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A new corporate governance code ‘fit for the future’

  • United Kingdom
  • Employment law

17-07-2018

Following feedback on consultation, the Financial Reporting Council (FRC) has published the 2018 UK Corporate Governance Code (the Code) which will replace the 2016 UK Corporate Governance Code for accounting periods beginning on or after 1 January 2019. The Code is aimed at companies with a premium listing on the London Stock Exchange. Such companies must meet the UK’s Listing Rules and are expected to meet the highest standards of regulation and corporate governance. The Financial Services and Markets Act 2000 requires public listed companies to disclose how they have complied with the Code.

The revised Code focuses on the application of the Principles in the Code. In the FRC’s own words this is a ‘shorter, sharper Code’ which calls on listed companies to report clearly and meaningfully and to avoid a tick-box approach. The Provisions are intended to establish good practice on a ‘comply or explain’ basis.

Unless companies choose to adopt early, the first ‘comply or explain’ reporting against the revised Code will take place in 2020. Reporting is, however, expected during 2019 against the new Provision requiring a company to explain what consultation will be undertaken where 20% or more votes are cast against a board recommended resolution together with a 6 monthly update and final notes in the company’s next annual report.

The Financial Conduct Authority is reviewing its Handbook to assess whether any consequential amendments are necessary.

The FRC has also published updated and expanded guidance on the Code which should be referred to by boards alongside the Code, although the guidance is not binding.

Corporate Governance Code 2018

Considerable emphasis is placed upon long-term sustainable success and strategy and senior appointments must be made with that in mind.

The main changes from the previous Code are as follows:

Workforce and stakeholders

The Government asked the FRC to consult on a Principle which would establish the importance of engagement with non-shareholders. Most respondents to the consultation agreed with engagement with the workforce .

The Code places emphasis on improving the quality of the board and the company’s relationships with a wider range of stakeholders. Communication with the workforce is often referred to as the ‘employee voice’. Engagement with the workforce should entail encouraging participation and understanding the views of the workforce. This can help to provide useful feedback about business practices. The Code provides that one or a combination of the following methods should be used to engage with the workforce 1:

  • a director appointed from the workforce
  • a formal workplace advisory panel
  • a designated NED

If the board fails to apply one or more of these methods it will need to explain what alternative arrangements are in place and why it considers that they are effective.

The guidance suggests that these are not the only ways of engaging with the workforce and boards may consider a combination of methods or multiple channels at different levels. The guidance sets out examples of workforce engagement activities.

The Code also asks boards to describe how they have considered the interests of stakeholders when performing their duties under section 172 Companies Act 2006 2 .

Culture

Boards are asked under the Code to create a culture that aligns company values with strategy and to assess how they preserve value over the long term. For example, executive pay and decisions about recruitment and succession planning will need to reflect these factors in the company’s annual reports. In addition, the board should assess and monitor culture and, where it considers that policy, practices or behaviour are not aligned with the company’s purpose, values or strategy, it should ensure that corrective action is taken.

The board should include an appropriate combination of executive and non-executive (and in particular independent non-executive) directors to avoid a small group or sole person dominating decision-making.

Succession and diversity

The Code emphasises the need to refresh the composition of boards and undertake succession planning for boards and senior management 3 , issues which should be evaluated annually.

Appointments and succession plans should be based on merit and objective criteria and should promote diversity of gender, social and ethnic backgrounds, cognitive and personal strengths.

The annual report should include a report on the company’s policy on diversity and inclusion; how it links to company strategy; how it has been implemented; and how it has or will influence board composition. It must also contain the gender balance of those in the senior management and their direct reports. This may lead to duplication in annual reports but the FRC considers that consistency in the way that this is reported will provide meaningful data which can be tracked over time to help companies assess whether attempts to improve gender equality are succeeding.

Independence and chair’s tenure

The revised Code does not adopt some of the more controversial proposals regarding independence following feedback during consultation. The proposed Provisions for the chair to remain independent throughout appointment and serve for no longer than 9 years have been watered down. The revised Code largely reverts to the 2016 Code maintaining discretion for the board to judge whether any non-executive is independent and requires the board to consider whether chair is independent on appointment only . The previous exemption for smaller companies from the requirement that at least half the board (excluding the chair) be regarded as independent is, however, removed.

The question of the chair’s tenure is moved to Guidance and aligned with other non-executive directors. Boards should consider the length of time that chairs remain in post beyond nine years. To facilitate effective succession planning and the development of a diverse board, the nine year limit can be extended for a limited time.

Open advertising and/or an external search consultancy should generally be used for the appointment of a chair and NEDs.

The Code also strengthens the role of the nomination committee on succession planning and establishing a diverse board. A majority of members of the committee should be independent NEDs.

Separately, the guidance encourages boards and their committees to think about how the gender pay gap is being addressed.

Remuneration

The Government asked the FRC to consult on giving remuneration committees a broader responsibility for overseeing pay and incentives and requiring them to engage with the workforce to explain how executive remuneration aligns with wider company pay policy (using pay ratios where appropriate).

The Code emphasises that the remuneration committee should review workforce remuneration 4 and related policies and the alignment of incentives and rewards with culture, taking these into account when setting the policy for executive director remuneration. In the context of pay also, the Code emphasises the need for decisions to be linked to successful delivery of company long term strategy. The guidance provides that the remuneration committee should be able to explain to the workforce how decisions on executive pay reflect wider company pay policy.

Formulaic calculations of performance related pay should be rejected and remuneration committees should apply discretion when the resulting outcome is not justified, taking into account company and individual performance and wider circumstances. Firms need to ensure that employment documentation and scheme rules empower them to apply such discretion. Remuneration schemes and policies should include provisions enabling the company to recover and/or withhold sums or share awards (malus and clawback) and specify the circumstances in which it would be appropriate to do so.

Large private companies

Meanwhile, the FRC is also consulting over draft Principles and supporting guidance on corporate governance principles for large private companies (consultation closes 7 September 2018). These principles are known as the Wates Corporate Governance principles as they have been developed by a coalition of organisations chaired by James Wates. Large private companies will be encouraged to follow six high level principles (accompanied by guidance) to inform their corporate governance practices and to adopt them on an ‘apply and explain’ basis.

Companies (Miscellaneous Reporting) Regulations 2018

The Wates consultation sits alongside the draft Companies (Miscellaneous Reporting) Regulations 2018 which were laid in Parliament in June which provide for a new corporate governance reporting requirement for firms (private as well as public) who satisfy either or both of the following conditions:

  • more than 2000 employees;
  • a turnover of more than £200 million and a balance sheet of more than £2 billion

This secondary legislation requires such companies to explain how their directors comply with requirements of section 172.

This reporting requirement will apply to financial years beginning 1 January 2019 with reporting to start in 2020. The regulations include a new requirement to report on the CEO-to-employee pay ratio.

Read the new Code

Read the guidance to the Code

1. The guidance provides a description of ‘workforce’ for the purpose of engagement (para 50). The guidance suggests that boards include individuals engaged under contracts of service, agency workers and remote workers
2. The Companies (Miscellaneous Reporting) Regulations 2018 require directors to explain how they have regard to various matters in performing their duty to promote the success of the company in section 172
3. ‘senior management’ for this purpose is the executive committee or the first layer of management below board level, including the company secretary
4. a definition of ‘workforce’ for remuneration purposes is contained in the guidance (paras 130, 131) and includes persons engaged under an employment contract or a contract or other arrangement to do work or provide services personally

 

 

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