Governance changes on the way: what you need to know

These arose primarily from a consultation by the FRC on changes to the UK Corporate Governance Code and a proposed Statutory Instrument (SI) on reporting from the Department of Business and Trade (DBT). In addition, there has been an FCA consultation on Proposed Reforms to UK Listing Rules. Everything, however, suddenly changed on 16 October 2023 when the Government withdrew its draft reporting regulations and the impact on the ongoing revisions to the UK corporate Governance Code is not yet clear.

The board’s role and responsibilities in relation to auditing, reporting and governance have been under the microscope in recent years in the wake of several high-profile collapses including BHS, Carillion and Patisserie Valerie.

Specific proposals published in recent months were expected to bring substantial changes in governance and reporting for leading companies. Even though the Government has now withdrawn its draft reporting regulations on the grounds of not imposing undue burdens on business, important changes remain in the proposed revisions to the UK Corporate Governance Code. However, it is not clear whether there will also be pressure to water these down and the situation is made more complicated because there was some overlap between the two documents.      

The Financial Reporting Council (FRC) has consulted on proposed changes to the UK Corporate Governance Code which form part of the wider reform package set out in the Government’s response to its White Paper consultation on ‘Restoring trust in audit and corporate governance’.

The Code changes will apply to all listed companies, not just premium listed as at present if the Proposed Reforms to UK Listing Rules come into effect, and will cover accounting periods beginning on or after 1 January 2025.

So what do you need to know about the proposed new UK Corporate Governance Code?  Here are some of the headlines:

Proposed changes to the UK Corporate Governance Code

The most significant – and for some the most controversial – proposal is a move to hold company directors to greater account. As such, there will be a requirement for boards of applicable companies to make a ‘declaration’ in their Annual Report on:

• The effectiveness of Risk Management and Internal Controls throughout the relevant accounting period and up to the date of the annual report;
• How the Board has assessed the effectiveness of those controls;
• Any material weaknesses in internal controls that have been identified and any remediation plans, along with timelines.

“This statement crucially covers all controls not just those related to financial reporting and therefore embraces those linked to sustainability matters” says Anthony Carey, our Senior Adviser, Board Practice and Public Policy.

In this context, Paul Winrow, our Partner, Audit Policy & Regulation notes that it is likely there will be widespread disclosures where companies do not fully comply with respect to the effectiveness of internal controls over non-financial reporting in the early years of adoption, given the relative immaturity of such controls compared to those over financial reporting. As such, regulators and the market should recognise this is the case.

Widening the audit committee’s remit to cover narrative reporting – including on sustainability

Another proposed change is that the audit committee will be made explicitly responsible for reviewing the integrity of narrative reporting, including sustainability reporting, for reviewing any significant reporting judgements and for describing its work in this area in the annual report. Additionally, the annual report will describe the assurance of ESG metrics and other sustainability matters where it has been commissioned by the board.

Winrow describes such an integrated approach to corporate reporting by companies, bringing together narrative and financial reporting, as essential.

“We agree that it would be appropriate for the audit committee’s remit to incorporate narrative reporting, especially as it will have responsibility in relation to the appropriateness of systems and controls over such reporting,” he says.

However, Winrow notes that the burden on audit committees is already considerable, and some may not necessarily have the appropriate skills to address complex sustainability issues or their expertise may overlap with that of other board committees.

“It will be also important for the audit committee to liaise effectively with the sustainability committee, or similar, in a company where this exists,” he says.

“Given our view that the content of the annual report needs to be considered as an integrated whole, we believe that ESG reporting should not be spread across different narrative reports some of which may be in the Annual Report and others outside of it. As proposed, the audit committee should also be involved in matters such as deciding the extent to which the narrative reporting, including that on ESG, should be subject to assurance.”

