Corporate Governance in the UK

The Large and Medium Sized Companies and Group (Accounts and Reports) (Amendment) Regulations 2013

Brought in new requirements for the reporting of directors' remuneration.

Corp governance and unlisted companies

- The owners of private companies are often their managers, so the issue of protecting the investor does not tend to exist. - Recent high-profile corporate scandals, relating to large private companies, for example at BHS, have raised a different concern - protecting the wider stakeholder group, which includes employees, former employees and suppliers of the company, when things go wrong.

Following the publication of the Cadbury Report, the LSE introduced a requirement into...

...its Listing Rules that listed companies should include a statement of compliance with the code of best practice in their annual report and accounts. The statement of compliance required an explanation of where the company had complied with the code of best practice and in circumstances where it had not and an explanation as to why not.

Companies adopting the QCA Code are required to...

...to issue an annual statement on how they comply with the QCA Code in their companies and where they depart from it and provide justification for doing so.

UK Listing Regime

- Companies which are listed on the LSE are required to comply with the rules issued by the UK Listing Authority (since 2013 the FCA). - The current rules are set out in the FCA Handbook, which comprises the UK Listing, Prospectus and Disclosure Guidance and Transparency Rules (LPDTR).

DTR 6

- Continuing obligations and access to information: a) Sets out what contributing obligations the listed company agrees to comply with. The obligations include: 1. Equality of rights of shareholders of the class 2. Exercise of rights by shareholders 3. Electronic communications 4. Information about dividend payments, shareholder meetings, changes in share capital. b) Also sets out the disclosure requirements for listed companies in relation to the continuing obligations.

Origins of the UK Stewardship Code

- In 1996 principles and a code of practice for institutional shareholders was developed and included in the Combined Code. The aim was to encourage institutional shareholders to: a) Take a more active role in the governance of those companies in which they invest. It was argued that institutional shareholders hold funds on behalf of many individuals and are therefore investing indirectly on behalf of those individuals. They thus have a responsibility on behalf of those individuals to make sure that the board of directors of the companies in which these individuals invest are made properly accountable and govern their companies responsibly. b) Have a dialogue with the companies in which they invested and to make their views known, through advisory reports and, if necessary, via their voting practices at shareholder meetings. - These provisions were replaced by a separate code for institutional shareholders, the UK Stewardship Code, which was first published in 2010 and revised in 2012 and 2020 by the FRC.

FRC Guidance:

1. Guidance on Board Effectiveness 2. Guidance on Audit Committee 3. Guidance on Risk Management, Internal Control and Related Financial and Business Reporting 4. Guidance on the Strategic Report

Listed companies are required to make a statement in their annual report/accounts on how they have:

1. Applied the spirit of the Principles; and 2. Complied with, or explain why they have not complied with, the Provisions and supporting guidelines for the Code. - The statement should allow shareholders to evaluate the application of the Principles by the company, the actions taken by the company in support of the Principles and the outcome of those actions, and whether a description of how the Provisions and additional guidance has been complied with. - The justification for any non-compliance should set out "the background, provide clear rationale for the action the company is taking, and explain the impact the action has had." - Any action that is timebound should also state the time limit for completion.

Five sections of the 2018 Code:

1. Board leadership and company purpose: this section concentrates on the role and responsibilities of the board as a whole 2. Division of responsibilities: this section focuses on the division of responsibilities between the chair and the CEO, the make-up of the board and the role of the non-executive directors. 3. Composition, succession and evaluation: this section talks about the selection and appointment process for directors and committee members. It also outlines the requirements for annual evaluation of the board, its committees and individuals members. 4. Audit, risk and internal control: this section focuses on the internal and external audit functions and on the establishment of procedures to manage risk and oversee internal controls. 5. Remuneration: this section concentrates on the process for developing and overseeing a remuneration policy for directors and senior executives.

