Corporate governance reforms – recent developments

Draft legislation has recently been published to take forward the government’s programme of reforms to corporate governance.

The programme began with a green paper published by the Department for Business, Energy and Industrial Strategy (BEIS) in November 2016, which launched a consultation. The government’s response to the consultation, published in August 2017, set out a package of measures designed to:

  • require large companies to disclose more information about executive pay;
  • improve large companies’ engagement with employees, customers, suppliers and other stakeholders; and
  • encourage large private companies to adopt stronger corporate governance arrangements.

Similar issues were considered in the report of the House of Commons’ Business, Energy and Industrial Strategy Committee on corporate governance, published in April 2017, and in the government’s response to the committee’s report (September 2017).

On 12 June 2018, BEIS published the Companies (Miscellaneous Reporting) Regulations 2018 in draft form, along with guidance in the form of questions and answers. It is intended that, if approved by Parliament, these Regulations will come into force on 1 January 2019.

In a related development, the Financial Reporting Council published draft corporate governance proposals for large private companies on 13 June 2018.

A revised corporate governance code for premium listed companies, on which the Financial Reporting Council consulted earlier in the year, is expected to be published in its final form in July.

The new requirements will affect differently sized companies in different ways, as explained below. They will not apply to limited liability partnerships. The BEIS guidance explains how the new requirements will apply to groups.

Companies with more than 250 employees – engagement with employees

All companies with more than 250 employees are currently obliged to include, in their directors’ report, a statement relating to the involvement of employees in the affairs, policy and performance of the company.

Such companies will now need to include in that statement a summary of how the directors have engaged with employees and how the directors have had regard to employee interests, and the effect of that regard, including on the principal decisions taken by the company in the financial year.

The directors will not, however, be required to disclose information about impending developments or matters in the course of negotiation if the disclosure would, in the opinion of the directors, be seriously prejudicial to the interests of the company.

Large companies and public companies – engagement with stakeholders

A large company is defined as a company having two or more of the following: a turnover of more than £36 million, a balance sheet total of more than £18 million, or more than 250 employees.

Strategic report – new section 172(1) statement

Large private companies – and public companies of any size – will have to include in their strategic report a statement describing how the directors have had regard to the following matters:

  • the likely consequences of any decision in the long term;
  • the interests of the company’s employees;
  • the need to foster the company’s business relationships with supplies, customers and others;
  • the impact of the company’s operations on the community and the environment;
  • the desirability of the company maintaining a reputation for high standards of business conduce, and
  • the need to act fairly as between members of the company.

These are the matters to which directors of all companies already have a statutory duty to have regard when acting in the way in which they consider, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole. Large companies and public companies will now have to explain how they have had regard to these matters.

The statement will be known as a section 172(1) statement, after the section in the Companies Act which sets out the matters to which directors must have regard. A large company will be required to make its section 172(1) statement freely available on its website.

The Financial Reporting Council plans to publish revised guidance on the strategic report to assist companies considering how to meet this new requirement.

Directors’ report – engagement with suppliers, customers and others

A large company will also be required to include in its directors’ report a statement summarising how the directors have had regard to the need to foster the company’s business relationships with suppliers, customers and others, and the effect of that regard, including on the principal decisions made by the company during the financial year. This requirement does not apply to public companies that are not large companies.

As with the statement relating to a company’s engagement with its employees, the directors will not be required to disclose information about impending developments or matters in the course of negotiation if the disclosure would, in the opinion of the directors, be seriously prejudicial to the interests of the company.

A company need not duplicate material from its strategic report in its directors’ report, but it should state in its directors’ report the matters that would otherwise have been included in the directors’ report which have been covered in the strategic report.

A guidance note on the stakeholder voice in board decision-making published by the Institute of Chartered Secretaries and Administrators and the Investment Association will assist companies considering how best to comply with these new requirements.

Very large unlisted companies – statement of corporate governance arrangements

This requirement will apply to unlisted companies (other than community interest companies and charitable companies) which have more than 2,000 employees and/or a turnover of more than £200 million and a balance sheet total of more than £2 billion.

A very large unlisted company will be required to include in its directors’ report a statement of its corporate governance arrangements (listed companies are already required to report on their corporate governance under the listing rules).

The statement of corporate governance arrangements must state:

  • which corporate governance code, if any, the company applied in the financial year;
  • how the company applied any such corporate governance code; and,
  • if the company departed from any such corporate governance code, the respects in which it did so and the reasons for so departing.

If the company has not applied any corporate governance code, the statement must explain the reasons for that decision and what arrangements for corporate governance were applied.

The statement of corporate governance arrangements must be made freely available on the company’s website.

