The UK is working on changing the fundamentals of the essential corporate governance framework.
On 5 December 2017, the UK Financial Reporting Council (FRC) published a consultation on proposed revisions to the UK Corporate Governance Code (the Code). The FRC then published proposed updates: These updates comprise a response from organisations and other stakeholders regarding needed changes in the UK corporate governance framework.
“This is not a tweaking of the Code, as in recent years, but a substantial re-write and simplification/reduction with the idea at its foundation that the focus of the revised Code is the company’s approach to governance through the application of the Code principles — principles which emphasise the value of good corporate governance to long-term success,” explain Deloitte analysts.
New UK corporate governance code principles
There are new Code principles on: the alignment of company purpose, strategy, values and corporate culture; responsibilities of the board to the workforce and other stakeholders; demonstrating independent and objective judgement from the chair (coupled with a hardening of the Code provision on independence so, for example, a tenure of longer than nine years would mean that a director was no longer independent); and alignment of remuneration and workforce policies to the long-term success of the company and its values.
Based on the changes in the Code, the basic corporate governance framework at most organisations must see a different design. Here are six ways in which organisations should make changes:
1) Boards must engage with the workforce.
As a report by the London office of Baker Mackenzie explains, “Boards must ensure effective engagement with, and encourage participation from, shareholders and stakeholders. On the basis that no single approach would be suitable for all, Provision 3 includes the Government’s three methods for gathering the views of the workforce, stating that this would “normally” be done by: (a) appointing a director from the workforce; (b) establishing a formal workforce advisory panel; or (c) designating a NED to do this. However, the revised “Guidance on Board Effectiveness” (the Guidance) makes it clear that this is not prescriptive and boards may opt for innovative alternatives (including adopting a combination of methods, or multiple channels for engagement at different levels) if they believe they would be as, or more, effective.
2) Boards must create a healthy corporate governance culture.
A healthy culture ensures that the systems, procedures, and overall functioning and mutual support of an organisation work effectively together, the report continues. In particular, new Principles A (requiring a company’s purpose, strategy and values to be aligned with its culture) and D (requiring the workforce to be able to raise concerns in relation to management and colleagues where they consider that conduct is not consistent with the company’s value and responsibilities), and Principles 2 (requiring directors to embody and promote the desired culture of the company) and 3 (regarding whistleblowing), link directly to culture.
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3) Boards must ensure diversity.
As a report by the Oxford Law Faculty concludes, the revised Code takes into account the recommendations of the recent diversity reviews. It aims to ensure that appointment and succession planning practices are designed to promote diversity of gender, social and ethnic backgrounds. Proposals also encourage the building of diversity in the executive pipeline, with oversight from the nomination committee and enhanced reporting from that committee on actions taken. The FRC also proposes that listed companies should disclose in their Annual Reports the gender balance of those in senior management (i.e., in the first layer of management below the board) and their direct reports.
4) Non-executive board members must have assured independence.
As the Faculty report points out, the revised Code gives greater focus to the importance of non-executive director independence with proposals to strengthen the independence provisions in the organisation’s corporate governance framework. These, in the past, have been rated lowest in terms of compliance. Specifically, a proposed change of emphasis means that a non-executive director will not be considered to be independent where the director does not meet the specific criteria laid down for independence. (As always, companies have the option to explain non-compliance.) The revised Code also proposes clarifying the role of the chairman as an independent director at all times (not just on appointment), and allowing the chair to be counted for the purpose of meeting committee composition recommendations.
5) Boards must ensure that remuneration criteria are transparent and within best-practice standards.
A report from the London-based CMS law firm explains that remuneration committees should now consider wider employee pay, not just those of executive directors and senior management. Wider employee pay is to be considered not just to judge any disparity between the executive and all-employee pay scene, but for general supervision too in terms of adequacy and other factors. This will be a major change for many remuneration committees, who have traditionally focused and been advised only on executive pay.
Shares from long-term incentives may not be sold within five years of award. Again, this was another recommendation from the Government’s corporate governance consultation. The proposed wording says that this should apply “in normal circumstances …,” which presumably still allows earlier receipt in good leaver and change of control situations, and shares to be sold to meet exercise price and tax commitments. Market practice has been moving in this direction anyway, according to the report.
6) Remuneration committees are not obliged to respect formulas, but must provide sufficient justification for vesting.
Remuneration committees should have discretion to override formulaic outcomes, the report continues. Remuneration committees should not be tied by the mathematical result of conditions set at award and should always have the discretion to change (by which is presumably meant reduce) vesting levels.
But greater explanation is required. Following the general trend, much greater disclosure of how decisions have been met is required. Clarity, transparency and alignment should be demonstrated, as well as a description of the remuneration committee’s work within the year.
Under the new Code, there is also more emphasis on a company explaining to its shareholders how it has applied the framework principles – for example, why the board has implemented certain structures, policies and practices. The framework principles should then be linked to the company’s strategy and business model, and related to outcomes achieved. Companies should then state the extent to which they have complied with the provisions, and explain any non-compliance, taking into account their own particular circumstances, the report says.
The Diligent Governance Cloud
Board directors are obligated to perform a host of varied duties and responsibilities. Diligent developed a suite of governance tools to help them fulfil their responsibilities accurately and efficiently. The Governance Cloud ecosystem of products includes:
As board directors, leadership teams and general counsels continue to express their needs to digitise governance processes, Diligent will be the partner to grow with them. Collectively, these tools enable corporations to achieve a fully digitised and integrated governance ecosystem to mitigate risk, plan for strategic growth and, ultimately, govern at the highest level.
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