QCA Corporate Governance Code 2018 principles:

1. Establish a strategy and business model which promotes long-term value for shareholders. 2. Seek to understand and meet shareholder needs and expectations 3. Take into account wider stakeholder and social responsibilities and their implications for long-term success. 4. Embed effective risk management, considering both opportunities and threats throughout the organisation. 5. Maintain the board as a well-functioning balanced team led by the chair. 6. Ensure that between them directors have the necessary up-to-date experience, skills and capabilities. 7. Evaluate board performance based on clear and relevant objectives, seeking continuous improvement. 8. Promote a corporate culture that is based on ethical values and behaviours 9. Maintain governance structures and processes that are fit for purpose and support good decision-making by the board. 10. Communicate how the company is governed and is performing by maintaining a dialogue with shareholders and other relevant stakeholders.

The UK Corporate Governance Code sets out good practices to enable boards to...

1. Establish their company's purpose, strategy and values, and satisfy themselves that these are aligned to their company's culture and aimed at achieving long-term success for the company; 2. Consider the practices and processes that need to be put in place to ensure an effective interaction with the company's employees, customers, suppliers and wider stakeholders; 3. Develop effective policies to ensure diversity (gender, social and ethnic backgrounds, cognitive and personal strengths) on the board, within the management team and in the management pipeline; and 4. Ensure that appointments to boards are based on merit and objective criteria to avoid group think.

The 2018 Code adds new requirements for the board to consider...

1. The needs and views of a wider range of stakeholders 2. Integrity and corporate culture 3. Diversity 4. How the overall governance of the company contributes to its long-term success.

The UK mainly follows what approach to corporate governance?

A principles-based approach through codes of best practice, such as the UK Corp Gov Code for listed companies.

AIM

Companies listed on the AIM, a sub-market of the LSE, do not have to comply with the UK Corp Gov Code. a) The companies listed on AIM are usually smaller and require a less tringent regulatory regime than the UK Corp Gov Code. b) AIM companies do have to adopt a set of governance standards and most choose to adopt the Corporate Governance Code for Small and Mid-Sized Quoted Companies issued by the Quoted Companies Alliance (QCA). c) From Sep 2018, AIM companies are required to set out in a statement the details of a recognised corporate governance code that has been selected by the board, how that code has been applied and, where the company departs from its selected code, an explanation for doing so.

DTR 7

Corporate Governance: a) Sets out the requirements for listed companies in relation to: 1. Having an audit committee 2. Including a corporate governance statement in its annual directors' report 3. Related party transactions

The Companies (Miscellaneous Reporting) Regulations 2018

Covers: 1. Executive pay 2. Guidance on s.172 of the CA2006 requirements relating to directors having a regard to employee interests and fostering relationships with customers, suppliers and others. 3. Corporate governance arrangements for large, privately-held businesses. These regs applied to companies reporting on financial years starting on or after 1 Jan 2019.

Recommendations of the Cadbury Report (internal financial controls)

Directors should also report to shareholders on the company's system of internal financial controls.

Disclosure Guidance and Transparency Rule 2

Disclosure and control of inside information by issuers: a) This rule sets out the requirements for prompt and fair disclosure of relevant information to the market. It also gives guidance on aspects relating to disclosure of such information, including the circumstances in which disclosure may be delayed. b) The rule should be read in conjunction with other regs that govern disclosure: the Market Abuse Regulations, Part 7 of the Financial Services Act 2012 relating to misleading statements and practices, Part V of the Criminal Justice Act 1993 relating to insider dealing, the Takeover Code.

The Companies Act 2006 (Strategic Report and Directors) Regulations 2013

Introduced a requirement for companies (excluding small companies) to include a strategic report, rather than the business review, in their annual report and accounts.

Corporate Insolvency and Governance Act 2020

Introduced in response to Covid and the resulting economic crisis. Introduced a number of extensions to the time periods for the filing of various documents at Companies House (e.g. accounts) Relaxed certain requirements relating to shareholder meetings Changes to insolvency laws which leave the current directors in office, with an opportunity to restructure the business with a benefit of a moratorium and stays of creditor and counterparty rights.

