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Corporate Governance update: FRC report on implementation of the UK Corporate Governance and Stewardship Codes 2014
The Financial Reporting Council (the FRC), the independent regulator responsible for promoting high quality corporate governance and reporting to foster investment, has published a report on developments in corporate governance during 2014.
Listed companies are required under the Financial Conduct Authority Listing Rules either to comply with the UK Corporate Governance Code (the Code), published by the FRC, or to explain to investors in their next annual report why they have not done so. In turn, investors are encouraged to commit to the principles of the UK Stewardship Code, also published by the FRC, which sets the standards for investors for monitoring and engaging with the companies they own and aims to improve the quality of dialogue between investors and companies. Whilst only listed companies are required to “comply or explain” with the Code, we increasingly see unlisted companies turning to the Code for guidance to ensure that they are adopting the highest standards of corporate governance, which in turn promotes the company’s long-term performance and makes the company attractive to new investment. Companies that are aiming to list should also improve their standards of corporate governance in advance of their flotation.
The FRC’s “Developments in Corporate Governance and Stewardship 2014,” (the FRC Report) published in January 2015, gives an assessment of corporate governance and stewardship in the UK and indicates to the market where the FRC would like to see changes in governance behaviour or reporting. The FRC Report focussed on the following areas in relation to corporate governance and the Code:
- Overall compliance rates
Overall, the FRC believe rates of compliance to be very high among companies of all sizes. Furthermore, data compiled on behalf of the FRC shows that, in respect of board and committee composition, compliance levels among companies on the FTSE Small Cap and Fledgling indices are generally consistent with those of larger companies.
- Board composition and evaluation
In 2010, provision B.6.2 of the Code was introduced stating that board evaluation of FTSE 350 companies should be externally facilitated at least every three years. According to data gathered on behalf of the FRC, nearly 40% of companies carried out such a review in 2014.
- Succession planning and the appointment process
The FRC’s project on succession planning is aimed at identifying and increasing good practice, and more specifically, at how the nomination committee can play its role effectively. The FRC believes that, unless boards are planning over the medium- to long-term, for both executive and non-executive positions, they will struggle to ensure that there is the right mix of skills and experience needed as the company evolves. The FRC’s intention is to publish a discussion paper in early 2015 which will include preliminary findings from a planned consultation and request views on these.
The FRC highlights that board diversity is significantly improved in relation to FTSE 100 companies, but smaller companies are lagging behind. In particular, 85% of FTSE 100 companies have published a clear diversity policy but this drops to 56% for FTSE 101 – 201 companies. The FRC considers that this remains an area where more improvement is required.
- Audit committee reporting and tendering
Changes to the Code in 2012 introduced requirements for audit committees to provide more detail on the work they do, including descriptions of the significant issues considered by the audit committee in relation to financial statements, how the audit committee assessed the effectiveness of the external audit process, and their approach to appointing the auditor and safeguarding objectivity and independence relative to the use of non-audit services. The FRC are encouraged by the fact that approximately two-thirds of audit committees now provide a good or detailed discussion of significant accounting issues in their Annual Report. The Code also added a recommendation that FTSE 350 companies should put their external audit contract out to tender at least every ten years – the FRC noted that 27 FTSE 350 companies reported in their 2013-14 annual report that they had carried out an audit tender, with 19 of those companies changing auditors as a result. The FRC considers it useful to disclose information regarding the timeline of past and future tendering, in addition to the name and tenure of both the audit firm and partner.
- Election of directors
Provisions B.7.1 and B.7.2 of the Code detail the information that should accompany the resolutions for the election of directors. This includes, in the case of non-executive directors, the reason why the company believes the individual should be elected. The FRC thought that companies should set out clearly how individual directors contribute to the effectiveness of the board as a whole, which is helpful to investors since it provides for better informed voting decisions.
- Fair, balanced and understandable
Following the 2012 update to the Code, boards were asked to confirm that the company’s annual report and accounts taken as a whole were fair, balanced and understandable. One desired outcome is that the narrative sections of the report are a more accurate reflection of the company’s position, performance and prospects. The Grant Thornton review of all FTSE 350 annual reports highlighted that disclosures range from a substantive testing of narrative and non-statutory information to a “sense checking” approach. Two-thirds of companies gave little or no justification to support their “fair, balanced and understandable” assertion – and it is of concern to the FRC that nearly 10% of companies made no comments at all.
Following the implementation of the Government’s new disclosure and voting requirements for directors’ remuneration in 2014, the Code was revised to include certain new provisions, including reference to designing remuneration to promote the long-term success of the company and recommending that companies put in place provisions to recover and/or withhold remuneration when appropriate. The FRC stated that Deloitte reported that for the FTSE 100 and FTSE 250, 90% and just over 80% respectively already had some form of these provisions in place.
The FRC regards the following as key issues for consideration by companies and investors in 2015:
- the importance of good corporate culture and embedding sound governance behaviours throughout companies;
- board composition and ensuring suitable succession planning is in place;
- effective board evaluation and reporting;
- active engagement between boards and investors and improved reporting in this area;
- early consideration of the new viability statement;
- maintaining effective risk management and internal controls;
- focussing on the quality of explanations under both Codes; and
- committing to clear and concise reporting.
The full FRC Report can be read here: https://www.frc.org.uk/Our-Work/Publications/Corporate-Governance/Developments-in-Corporate-Governance-and-Stewardsh.pdf
For more information, please contact Pippa dos Santos, Corporate Associate