Financial Reporting Council
2019 has been a transitional year. In December 2018 Sir John Kingman published his report into the Financial Reporting Council (FRC). He concluded that the FRC should be replaced as soon as possible by a new independent regulator, to be named the Audit, Reporting and Governance Authority (ARGA). This new body should have clear statutory powers and objectives and be accountable to Parliament, and to the Department for Business, Energy and Industrial Strategy. Its chair and chief executive should be subject to a pre-approval hearing with the BEIS select committee, and thereafter appear annually in front of the select committee.
Sir John’s report envisaged that the duty of the new regulator should be recalibrated to promote the interests of consumers of financial information, not those of its producers. In addition, it should promote competition and innovation. The board of ARGA should be reinforced and re-energised, and should exercise significantly stronger ownership and oversight of its investigation and enforcement functions.
The FRC welcomed the recommendations and is working through its transition to ARGA with the appointment of Simon Dingemans as chair and Sir Jon Thompson as CEO, who at the time of writing is just taking up his role. Legislative changes are necessary to establish ARGA, and for any enhanced sanctions regime for auditors and directors. The government’s consultation on its response to the review’s recommendations closed in June; in the meantime, the FRC has been able to begin implementing some recommendations.
“We are seeing an increased emphasis on reporting action, implementation and process, rather than policies”
This is the final year of reporting under the 2016 UK Corporate Governance Code. However, most companies are already starting to comply with the new 2018 Code (which applies to accounting periods beginning on or after 1 January 2019) — for example, in terms of addressing chair tenure, employee engagement, nomination committee responsibilities, remuneration, and transparency across all aspects of reporting. Transparency has been at the forefront of discussions for several years. The new regulator will extend its corporate reporting activities to include the whole annual report.
Further, ahead of the new Code’s formal implementation, we are seeing across all consultations and reports an increased emphasis on reporting action, implementation and process, rather than policies.
Following the high-profile collapses of Carillion, BHS and Patisserie Valerie, the demise of Thomas Cook is now centre stage, with the FRC having announced an investigation into auditing stewardship and senior management.
In July 2019, the FRC issued a consultation on revisions to ethical and auditing standards. Following an unusually short consultation period, it proposes to introduce the new revised ethical standards with effect from 15 December 2019. These revisions may have a substantial impact in drawing within its scope entities not previously included and also implications for the global network within each auditing firm.
“The FRC proposes to introduce its new revised ethical standards with effect from 15 December 2019”
The report of the Brydon Review is due by the end of the year. The review, led by Sir Donald Brydon, former chair of London Stock Exchange Group, was set up by the government in December 2018. Its remit is to review the quality and effectiveness of audit, building on the findings of both the Kingman report and the Competition and Markets Authority (CMA) study of the UK audit market, the latter having raised competition concerns.
The review is expected to recommend standards and requirements dealing, for example, with robust oversight of audit committees; mandatory joint audit to encourage involvement of challenger firms; a split between audit and non-audit activities, with attendant transparency; and regular review by the regulator.
The role of internal audit has also come under scrutiny. The Chartered Institute of Internal Auditors launched a draft code of practice in July 2019 to strengthen corporate governance and help reduce the risk of major corporate collapses. This builds on the work of 2013, which developed a code for financial services, in order to provide benchmarks and guidance for other sectors. Consultation closed in October.
The FRC published the UK Stewardship Code 2020, along with a discussion paper (“Building a regulatory framework for effective stewardship”) prepared jointly with the FCA. The Code follows the trend mentioned earlier in focusing on outcomes and effectiveness and not on policy statements. It was last reviewed in 2012, and the new edition raises the bar significantly, redefining its purpose and broadening its scope to include assets other than listed equities.
It has also been brought into closer alignment with the Corporate Governance Code and restructured accordingly, with emphasis on strategy, values and culture, and better-quality information. There is recognition too of the heightened importance of environmental, social and governance (ESG) issues, and more rigorous reporting requirements that go further than the EU Shareholder Rights Directive II (SRD II).
Some aspects of the directive need to be implemented locally in each member state and it is assumed that any transition period agreed between the UK and the EU will mean that SRD II will be implemented in the UK.
Investment association public register
Last year we noted for the first time the number of constituents of the UK Spencer Stuart Board Index that also appeared in the Investment Association’s newly established public register of companies that recorded shareholder opposition of more than 20% to AGM resolutions. This year, the number of companies in the Board Index that fell into the relevant proportion of dissenting votes on their remuneration policy and/or remuneration report rose from 19 to 20. Six of the constituents also recorded such votes against director re-election.
