Changes to the UK Corporate Governance Code
Background
Earlier this year, the UK Financial Reporting Council (FRC) published a consultation paper on proposed changes to the 2018 UK Corporate Governance Code.
The consultation follows the UK Government response to the ‘White Paper’ entitled Restoring Trust in Audit and Corporate Governance, which highlighted areas of the Code that could be enhanced.
Responses to the Consultation have been requested by 13 September 2023.
The primary purpose behind the changes is a clear desire from the FRC to improve the quality and relevance of reporting from companies; more generally and in response to the UK Government’s response to the White Paper.
What should you do?
If you are a director of a company listed on the London Stock Exchange, and which complies with the Code; you should make sure that your board has reviewed the consultation and, if appropriate, provides feedback – directly or through your advisers.
Equally, you should consider what provisions of the Code might present challenges or opportunities to your business so that you can be on the front foot ahead of the Code’s implementation from 2025 onward. Time flies!
If you are an administrator, company secretary, adviser or similar, to such a company then you should be engaged with the board to ensure they are adequately supported through the changes to the Code.
What are the Changes to the UK Corporate Governance Code?
The FRC has not proposed changes to the structure of the Code; which has been welcomed as the Code sets a high standard for its ease of use and understandability through its five sections split between Principles (things which companies must comply with) and Provisions (things that companies should comply with or explain why they do not).
The ‘comply or explain’ nature of the Code signifies an understanding that the Code is not a one-size fits all approach and allows companies to have the flexibility to adopt and adapt the Code to suit their nature, scale and complexity. However, if a company deviates from a Provision, it is imperative that their explanation is clear, sufficiently detailed, and appropriate.
Whilst the structure of the Code and its beloved ‘comply or explain’ methodology has not changed; the FRC has proposed changes within each of the five sections of the Code.
Some of the key changes are:
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When reporting on governance activity the board should focus on outcomes to demonstrate the impact of those practices and how the Code has been applied
The FRC has placed additional emphasis on the importance of explaining how companies have applied the Code, in an effort to address its ongoing concerns about quality of governance reporting.
These changes will introduce requirements that the board explain how certain ESG-related matters are taken into account through the strategy of the company.
Although these changes don’t materially change the existing expectations under the Code, they do increase the emphasis of better reporting on governance and more broadly in respect of a director’s duty to ‘promote the success of a company’ – through mention of culture for example.
It will be interesting to see what changes companies make to their reporting in an effort to continue to comply – and to meet the expectations of institutional investors who are most likely to apply pressure to the quality of this reporting.
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Additional duties for the Audit Committee to develop, implement and maintain the company’s audit and assurance policy (AAP) and to oversee ESG reporting
The revisions to the Code have included several incidental changes to the description of the role of the Audit Committee, which are expected, and the most material is possibly the duty to develop, implement and maintain the AAP of the company.
Secondary legislation is yet to be published which will set out the statutory requirements for an AAP; the FRC has helpfully provided a summary of the proposals from the UK Government in the meantime.
It is envisaged that the Code will follow the statutory regime, when introduced, however the proposed changes to the Code intend that all companies should publish an AAP – rather than only applying to companies which meet the definition of a ‘Public Interest Entity’ (PIE). We all love a good PIE.
The challenge here is how companies who adopt the Code, and which might not necessarily meet the definition of a PIE, will comply or, more likely, explain why they do not comply. Additionally, the proposed changes place oversight of narrative reporting on sustainability and assurance of the various ESG metrics with the Audit Committee. The Board will remain ultimately responsible, however this change in duty may improve the review and scrutiny of that reporting – and its quality.
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The board will need to make an annual declaration that the company’s risk management and internal control systems have been effective throughout the respective reporting period
These changes result from the concept that the company directors must be required to ‘assess and report annually on the effectiveness of their company’s internal control structure and financial reporting procedures’ as part of the response from UK Government to the White Paper.
The proposed changes imply that the annual declaration will need to include detailed narrative reporting beyond financial reporting – such as a description of material weaknesses or failures, and remedial action taken or proposed.
