New corporate governance reporting requirements for large private companies; FRC consultation on a draft corporate governance code for large private companies.

The UK Department for Business, Energy & Industrial Strategy (BEIS) has released a guidance document setting out how and when companies will be effected by new corporate governance reporting requirements in the proposed Companies (Miscellaneous Reporting) Regulations 2018 currently before parliament for approval. The BEIS notes that the regulations are not yet law, and will not become so until approved by parliament, but that the guidance is being released to give companies and stakeholders as much time as possible to understand the proposed changes.

Separately, The Financial Reporting Council (FRC) has released the Wates Corporate Governance Principles for Large Private Companies (the Principles) for consultation. The FRC states that in addition to improving corporate governance standards, compliance with the Principles will satisfy the reporting requirements under the proposed: Companies (Miscellaneous Reporting) Regulations 2018.

A high level overview of both the new corporate governance reporting requirements as outlined in the BEIS guidance document and a broad overview of the Wates Corporate Governance Principles is below.

Key points: New corporate governance reporting requirements

The regulations will require certain companies (all companies that do not have an existing corporate governance reporting requirement and which have more than 2000 employees and/or a turnover of more than £200 million, and a balance sheet of more than £2 billion) to include additional content in their annual reports.

In particular, the BEIS highlights the following additional requirements.  

Compliance with corporate governance code: Very large private and public unlisted companies will be required to include a statement as part of their directors’ report stating which corporate governance code (if any) has been applied and how. If the company has departed from any aspect of the code, the company will be required to outline how it did so and to provide reasons. If the company has not applied any corporate governance code, the statement must explain why that is the case and what arrangements for corporate governance were applied.

Report on how directors have had regard to their duty to promote the success of the company: Large companies will be required to include a statement as part of their strategic report describing how the directors have had regard to the matters in section 172(1)(a) to (f) of the Companies Act 2006 (UK). Specifically, the legislation states:

172 Duty to promote the success of the company

(1) A director of a company must act in the way 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—

1. the likely consequences of any decision in the long term,
2. the interests of the company's employees,
3. the need to foster the company's business relationships with suppliers, customers and others,
4. the impact of the company's operations on the community and the environment,
5. the desirability of the company maintaining a reputation for high standards of business conduct, and
6. the need to act fairly as between members of the company.

[Note: The proposed changes to the UK Corporate Governance Code released by the FRC for consultation in December 2017 included (among other things) proposals for annual reports to include new information on how the interests and the matters included in s172 of the Companies Act 2006 UK had influenced the board's decision making. In putting forward the proposal, the FRC noted the government's intention to introduce secondary legislation to require all companies of significant size (private as well as public) to explain how their directors comply with the requirements of s172 and noted further, that the code would be finalised pending the outcome of the government's measures in this regard. Consultation on the revised Code closed in February of this year, and a final version is yet to be released. A recent post on University of Oxford, Faculty of Law blog suggests that the final version of the FRC Corporate Governance Code is unlikely to be released until the end of July 2018 which may delay implementation. ]

Employee engagement: Companies with more than 250 UK employees will be required to include a statement as part of their directors’ report summarising how the directors have engaged with employees, how they 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.

Business relationships: Large companies will be required to include a statement as part of their directors’ report 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 taken by the company during the financial year.

Median pay: Quoted companies with more than 250 UK employees will be required to publish, as part of their directors’ remuneration report, the ratio of their CEO’s total remuneration to the median (50th), 25th and 75th percentile full-time equivalent (FTE) remuneration of their UK employees. Companies will also have to publish supporting information eg how the median ratio is consistent with the company’s wider policies on employee pay, reward and progression and the reasons for changes to the ratios from year to year.

Director remuneration: All quoted companies will be required to explain, in the directors' remuneration policy within their directors’ remuneration report, the effect of future share price increases on executive pay outcomes. Companies will also be required to include a summary in their directors’ remuneration report of any discretion that has been exercised on executive remuneration outcomes reported that year in respect of share price appreciation or depreciation during the relevant performance periods.

[Note: The pay ratio proposal was outlined by Prime Minister Theresa May in 2016, when she called for 'responsible capitalism' and curbs to excessive executive remuneration. The additional requirements also follow the recent introduction of pay gap reporting requirements in the UK . Broadly, the remuneration reporting requirements appear similar to those recently implemented in the US.]

Timeframe

Subject to Parliamentary approval, the new reporting requirements will apply to company reporting on financial years starting on or after 1 January 2019 ie the first actual reporting under the new regulations will start in 2020. 

The Financial Reporting Council has released the Wates Corporate Governance Principles for Large Private Companies (the Principles) for consultation.

