In December 2017, the Financial Reporting Council announced proposals for a significant overhaul of the UK Corporate Governance Code and various other related materials. A copy of the announcement, which includes links to the full proposal, consultation and revised Code can be found here.
What is the Corporate Governance Code?
The Corporate Governance Code (the Code), now in its 25th anniversary year, sets standards of good practice for listed companies in relation to various issues including board composition and development and remuneration. Companies listed on the London Stock Exchange are required to report on how they have applied the Code. The most recent version of the Code was published in April 2016 and can be found here.
What have the Financial Reporting Council announced?
The Financial Reporting Council (FRC) is the body responsible for overseeing the Code. The FRC announcement includes:
- a shorter and sharper Corporate Governance Code;
- changes to the Guidance on Board Effectiveness, which supplements the Code;
- a review of the UK Stewardship Code;
- greater focus on long-term success and sustainability;
- enhanced efforts to promote board diversity; and
- broader responsibility for remuneration committees.
The proposals which impact the Code and associated Guidance are subject to an ongoing consultation. The changes to the Stewardship code will be the topic of a formal consultation in 2018.
What are some of the key changes?
The proposals span 31 pages with 31 questions for consultation. Some of the key changes are as follows:
- Shorter/principled focus code: the revised code is significantly shorter. In its proposed form it runs to 13 pages of content rather than the 32 pages found in the current version. Schedule A, relating to performance-related remuneration, has been removed and incorporated into Section 5 (Remuneration).
Although research shows that compliance with the Code is relatively high, the new shorter Code should make it easier for companies. The principle of ‘comply or explain’ remains but there is a new focus on applying the Principles to company strategy and business models, and reporting on this application. Companies will need to review the new Principles in advance of the new Code applying.
- Shareholder dissent: the FRC propose that where more than 20% of votes are cast against a resolution, in addition to having to explain remedial actions, companies should publish a progress update no later than 6 months after the dissenting vote, before the final summary is published in the next annual report.
AGM season has become increasingly problematic in recent years with more shareholders and institutional investors voting against remuneration policies, reports and other resolutions. This change will be a further burden on companies and another reason to enter into transparent discussions to understand the reasons behind shareholding voting.
- Board diversity: the FRC have reported a clear alignment between performance and greater female representation in the senior management. The revised Code asks boards to intensify their efforts in promoting diversity by disclosing the gender balance of the Executive Committee. The FRC propose this disclosure applies to all companies.
Many UK listed companies have already been participating in the Hampton-Alexander review on gender diversity below the main board. Together with the work being done in companies in relation with gender pay gap reporting, and work to look at talent management in companies, the FRC approach embeds these initiatives into the Code.
- Holding periods: the FRC were explicitly asked by the Government to consult on extending the recommended minimum vesting and post-vesting holding period for executive share awards from 3 years up to 5. This change is reflected in the revised Code which acknowledges that periods longer than 5 years may be appropriate.
This is an unsurprising development and one that will have limited impact. Many companies already including two-year post-vest holding periods for their executive awards following growing pressures from institutional investors. Tapestry reviewed the use of holding periods in the FTSE 100 this year – if you would like to have a copy of our report on the use of holding periods, whether they apply to bonus plans and/or LTIPs, and how long they apply, please ask us.
- Remuneration committees: several changes have been proposed. The remuneration committee chair should be independent and have at least 12 months of experience on a remuneration committee before becoming chair. In addition, the committee itself is to have an expanded remit taking on responsibility for wider company remuneration and workforce policies.
Remuneration committee’s face an increased workload. It may be in their best interests to delegate some of the policy oversight to other committees where possible. Some companies may need to review their terms of reference. The requirement for 12 months’ experience was fully expected though, given the comply or explain nature of the code, may have little impact.
- Increased scope for board requirements: under the current Code, companies listed below the FTSE 350 are exempt from several requirements placed on boards. The FRC are proposing to remove these exemptions. Under the revised Code, all listed companies will have to ensure that the board, including the chair, should be made up of a majority of non-executive directors; all directors should be subject to annual re-election; and, the board should be subject to an external evaluation at least every three years.
Removing exemptions for companies listed below the FTSE 350 will help promote transparency and effective governance in those smaller companies, however, this will come at a cost. Some boards may need to recruit more NEDs to meet the ‘majority’ requirement and all directors will need to be put up for annual election.
What is the timeline for these proposals?
The consultation is now open. Comments on the questions set out in the consultation document should be sent to the FRC by 28 February 2018. A final version of the Code is expected to be published in early Summer 2018.
Finally, the new Code will apply to accounting periods beginning on or after 1 January 2019.
There are no major surprises here. We previously reported on the UK Government’s corporate governance proposals here where the FRC were instructed to review the Code and Guidance. Changes such as the increased vesting and post-vesting period and the changing powers of remuneration committees were all part of the Government’s proposals.
One expected omission was the Government’s past pledge of putting workers on boards. The FRC are consulting on various options intended to give employees a voice in the boardroom but there is no guarantee of worker representation.
If you would like to discuss the potential impact of these changes or any other aspects of your wider remuneration compliance, please do let us know. We are always happy to help.
Janet and Matthew