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Remuneration outcomes should be clearly aligned to company performance, purpose and values, and the successful delivery of the company’s long-term strategy including environmental, social and governance objectives
A host of changes are proposed to Section 5 which reflect a desire to improve the link between remuneration and long-term strategy, particularly for executive directors, and warrant review in much more detail.
These changes broadly involve:
- Principles regarding executive remuneration have been amended to clarify that remuneration arrangements should be aligned to the delivery of long-term strategy and to ‘performance, purpose and values’ – which implies some consideration of ESG-related matters when setting remuneration.
- Companies must report in their annual report on remuneration details of any ‘malus and clawback provisions’ as well as the application or use of those provisions in the prior year and prior five years.
- Provision 40 will be removed; which establishes six factors to consider when determining executive remuneration. It is likely this has been removed to avoid circumstances where these factors are used as ‘boilerplate’ - so as to encourage proper thought to the disclosures or arrangements. Therefore, determining what factors are pertinent would likely rest with the remuneration committee and allow for more flexibility in reporting.
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The board will need to disclose all significant director appointments in the annual report and explain how each director has sufficient time to undertake their role (to the company) effectively
An addition to Provision 15 of the Code will require disclosure in the annual report of all other significant appointments held by the directors of the company, along with an explanation of how those directors continue to have sufficient time to meet their commitments to the company. Helpfully, the FRC has not introduced an upper limit on the number of other commitments that a director may have.
Further changes also require the annual performance review to consider whether a director’s commitments outside the company remain appropriate in the context of the time commitment expected of the director.
Over-boarding has been an area of focus for many years, especially by proxy advisors who are likely to increase pressure on companies through voting recommendations to shareholders. This is often a challenge for non-UK issuers from smaller overseas jurisdictions which are listed on the LSE, such as Guernsey or Jersey, where the available pool of directors for listed companies is significantly smaller than compared to the UK – and thus leads to claims of over-boarding and, potentially, impacting resolutions to appoint directors.
While the obligation presented appears relatively straightforward, it will be a challenging area in which to provide adequate explanation to the extent that it might satisfy the expectations of stakeholders.
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Board appointments and succession plans should promote equal opportunity, diversity and inclusion
The proposed changes to Section 3 of the Code aim to further integrate diversity and inclusion initiatives, updating the wording with more modern terminology.
The updated Principles reflect an emphasis on concepts of inclusion of ‘protected and non-protected characteristics’ within the process for succession planning and nomination; instead of somewhat outdated descriptions of ‘gender, social and ethnic backgrounds’.
Boards will continue to be encouraged to also consider neurodiversity and emotional intelligence in succession and nomination decisions as references to ‘cognitive and personal strengths’ will not be removed from the Code.
What’s next?
The FRC has proposed that the revised Code will apply to accounting years beginning on or after 1 January 2025.
Boards will need to ensure that they are primed to address the changes to the Code in good time and ahead of their first reporting period under the revised Code.
Following implementation of the updated Code, the FRC intends to update several other enactments to align with, amongst other things, the revised Code, including:
- the Guidance on Audit Committees
- the Guidance on Board Effectiveness; and
- the Guidance on Risk Management, Internal Control and Related Financial and Business Reporting
FRC Becomes the Audit, Reporting and Governance Authority
Don’t forget that the FRC will (soon?) become the Audit, Reporting and Governance Authority (ARGA). ARGA will then become the regulator who is responsible for the revised Code. The FRC will transition to ARGA once the necessary legislation is in place – originally anticipated for 2020 and then delayed to this year; the timeframe has now been pushed back to 2024.
How Can We Help?
At Horsepool Consulting, we have a broad range of risk, governance and compliance solutions. We would be happy to discuss the proposed changes to the Code in further detail and consider how we may be of assistance. We can provide an independent assessment, aide in the establishment of improved controls, procedures or policies and assist you or your advisers with continued compliance.
Let us know what you thought about this article or if we can be of any assistance by saying hello@horsepool.gg.