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Mondial | Publication | July 2018
The Financial Reporting Council (FRC) published its new 2018 UK Corporate Governance Code (2018 Code) on July 16, 2018, together with revised Guidance on Board Effectiveness (Guidance) which supplements the 2018 Code by suggesting good practice to assist companies in applying the 2018 Code's Principles and reporting on that application.
The 2018 Code has been designed to set higher standards of corporate governance in the UK so as to promote transparency and integrity in business and, at the same time, attract investment in the UK in the long-term, benefitting the economy and wider society. As a result, the definition of governance has been broadened in the 2018 Code. It 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, and remuneration which is proportionate and supports long-term success.
In light of feedback received during the consultation process on the 2018 Code, the FRC has revised some of the Principles and Provisions in it and the 2018 Code will apply to accounting periods beginning on or after January 1, 2019. This briefing considers both the 2018 Code and the Guidance, and the steps that companies now need to start taking prior to its implementation.
The Introduction stresses the importance of culture and dialogue with a wide range of stakeholders in promoting the success of companies in the long-term, as well as the importance of applying the Principles in the 2018 Code since they emphasise the value of good corporate governance to long-term sustainable success.
The 2018 Code retains the "comply or explain" approach but provides guidance on discussions about how the Principles have been applied – action taken and resulting outcomes should be articulated, and signposting and cross-references to those parts of the annual report that describe how the Principles have been applied will help investors evaluate the company's practices.
While the Introduction states that corporate governance reporting should relate coherently to other parts of the annual report, particularly the strategic report which will include information enabling shareholders to assess how the directors have performed their duty under section 172 Companies Act 2006 (CA 2006), it makes it clear that nothing in the 2018 Code overrides or is intended as an interpretation of the statutory statement of directors’ duties in the CA 2006.
The Introduction also includes a new requirement on the boards of parent companies with a premium listing, whether incorporated in the UK or elsewhere. They should ensure that there is adequate co-operation within the group to enable the parent company board to discharge its governance responsibilities under the 2018 Code effectively, and this includes communicating the parent company's purpose, values and strategies.
Section 1 comprises five Principles and eight Provisions and it emphasises the need for boards to determine and promote the culture of their company and to engage with shareholders and their wider stakeholders.
In terms of changes to the consultation draft, the following should be noted
Section 2 comprises four Principles and eight Provisions. It considers the separation of duties within the board and the role of the non-executive directors, and it provides guidance on determining the independence of directors. Changes from the 2017 Draft Code include the following
Section 3 comprises three Principles and seven Provisions, with new emphasis on diversity in the 2018 Code. The FRC had asked for views on encouraging companies to report on levels of ethnicity in their executive pipelines. In light of feedback, the FRC has not added a new reporting requirement to the 2018 Code in relation to this but the Guidance encourages companies to think about providing more information about different aspects of diversity in their workforce, other than gender.
Other points to note in relation to Section 3 include the following
This section comprises three Principles and eight Provisions and largely replicates the requirements in Section C of the 2016 Code. The section duplicates requirements in the Listing Rules, the DTRs and the CA 2006 but a majority of respondents to the consultation confirmed that this is the right approach and the FRC has reintroduced some elements missing from the 2016 Code. As a result, there are some additional references to risk and emerging risks in the 2018 Code and the Guidance discusses risk in some detail.
The FRC has also reverted to the membership of the audit committee comprising two independent non-executive directors in the case of smaller companies, rather than its original proposal that it should comprise three independent non-executive directors in all companies, regardless of their size. However, the board chair of a smaller company can no longer be a member of the audit committee.
This section comprises three Principles and 10 Provisions. These cover both the remit of the remuneration committee and the structure of remuneration schemes. The FRC believes that the 2018 Code should be non-prescriptive on the structure of remuneration schemes and should avoid encouraging companies, explicitly or through implication, to adopt one form of scheme over another. As a result, it has removed language which could be perceived to encourage long-term incentive plans.
Key points to note are as follows
In its Feedback Statement, the FRC summarises the key changes that have been made to the Guidance in light of responses received. These include the following
When the FRC consulted on the 2017 Draft Code, the FRC also included some initial questions about the future of the UK Stewardship Code. The FRC’s feedback statement summarises responses to the questions raised. The feedback to those questions will inform the development of a revised Stewardship Code that the FRC will put out for public consultation later this year.
In drafting the 2018 Code, the FRC’s aim has been to improve corporate governance practice, stimulate constructive challenge in the boardroom and improve governance reporting. The 2018 Code’s 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 have been welcomed by investors.
Companies, particularly those below the FTSE 350, will be relieved that the FRC has amended the 2018 Code in certain respects in light of feedback in the consultation process but with no transitional implementation process, smaller companies with less than half the board (excluding the chair) comprising non-executive directors will need to review their board composition imminently, as will companies whose chair has been on the board for a period approaching nine years or more since it is not yet clear what investors and others will consider an acceptable “limited time” beyond nine years to be. However, smaller companies will also be pleased that they will not be required to make changes to the composition of their audit or remuneration committees (unless the board chair sits on the audit committee), and that external board evaluations are something that they should consider rather than be obliged to undertake going forward.
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