regulations and the qualifying conditions should be conducted each year to check whether intervening changes in size mean that a company is now caught by, or is no longer covered by, the Regulations. There are ‘smoothing provisions’ in the Regulations, designed to address this situation.
The Government has also produced FAQs on the Regulations.
What are the new reporting obligations?
In broad terms, for UK companies reporting on financial years starting on or after 1 January 2019:
― All companies with more than 250 UK employees3 must include a statement in their Directors’ Report summarising how the directors have engaged with employees, how they have had regard to employee interests and the effect of that regard, including on the principal decisions taken by the company in the financial year.
For example, in this statement the company could describe its chosen methods of communication with employees (e.g. formal workforce advisory panel/nominated ‘workforce’ director/regular employee surveys/union representatives etc.) and explain (perhaps citing specific examples of) how this engagement has secured meaningful two-way dialogue and influenced the company’s policies, procedures and decision-making.
The Regulations provide that there is no requirement to disclose information about impending developments or matters in the course of negotiation if this would, in the opinion of the directors, be seriously prejudicial to the interests of the company.
― All large companies are required to include a statement in their Directors’ Report summarising 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 taken by the company during the financial year.4
For example, in this statement the company could explain the steps it has taken to identify stakeholders integral to its ability to generate and preserve value. It could describe its chosen channels of communication with such stakeholders and provide some examples of how this engagement has influenced the company’s policies, procedures and decision-making.
As with the statement on employee engagement, there is no requirement to disclose information about impending developments or matters in the course of negotiation if this would, in the opinion of the directors, be seriously prejudicial to the interests of the company.
― All large companies are required to include a separately identifiable statement in their Strategic Report describing how the directors have had regard to the matters specified in section 172 of the Companies Act 20065 when performing their duty to, in good faith, promote the success of the company for the benefit of its members as a whole. This section 172 statement must be made available as soon as reasonably practicable on the company’s (or another group company’s website) and remain available until the statement for the next financial year is made available;6
For example, one part of the Section 172 statement could explain how the directors have had regard to the long-term success of the company and the interests of stakeholders in determining the capital allocation and dividend policies; the company could include a quantified analysis of allocations of free cash flow, to enable anyone reading the accounts to understand how discretionary resources have been allocated between shareholders, other stakeholders and the company’s own resources.
― Very large private (and public unlisted) companies are required to include a statement in their Directors’ Report setting out the following:
− which corporate governance code (if any) they have applied (see ‘Wates and corporate governance code’) and how they have applied it; and
− whether they have departed from any of the provisions of their chosen code and, if so, how and why they did so; or, if they did not comply with a corporate governance code, the reasons why and what corporate governance arrangements were applied.
The Regulations FAQs contain guidance for companies on the general content of all such statements.
In relation to the Section 172 statement, more detailed guidance, with specific examples of the types of information that companies may wish to disclose, can be found in Section 8 of the FRC Guidance on the Strategic Report.
Wates and other corporate governance codes
The Government’s intention is that the Wates Principles will be the corporate governance code adopted by most large private companies. However, companies are permitted to choose the most appropriate code for their circumstances. Some companies, as part of a larger group, will already be on course to comply with a corporate governance code, such as the UK Corporate Governance Code for premium-listed companies, or the QCA Corporate Governance Code. In other cases, companies may select an industry-specific code, such as the BVCA Walker Guidelines for disclosure and transparency in private equity. A company is not obliged to apply a code at all, but in that case, it must explain why it has made that decision and what corporate governance arrangements it has made.
The Wates Principles
There are six Wates Principles, each of which is supported by guidance. Companies that choose to apply the Wates Principles are expected to explain how they have applied each of the principles during the financial year (‘apply and explain’). The principles are intentionally high level and flexible so that each company has scope to implement the principles in a way that is appropriate to its nature and complexity, taking into account the company’s relationships with its shareholders and other stakeholders. The Principles do not override or interpret directors’ duties contained in the Companies Act 2006.
The six principles are:
― Purpose and Leadership: An effective board develops and promotes the purpose of a company and ensures that its values, strategy and culture align with that purpose.
― Board 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 reflect the scale and complexity of the company.
― Board Responsibilities: The board and individual directors should have a clear understanding of their accountability and responsibilities. The board’s policies and procedures should support effective decision-making and independent challenge.
― Opportunity and Risk: A board should promote the long-term sustainable success of the company by identifying opportunities to create and preserve value and establishing oversight for the identification and mitigation of risks.
― Remuneration: A board should promote executive remuneration structures aligned to the long-term sustainable success of a company, taking into account pay and conditions elsewhere in the company.
― Stakeholder Relationships and Engagement: Directors should foster effective stakeholder relationships aligned to the company’s purpose. The board is responsible for overseeing meaningful engagement with stakeholders, including the workforce, and having regard to their views when taking decisions.
The guidance relating to each principle provides recommendations of specific behaviours, systems and controls that companies should consider putting in place. However, the guidance is not prescriptive, and companies are not required to explain whether or how they have applied it. Instead, the guidance is effectively a description of best practice.
One criticism levied at the Wates Principles and the surrounding reporting regime is that there is no official body responsible for monitoring or enforcing compliance: there is no effective legal ‘stick’ to ensure compliance.7 The focus is on encouraging stakeholders to engage and monitor, rather than giving the message that the state or a regulator will do so. Wates anticipates a review of the Principles in five or six years’ time. In the meantime, under the existing regime, monitoring will be ‘light touch’ with the FRC proposing to publicise and praise good compliance, rather than taking a ‘name and shame’ approach.
The year(s) ahead
An estimated 1,700 companies will become subject to the new section 172 statement and supplier and customer relations statements, with around 9,900 being subject to the employee engagement statement. The Government has said that this relatively small number of companies is a starting point and that the regime may be adapted or expanded in the future. In the meantime, government statements and the Wates Report envisage that companies currently not required to adopt a corporate governance code under the Regulations may still choose to adopt the Wates Principles voluntarily, as an aspirational best practice model for corporate governance.
Companies subject to the new reporting requirements should start preparing now, if they have not already done so, for the first actual reporting under the new Regulations in 2020. For companies that do not already have these in place, systems and processes will need to be established for the initiation, capture and recording of company policies and board practices that will enable the company to comply with the new reporting requirements. The Wates Principles will provide a framework for this for some companies; others will have recourse to other corporate governance codes and guidance as flagged above.