The UK is coming to terms with a new corporate governance code. Published in July, the document makes a number of big changes, giving the corporate world much to think about.
The code asks boards to consider their “contribution to wider society”, places new responsibilities on directors to manage company culture, and asks boardrooms to engage with their employees.
However, the code has pulled back from a rigid nine-year limit for chairmanships, offering more flexibility.
Principle A of the code places “society” at the heart of boardroom thinking. It says: “A successful company is led by an effective and entrepreneurial board, whose role is to promote the long-term sustainable success of the company, generating value for shareholders and contributing to wide society.”
Meanwhile, Provision 2 says: “The board should monitor and assess the culture to satisfy itself that behaviour throughout the business is aligned with the company’s values. Where it finds misalignment it should take corrective action. The annual report should explain the board’s activities and any action taken.”
The code’s watchdog, the Financial Reporting Council, has heard complaints about clauses on the independence of directors that may have affected the term a chairman could serve. December’s first draft suggested chairs should change after nine-years with a board. However, this has been amended to exclude time spent as a non-executive prior to taking on the chairmanship. The FRC believes that this will make it easier to recruit women into the role of chair.
The new code also asks boards to engage with employees, offering three methods: a director from the workforce, an employee panel, or a non-executive designated to represent worker opinion. The code now makes plain that any of these methods, or a combination of them, can be used.
Luke Hildyard: Director, High Pay Centre
The UK’s reputation for good corporate governance is perhaps grounded more in our record of chin-stroking on corporate governance issues than in the actual quality of our governance of UK companies.
Since the 1990s this has included initiatives such as the Cadbury and Greenbury Reports, the introduction and subsequent revisions of the corporate governance code, and the shareholder “say on pay” reforms introduced by the coalition government.
It would be churlish to suggest that these efforts have had no positive impact.
But the list of corporate scandals to have engulfed major British businesses in recent years is long. It includes, but is not limited to, the banks that imploded during the global financial crisis and various misselling, market manipulation and debt-recovery scandals in its aftermath; the mis-treatment of workers at Sports Direct; accountancy malpractices at companies including Tesco and BT; bribery cases (settled out of court) at BAE Systems, Rolls Royce and GSK; extortionate executive pay awards at the likes of Persimmon and WPP; and the complete collapse of Carillion as the directors made off with millions.
These stories have played out against a backdrop of increasingly low-paid and precarious work; the increasingly urgent need to prevent devastating climate change; and concern about the tax contribution of multinational companies in the face of major public-service funding challenges.
The response has been a drastically reformed corporate governance code, intended to remind companies of the need to align their actions with broader socio-economic interests. The code places stronger emphasis on the responsibility of remuneration committees to consider pay and conditions as a factor when deciding executive pay awards. Companies will also be required to report on how directors have fulfilled their responsibilities to all their different stakeholder constituencies outlined in the 2006 Companies Act.
However, the code has retreated from Theresa May’s promise to put workers on boards, meaning that oversight of companies will be concentrated solely in the hands of the shareholders on whose watch the aforementioned governance failures occurred, and who have repeatedly shown themselves to be overly short-termist and disengaged from their investee companies.
This U-turn may ensure that corporate governance continues to be something the UK is good at talking about, rather than doing.
Peter Swabey: Policy and research director, ICSA: The Governance Institute
In my view, the most important outcome of the review of the UK Corporate Governance Code has been the retention of its structure. We often think of and describe the code as a “comply or explain” model, but there is more to it than that. The Listing Rules require that companies explain how they have applied the principles of the code, so in truth it is a question of “apply and explain” the principles and “comply or explain” with the provisions.
This distinction is important. It is more difficult to explain how you have applied the principles than it is to say that you have complied with—or ticked the boxes of—the provisions and perhaps explained one or two. This is one of the reasons that the FRC has given for the restructuring of the code with more focus on the principles. There has been too much corporate governance box-ticking on both sides and explanations of how companies apply the principles of the code will be more informative and useful.
In terms of the detail of the code, the changes are well judged and I am pleased that some of the more radical proposals have not been implemented. The code should be a practical document, balancing the needs of companies and their stakeholders, and should not be used to make new law; that would create a “one-size-fits-all” approach which would inevitably fail to recognise the individuality of companies. The decisions not to impose an arbitrary limit on chairman tenure, to take away from boards the primary role in assessing director independence or to stipulate how boards should engage with stakeholders are, therefore, good ones.
Of course, we as commentators on the changes to the code all have our own views and our own dogs in the race; it was never possible that the FRC would please everyone. But it has worked very hard to take account of views from all segments of the market. We are pleased that the FRC has seen fit to incorporate some of the suggestions that we made during the consultation process.
Frances O’Grady: Secretary general, TUC
The previous Corporate Governance Code had almost nothing to say about relationships with stakeholders, focusing instead on board processes and composition and relationships with shareholders.
