Essential Corporate News – Week ending May 26, 2023

FRC: UK Corporate Governance Code – Consultation

On May 24, 2023 the Financial Reporting Council (FRC) published a consultation paper (Consultation) proposing revisions to the UK Corporate Governance Code (Code). 

The Consultation follows the UK Government's June 2022 response to the White Paper, Restoring Trust in Audit and Corporate Governance, which identified areas of reform relating largely to directors' responsibilities for internal control, risk, audit and corporate reporting. As a result, the Consultation focuses primarily on Code provisions relating to internal control, assurance and resilience, with the main proposed changes being to Section 4 of the Code dealing with the need for a more robust framework of prudent and effective risk management and internal controls. 

The main proposed changes to the Code are as follows:

Section 1 – Board leadership and company purpose

• Principle A is being revised to make it clear that for a company to meet its objectives and measure performance against them, boards need to ensure that as well as having the necessary resources in place to achieve this, the necessary policies and practices should also be in place. 
• A new Principle D has been included which requires boards, when reporting on their governance activity, to focus on activities and outcomes to demonstrate the impact of governance practices and how the Code has been applied.
• Amendments have been made to current Provisions 1 and 2 to bring more focus to environmental and social matters, including climate ambitions and transition planning, and to encourage companies to report on the effectiveness of embedding their culture.
• A new annual reporting requirement for the board chair has been introduced into Provision 3, so the chair must report on the outcomes of the engagement which has taken place with shareholders during the reporting period.

Section 2 – Division of responsibilities

• Given increased investor concern about the number of board positions directors of listed companies hold, the FRC proposes strengthening Provision 15 to require annual reports to include more information on directors’ other commitments and how they manage these. This should include setting out not only board positions but also committee roles and the potential number of commitments each year. A further connected proposal concerns a change to current Code Principle L in Section 3 (see below).

Section 3 – Composition, succession and evaluation

• An amendment to current Principle J (Principle I in the revised Code) is proposed to include a reference to inclusion, and to give equal weight to all protected and non-protected characteristics, to encourage companies to consider diversity beyond gender and ethnicity.
• The FRC suggests a possible change to current Code Principle L (Principle K in the revised Code), to specify that the annual board performance review should consider each director’s commitments to other organisations, and how directors are able to make sufficient time available to discharge their role effectively. The FRC is interested in views on whether giving the issue more prominence in a board’s discussions on its own performance is likely to lead to positive changes.
• Other suggested changes to Provisions in this section are aimed at providing improved clarity on company approaches to succession planning and board and senior management appointments, as well as at improving transparency to understand the role of any targets or initiatives companies have chosen to use to achieve greater diversity and inclusion in their boards and executive management. This will be through reporting by the nomination committee in its report in the annual report.
• The FRC also proposes amending Provision 21 (Provision 22 in the revised Code) to clarify that the chair should commission, rather than consider having, a board performance review, given the increased maturity of the board performance review market. 

Section 4 – Audit, risk and internal control

• In relation to risk management and internal controls, the FRC has merged the requirements of existing Principles C and O in  Principle N (in the revised Code), which goes further than the previous Principles by making the board responsible not only for establishing, but also for maintaining the effectiveness of, the risk management and internal control framework. 
• Provision 26 in the revised Code, which sets out the audit committee’s responsibilities, will require all companies reporting against the Code (whether or not they meet the proposed new “public interest entity” (or PIE) definition) to consider producing an Audit and Assurance Policy (AAP) on a “comply or explain” basis. 
• Current audit committee responsibilities (and reporting obligations) that mirror those in the new FRC Minimum Standard for Audit Committees are being removed from the Code to avoid duplication, with the Code instead referring companies to the new Minimum Standard. 
• In relation to sustainability reporting, Provisions 26 and 27 (in the revised Code) give the audit committee a new responsibility for monitoring the integrity of narrative reporting, including sustainability reporting, and for describing its work in this area in the annual report (where these matters have not been reserved for the board). The annual report should also describe, where commissioned by the company, the assurance of ESG metrics and other sustainability-related information.
• Risk management and internal controls are largely dealt with in Provisions 29 and 30 of the revised Code. The approach proposed is designed to strengthen board accountability for the effectiveness of the risk and internal controls framework by confirming that the board has put in place and maintains effective systems that deliver the expected outcomes. Among other things, clearer reporting expectations around the effectiveness of that framework are also set out in Provision 30, particularly on the evidence gathered by the company in support of its reporting. The aim of some of the changes is to avoid a situation where the review of effectiveness is seen as a one-off exercise, and which only assesses the effectiveness of the company’s systems at one point in time.
• The going concern statement required by current Provision 30 is being retained in the revised Code but, to avoid duplication with the new proposals for a Resilience Statement to be prepared by PIEs, the FRC proposes amending current Provision 31 to ask the board to explain in the annual report how it has assessed the future prospects of the company.