In May, the Governance Institute opened a consultation into the effectiveness of independent board evaluation in UK listed companies. The review, which is being carried out at the request of the Department of Business, Energy and Industrial Strategy, will assess the quality of evaluations and identify ways in which board evaluation might be improved.
The question of the time commitment required of directors has been discussed more and more openly in recent years, both by investors and by those considering taking on non-executive roles. High-profile corporate collapses have added further fuel to this fire, and most large investors have published guidelines and voting policies regarding what they consider to be the maximum feasible workload.
These take into account not only demands made of a ‘vanilla’ non-executive role, but also the increased time required of chairs, senior independent directors and committee chairs. The trend seems to be towards a recommendation of four or, at the very most, five mandates, with chair counting as two; and further reinforcement of the general principle that executives should have no more than one external role.
“Companies are strongly urged to be more transparent in their reporting about the true time commitment required to be a director”
Companies are strongly urged to be more transparent in their reporting about the true time commitment required; about the activities of their directors and where they might change, and to ensure that they think carefully about what would be necessary in time of crisis. Disclosure in this area will be closely monitored by the FRC and investors in 2020.
There continues to be some disparity between those investors who limit their consideration of overboarding to quoted company mandates and those who mention “significant activity”, implying a wider range of commitments. This gap will need to be addressed if accurate assessment of directors’ true availability and workload is to be made.
Audit and remuneration committees have been drawing scrutiny for the past decade. The nomination committee is now joining them in the spotlight. Its role and responsibilities have broadened under the new Code, particularly in preparing succession plans not only for board level appointments, but also for senior management roles.
“Given new provisions on chair tenure, nomination committees need to pay even closer attention to chair and CEO succession planning”
Diversity is also defined more widely, beyond gender and ethnicity, to include social background and cognitive and personal strengths. We discuss developments in gender and ethnic diversity on pages 20 and 26 respectively.
Given new provisions on chair tenure, nomination committees need to pay even closer attention to chair and CEO succession planning. They should certainly seek to avoid both appointments changing at the same time, if at all possible. Equally, board renewal should take place in a manner that avoids too many directors leaving at the same time. Nevertheless, these responsibilities should not be construed as barriers to encouraging diversity and thinking further ahead about what the board will need in years to come.
Companies continue to develop effective mechanisms for engaging with all stakeholders, paying attention to the options laid out in the Code. Boards need to ensure that they are comprehensively informed about what is happening throughout the organisation, and should be ready to report on what action is being taken to boost engagement, its impact, and how it will evolve further.
The global nature of companies listed in London means that some do little or no business in the UK. It will be interesting to see if cultural differences affect how these organisations respond to new workforce provisions and to expectations surrounding stakeholder engagement.
The new Code places emphasis on the clear articulation of a company’s purpose, values and culture. Interested parties are discussing the best way to report on how this is implemented. The consensus seems to be that data and metrics have their place, but to be really informative and meaningful, the annual report and/or the company website should provide some narrative on how strategy and culture are aligned, together with case studies to illustrate how this translates into action.
Climate change starts to appear on the board agenda
It will come as no surprise that climate change is making its way on to board agendas. Many companies have been taking ESG issues seriously for some time, but have tended to address them in sector- or geography-specific circumstances.
“Climate change is making its way on to board agendas... investors are taking more robust positions on the topic”
The Financial Stability Board’s Task Force on Climate-Related Financial Disclosures released its recommendations in 2017, suggesting a framework for climate-related financial disclosure, alongside concomitant transparency in pricing climate-related risk. The task force’s latest report, in June 2019, notes that it is “concerned that not enough companies are disclosing decision-useful climate-related information” and argues that many companies still regard climate-related risk as a long-range concern. This is despite the fact that investors are taking more robust positions on the topic. More open discussion is needed on the potential impact of climate-related issues on businesses, and of how awareness and action should not be confined to esoteric risk discussions, but can be disseminated throughout organisations.
In summary, the governance landscape is constantly evolving, both in reaction to events and in trying to prepare for future challenges. This evolution is taking place in an environment of increasing regulation and demand for transparency in reporting.
This article is taken from the 2019 UK Spencer Stuart Board Index.