Following the publication of reports regarding practices at BHS and Sports Direct and in an environment of increased regulation requiring board accountability for executive pay and ESG, the Government published a Green Paper in 2016 on corporate governance focussing on executive pay, workers on boards, board responsibility and private companies.
A voluntary corporate governance code for private companies was subsequently developed under the stewardship of James Wates and new annual reporting requirements for UK incorporated companies have now been introduced by the Companies (Miscellaneous Reporting) Regulations 2018.
The new reporting requirements apply for financial years starting on or after 1 January 2019. The first reporting commences in 2020 and companies will be addressing this in their financial reporting in 2020 onwards. Directors will need to consider whether the changes in the reporting requirements will necessitate changes to be introduced to internal governance practices during a reporting period in order to be in a position to fulfil the reporting requirements at the end of the relevant year.
UK incorporated companies qualify for the new reporting requirements as follows:
All qualifying companies are required to comply with the new reporting requirements – a parent or holding company can not fulfil the reporting obligations on behalf of subsidiaries even if the parent or holding company is required to produce a consolidated "group strategic report" or a "group directors report". Where policies are set at a group level and the parent provides a full explanation of the policy or strategy in its statements in the group reports, a subsidiary may cross reference the parent company statements and provide less detail in its report however it will need to explain how its directors have applied or reflected the group policies or decisions. Where a parent company does not meet the qualifying it may still need to publish a section 172(1) statement as part of the group strategic report through consolidation.
If the directors of a UK incorporated company knowingly do not comply with the required provisions or are reckless as to their compliance they will commit a criminal offence.
Section 172 (1) compliance
In the directors' report a statement will need to be included with respect to matters of strategic importance explaining the issues, factors and stakeholders that the directors consider relevant under section 172(1) and how they have formed that opinion.
Details of the requirements of section 172(1) are set out in the box. Stakeholders that the directors will need to consider will include shareholders, employees, suppliers, customers and others. Other issues that the directors will need to consider will include the community, the environment and the likely long term impact of any decision. The statement will need to explain the main methods that the directors have used to engage with stakeholders and the effect that this has had on the company's decisions and strategies during the financial year.
In order to comply with these reporting requirements, directors will need to determine the stakeholders and other issues relevant for matters of strategic importance to which they will need to have regard as part of the decision making process. This may then require structural changes during the year to implement procedures and practices to be able to evidence board engagement with these stakeholders and issues during the relevant reporting period.
What is section 172(1) of the Companies Act 2006?
A director of a company must act in a way which he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to:
- 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 suppliers, 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 conduct; and
- the need to act fairly as between members.
Notwithstanding the section 172(1) reporting requirements in the strategic report, the directors' report will now need to include a statement (ie for non strategic matters) to summarise how the directors have engaged with employees, how they have had regard to employee interests and the effect this had, including on principal decisions taken by the company in the financial year.
Relationships with suppliers, customers and others
Notwithstanding the section 172(1) reporting requirements in the strategic report, the directors' report will now need to include a statement (ie for non strategic matters) to summarise how the directors have had regard to the need to foster the company's business relationships with suppliers, customers and others and the effect this has had, including on principal decisions taken by the company in the financial year.
Impact of employee and other relationship reporting requirements
In order to comply with these reporting requirements, directors will need to determine how they are engaging with employees, customers, suppliers and others and how they are building their comments and feedback into the decision making process and how this has impacted decision making.
This may then require structural changes during the year to implement procedures and practices to be able to evidence board engagement (eg employee town halls or employee board representation) during the relevant reporting period.
Corporate governance code
Very large private and public unlisted companies are required to include a statement in the directors' report to explain which corporate governance code, if any, has been applied and how. If the company has departed from any aspect of the code it must set out details of how it did so and the reasons. If no corporate governance code has been applied the statement must explain why this is the case and what arrangements for corporate governance were applied.
Large private companies are encouraged to apply the Wates Corporate Governance Principles published by the FRC although can, if appropriate, apply foreign codes which may be relevant where the parent company is incorporated in another jurisdiction and policies are applied from a group level. For quoted companies, the FRC's Corporate Governance Code 2018 will apply.
For qualifying subsidiaries of overseas listed parents, a foreign corporate governance code may apply. Where a foreign code applies an English language version of the code must be accessible via the company's website free of charge. The company will also need to provide sufficient detail in the statement to ensure the corporate governance arrangements are explained. This may require more detailed consideration by the directors to be able to report on how a foreign code is applicable in the context of a UK company (for example if the code is based on and applies non UK legislation and standards) and how this has then been applied by the relevant UK company.
Quoted companies with more than 250 employees are required to publish as part of the directors' remuneration report details of the CEO's remuneration ratio to the median 50th, 25th and 75th percentile full time equivalent remuneration of their UK employees.
Reasons for any changes to the ratios from year to year will also need to be published and in the case of the median ratio, whether and if so, how the company believes this ratio is consistent with the company's wider policies on employee pay, reward and progression. In addition, all quoted companies are required to illustrate in remuneration report the effect of future.
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