Section 5 – Remuneration

• The FRC proposes amendments to current Principles P, Q and R to strengthen the links between companies’ remuneration policies and corporate performance in the wider sense, including ESG objectives. In doing this, some changes have been made to the order in which these Principles are presented to ensure a logical flow.
• Current Provision 37 (which will become Provision 39) now includes a specific mention of malus and clawback. A new Provision 40 is also proposed, which sets out a requirement for additional information to be included about malus and clawback arrangements in companies’ remuneration reports. This includes a statement on whether the company has malus and clawback arrangements in place, the minimum conditions in which these would apply, the minimum period for applying them and why the selected minimum period is best suited to the organisation, as well as whether they have been used in the last financial year.
• In relation to current Provision 41, some elements of it have been removed and Provision 43 in the revised Code now takes a more direct approach in asking how a company’s executive remuneration policies, structures, and performance metrics support company strategy, including ESG objectives. The reference to pay ratios and pay gaps in the Provision has been removed, given increased access to gender pay gap reports and disclosures on company websites, but the FRC welcomes views on an alternative approach which may strengthen reporting on pay gaps, for example asking companies to report on what measures have been implemented to reduce and eliminate pay gaps within their organisation.

Updated guidance to accompany the revised Code

The FRC notes that its current Guidance on Audit Committees and Guidance on Board Effectiveness are being revised so they are aligned with the updated Code and the new Minimum Standard for Audit Committees. 

In addition, the FRC’s Guidance on Risk Management, Internal Control and Related Financial and Business Reporting is also being revised to take account of the proposed changes to the Code’s Principles and Provisions on risk management and internal control. The Consultation indicates some of the key changes being considered in relation to that guidance and views are requested. It is expected that the revised guidance will set out possible structures, responsibilities, actions and recommendations but allow companies flexibility to adapt it to their unique circumstances and characteristics (e.g. industry, size, geography etc). The updated guidance will be available when the revised Code becomes applicable.

Proposed implementation date for the revised Code

The FRC is proposing that the revised Code applies to accounting years beginning on or after January 1, 2025 to allow sufficient time for implementation.  

Responses to Consultation

Responses to the Consultation are requested by September 13, 2023. 

With the Consultation, the FRC has provided the following in Appendices:

• Appendix A: Draft revised UK Corporate Governance Code (tracked changes version);
• Appendix B: Draft revised UK Corporate Governance Code (clean version); and
• Appendix C: Summary of draft secondary legislation on corporate reporting.
• Appendix D: Summary of draft secondary legislation on corporate reporting.

(FRC, UK Corporate Governance Code – Consultation document, 24.05.2023)

FRC: Audit Committees and the External Audit – Minimum Standard

On May 22, 2023 the Financial Reporting Council (FRC) published the final version of a new Standard to be applied by the audit committees of FTSE 350 companies with a premium listing on the London Stock Exchange in relation to their responsibilities for the appointment and oversight of the external auditor.  

It follows consultation on a draft Standard launched by the FRC in November 2022 in direct response to the Government's consultation on Restoring Trust in Audit and Corporate Governance, which expressed the intention to grant statutory powers to ARGA (the Audit, Reporting and Governance Authority) for mandating minimum standards for audit committees in their role on external audits. The FRC has published a Feedback Statement and Impact Assessment with the Standard.

The FRC states that the primary objective of the Standard is to enhance performance and ensure a consistent approach across audit committees within the FTSE 350. By setting out clear expectations and guidelines, the FRC aims to support the delivery of high-quality audits and reinforce public trust in the financial reporting process. 