Strengthening of ‘malus and clawback’ provisions on directors’ remuneration

The Code proposals also include specific reference to malus and clawback arrangements. These are intended to ensure that there are malus and clawback provisions in director remuneration schemes, including share award schemes, with the circumstances when these provisions would be applied being disclosed within the annual report. In addition, companies are expected to set out how the provisions have been used within the last five years.

These measures will be widely welcomed, although such disclosures are already becoming standard practice.

Proposed Reforms to UK Listing Rules

As mentioned, whilst the Corporate Governance Code currently covers premium listed companies, the FCA’s Proposed Reforms to UK Listing Rules proposes a single listing category whereby both current premium and standard listed companies would have to apply the UK Corporate Governance Code.

The proposed changes, generally designed to make the London market more attractive for listings, include:

- A single listing category to replace Premium and Standard listings.

- All listed companies, not just Premium as at present, to apply the UK Corporate Governance Code.

- Removal of the three-year financial track record requirement as a condition for listing and no longer needing a ‘clean’ working capital statement.

- Simplified rules related to the current requirement that a company has an independent business and operational control over its main activities.

- More flexible rules covering a shareholder agreement with a controlling shareholder by moving to a ‘comply or explain’ and disclosure-based approach.

- A more permissive approach to dual-class share structures, whose allowance was previously a matter of controversy on the London Stock Exchange with pressure for one share one vote

- Removal of compulsory shareholder votes/circulars for significant transactions.

- Removal of compulsory shareholder votes/circulars for related party transactions, including where a controlling shareholder is involved.

Next steps

On controls, Winrow advises boards to start examining which ones the company has in place and to identify any gaps. “Check if you are going to have to make a declaration and, if so, identify the areas that need improvement, the best way to do it to strengthen the business and the time needed so that you are ready in good time ready for the changes.”

“Another big issue to consider,” Carey adds “is when having to make additional disclosures.  As businesses will have to be more transparent on a number of areas, how will it look relative to competitors? And now there is the additional challenge of having to focus on the likely changes whilst keeping track of the FRC’s response to the Government’s recent climb-down.”

Published November 2023

These arose primarily from a consultation by the FRC on changes to the UK Corporate Governance Code and a proposed Statutory Instrument (SI) on reporting from the Department of Business and Trade (DBT). In addition, there has been an FCA consultation on Proposed Reforms to UK Listing Rules. Everything, however, suddenly changed on 16 October 2023 when the Government withdrew its draft reporting regulations and the impact on the ongoing revisions to the UK corporate Governance Code is not yet clear.

The board’s role and responsibilities in relation to auditing, reporting and governance have been under the microscope in recent years in the wake of several high-profile collapses including BHS, Carillion and Patisserie Valerie.

Specific proposals published in recent months were expected to bring substantial changes in governance and reporting for leading companies. Even though the Government has now withdrawn its draft reporting regulations on the grounds of not imposing undue burdens on business, important changes remain in the proposed revisions to the UK Corporate Governance Code. However, it is not clear whether there will also be pressure to water these down and the situation is made more complicated because there was some overlap between the two documents.

The Financial Reporting Council (FRC) has consulted on proposed changes to the UK Corporate Governance Code which form part of the wider reform package set out in the Government’s response to its White Paper consultation on ‘Restoring trust in audit and corporate governance’.

The Code changes will apply to all listed companies, not just premium listed as at present if the Proposed Reforms to UK Listing Rules come into effect, and will cover accounting periods beginning on or after 1 January 2025.

So what do you need to know about the proposed new UK Corporate Governance Code? Here are some of the headlines:

Proposed changes to the UK Corporate Governance Code
The most significant – and for some the most controversial – proposal is a move to hold company directors to greater account. As such, there will be a requirement for boards of applicable companies to make a ‘declaration’ in their Annual Report on:

The effectiveness of Risk Management and Internal Controls throughout the relevant accounting period and up to the date of the annual report;
How the Board has assessed the effectiveness of those controls;
Any material weaknesses in internal controls that have been identified and any remediation plans, along with timelines.
“This statement crucially covers all controls not just those related to financial reporting and therefore embraces those linked to sustainability matters” says Anthony Carey, Senior Adviser, Board Practice and Public Policy.

