FRC: next steps for corporate governance

The Financial Reporting Council has published its first annual review on how the UK Corporate Governance Code and the Stewardship Code, introduced in 2010, are being implemented, and has also outlined its plans to consult in 2012 on amendments to both Codes and related FRC guidance.

UK Corporate Governance Code

The FRC reviewed 60 corporate governance statements over the past year and noted the high take up of new Code provisions, such as annual election of directors and use of external advisers to conduct board evaluations. It was also pleased to see that many chairmen made a personal statement in the annual report and that many committee chairmen adopted the same approach for the report on their committees.

However, the FRC expresses concerns about the following:

  • The explanations provided by some companies that do not comply with the UK Corporate Governance Code. Whilst the majority provide good explanations, a minority do not and occasionally provide no explanation at all. The FRC is currently holding discussions with companies and investors to identify common criteria that companies can refer to when preparing their comply or explain statements.
  • Business model, strategy and risk. Whilst recognising improvements by companies when disclosing principal risks and uncertainties in their business reviews, the FRC considers that more effort is needed in relation to risk and how it is mitigated and managed. It stresses that companies should focus on strategic risks and the major operational risks inherent in their business models and strategies, rather than general risks applicable to all companies.
  • Reporting by audit committees. The FRC notes that very few audit committees report key decisions taken or judgments made and limit themselves to repeating their terms of reference. In the FRC’s view, their reports are “unenlightening” and this threatens to undermine confidence at a time when there is “considerable scepticism about the effectiveness of audit and audit committees”.
  • Reporting by remuneration committees. Similar criticisms can be made of remuneration committees. Companies need to be more transparent about the link between remuneration policy and strategy and its approach to risk in the current climate.

UK Stewardship Code

The FRC notes that over 230 asset managers, owners and service providers signed up to the Stewardship Code. The numbers exceeded the FRC’s expectations but it stresses that signing up to the Code is only a first step and that it is too early to tell if the objective of better engagement will be met. It notes that reporting on stewardship is variable, especially in relation to managing conflicts, collective engagement and the use of proxy voting agencies.

Next steps – FRC proposals for 2012

UK Corporate Governance Code: the FRC is expected to consult on the following amendments to the Code:

  • to extend the reports that the audit committee gives to the board and to require clearer disclosures of how the external auditor is selected;
  • to reflect any recommendations on going concern following Lord Sharman’s enquiry (expected to be published in February 2012); and
  • to tie in with proposals from BIS on narrative reporting (expected to be finalised in the first few months of 2012).

These would be in addition to the recently reported changes to the Code requiring FTSE 350 companies to report annually on their diversity policy.  Any amendments to the Code will take effect on 1 October 2012 to tie in with proposals from BIS.

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