The 2018 UK Corporate Governance Code has been published today by the Financial Reporting Council.
The 2018 Code puts the relationship between companies, shareholders and stakeholders “at the heart of long-term sustainable growth in the UK economy”. It is shorter and sharper than the previous Code and is structured by high-level Principles and more detailed Provisions. The supporting Principles from the previous Code have been removed and, in some cases, been incorporated into the new Principles or Provisions, while others have been moved to the supporting Guidance on Board Effectiveness. Boards should also take into account the Financial Reporting Council’s Guidance on Audit Committees and Guidance on Risk Management, Internal Control and Related Financial and Business Reporting.
The 2018 Code has five sections:
Section 1—Board leadership and company purpose
Section 2—Division of responsibilities
Section 3—Composition, succession and evaluation
Section 4—Audit, risk and internal control
The majority of changes have been made to the first three sections, which broadly correlate to the former Sections A (Leadership) and B (Effectiveness). Section E (Relations with shareholders) has been integrated within Section 1 (Leadership and purpose) of the revised Code to reflect its importance as a key aspect of good governance. Section 4 (Audit, risk and internal control) remains largely unchanged as this section of the Code was recently amended. The former Schedule A has been removed and where appropriate incorporated into Section 5 (Remuneration).
Key changes include:
- Increased emphasis on engagement with the workforce, customers, suppliers and other stakeholders, including a requirement for companies to establish a method for gathering views of the workforce.
- Requiring Boards to describe in the annual report how key stakeholders’ interests and the matters set out in section 172 of the Companies Act 2006 have been considered in Board discussions and decision-making.
- Requiring Boards to create a culture which aligns company purpose, values and strategy and to assess how they preserve value over the long-term.
- Requiring Boards, where 20% or more of votes on a shareholder resolution have been cast against the Board recommendation, to explain what action they intend to take to consult shareholders to understand the result.
- Removing the exemptions for smaller companies relating to annual director re-election and the composition of the Board, the Audit Committee and the Remuneration Committee.
- Broadening the recommendations around diversity, including encouraging Boards and Nomination Committees to consider the composition of not only the Board, but also the senior management pipeline.
- Giving Remuneration Committees greater responsibility for overseeing pay and incentives across their company and requiring them to engage with the wider workforce.
- Extending the recommended minimum vesting and post-vesting holding period for executive share awards from three to five years to encourage companies to focus on longer-term outcomes in setting pay.
- Rejecting formulaic calculations of performance-related pay.
Over time, compliance with the former Code focused on the “comply or explain” aspects of the Provisions (Listing Rule 9.8.6 (6)) rather than the application of the Principles. The 2018 Code instead emphasises the importance of applying the Principles effectively. When reporting on these, Boards will be expected to justify to shareholders why the Board implemented certain structures, policies and practices. The Principles will need to be linked to the company’s strategy and business model, and related to outcomes achieved. Companies will need to signpost and cross-refer to those parts of the annual report which describe how the Principles have been applied.
In line with previous practice, the Provisions should be complied with or an explanation given. Explanations should set out a clear rationale for the decisions the Board has taken, allowing investors to understand Board thinking clearly and to engage constructively with the company.
The 2018 Code’s inclusion of company culture, diversity and a wider range of stakeholders seems likely to positively enhance corporate governance in the UK.
The 2018 Code is expected to be effective for financial years beginning on or after 1 January 2019.
For more information please contact the author, or your usual Squire Patton Boggs contact.