In this context, Paul Winrow, Partner, Audit Policy & Regulation notes that it is likely there will be widespread disclosures where companies do not fully comply with respect to the effectiveness of internal controls over non-financial reporting in the early years of adoption, given the relative immaturity of such controls compared to those over financial reporting. As such, regulators and the market should recognise this is the case.

Widening the audit committee’s remit to cover narrative reporting – including on sustainability

Another proposed change is that the audit committee will be made explicitly responsible for reviewing the integrity of narrative reporting, including sustainability reporting, for reviewing any significant reporting judgements and for describing its work in this area in the annual report. Additionally, the annual report will describe the assurance of ESG metrics and other sustainability matters where it has been commissioned by the board.

Winrow describes such an integrated approach to corporate reporting by companies, bringing together narrative and financial reporting, as essential.

“We agree that it would be appropriate for the audit committee’s remit to incorporate narrative reporting, especially as it will have responsibility in relation to the appropriateness of systems and controls over such reporting,” he says.

However, Winrow notes that the burden on audit committees is already considerable, and some may not necessarily have the appropriate skills to address complex sustainability issues or their expertise may overlap with that of other board committees.

“It will be also important for the audit committee to liaise effectively with the sustainability committee, or similar, in a company where this exists,” he says.

“Given our view that the content of the annual report needs to be considered as an integrated whole, we believe that ESG reporting should not be spread across different narrative reports some of which may be in the Annual Report and others outside of it. As proposed, the audit committee should also be involved in matters such as deciding the extent to which the narrative reporting, including that on ESG, should be subject to assurance.”

Strengthening of ‘malus and clawback’ provisions on directors’ remuneration

The Code proposals also include specific reference to malus and clawback arrangements. These are intended to ensure that there are malus and clawback provisions in director remuneration schemes, including share award schemes, with the circumstances when these provisions would be applied being disclosed within the annual report. In addition, companies are expected to set out how the provisions have been used within the last five years.

These measures will be widely welcomed, although such disclosures are already becoming standard practice.

Proposed Reforms to UK Listing Rules
As mentioned, whilst the Corporate Governance Code currently covers premium listed companies, the FCA’s Proposed Reforms to UK Listing Rules proposes a single listing category whereby both current premium and standard listed companies would have to apply the UK Corporate Governance Code.

The proposed changes, generally designed to make the London market more attractive for listings, include:

A single listing category to replace Premium and Standard listings.
All listed companies, not just Premium as at present, apply the UK Corporate Governance Code.
Removal of the three-year financial track record requirement as a condition for listing and no longer needing a ‘clean’ working capital statement.
Simplified rules related to the current requirement that a company has an independent business and operational control over its main activities.
More flexible rules covering a shareholder agreement with a controlling shareholder by moving to a ‘comply or explain’ and disclosure-based approach.
A more permissive approach to dual-class share structures, whose allowance was previously a matter of controversy on the London Stock Exchange with pressure for one share one vote
Removal of compulsory shareholder votes/circulars for significant transactions.
Removal of compulsory shareholder votes/circulars for related party transactions, including where a controlling shareholder is involved.

Next steps
On controls, Winrow advises boards to start examining which ones the company has in place and to identify any gaps. “Check if you are going to have to make a declaration and, if so, identify the areas that need improvement, the best way to do it to strengthen the business and the time needed so that you are ready in good time for the changes.”

“Another big issue to consider,” Carey adds “is when having to make additional disclosures. As businesses will have to be more transparent in a number of areas, how will it look relative to competitors? And now there is the additional challenge of having to focus on the likely changes whilst keeping track of the FRC’s response to the Government’s recent climb-down.”