Watchdogs have called on investors and proxies to recognise that deviation from the UK Corporate Governance Code can be a “sign of strong governance, not a red flag”.

The warning comes as the UK approaches this year’s AGM season and companies report under the 2024 update of the governance code. Regulators had underlined to boards that the code was “comply or explain” and not written for strict compliance.

Richard Moriarty, chief executive of the Financial Reporting Council, the body responsible for the code, says that its underlying principle has been “misconstrued” as “comply or else”, convincing companies to follow every provision and “avoid departures altogether”.

Moriarty added that boards have “flexibility” under the code and offered the examples of Marks & Spencer and British American Tobacco, both of which offered their chairs extended tenure beyond the code’s recommended nine years.

“Boards should feel confident using that flexibility. Good governance comes from boards thinking for themselves and explaining their judgement, not tick-boxing compliance,” Moriarty says.

The FRC has now issued updated guidance about reporting on governance decisions under the “comply or explain” principle.

‘Simple and high level’

It reminds users that the code’s principles are “simple and high level” and that reporting should reflect a “board’s” decision-making under the code. Explanations should reflect “actions and outcomes not just policies and procedures”.

For provisions in the code, the guidance makes clear “all companies are different and often they are able to demonstrate good governance without following all the provisions.”

But it warns: “When a company does depart from a provision, it is important that they are transparent about this in their reporting and include an explanation.”

The FRC has found instances where companies reported full compliance but on further examination had clearly departed from the code.

“Such discrepancies can call into question the other information within the annual report and leave the reader wondering what else is not accurate in the report.”

Hit or myth?

When the FRC put out a revised governance code in 2024, it included among the documents a “mythbuster” which, among other issues, addressed the question of comply or explain. It said this “gives companies the scope to communicate salient and pertinent information to stakeholders whilst recognising that there no one-size-fits-all approach for companies reporting on their governance.”

Watchdogs have faced many complaints from observers about “comply or explain”. In 2023, Julia Hoggett, chief executive of the London Stock Exchange, complained to the House of Commons Treasury committee.

“I do not think that we can lose sight of the corporate governance demands and pressures that we place on companies,” she said.

“We have created an environment where ‘comply or explain’ has become ‘comply or else’ and that has become a standard.”

Discussion of “comply or explain” has taken place at a time when many City figures have questioned the burden of regulation facing UK companies.

The argument is that the UK’s regulatory approach has hampered the ability of companies to match competitors, especially those in the US.

It has also been claimed that the code may have played a part in dissuading companies from listing in the UK, which has seen a fall in the number of companies floated on the London Stock Exchange.

The current government has created an environment in which it works on “growth” instead of regulation. Earlier this year, business ministers killed off further attempts to regulate auditors and corporate reporting. The FRC’s effort to push the “flexibility” of the comply or explain principle is likely to continue.