As mentioned above, on 13 June 2018 the Financial Reporting Council published a consultation on draft corporate governance principles for large private companies developed by a coalition group chaired by James Wates CBE, the chairman of the Wates Group. The consultation sets out six principles concerning the following matters:

  • the purpose of the company;
  • the composition of the board;
  • the responsibilities of the board;
  • the board’s approach to opportunity and risk
  • the remuneration of directors and senior managers; and
  • the board’s engagement with stakeholders.

Guidance for each principle is provided. Responses to the consultation are requested by 7 September 2018, and it is intended that the principles and guidance will be finalised towards the end of the year.

A company may choose to comply with this requirement by explaining in its statement of corporate governance arrangements how it has applied the Wates principles or, if it prefers, some other corporate governance code.

Quoted companies – changes to the directors’ remuneration report

This requirement will apply to all UK companies which are listed on the main market of the London Stock Exchange, a recognised stock exchange in the European Economic Area, the New York Stock Exchange or Nasdaq. It will not apply to companies listed on the Alternative Investment Market.

A quoted company’s directors’ remuneration report will have to:

  • summarise any discretion which has been exercised in the award of directors’ remuneration;
  • include the amount of any performance award made to a director that is attributable to share price appreciation, or an estimate if the amount is not ascertainable;
  • state whether any discretion exercised in determining the resulting level of performance award was exercised as a result of share price appreciation or depreciation; and
  • include in its directors’ remuneration policy, for performance targets or measures relating to more than one financial year, an indication of the maximum remuneration receivable by each director assuming company share price appreciation of 50% during the relevant performance period and a short description of the basis of the calculation so reported.

Quoted companies with more than 250 employees – pay ratio information

A quoted company (as defined above) which has more than 250 employees will have to include pay ratio information in its directors’ remuneration report.

This must be set out in the form of a table stating the ratio of the remuneration of the company’s chief executive officer to the remuneration of the company’s employees whose pay and benefits are, respectively, on the 25th, 50th and 75th percentile of pay and benefits for its employees.

The regulations set out three possible ways in which these ratios may be calculated (referred to as Options A, B and C); the company must explain why the option adopted has been chosen. Further information about the calculations needed is provided in the BEIS guidance.

Going forwards, comparisons with the previous year’s pay ratios will need to be made and any changes accounted for, so that a company’s pay ratios table will eventually cover a ten-year period. The report must also explain whether, and if so why, the company believes the median pay ratio for the relevant financial year is consistent with the pay, reward and progression policies for the company’s employees taken as a whole.

Premium listed companies – revisions to the corporate governance code

As mentioned above, revisions to the corporate governance code applicable to premium listed companies are also under way. The Financial Reporting Council published proposals for a draft revised code on 5 December 2017, after a separate report of observations on corporate culture and the role of boards was published in 2016.

The current code was last amended in 2016. A company to which the code applies must either comply with the code or explain why it does not; there is separate guidance as to what constitutes an explanation under the comply-or-explain principle.

The draft revised code is shorter than the existing code, with a simpler structure. Among the changes incorporated are the following proposals requested by BEIS in the green paper:

  • requiring companies to have a method of consulting with their employees;
  • extending recommended minimum vesting and post-vesting holding periods for executive share awards from three years to five years;
  • requiring chairs of remuneration committees to have at least twelve months’ experience; and
  • specifying the steps to be taken when there is significant shareholder opposition to executive pay policies and awards.

Draft revised guidance on board effectiveness has been published separately. The proposals include an initial consultation on the future direction of the stewardship code, which applies to institutional investors; a more detailed consultation on the stewardship code is expected once the review of the corporate governance code has been finalised.

Consultation on the draft revised corporate governance code closed on 28 February 2018, and the Financial Reporting Council intends to publish a final version of the revised code in July, taking the requirements of the new Regulations into account. Numerous responses to the consultation were received; it remains to be seen to what extent the views expressed will be reflected in the final version. It is expected that the new corporate governance code will also come into effect on 1 January 2019, in line with the new Regulations.

Community interest companies

The Regulations also include a new requirement for small community interest companies to publish information about directors’ remuneration.

Insolvency and corporate governance

A separate BEIS consultation, on insolvency and corporate governance, has recently closed. Among other matters, that consultation proposed that directors responsible for the sale of an insolvent subsidiary of a corporate group should be required to take proper account of the interests of the subsidiary’s stakeholders. Views were also requested as to whether further action is needed  to strengthen corporate governance in pre-insolvency situations. Proposals may be brought forward when the responses to the consultation have been considered.

Next steps

The new Regulations are intended to come into force on 1 January 2019, and will apply to reporting periods starting on or after that date. The first actual reporting under the new Regulations will therefore begin in 2020.

Companies to which the new requirements apply should start considering now how they will engage with employees and other stakeholders in 2019 in order to be able to report on these matters in 2020.

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