DTR 4

Periodic Financial Reporting: Sets out the requirements for the content and publication of a company's: annual report and financial statements, half-yearly report and interim statements, reports on payments to government.

What areas does the Companies Act 2006 cover?

Regulations on: Shareholder rights and voting, General meetings, Disclosure of info to shareholders including info on directors' remuneration and information required in the annual report and accounts such as the strategic report, Powers and duties of directors, Preparation and auditing of the annual financial statements.

UK Listing Rules

Require all companies, UK or non-UK incorporated, with a premium listing on the LSE to comply with the UK Corporate Governance Code or explain their non-compliance in a governance statement in the company's annual report and accounts.

The Cadbury Report introduced for FTSE 350 companies...

The requirements for non-exec directors, independent directors, audit, nomination and remuneration committee, evaluation of performance and reports on the internal controls of a company.

DTR 3

Transactions by persons discharging managerial responsibilities and their connected persons: a) This rule sets out the notification obligations of Persons Discharging Managerial Responsibilities (PDMRs) and their connected persons in relation to shares, debt instrument or derivatives of the company. b) Directors and senior executives are usually classified as PDMRs.

DTR 5

Vote Holder and Issuer Notification Rules: a) Sets out the requirements for holders of shares in a company to disclose the percentage of their holding above certain thresholds to the company. b) Also sets out the disclosure relating to a company's share capital which are to be made by the company to enable holders to fulfil their requirements.

Companies (Directors' Remuneration Policy and Directors' Remuneration Report) Regulations 2019

a) Apply to company reporting for financial years starting on of after 10 June 2019. They implement Articles 9a and 9b of the European Directive on Revised Shareholder Rights 2017.

Recommendations of the Cadbury Report (non-executive directors):

a) At the time of the Cadbury Report, non-executive directors were not common and those that did exist were major shareholder appointments or former executives. b) The Committee recommended that there should be sufficient non-executive directors for their views to carry weight, and most of them should be independent. c) Independent non-executive directors should be able to bring judgment and experience to the deliberations of the board that the executive directors on their own might lack. d) Non-executive directors should be selected though a formal process overseen by a nominations committee. Recommendations would then be made to the board, who would formally appoint them. Their appointment would be for a fixed term, and their reappointment should not be automatic. e) Although the Cadbury Report Committee did not set maximum terms for non-exec directors, it did imply that they became less independent over time.

1. Guidance on Board Effectiveness (2018):

a) Based on the Higgs Report (2003), latest version of the guidance published in 2018. b) Primary purpose 'is to stimulate boards' thinking on how they can carry out their role and encourage them to focus on continually improving their effectiveness.

1. Guidance on Risk Management, Internal Control and Related Financial and Business Reporting (2014):

a) Replaced the Turnball Guidance. b) Aimed at encouraging boards to consider how: a) To discharge their responsibilities in relation to existing and emerging principal risks of the company; and b) To embed risk management and internal control systems into the businesses processes of the company. It introduced the concept of cultures of risk.

Common themes in company collapses in the late 80s/early 90s

a) Investors were not kept informed about what was really going on in the company. b) The published financial statements were misleading c) External auditors were accused of failing to spot the warning signs d) The companies had self-seeking powerful chiefs, who lacked business ethics. e) Board members were unable to restrain management from acting improperly. f) Risk management systems were inadequate or ineffective.

Guidance on Audit Committees

a) Previously known as the Smith Report b) Provides more detailed guidance on the role and responsibilities of audit committees.

