On 16 July 2018, the Financial Reporting Council (FRC) published the 2018 edition of the UK Corporate Governance Code (the Code), following a public consultation launched in December 2017. The new Code is accompanied by an updated Guidance on Board Effectiveness, a Feedback Statement comparing the 2016 and the 2018 versions of the Code, and an Annex to the Feedback Statement outlining the amendments to Code resulting from the 2017 consultation.
As indicated in a previous post, the new code is shorter and more concise, due to the elimination of the supporting principles (most of which are incorporated in the new Guidance on Board Effectiveness). Companies who are bound by the Code are required to apply the Principles and state, on a ‘comply or explain’ basis, how they applied the Provisions. Companies are urged to avoid a box-ticking approach or boilerplate statements and provide meaningful explanations of their implementation of the Code.
Key changes to the consultation version of the Code include the following:
Section 1 – Board leadership and company purpose
- The purpose of the company
The Code maintains a principle of stakeholder engagement, which requires the board to ensure effective participation and engagement of shareholders and other key stakeholders (Principle D and Provisions 2 and 5). Principle A, stating that the board should promote the long-term success of the company, generate value for shareholders and “contribute to wider society” has been criticised during the consultation process as being misaligned with s172 (1) of Companies Act 2006 (Duty to promote the success of the company), which does not mention the wider society. In response, the Feedback Statement clarifies that “Nothing in this new Code overrides or is intended as an interpretation of the statutory statement of directors’ duties in the [Companies] Act.”
- Significant shareholder dissent
The consultation version introduced an obligation to disclose and engage with significant shareholder votes against a board recommendation for a resolution. The Code maintains this obligation but the new wording of Provision 4 clarifies that a significant vote against is a vote of “20% or more” (compared to “more than 20%” in the consultation draft). In such a case, the board should explain what actions it intends to take to consult shareholders in order to understand the reasons behind the result, publish an update on actions taken within six months from the vote and provide a final summary, normally in the annual report. Details of significant votes against and related company updates are available on the Public Register maintained by the Investment Association.
- Engagement with the workforce
The Code maintains the three methods of engagement introduced by the consultation document (a director appointed from the workforce; a formal workforce advisory panel; or a designated non-executive director), but states that one or more of these methods “should” be used (as opposed to the previous version, “would normally be”). However, the Code allows companies to adopt alternative arrangements, provided that they explain why they are more effective. The Code maintains the requirement of implementing a whistleblowing procedure allowing the workforce to report anonymously “any matters of concern” (Principle E and Provision 6).
Section 2 – Division of responsibilities
- Independence of non-executive directors and the Chair
The Code retains the current position that at least half of the board, excluding the chair, should be independent. Following significant concerns raised during the consultation, the FRC has reconsidered its position on independence criteria, by removing the requirement that individual non-executive directors (NEDs), including the chair, should not be considered independent if they don’t meet one or more of the independence criteria. Instead, the FRC has restored the previous provision which gave the board discretion to determine whether a NED is independent when he or she does not satisfy one of the independence criteria. The FRC has indicated that it expects “a clear explanation” when companies report on their assessment of independence of board members (Provision 19). The FRC has also reconsidered its position on the independence requirement for the Chair, abandoning the requirement of independence throughout the entire term of the tenure (Provision 9).
- Time commitments
The Code expands on the provisions regarding time commitment of directors, by requiring prior disclosure of significant commitments, “with an indication of the time involved”. Full-time executive directors are not allowed to take on more than one non-executive directorship in a FTSE 100 company or any other “significant appointment”. (Provision 15)
Section 3 – Composition, succession and evaluation
- Length of tenure of the Chair
The new Provision 19 states that the chair should not remain in post beyond nine years from the date of first appointment to the board. This period may be extended in exceptional circumstances, to facilitate effective succession planning and the development of a diverse board. In such cases a clear explanation should be provided.
- Diversity and inclusion policy
The code expands a previous provision of the consultation version, by requiring inclusion in the annual report the company’s policy on diversity, its objectives and link to company strategy, how it has been implemented, and the progress made on achieving the objectives (Provision 23). Further requirements on diversity of board members and pipeline are included in Principles J and L and Provision 17, and remain largely unchanged.
Section 4 – Audit, risk and internal control
There are no notable changes in this section compared to the consultation version. The Code highlights the need for the board to satisfy itself on the integrity of financial and narrative statements (Principle M). Provision 25 spells out the responsibility of the audit committee to provide advice (where requested by the board) on whether the annual report and accounts, taken as a whole, are fair, balanced and understandable, and provides the information necessary for shareholders to assess the company’s position and performance, business model and strategy.
Section 5 – Remuneration
- The role of the remuneration committee
The remuneration committee has the responsibility to determine the remuneration policy for executive directors, and setting the remuneration for the chair, executive directors and senior managers. In response to concerns raised during the consultation, the updated Provision 33 states that the remuneration committee also “reviews” remuneration policies for the wider workforce, as opposed to “overseeing” them (a role traditionally held by executives).
- Remuneration policy and practices
The Code maintains an emphasis on the need to align executive remuneration with the company purpose, values and long-term strategy. Provision 40 adds risk to the list of factors that the remuneration committee should consider. It states that remuneration arrangements should ensure reputational and other risks from excessive rewards, and behavioural risks that can arise from target-based incentive plans, are identified and mitigated.
- Remuneration schemes
The updated Provision 36 states that share awards should be released for sale on a phased basis and be subject to a total vesting and holding period of five years or more. Provision 38 emphasises that executive pension entitlements should be in line with those available to the rest of the workforce. Moreover, the remuneration committee has to ensure that remuneration schemes do not reward poor performance and are flexible enough to accommodate a departing director’s obligation to mitigate loss (Provision 39).
The Code will apply to accounting periods from 1 January 2019, with the first annual reports based on it due to be published in 2020. However, during 2019 companies will have to comply with Provision 4 on disclosure requirements following a 20% or more negative vote, and will have to take into account the provisions of the Code and the Guidance on remuneration policies.