On May 24, 2023, the Financial Reporting Council (the “FRC”) released a public Consultation Document on its proposed revision to the UK Corporate Governance Code (the “Code”).

Last updated in 2018, the revised Code aims to enhance the Code’s effectiveness in promoting good corporate governance by:

  • Improving the functioning of comply-or-explain by taking into account of recently published FRC research and reports;
  • Making revisions to reflect the responsibilities of the board and audit committee for sustainability and ESG reporting, and associated assurance in accordance with a company’s audit and assurance policy;
  • Setting out a revised framework of prudent and effective controls to provide a stronger basis for reporting on, and evidencing their effectiveness; and
  • Updating the Code to ensure that it aligns with changes to legal and regulatory requirements as set out in the Government’s response to the White Paper, including strengthening reporting on malus and clawback arrangements.

Glass Lewis reviewed the FRC’s proposed updates and issued a response. This blog post provides a summary of the key points of the consultation, along with our position on the proposed alterations.

Board Leadership & Company Purpose

The proposed revisions to Section 1 of the Code are aimed at delivering effective outcome-based reporting. The consultation also asks whether stakeholders believe climate ambitions should be reported in the context of strategy, as well as the surrounding governance.

We expect that the proposed changes will likely encourage outcome-oriented disclosure, however, absent a reporting template or guidance, we consider it is too early to comment on the extent to which the changes will lead to more meaningful outcome-based reporting. Further, while we agree that boards should report on climate ambitions and transition planning in the context of its strategy, we caution against the decision to remove the reference to ‘governance’ from Provision 1, which may work contrary to encouraging such TCFD-aligned best-practices reporting on climate-related issues in the context of governance.

Division of Responsibilities

The amendments to Section 2 are aimed at improving reporting on directors’ external commitments. It is proposed that annual board performance reviews consider each director’s commitments to other organisations, and how directors are able to make sufficient time available to discharge their role effectively. Further, an update to Provision 15 would require that companies include more information on directors’ other commitments and how they manage these.

Glass Lewis welcomes the proposed changes, which may contribute to more comprehensive discussion of directors’ time commitments. Further, narrative discussion of additional mandates can supplement bare quantitative data and guide more informed decisions.

However, we suggest that Provision 15 should also be amended to recommend that – annually as part of the board’s performance review rather than only prior to new appointments — the board “take into account other demands on directors’ time” and “significant commitments should be disclosed with an indication of the time involved”.

Composition, Succession and Evaluation

Section 3 is primarily concerned with board performance reviews, succession planning and diversity reporting.

One of the proposed changes to this section is an expansion of the definition of diversity to include all protected characteristics and nonprotected characteristics. Glass Lewis welcomes this approach, which also accounts for cognitive and personal strengths; however, we caution against the proposal to remove references to “gender” and “ethnicity” from Principle I. Given current emphasis on reporting against the diversity targets set out by the FCA’s revised Listing Rules, FTSE Women Leaders Review, and the Parker Review, it might be premature to remove explicit reference to gender and ethnic diversity from Provision 24.

Audit, Risk, and Internal Control

Glass Lewis supports the proposed alterations to Section 4, which are primarily aimed at enhancing reporting by boards regarding the effectiveness of risk and internal control. Requiring Code companies to prepare an Audit and Assurance Policy on a ‘comply or explain’ will likely promote director accountability and provide stakeholders with a deeper understanding of a company’s risk management and internal control systems.

Changes to this Section also include an expansion of the remit of audit committees to include narrative reporting in relation to sustainability and ESG issues, where such matters are not reserved for the board. While Glass Lewis believes that companies should generally determine the most suitable structure for overseeing material environmental and social issues, we recognise that audit committees can play a vital role in bridging the gap between financial and ESG disclosures, potentially resulting in more thorough and consistent reporting. The successful broadening of the responsibilities of the audit committee is also dependent on the extent to which these additional tasks can be effectively managed by the committee, which in turn, is contingent on the presence of directors possessing the requisite skills, experience, or training on ESG-related matters.

Remuneration

The proposed changes to Section 5 of the Code aim to strengthen the links between companies’ remuneration policies and corporate performance, including ESG objectives. In addition, the FRC proposes greater transparency around companies’ malus and clawback arrangements. Further, Section 5 seeks stakeholder opinion on whether the reference to pay gaps and pay ratios should be removed or strengthened.

Glass Lewis concludes that the proposed revisions to Section 5 of the Code strengthen the links between remuneration policy and corporate performance. Further, we agree that the proposed reporting changes around malus and clawback will result in an improvement in transparency.

The gender pay gap and CEO pay ratio data remain important lenses through which executive pay may be viewed. We recognise that extant regulations, outside the Code, require disclosure of, and narrative reporting regarding, CEO pay ratios in a company’s annual report. This narrative reporting is, however, often boilerplate. The Code may be positioned to build on, rather than duplicate, this disclosure by encouraging more meaningful, or outcomes-based, disclosure in this regard, which may contextualise year-on-year movements in remuneration.

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The consultation closed on September 13, 2023. Glass Lewis submitted its response as an interested industry advisor and not on behalf of any of its clients. Further, Glass Lewis’s review was solely focused on the proposed amendments and was limited to the consultation questions.

Read our full response to the UK Corporate Governance Code Consultation here.

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