UK Corporate Governance Code update: emphasis on longer term sustainability

Market reCap November 2014 edition 

• UK Corporate Governance Code update: emphasis on longer term sustainability
• Sponsor competence, joint sponsors and sponsor conflicts
• Takeover Code: consultation on post-offer undertakings and intention statements
• Insider dealers pay the price for print room dealing
• QCA Audit Committee Guide for Small and Mid-Size Quoted Companies

The Financial Reporting Council (FRC) has updated the UK Corporate Governance Code for accounting periods beginning on or after 1 October 2014.  The Code, which applies only to those with a premium listing but whose lead many investors expect other companies to follow, has been amended to reflect the most important post-crisis concern in corporate governance: how to ensure a company has the necessary stability to be financially secure over the longer term.

Summary of principal changes

Changes have been introduced to financial reporting requirements to ensure that any uncertainties around the going concern basis of accounting are reported, and that risk reporting reveals any problems in meeting liabilities over the coming years.

The Code provision requiring the notice of annual general meeting and related papers to be sent to shareholders at least 20 working days before the meeting has been expanded to require notice of other general meetings and related papers to be sent to shareholders at least 14 working days in advance.

Companies must also demonstrate a strategy for greater shareholder engagement where a resolution has been voted against by a significant percentage of shareholders (it is left to the company to decide on the meaning of "significant" in this context).

The provisions regarding remuneration of directors have changed to encourage a stronger link between long term sustainable performance and reward, as set out in more detail below.

Diversity is identified as an important tool in governance, enabling an organisation to avoid "groupthink" with constructive and challenging dialogue.  While gender and race are mentioned as priorities for diversity, the FRC recognises the importance of diversity in other areas such as education, sector and professional expertise.  The Code includes a specific requirement that remuneration committees be independent, and a diverse board - particularly as regards non-executive directors - will assist in this.

Changes to directors' remuneration

There are two Main Principles of the Code relating to directors' remuneration, the first of which has been changed significantly in the revised Code:

"D.1 Executive directors' remuneration should be designed to promote the long-term success of the company.  Performance-related elements should be transparent, stretching and rigorously applied.

D.2 There should be a formal and transparent procedure for developing policy on executive remuneration and for fixing the remuneration packages of individual directors.  No director should be involved in deciding his or her own remuneration."

The revised Principle D.1 emphasises the need for long-term thinking, a recurring theme in the changes brought by the new Code.  Previously, the need to take a long-term view in relation to remuneration had been a Supporting Principle.

Guidance in Schedule A to the Code expands on what is expected: "In normal circumstances, shares granted or other forms of deferred remuneration should not vest or be paid, and options should not be exercisable, in less than three years.  Longer periods may be appropriate".  In accordance with the "comply or explain" approach of the Code, a company can give remuneration with a shorter term if it is justified.

There is an important new requirement in Code provision D1.1 to include claw back and withholding provisions: "Schemes [of performance-related remuneration] should include provisions that would enable the company to recover sums paid or withhold the payment of any sum, and specify the circumstances in which it would be appropriate to do so".  It is not clear whether these mechanisms are intended to operate only in the event of fraud or mistake, or whether a failure to instil a sufficiently long term view would also result in a remuneration strategy having to be undone.

Revised guidance on risk management and internal control and related financial and business reporting

The FRC has also finalised and published its Guidance on Risk Management, Internal Control and Related Financial and Business Reporting.  This guidance revises, integrates and replaces the previous editions of the FRC's Internal Control: Guidance to Directors (formerly known as the Turnbull Guidance) and its Going Concern and Liquidity Risk: Guidance for Directors of UK Companies.

Tom Martin is a Director in Fieldfisher's Corporate Group in London.