Insights

Financial Reporting Brief

September 2018

This month’s article 'New Governance Code – More Robust Measures' comments on the new UK Corporate Governance Code and its focus on measures to strengthen business trust and confidence.

New Governance Code – More Robust Measures

There has been a growing call for response to social and commercial reform amid shifting areas of focus.

Much of this has emanated from a decline in public trust in business which has been fuelled by such matters as high profile business failures, excessive executive pay packets, accusations of multinational firms avoiding paying their fair share of tax, stagnant real wage growth, and an increase in what are perceived to be insecure or even exploitative employment contracts. 

The new UK Corporate Governance Code ('the Code') and its key Principles and underlying Provisions are a response to this and it is critical that for business to regain trust, it needs to focus also on building respect. The new Code emphasises the importance of four keys areas of governance:

  • Building a positive relationship between companies, their shareholders and stakeholders, particularly its workforce;
  • Aligning the company’s purpose and strategy with a healthy corporate culture;
  • Ensuring Board membership is of a high quality and focused on diversity; and
  • Remuneration that is proportionate and supports long-term success.

The new Code was published in July 2018 by the Financial Reporting Council (FRC) is the latest edition of the Code which was first published in 1992. This is not a tweaking of the code as in previous years but a substantial rewrite and simplification. The focus of the revised code is to emphasise the value of good corporate governance to long term success.

A guiding principle of the FRC’s mission is to promote integrity in business. The FRC sets the UK Corporate Governance Code and Stewardship Code and UK standards for accounting and actuarial work; it monitors and takes action to promote quality reporting and operates independent enforcement arrangements for accountants and actuaries. 

The Code – Fundamental Principles

Fundamental to the Code are the set of principles that emphasise the value of good corporate governance to achieve long-term sustainable success. The new Code Principles are under the following headings: 

  • Board leadership and company purpose
  • Division of responsibilities
  • Composition, succession and evaluation 
  • Audit risk and internal control 
  • Remuneration

Applying these Principles by way of the more detailed Provisions and using the associated guidance, companies can demonstrate throughout their reporting how the governance of the company contributes to its success. 

The effective application of the Principles should be supported by high-quality reporting on the Provisions where required. These operate on a ‘comply or explain’ basis and companies should avoid a ‘tick-box’ approach. An alternative to complying with certain Provisions may be justified in particular circumstances based on a range of factors. Explanations should be considered as a positive opportunity to communicate, not an onerous obligation. Corporate governance reporting should relate coherently to other parts of the report.  

The FRC has published, with the new UK Code, the ‘Guidance on Board Effectiveness’ which is aimed at stimulating Boards’ thinking on how they can carry out their role and encourage them on continuing to improve their effectiveness. The structure of the Guidance follows the Code. The Guidance is intended to act as a reminder to boards and their management that good practice and procedure should continue to be followed. 

Long - Term Sustainable Success

The Code and Guidance promote the fundamental that a sound understanding at Board level of how value is created over time is key in steering strategies and business models towards a sustainable future. Boards have a responsibility for the health of the company and need to take a long term view and consider all stakeholders, not just shareholders. 

The Board is responsible for setting and reconfirming the company’s purpose, the reason for which it exists.  An effective Board will have a focus on the main trends and factors affecting the long-term success and future viability of the company. 

Boards have a responsibility to the health of the company and need to take a long-term view.  The potential conflict between some shareholders’ short-term interests and the long-term sustainable success of the company needs to be effectively managed by the Board. 

The Boardroom should never be an overly comfortable place. One only needs to look at the evidence coming out of the autopsies of recent corporate failures to see that without an effective Board a company can go wrong, fast. A Board that equips itself with relevant knowledge and skills, that is aware of its legal duties and can effectively scrutinise the performance of senior management, has a far greater chance of contributing to a company’s long-term sustainable success

Code - Highlights

Culture

Corporate culture is a feature of the Code, following other developments in recent times. Careful thought must be given to how culture is measured and reported and how to achieve the right culture and behaviours with appropriate incentives and disincentives. The Board must be credible in the eyes of employees and stakeholders. 

Stakeholder Engagement 

The new Code places greater emphasis on the wider group of stakeholders, which importantly includes the employees. It puts forward three ways for Boards to achieve stronger relationships with employees – being (1) a director appointed from the workforce, (2) a formal work wide advisory council, and (3) a designated non-executive director, but it is also open to other mechanisms being adopted which meet the circumstances of the company and the workforce. 

Independence

The new Code emphasises the importance of independence and constructive challenges in the Boardroom, it strengthens considerations of “overboarding” where members may be unable to devote sufficient time to their responsibilities and focuses on diversity, Board refreshment and length of service of directors. 

Remuneration

The new Code sets out to address concerns with public confidence emanating from excessive public pay and the absence of correlation and alignment with company strategy and performance. It calls on companies to address difficult issues by taking various initiatives, to include:

  • Set more demanding criteria for remuneration policies and practices;
  • Report more clearly on remuneration and how it delivers strategy, long-term success and its alignment with workforce remuneration, and;
  • Give remuneration committees broader responsibility for understanding how remuneration policies align with strategic objectives and support long-term success.

Conclusion

The Code is a major part of the Governance framework which also includes the Stewardship Code and other key documents and initiatives. The UK is also introducing a new Code for companies of a significant size (private as well as public) which are outside the scope of the UK Governance Code. 

Companies should be ensuring that a process is in place to understand how they are impacted from the perspectives of both internal guidence and external reporting. 

Codes put forward principles that make inappropriate or inadequate behaviour less likely to occur, and public reporting makes it harder to conceal. By itself, a Code does not prevent inappropriate behaviour, strategies or decisions. Only people, particularly the leaders within a business, can do that. The new Code is a strong blueprint for strong governance and providing direction for leaders. 

The new Code is applicable for periods commencing on or after 1 January 2019.

The Deloitte publication ‘Governance in Brief: New UK Corporate Governance Code’ provides comments and observations on the new Code.  

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