The new code changes this. It includes a principle on board responsibilities to shareholders and stakeholders, and another on the workforce: “The board should ensure that workforce policies and practices are consistent with the company’s values and support its long-term sustainable success. The workforce should be able to raise any matters of concern.”
Recognition that company relationships with stakeholders and the workforce are a key part of good corporate governance is overdue—and welcome. But the real test of the new code is whether it will make any difference to how companies treat their workforce and other stakeholders in practice.
The code provisions on workforce engagement say that boards should include a director from the workforce, use a workforce advisory panel, or “designate” a non-executive director.
We hope that companies will include at least two elected workforce directors on their boards, and shy away from the “business as usual” option of a designated non-executive director.
The guidance that accompanies the new code asks boards to consider whether there is “a forum for the workforce to share ideas and concerns?” Boards should understand that for this to be effective it must be a collective forum that is independent of management; only then will staff be prepared to speak openly and without fear.
Recognising trade unions for collective bargaining is the best way of gauging and addressing staff views, and ensuring fairness in the distribution of rewards and other benefits.
Overall, UK employment conditions have worsened over recent years. More than three million people are now in precarious work and average real pay is lower than a decade ago. Some companies have outsourced their personnel function to agencies, disavowing responsibility for staff while continuing to benefit from their work. So it’s welcome that the new code refers to the “workforce” rather than employees.
Ultimately, we will judge the new code by the extent to which it encourages companies to move away from these damaging and unsustainable employment practices and turn the workforce voice from a slogan into reality.
David Cooke: Lawyer, ClientEarth
The Financial Reporting Council (FRC) missed an opportunity to clarify legal requirements relating to management and disclosure of climate risk.
The regulator updated its UK Corporate Governance Code—but this fails to sufficiently address climate risk.
The Guidance on Board Effectiveness, which accompanies the updated code, identifies the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) as one of several frameworks that can “help identify social and environmental considerations … relevant for the business and link these to company strategy”.
It is extremely disappointing that the FRC has failed to integrate the TCFD recommendations more fully in the corporate governance and reporting framework. With this minimal reference to the TCFD recommendations, it has failed to take sufficient steps to address climate risk as a leading concern of investors.
The reference to the TCFD recommendations appears in the section of the FRC guidance on relations with stakeholders. What this fails to reflect is that the TCFD recommendations focus on the financial implications to the business from climate change. They provide a framework to manage climate risk and opportunities, and—through analysing the associated disclosures—for shareholders to assess that management of climate risk.
Relegating the reference to the TCFD recommendations to the section on stakeholder relations fails to recognise the central importance of climate risk information for shareholders.
This misunderstanding continues to put the FRC at odds with the government, the Environmental Audit Committee, the Green Finance Taskforce, the Bank of England and other financial regulators across the globe, which have all endorsed the TCFD recommendations.
Investors will be no better equipped to assess and price climate-related risks and opportunities.
ClientEarth submitted complaints to the FRC in 2016 in respect of two energy companies, Cairn Energy and SOCO International, which had failed to disclose climate-related risks adequately. The regulator subsequently failed to reach a decision on whether there had been a breach of reporting requirements, or provide guidance clarifying that climate risk reporting is required under the law.
This new guidance does little to reassure us that the FRC’s thinking on climate risk has progressed.
James Jarvis: Corporate governance analyst, Institute of Directors
The new UK Corporate Governance Code is a welcome redraft of the UK’s primary governance document. It is shorter and sharper; its greater use of principles builds on the code’s flexible nature; and it addresses contemporary issues facing corporate boards, such as the need to engage with a wide range of stakeholders, and recognition of the board’s role in overseeing a company’s purpose and culture.
Companies will now need to examine how they will apply the code. One of the biggest decisions they will need to make is how to implement the requirement to increase employee engagement.
While it will be interesting to see which of the options firms opt for—a director appointed from the workforce, a formal workforce advisory panel, a designated non-executive director or a combination of these—it is more important that they ensure that whichever path is taken leads to meaningful engagement with the workforce.
Though many of the changes made are positive, we are disappointed that a crucial recommendation for directors to undertake continued professional development has been demoted to the accompanying Guidance on Board Effectiveness. As we highlighted during the consultation period, the role of the modern director is increasingly complex and specialised, and there is an ongoing need for these individuals to take stock of their competencies.
By removing reference to the professional development of directors from the code and only mentioning it briefly in the Guidance, the Financial Reporting Council risks indicating to directors that it is not important.
Interestingly, the recent Wates Corporate Governance Principles for Large Private Companies chose to include an emphasis on professional development, so it seems strange that it is not replicated in the code.
Recent corporate failures have shown the risk of company boards not being aware of their responsibilities and duties. As the primary governance document for many UK companies, the Corporate Governance Code should be playing a key role in raising the standards of UK directors.