Following the release of the UK government’s 2016 Green Paper and the Business, Energy & Industrial Strategy (BEIS) Select Committee’s report of April 2017, The Financial Reporting Council (FRC), has released the Wates Corporate Governance Principles for Large Private Companies (the Wates Principles) (and accompanying guidance) for consultation. The FRC has urged companies to engage in the consultation process, and to adopt the Code once finalised, both to inform and develop their corporate governance practices and to help restore trust in the sector. FRC Executive Director, Corporate Governance and Reporting Division Paul George commented: 'These principles pave the way for more clarity of purpose and positive corporate behaviours amongst this significant sector of the business community. This work has the potential to help restore trust in business and contribute to long-term sustainable growth in the UK economy.'

Consultation on the Wates Principles is open until 7 September 2018. The final version of the Principles will be published in December 2018.  The FRC writes that companies will be able to apply them to meet anticipated new reporting requirements (outlined above).

Six principles

The six principles are:

1. 'Purpose – An effective board promotes the purpose of a company, and ensures that its values, strategy and culture align with that purpose'.
2. 'Composition – 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 a board should be guided by the scale and complexity of the company'.
3. 'Responsibilities – A board should have a clear understanding of its accountability and terms of reference. Its policies and procedures should support effective decision-making and independent challenge'.
4. 'Opportunity and Risk – A board should promote the long-term success of the company by identifying opportunities to create and preserve value and establish oversight for the identification and mitigation of risk'.
5. 'Remuneration – A board should promote executive remuneration structures aligned to sustainable long-term success of a company, taking into account pay and conditions elsewhere in the company'. in order to assess how workforce pay and conditions have been taken account in setting directors’ remuneration?
6. 'Stakeholders – A board has a responsibility to oversee meaningful engagement with material stakeholders, including the workforce, and have regard to that discussion when taking decisions. The board has a responsibility to foster good relationships based on the company’s purpose'.

Consultation questions

Among the issues on which the FRC has requested feedback are the following.

• Whether the principles provide 'sufficient visibility' of remuneration structures 'in order to assess how workforce pay and conditions have been taken account in setting directors’ remuneration?'
• Whether the draft Principles should be 'more explicit in asking companies to detail how their stakeholder engagement has influenced decision-making at board level?'
• What approach to monitoring of the application of the principles would encourage best practice and whether the 'apply and explain' approach to reporting is the best approach.  

Comments on the Wates Principles

• James Wates CBE, Chair of the Coalition Group that developed the principles stated: 'Good business well done is good for society…These principles will provide a flexible tool for companies of all sizes, not just those captured by the new legislative reporting requirement, to understand good practice in corporate governance and, crucially, adopt that good practice widely. The principles are about fundamental aspects of business leadership and performance.'

  Director-general of the Institute of Directors Stephen Martin is quoted in The Times as commenting: 'As we saw in the case of BHS, the collapse of a large private company can have far-reaching consequences for a range of individuals…It is right that these organisations should be required to report on their governance arrangements so they can provide a degree of transparency to employees, customers and suppliers.'

  Director of the Institute for Family Business Elizabeth Bagger is quoted in The Times as saying: 'Whilst most family businesses act responsibly, the actions of a few businesses has damaged trust in UK business as a whole. We hope that the adoption of new corporate governance principles will help to repair that trust.'

  Australian Position

  Commenting on the proposed changes, MinterEllison Partner Mark Standen suggested that they are part of a global trend towards holding companies to a higher standard of behaviour than has previously been the case. 'Increasingly, companies are expected to deliver more than strong financial returns. They are also expected, as BlackRock's Larry Fink suggested in his 2018 letter to CEOs, to contribute to society' he said. 'What is interesting is that this trend is now translating into formal regulation of both private and public companies, where previously, this has not been the case'.

  Though there are no parallel formal requirements for private companies in Australia Mr Standen said, there are some signs of a similar shift in community expectations, and to some extent a shift in regulators’ expectations of corporate behaviour for both private and public entities in this country. The release of APRA's recent report corporate governance, culture and accountability within the CBA which called for greater focus on the management of non-financial risk; recent speeches by ASIC Chair James Shipton on the topic of rebuilding 'trust' calling for industry to raise standards of professionalism if further regulation is to be avoided; and the focus not only on meeting minimum legal requirements, but on meeting community standards of behaviour at the Financial Services Royal Commission is evidence of this shift in thinking, Mr Standen suggested.

  There are also signs that industry is proactively moving to implement changes in this regard, Mr Standen added.  For example, the release by ACSI of the first stewardship code for asset owners and the recently revised Banking Code of Practice (currently awaiting APRA approval) have a similar focus on raising standards.  ‘Though Australia has not moved as far as the UK towards formally regulating governance and culture, no company can afford not to focus on building strong corporate governance standards into their everyday business’ Mr Standen said.