The Financial Reporting Council (FRC) has issued advice for companies on how to report transparently and effectively when departing from certain provisions of the UK Corporate Governance Code
The Code sets high standards for corporate governance but the FRC recognises that companies have differing circumstances and so the Code offers flexibility through its ‘comply or explain’ approach to reporting.
The FRC encourages companies to embrace the flexibility offered by the Code so that investors and wider stakeholders benefit from reporting that clearly demonstrates a commitment to good governance, and sets out a company’s circumstances.
The FRC guidance stated: ‘Sometimes a departure from the Code is unavoidable: for example, if a director resigns without advance notice, leaving the board with less than half of the board made up of independent non-executive directors (NEDs). Companies should use the flexibility offered by the Code to adjust their governance to their changing circumstances in both the short and long term.’
However, there was a lack of transparency in some instances where companies did not follow the code. The FRC said: ‘We were disappointed with the quality of the explanations provided by companies for non-compliance with the provisions of the Code and struggled to find robust explanations. Our sample identified 74 cases of non-compliance with the Code, but we found only four explanations that we considered high quality and offered an insight into the companies’ approach to good governance. The majority of explanations were inadequate, and in one instance, not given at all.’
A good explanation should demonstrate that departure is justified given the company’s specific circumstances. It should set the context and background, give a convincing rationale for the approach being taken and consider any risks and describe any mitigating actions. It should also set out when the company intends to comply with the timescales, particularly when it extends beyond the full accounting year.
Stakeholders’ interests and matters set out in section 172(1) of the Companies Act 2006 need to be followed. Companies are required to describe in the annual report how their key stakeholders’ interests and matters set out in s172 have been considered in board discussions and decision-making. If a company does not provide a description as required by Provision 5 covering stakeholders’ interests and workforce engagement, it is not complying with it.
To comply with this provision, companies need to give clear and specific examples of how they have considered in their board discussions and decision-making the interests of the key stakeholders of the company and s172 matters.
Companies should engage with the workforce using one of the engagement methods prescribed by this provision, or a combination of them. This means that the company needs representation from the workforce, whether through a director appointed from the workforce, a formal workforce advisory panel or a designated non-executive director.
The FRC stressed that ‘Effective engagement is more than reporting that the company has sought the workforce’s views on remuneration via surveys. Engagement should be two-sided. It should describe the method of engagement, the parties involved, what explanation was given to the workforce as to how executive remuneration aligns with wider company pay policy and the views of the workforce on it’.
It is important that companies:
- embrace the flexibility offered by the Code and develop bespoke governance processes and practices which raise standards.
- make it easy for readers to find out which provisions of the Code they have departed from in their annual report.
- ensure that they provide full, clear and meaningful explanations for any such departures.
This new guidance builds on the findings of the FRC’s Review of Corporate Governance Reporting issued in November. These reports are part of the FRC’s ongoing drive to promote good practice and support companies to continually improve their reporting against the Code.