The UK Corporate Governance Code 2018: avoiding failure, fraud and scandal

A rise in anti-globalisation and anti-business sentiment in the years following the financial crisis and apparent corporate governance failings in companies such as Steinhoff International, Carillion, Patisserie Valerie and BHS have forced the government to address these issues by introducing a new Corporate Governance Code 2018 (the Code).

Aims

The new Code will apply to accounting periods beginning on or after 1 January 2019. This means that the first reporting by reference to the Code will generally be seen in 2020, although some companies may choose to adopt the Code earlier.

In drafting the Code, the Financial Reporting Council’s (FRC) aim has been to improve corporate governance practice, stimulate constructive challenge in the boardroom and improve governance reporting. There is also an emphasis on the importance of corporate culture and diversity, the need for companies to engage with all their key stakeholders (including their workforce) and the requirement for executive remuneration and workforce policies to be aligned with the company’s strategy and values.

Key changes for companies to consider

Workforce and stakeholder

The new Code expects boards to understand the views of the company’s key stakeholders and to describe in their annual report how the stakeholder’s interests and the duties set out in section 172 Companies Act 2006 (duty to promote the success of the company) have been considered in board discussions and in their decision making process. The Companies (Miscellaneous Reporting) Regulations 2018 now require certain (larger) companies to include s172 Statements in their annual reports.

Significant shareholder dissent at General Meetings

The Code sets out how companies are expected to respond when 20% or more of shareholder votes are cast against the board recommendation for a resolution. In these circumstances, companies will be expected to consult shareholders in order to understand the reasons behind the result.

Chair limited to tenure of nine years

There is a new recommendation that the Chair of a company should not remain in post for more than nine years. Whilst some flexibility is allowed, companies may need to review their board composition and succession planning as a result.

Directors’ commitments

There have been concerns in recent years that non-executives are holding too many directorships, limiting their ability to derive sufficient time to the initial role of an independent voice. As a result, the FRC is encouraging caution when taking on new appointments and they have recommended that directors should seek prior board approval before taken on a new commitment.

Remuneration committee

The Investment Association’s Public Register of shareholders shows that pay-related issues topped the list of shareholder concerns. As such, to address public concern over executive remuneration, the Code now recommends that remuneration committees should take into account workforce remuneration and related policies when setting the remuneration policy for the executive directors.

Audit, risk and control

The Code also focuses on the audit committee’s role and relationship with the external auditor which is likely to be a response to the recent scandals involving the ‘Big Four’ accountancy firms. In view of this, the Code introduces a requirement for companies to carry out a full assessment of emerging risks, explain what procedures are in place to identify the emerging risk and explain how these are being managed or mitigated.

Compliance/one size does not fit all

Compliance with the provisions of the Code is voluntary, but the Code operates on a “comply or explain” basis and companies are encouraged to avoid a “tick-box approach” i.e. boilerplate reporting will not be acceptable. Indeed, the FRC recognises that companies may be able to justify different ways of complying with a specific provision based on a range of factors, including the size, complexity, history and ownership structure of a company.

Comment

It is difficult to predict if there will be an increase in claims against directors in the near future as a result of the new Code but the FRC is hoping to encourage shareholders to take a more proactive and vocal approach challenging governance decisions going forward and bringing directors to account if needed.

Read other items in Professions and Financial Lines Brief - March 2019