Essential Corporate News – Week ending December 2, 2022

FRC: Competition in the audit market – Policy paper

On December 1, 2022 the Financial Reporting Council (FRC) published a policy paper which gives an overview of the FRC’s approach to competition in the audit market. It also covers recent developments with competition in the audit market and the FRC’s current competition policy work. 

The FRC has produced the policy paper in light of the publication of the Government Response to the consultation on strengthening the UK’s audit, corporate reporting and corporate governance systems in May 2022. The policy paper follows on from the FRC’s position paper, in July 2022, which set how the FRC will support the Government’s reforms as it transition’s into the Audit, Reporting and Governance Authority (ARGA). The July position paper gave details of the development of a minimum standard for Audit Committees (published for consultation in November 2022) and also set out that the FRC would publish a paper setting out its approach in respect of the Government’s reforms relating to competition more broadly, and the work the FRC is doing ahead of legislation.

The policy paper covers the following:

The FRC’s approach to competition in the audit market

The FRC seeks a well-functioning audit market, being one that consistently delivers high quality audit and is resilient. 

The FRC’s approach to competition is broader in focus than the audits of the UK’s largest listed companies (the FTSE 350 audit market). Its remit covers the public interest entity (PIE) audit market as a whole and the FRC wants the entire market for audit to consistently deliver high quality audits and be resilient and to be well-functioning. However, the FRC also recognises that its approach to competition needs to take account of differences across the market and that it may take time to realise significant change in the UK audit market, especially in respect of the FTSE 350 audit market.

Recent developments with competition in the audit market 

The policy paper includes a brief snapshot of some key indicators relating to market dynamics and competition. The FRC notes that in broad terms, the recent developments in the audit market suggest no significant improvements with competition in the audit market since the Competition and Markets Authority’s (CMA) audit market study in 2018/19. While some FTSE 350 companies have switched to hiring non-Big Four firms in recent years, this is in relatively low numbers and is not yet a sustained trend. There remains high concentration among four audit firms, resulting in limited choice and ongoing concerns about resilience. 

The FRC states that improving competition in the audit market will require a range of actions. The route to increasing choice will require challenger firms to continue developing their capacity and capability to deliver high quality audits, and for these firms to have greater opportunity to deliver more audit work, especially for FTSE 350 companies. Alongside greater choice, there will need to be a sufficient focus on audit quality by all market participants, on both the demand and supply sides. These developments, combined with regulation and regulatory activities, should ensure a well-functioning audit market that consistently delivers high quality audits and is resilient.

The FRC’s current work on competition in the audit market

The FRC notes that it continues to work closely with the Government (particularly BEIS) on the legislation required for the competition policy measures but it is also seeking to advance all these proposals ahead of the creation of ARGA, where possible in the context of its existing powers and other priorities and work. The policy paper sets out particular activities being pursued. 

(FRC, Competition in the audit market – A policy paper, 01.12.2022)

ISS: UK Proxy Voting Guidelines – Benchmark policy changes for 2023

On December 1, 2022 ISS published its policy updates setting out changes to its UK Proxy Voting Guidelines. These changes will be effective for company meetings held on or after February 1, 2023.

Key changes to the 2022 UK Proxy Voting Guidelines are as follows:

Board diversity - gender

For standard and premium listed companies, ISS may consider recommending against the chair of the nomination committee (or other directors on a case-by-case basis) if the company has not met the reporting requirements of the FCA’s Listing Rules, which require boards to meet the following targets:

• At least 40% of the board are women; and
• At least one of the senior board positions (Chair, CEO, Senior Independent Director or CFO) is a woman. 

In respect of ISEQ 20 constituents and AIM-listed companies with a market capitalisation of over £500 million, ISS will generally recommend against the chair of the nomination committee (or other directors on a case-by-case basis) if there is not at least one woman on the board.

Mitigating factors include: 

• Compliance with the relevant board diversity standard at the preceding AGM and a firm commitment, publicly available, to comply with the relevant standard within a year. 
• Other relevant factors as applicable. 

Board diversity – ethnicity

For companies with financial years beginning on or after April 1, 2022, the following guideline will apply: 

For standard and premium listed companies, ISS may consider recommending against the chair of the nomination committee (or other directors on a case-by-case basis) if the company has not met the relevant reporting requirement of the FCA’s Listing Rules, which require boards to confirm that at least one member of the board is from a minority ethnic background. Mitigating factors include those set out above. 

In respect of ISEQ 20 constituents and AIM-listed companies with a market capitalisation of over £500 million, ISS will generally recommend against the chair of the nomination committee (or other directors on a case-by-case basis) if such companies have not appointed at least one individual from an ethnic minority background to the board by 2024. 

Climate accountability

For 2023, high emitting companies will continue to be identified as those in the Climate Action 100+ Focus Group. ISS is extending globally its policy on climate board accountability first announced last year and introduced in selected markets for 2022, and is updating the factors considered under the policy as follows: In cases where a relevant company is not considered to be adequately disclosing climate risk disclosure information, such as according to the Task Force on Climate related Financial Disclosures (TCFD), and does not have either medium-term GHG emission reductions targets or Net Zero-by-2050 GHG reduction targets for at least a company’s operations (Scope 1) and electricity use (Scope 2), ISS policy will generally be to recommend voting against what it considers to be the appropriate director(s) and/or other voting items available. Emission reduction targets should also cover the vast majority (95%) of the company’s operational (Scope 1 & 2) emissions. 

For 2023, ISS will apply the same analysis framework for all Climate Action 100+ Focus Group companies globally but with differentiated implementation of any negative vote recommendations depending on relevant market and company factors (for example, voting item availability). 

Audit Committee/Frequency of Audit Committee Meetings

For FTSE 350 companies, ISS will note where four or fewer audit committee meetings have been held during the reporting period. For FTSE All-Share companies, excluding investment companies, ISS will draw attention to cases where three meetings, or fewer, of the Audit Committee have been held. This recognises the importance and complexity of the Audit Committee’s role, and the likely increased focus on Audit Committee oversight of the external auditor.

Remuneration report – Base salaries, benefits and pensions

ISS notes that there is a concern that part of the current wording of the ISS UK (and Ireland) policy on remuneration may be misunderstood as encouraging companies to increase directors' base salaries proportionally in line with increases made to the wider company workforce. Adopting such a pattern would lead to a widening of the gap between total opportunity available to executives compared to that of the average employee. The policy language has been changed to clarify that keeping directors' annual salary increases low and ideally lower proportionally than general increases across the broader workforce is considered to be good market practice.

Authorise issue of equity with and without pre-emptive rights

In light of the updated Pre-Emption Group’s Statement of Principles (November 2022), ISS has updated its guidelines to reflect the revisions to the Statement of Principles. The revised guidelines on disapplication authorities will also apply to smaller companies