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Revisions to UK corporate governance code welcomed by experts

The UK Financial Reporting Council (FRC) has published changes to the UK corporate governance code to bring it up to date and promote continued improvement in the quality of governance.05 Dec 2017

The revisions (31-page / 923KB PDF) focus on issues such as diversity in the boardroom, engagement with stakeholders and executive pay, and follow an announcement of a wide-ranging package of corporate governance reforms earlier this year.

The proposed changes make the code “shorter and sharper” than its previous iteration with supporting principles removed and either incorporated into new principles and provisions, or moved to guidance on board effectiveness. The revisions put a new focus on stakeholders, integrity and corporate culture and the contribution of a company's governance to its overall success.

Corporate governance expert Tom Garbett of Pinsent Masons, the law firm behind Out-Law.com, said the FRC had shifted the code's emphasis to desired outcomes rather than compliance with process.

“The focus is now on progression towards a particular position and any accompanying explanation, rather than a simple assertion that a company complies,” Garbett said.

The revised code is divided into five sections: leadership and purpose; division of responsibilities; composition, succession and evaluation; audit, risk and internal control; and remuneration. The code also emphasises the importance of applying the principles it contains, and relating these to the outcomes achieved by a company.

“The proposed changes emphasise the need for boards to set the tone from the top. The proposals encourage and in some cases require a wider range of stakeholder voices to be heard in the boardroom, most notably from a company's workforce,” Garbett said.

“In addition, creating an appropriate culture, through the establishment of a suitable purpose, strategy and set of values for that company, is a running theme of the revised code. It is clear that the FRC sees diversity and an explicitly recorded culture as important in developing trust and ensuring integrity in the corporation,” Garbett said.

The proposed revisions follow the Hampton-Alexander review and Parker Review on gender and ethnic diversity issues, as well as the government's green paper on corporate governance reform last year.

Changes include a new principle seeking to ensure appointment and succession planning at company management level was designed to promote gender, social and ethnic diversity. Companies will be asked to report specifically on gender balance in the first layer of management below board level, although currently the proposed code will not ask companies to provide ethnic diversity data too.

Remuneration committees are set to be given more responsibility to engage with their workforce over executive pay, and take on a wider remit covering remuneration and workforce policies across the business as a whole.

Incentives expert Lynette Jacobs of Pinsent Masons said the FRC had clearly noted the responses to the government's green paper on issues of employee engagement.

“The incorporation of the government’s three options to ensure that the employee voice is heard in the boardroom - being a director appointed from the workforce, a formal workforce advisory council, or a designated non-executive director - is sensible, allowing a company to choose the mechanism or mechanisms most appropriate to its circumstances,” Jacobs said.

"Response to a Pinsent Masons survey in October on indicated that a majority of companies would choose a combination of a designated non-executive director and an advisory council," said Jacobs. "Of course, the chosen mechanism will only be of any value if a company makes appropriate use of the views expressed.”

The current code exempts companies outside the FTSE 350 from having an independent board evaluation every three years, but the FRC has proposed removing this exemption to encourage the highest standards of corporate governance in smaller companies.

Companies will also have to be more specific about their actions when they encounter significant shareholder opposition of more than 20% of the vote on any resolution, including those on executive pay policies and awards. Boards will be required to undertake effective engagement with wider stakeholders, to improve trust and achieve mutual benefit, and to have regard to wider society.

Jacobs said the requirement for boards to explain their actions in the face of shareholder opposition was a positive step. Companies will also have to publish an update no later than six months after the relevant annual general meeting (AGM) and to provide a final summary in their next annual report, or in the explanatory notes to resolutions at the next AGM, on what impact the feedback has had on the decisions its board has taken and any actions or resolutions now proposed. 

“These further requirements, together with the ability for shareholders to cross-check actions a company has taken in the public register which the Investment Association will be publishing and updating from the end of this year of companies which have withdrawn or received significant votes against any AGM or EGM resolutions should encourage a step change in greater accountability and, company behaviour,” Jacobs said.

The revised Code includes a requirement for remuneration committees to engage with the workforce “to explain how executive remuneration aligns with wider workforce pay policy”. Those committees will also have a broader responsibility to oversee “wider workforce pay policy". The consultation said that the 'wider workforce' includes all those paid to work for the company, such as employees and other workers, agency workers and individual contractors. 

"Remuneration committees could find such engagement and explanation quite difficult at many FTSE companies in many reporting years, even if limited only to employees," said Jacobs. "If the 'wider workforce' could include workers at businesses providing outsourced services it is hard to see how the remuneration committee could effectively engage with such workers, and companies might have concerns about exposing themselves to liability or perceived responsibility for those workers’ terms and conditions."

"This is also something that would be hard to report about, as required by the revised Code, in a “tickbox” or “boilerplate” fashion, given that at least some employees, employee representatives and individual consultants will certainly read the directors’ remuneration report," she said. It will also interact with the new requirement to have a mechanism to enhance “employees’ voice” in the boardroom.”

The consultation on the new code is open until 28 February 2018.