The intention is that the Standard will become mandatory for FTSE 350 audit committees once the necessary primary legislation to bring ARGA into being is passed and the relevant powers are granted to ARGA to make the Standard mandatory. In the meantime, FTSE 350 audit committees are encouraged to start applying the Standard as soon as they are able on a comply or explain basis. The FRC believes this voluntary adoption period will allow audit committees to familiarise themselves with the requirements and proactively enhance their practices.

Companies outside the FTSE 350, particularly those aspiring to join the FTSE 350 and smaller companies that are subject to mandatory tendering and rotation of audit firm appointments, are also invited to apply the Standard on a voluntary basis as its provisions are seen as examples of good governance. 

The Standard covers the following matters:

Responsibilities of the audit committee 

The Standard focuses on certain responsibilities of the audit committee, including the management of the company’s non-audit relationship with audit firms, tendering the audit appointment, engaging with shareholders on the scope of the external audit (where appropriate), aspects of the external audit and the relationship with the external auditor, and reporting to the board and shareholders on how the audit committee has discharged its responsibilities with respect to the external audit.

Tendering

The Standard sets out provisions to be adhered to in relation to the audit tender process. For example, it requires the audit committee to lead the tendering process and to not preclude the participation of “challenger” audit firms (those other than the four largest audit firms) from that tender process without good reason. It states that the choice of auditor should be based on quality (including independence), challenge and technical competence and not price or perceived cultural fit. It also states that audit committees should consider running a price-blind tender, and that they should submit two possible audit firm options for engagement to the board, with a justified preference for one of them.

Oversight of auditors and audit

In this section of the Standard, several provisions have been added following the consultation process. An assessment of the effectiveness of the audit process is seen as key to the audit committee’s oversight of the external audit and the Standard now sets out steps the audit committee should take in the course of its effectiveness assessment. These include asking the auditor for an explanation of the risks to audit quality identified by the auditor and how they have been addressed, reviewing whether the auditor has met the agreed audit plan and understanding the reasons for any changes, and obtaining feedback about the conduct of the audit from key people involved (such as the finance director and head of internal audit). The importance of Audit Quality Indicators is also highlighted.

Reporting

The Standard sets out certain matters the audit committee should report on in the annual report as part of the description of its own work. In addition, if a tender process has taken place in the year being reported on, the audit committee should explain the criteria used to make the selection and the process followed, and it should also report on the activities it has undertaken to meet the Standard’s requirements.

(FRC, Audit Committees and the External Audit – Minimum Standard, 22.05.2023)

(FRC, FRC publishes minimum standard for audit committees, 22.05.2023) 

DBT: Smarter regulation non-financial reporting review – Call for evidence

On May 24, 2023 the Department for Business and Trade (DBT) announced that it is working with the Financial Reporting Council (FRC) to review the non-financial reporting requirements UK companies need to comply with to produce their annual report and to meet broader requirements that sit outside of the Companies Act 2006 (CA 2006). The review will also consider if current company size thresholds (micro, small, medium and large) that determine certain non-financial reporting requirements, and the preparation and filing of accounts with Companies House, remain fit for purpose.

This builds on the Smarter regulation to grow the economy policy paper which set out how the Government would improve regulation across the board to reduce burdens and drive economic growth now that the UK has left the EU, and this call for evidence is the first stage of the review process.

The call for evidence primarily focuses on non-financial information requirements that are contained in Part 15 CA 2006 only, as well as equivalent requirements for Limited Liability Partnerships. However, respondents are invited to provide feedback on other reporting requirements that they need to comply with, as well as any other observations on the UK’s reporting requirements that they consider relevant.

The call for evidence ends on August 16, 2023. The Government will then use the information collected to develop detailed proposals for public consultation in 2024. Subject to the views shared, the Government will then look to legislate for any changes. When assessing future reforms the Government will also consider how any changes could interact with its ambitions for the UK to become a centre for green finance as set out in the Mobilising Green Investment: 2023 Green Finance Strategy.

(DBT, Smarter regulation non-financial reporting – Call for evidence, 24.05.2023)

(DBT, Government puts business first with Brexit regulation shakeup, 24.05.2023)