When the Financial Reporting Council (“FRC”) submitted a draft version of its new UK Corporate Governance Code for consultation in December 2017, they were so inundated with responses (275 individual responses and far in excess of previous consultation exercises) that the release date of the New Code was pushed back from mid-June to mid-July.
That set the tone for what has been a rollercoaster year so far. The collapse of Carillion in January lead to a joint inquiry by two select committees which surmised that the FRC was “chronically passive” when it comes to influencing corporate behaviour. Subsequently, in April, the UK government announced a “root and branch review” of the FRC, particularly its “governance, impact and powers, to help ensure it is fit for the future.” Add to this an increased number of audit reporting investigations (Carillion, Conviviality & SIG), and the new Stewardship Code consultation which is fast approaching, and it is fair to say that the FRC has been kept occupied.
The much-anticipated New Code, released July 16, 2018, is described as shorter and sharper, having been designed to promote “clear, meaningful reporting”. In the highlights document, released as an appendix, the FRC states that the New Code “broadens the definition of governance and emphasises the importance of:
- Positive relationships between companies, shareholders and stakeholders.
- A clear purpose and strategy aligned with healthy corporate culture.
- High quality board composition and a focus on diversity.
- Remuneration which is proportionate and supports long-term success.”
The major changes, other than the clear structural differences (fewer provisions and the removal of “supporting principles”), largely mirror the calls made by Theresa May and the Green Paper in the two preceding years, with the spotlight firmly trained on corporate culture, stakeholder engagement and board composition. The section covering remuneration, ever the lightning-rod for public malcontent, has been revamped too.
Under the Board Leadership and Company Purpose section, the board will be required to outline company culture, and to report on how they have discharged their duties under s172 of the 2006 Companies Act; namely stakeholder engagement (both internal and external) and the adoption of a formalised employee relations mechanism (employee director, formal advisory panel, designated NED or a fully explained alternative). In line with the Public Register maintained by the Investment Association, this section of the New Code also mandates immediate responses to shareholder dissent in excess of 20% with periodic updates at 6 months and in the subsequent annual report detailing the impact of feedback received on how the board has responded.
One mooted, and heavily-debated, proposed change that was amended post-consultation is the consideration of chair independence. Historically, UK chairs have been treated differently from other directors – while prior versions recommended that they be independent prior to appointment, the Code has also recognised that, following appointment, the unique responsibilities of the role make traditional independence tests inappropriate. In the original iteration, the chair had been included for the first time in the general NED independence section. This has been amended in the final version to maintain the prior language, and to read that a chair should not serve for longer than nine years save for the facilitation of board succession and board diversity. The New Code is also softer in its approach to NED independence than originally proposed, providing more accommodation for unusual situations; the language has changed from “should not be considered independent” to “circumstances which are likely to impair, or could appear to impair” independence.
In terms of the role of the remuneration committee, the New Code expands the remit and expectations of the committee to include taking account of workforce remuneration and policies in setting policies for the executive directors. Further, the New Code sets the expectation that remuneration committees “exercise independent judgement and discretion” when signing off on remuneration outcomes. In terms of tackling the alignment of executive interests, the New Code advocates for long-term incentive plans to be “subject to a total vesting and holding period of five years or more”.
The announcement of the New Code references the desire to move away from a tick-box approach to comply or explain, and the FRC has called on investors and proxy advisors alike to pay due regard to a company’s individual circumstances when evaluating company performance. The New Code will apply to those issuers with reporting periods beginning on or after January 1, 2019 and, as such, it will be 2020 AGM season before we see the implications of its content.
Natasha is a manager covering the UK market.