Companies of all sizes could benefit from Corporate Governance and Stewardship Codes

December 19, 2012

Empty Conference RoomFRC reports positive uptake of UK Corporate Governance and Stewardship Codes in 2012

The Stewardship Code has been a catalyst for greater engagement between companies and their shareholders in 2012. Introduced in 2010, there are now over 250 signatories to the Code, including most major institutional investors.

This is one of the conclusions in the Financial Reporting Council’s annual report on its monitoring of developments in corporate governance, published today.

The FRC also found strong take-up by companies of the recommendations introduced to the UK Corporate Governance Code in 2010. Ninety-six per cent of FTSE 350 companies now put all directors up for re-election every year, and the majority of those companies will have the effectiveness of their board independently reviewed at least every three years. Overall compliance with the Code among listed companies of all sizes remains high.

Commenting on progress during 2012, FRC Chairman Baroness Hogg said:

“Companies and investors have responded positively to the changes we introduced in 2010, as they have done consistently in the twenty years since the first corporate governance code was published. In response to further consultation, the 2012 Code focuses on the role of the audit committee – its selection of auditors and how it reports – and asks companies to articulate their policies on boardroom diversity, which many are doing even in advance of the new Code taking effect. Meanwhile changes to the Stewardship Code ask investment managers to explain what use they make of proxy advisers, and ask asset owners such as pension funds to reflect their stewardship policies in the mandates they award to managers.”
Corporate Governance is not just for listed companies however, no matter what their size, companies should be looking to review the effectiveness of their boards annually – and they should check their Articles of Association to see when their directors should be put up for re-election by the shareholders.



Is ‘comply or explain’ working?

February 15, 2012

Yes and no is the view of the Financial Reporting Council (FRC) citing research by Grant Thornton which shows that whilst 96% of FTSE 350 companies comply with corporate governance codes, those that do not should provide greater detail when they choose to exempt themselves from corporate governance procedures.

The concept of “comply or explain” has been the foundation of the corporate governance rules that have been developed and implemented since the early 1990s.

A company should comply with the code – for instance not having the same person acting as chairman or chief executive – but can choose not to if they are able to explain their actions convincingly to shareholders.

The research noted that the vast majority of UK companies abide by all the provisions in the Code but noted a small number of firms who provided inadequate justifications for ignoring certain clauses.

Grant Thornton said that some of these justifications “can come across as an assertion of difference rather than a full explanation of why the company in question has chosen to deviate from agreed best practice”

The EU is also concerned about the reasons companies give for their deviation from the rules set out in the codes.

By defining a “substantive explanation” and increasing pressure on companies to follow suit the FRC hopes to avoid the need to introduce additional regulation.

Baroness Sarah Hogg, chair of the FRC, commented: “The comply or explain approach to corporate governance has given us flexibility and enabled us to raise the standards of UK corporate governance over the years in ways that regulation cannot always achieve.

“This exercise is designed to reinforce our approach at a time when Europe has shown signs of driving towards more prescriptive regulation with a consequent diminution of shareholder rights.”

The Code came into force during 2010 but Britain’s light-touch approach to governance regulation faces reform as part of European Commission proposals.

The FRC has held a couple of discussions on what counts as a convincing explanation.

There are three basic elements:

  • Set the context and historical background.
  • Give a convincing rationale for the action.
  • Describe mitigating action to address the deviations from the code.

The explanation should also indicate whether the deviation from the code’s provision was limited and when the company intended to return to conforming with the provisions.

The FRC is now considering whether to incorporate these ideas into future consultations on the code.

However a leading accounting academic does not think that this goes far enough and has said that the FRC itself should be scrapped because it has failed to deal with major accounting and auditing problems highlighted by the banking crisis and has supported “onerous and costly” reporting rules for small and medium-sized businesses.

In response to a consultation on plans to streamline the UK’s regulator for accounting and auditing and corporate governance, Stella Fearnley, professor in accounting at Bournemouth University, said the FRC had “failed to take an effective lead in the UK’s interests regarding both the accounting and auditing problems associated with the financial crisis and market concentration in the audit market”.

A joint consultation with the department for Business Innovation and Skills and the FRC suggested narrowing the body’s regulatory functions and streamlining its structure, but Fearnley said more radical changes were needed.

She added the FRC should be disbanded and its oversight of listed companies taken over by a separate securities commission with “overall responsibility for market regulation and oversight of standard setting, and enforcement of accounting and auditing activities”.

Fearnley also said the Accountancy and Actuarial Discipline Board should be abolished because its remit is too limited.

“Qualified accountants and firms in the listed market should be treated like any other party suspected of committing an offence and if they are found guilty, it should up to the professional bodies to decide on their continuing membership,” Fearnley wrote in a submission to the FRC consultation last week.

She said small and medium-sized businesses and the not-for-profit sector had “been badly served by the FRC for a long time”.

Fearnley added an independent commission should be set up to focus on accounting and auditing regulation of these two sectors.

She may have a point. Clearly there is some concern that our corporate governance regulation is too light touch at the top and too onerous lower down. What is needed is regulation which will inspire investor confidence and avoid major corporate calamities without stifling growth and entrepreneurship.

FRC: next steps for corporate governance

January 4, 2012

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.

%d bloggers like this: