A new 2018 version of The UK Corporate Governance Code has been published by the Financial Reporting Council (FRC) following a period of consultation. The new Code is broadly similar to the current 2016 Code, but is in a shorter and simpler format. Some provisions have been moved into the accompanying guidance, the FRC Guidance on Board Effectiveness, which has also been revised.
As with the previous version of the Code, the new Code applies to all companies with a premium listing of equity shares (whether UK incorporated or not) and applies to accounting periods starting on or after 1 January 2019.
In the final version of the new Code, the FRC has dropped a number of proposals that had been suggested in the consultation process and proved to be controversial. For example, there was a proposal that the chair be required to be independent not only on appointment but throughout the appointment. This has been dropped, and the requirement remains only that the chair should be independent on appointment. There is, however, a requirement that the chair should demonstrate objective judgement throughout their tenure.
The new Code is shorter and simpler than the prior version of the Code. It is structured as a set of high level Principles, and more detailed Provisions. The Introduction states that the Code is not intended to be a rigid set of rules, but to offer flexibility and allow a company to take its individual circumstances into account. Companies are expected to apply the Principles and to report on how they have done so, in a manner which enables investors to evaluate the company’s approach to governance. In relation to the Provisions, there is a “comply or explain” approach.
Investors and their advisers should also have regard to a company’s particular circumstances, and while they should challenge unconvincing explanations, they should not evaluate compliance in a “mechanistic” way.
Key points to note in the new Code include:
The board should assess and monitor the company’s culture. The board should establish the company’s purpose, values and strategy and satisfy itself that these are aligned with the company’s culture. Where the board is not satisfied that policy, practices or behaviour throughout the business are aligned with the company's purpose, values and strategy, it should seek assurance that management has taken corrective action. The annual report should explain the board's activities and any action taken.
The new Code emphasises that to succeed in the long term, it is important for companies to build and maintain positive relationships with a wide range of stakeholders, including shareholders and the workforce. In particular:
Shareholders - the new Code clarifies and expands the provisions for company reporting where there is significant shareholder dissent. When the board makes a recommendation whether to vote for or against a resolution, and 20% or more of votes are cast against the board recommendation, the company should explain, when announcing voting results, what actions it intends to take to consult shareholders in order to understand the reasons behind the dissent. The company should publish an update on the views received from shareholders and actions taken, no later than six months after the shareholder meeting. The board should provide a final summary in the annual report and, if applicable, in the explanatory notes to resolutions at the next shareholder meeting, on what impact the feedback has had on board decisions and any actions or resolutions now proposed.
Other stakeholders - the board should understand the views of the company's other key stakeholders and should describe in the annual report how their interests have been considered in board discussions and decisions. This would include a description of how the board has complied with its duty to promote the success of the company set out in section 172, Companies Act 2006, which requires the company to consider the effect of its operations on the community and the need to foster relationships with suppliers, customers and others. The board should keep engagement mechanisms under review so that they remain effective. The provisions overlap with the requirements to report on compliance with section 172, Companies Act 2006 in The Companies (Miscellaneous Reporting) Regulations 2018, which are due to come into effect on 1 January 2019.
Workforce - one or a combination of the following methods should be used by the Company to engage with the workforce:
a director appointed from the workforce
a formal workforce advisory panel
a designated non-executive director.
If the board has not chosen one or more of these methods, it should explain what alternative arrangements are in place, and why it considers that they are effective. For these purposes, “workforce” is broadly defined in the Guidance and would include agency workers.
As part of the requirement to have effective workforce engagement, any member of the workforce should be able to raise any matters of concern, anonymously if they wish, through (for example) effective whistleblowing policies.
The new version of the Code provides that the annual report should include an explanation of the company's approach to investing in and rewarding its workforce.
The board should ensure that workforce policies and practices are consistent with the company’s values and support its long-term sustainable success.
Board composition, succession and evaluation
Appointments to, and succession planning for, the board and senior management should be based on merit and objective criteria to protect against discrimination, and to promote diversity not only in terms of gender but also social and ethnic backgrounds, cognitive and personal strengths. (Senior management is defined as the executive committee or the first layer of management below board level).
The nomination committee has a responsibility to ensure that there are plans in place for orderly succession to both the board and senior management positions, and to oversee a diverse pipeline for succession.
The annual report of the nomination committee should describe its work in relation to the policy on diversity and inclusion and linkage to company strategy, how it has been implemented, and progress on achieving the objectives. It should also report on the gender balance of senior management.
All directors should now be subject to annual re-election. Previously this applied only to directors of FTSE 350 companies.
The chair of the company should not remain in post for more than nine years, although there is discretion to extend this period for a limited time where this is necessary to facilitate effective succession planning and the development of a diverse board, particularly where the chair was an existing non-executive director on appointment. When this is the case, a clear explanation should be provided.
There should be formal and rigorous annual evaluation of the performance of the board. For FTSE 350 companies, this should include regular externally facilitated board evaluations every three years.
When making new appointments, companies should be careful to assess other demands on the prospective director’s time. Significant commitments, with an indication of the time involved, should be disclosed prior to appointment. An existing director should not take on additional external appointments without the prior approval of the board. If approval is given, the reasons for this should be explained in the annual report. Full-time executive directors should not take on more than one non-executive directorship in a FTSE 100 company or similar.
There is a new requirement that before appointment, the chair of the remuneration committee should have served on a remuneration committee for at least 12 months. The remit of the remuneration committee is extended to cover setting the policy not just for directors but also for senior management.
The remuneration committee should also now review workforce remuneration and related policies and the alignment of incentive and rewards with the company culture, taking these into account when setting the policy for executive director remuneration.
In order to align the interests of executive directors with long-term shareholder interests, share awards should be released for sale on a phased basis and subject to total vesting and holding periods of five years or more. The remuneration committee should also develop a formal policy for post-employment shareholding requirements (including both vested and unvested shares).
Pension contribution rates for executive directors should now be aligned with those available for the workforce. Workforce is more narrowly defined here than in the stakeholder engagement section so includes employees and workers but not agency workers.
Finally, there is a new requirement that the remuneration committee should address risk when determining executive director remuneration policy. This includes the reputational risk of excessive rewards, and the behavioural risks which can arise from target-based incentives.