Six principles of the Wates Corporate Governance Principles for Large Private Companies

a) Principle One - Purpose and Leadership: 1. An effective board develops and promotes the purpose of a company, and ensures that its values, strategy and culture align with that purpose. b) Principle Two - Board Composition: 1. Effective board composition requires an effective chair and a balance of skills, backgrounds, experience and knowledge, with individual directors having sufficient capacity to make a valuable contribution. The size of the board should be guided by the scale and complexity of the company. c) Principle Three - Director Responsibilities 1. The board and individual directors should have a clear understanding of their accountability and responsibilities. The board's policies and procedures should support effective decision-making and independent challenge. d) Principle Four - Opportunity and Risk: 1. A board should promote the long-term sustainable success of the company by identifying opportunities to create and preserve value, and establishing oversight for the identification and mitigation of risks. e) Principle Five - Remuneration: 1. A board should promote executive remuneration structures aligned to the long-term sustainable success of a company, taking into account pay and conditions elsewhere in the company. f) Principle Six - Stakeholder Relationships and Engagement: 1. Directors should foster effective stakeholder relationships aligned to the company's purpose. The board is responsible for overseeing meaningful engagement with stakeholders, including the workforce, and having regard to their views when taking decisions.

The Companies (Miscellaneous Reporting) Regulations 2018:

a) Provide that large private unlisted companies, defined as those with more than 2000 employees or with turnover of more than £200 million and a balance sheet of more than £2 billion, will have to include a statement as part of their directors' report stating: 1. Which corp governance code they are following and how; 2. If they deviate from their chosen code and an explanation as to why; and 3. If they have not adopted a code, an explanation as to why not and what arrangements for corporate governance have been applied instead. b) The statement will have to be made available online through the company's website or another suitable website on behalf of the company. c) In addition, large private companies will have to provide within their strategic reports, a s172 statement describing how the directors have had regard to the matters set out in s172 CA2006 when performing their duty under s172.

The Wates Corporate Governance Principles for Large Private Companies

a) Published by the FRC in December 2018 b) Six principles that can be 'applied to any large private company, while allowing sufficient flexibility for the companies to explain the application and relevane of their governance arrangements.' c) Adopt the 'apply and explain' approach

Recommendations of the Cadbury Report (a 'going concern' statement):

a) Recommended that companies should include a 'going concern' statement in their annual report and accounts. b) An implication of this recommendation is that before approving the report and accounts, each director is under a personal responsibility to reassure themselves that the company is a going concern and is not on the brink of insolvency.

1. Guidance on the Strategic Report (2018):

a) The 2014 version of the Guidance explained the requirements of the CA 2006 (Strategic Report and Directors Report) Regulations 2013. The revised Guidance has been enhanced to recognise the increasing importance of non-financial reporting.

Recommendations of the Cadbury Report (board of directors):

a) The Cadbury Committee agreed that the balance of power between directors and shareholders was appropriate, but that there should be more accountability by directors to shareholders. b) Control over the company should be exercised collectively by the board as a whole. There should be no domination by a single individual. c) There should be a separate chairman and chief executive, and both should have clearly defined roles. d) The board should have reserved matters which should not be delegated to management. e) The board should meet regularly and should monitor the performance of the executive management. f) Individuals board members should be able to seek professional advice at the company's expense. This recognised the risk that some directors might not have the necessary experience or skills in a particular area to play an effective role in a particular discussion.

Recommendations of the Cadbury Report (Audit Committee):

a) The Committee recommended that all listed companies should have an audit committee and set out its remit. b) The Audit committee should comprise at least three non-executives and should be the main relationship with the external auditors. c) Previously the external auditors' main relationship had been with executive management. d) The audit committee should also review the interim and annual financial statements before their submission to the full board for approval.

Recommendations of the Cadbury Report (executive directors):

a) The Committee recommended that directors' service contracts should not exceed three years without shareholder approval. This was to reduce large pay-outs for poor performance. At this time, there was not the debate about directors' remuneration and pay for failure that we see in many countries today. b) The Committee also recommended that directors' remuneration should be decided by a remuneration committee consisting wholly or mainly of non-executives.

The aim of the 2018 Code is to...

a) To get away from box-ticking or boilerplate responses. b) It is hoped that the statements will provide the basis for a positive and constructive dialogue with shareholders. Shareholders have responsibilities under the Stewardship Code to engage with companies on their corporate governance practices, especially where they have provided an explanation for non-compliance with a code provision.