UK Governance Reforms

The UK Government has flagged significant corporate governance reforms, including new disclosure of pay ratios and reporting obligations for directors.

The direction of corporate governance reform in the United Kingdom is becoming clearer, following the UK Government’s release of its White Paper on Corporate Governance Reform (released 29 August 2017).

The report, responding to submissions received on the Government’s earlier Green Paper, sets out 12 proposals, called ‘actions’, that will require a mix of legislative, Corporate Governance Code and regulatory reforms.

After the dramatic nature of some of the Green Paper proposals, the Government’s final proposals have been greeted as more ‘evolution’ than revolution.

As examples, initial proposals for a binding vote on remuneration reports have been rejected and initial proposals for mandatory worker representatives on boards replaced with more modest engagement options on a ‘comply or explain’ basis. Nonetheless there are significant new obligations on companies and directors that will flow from the paper.

UK governance developments are an important influence on Australian regulation – as one current example, the proposed Banking Executive Accountability Regime (BEAR) is based on the UK Senior Managers regime.  For directors keen to stay abreast of the latest international thinking, the UK report is an important reference.

The UK Financial Reporting Council, which oversees the UK Corporate Governance Code, has committed to a ‘fundamental review’ of the Code including those elements proposed for inclusion in the Government’s paper. The UK Corporate Governance Code applies to UK listed firms in a similar manner to our own ASX Corporate Governance Council, on a ‘comply or explain’ model.

The AICD’s summary of the key proposals from the UK White Paper are below.

1. Executive pay

1. Action on shareholder opposition to pay: Instead of the Green Paper’s proposal for a binding annual ‘say on pay’ by shareholder approval:
   
   
   • Invite the Financial Reporting Council (FRC) to revise the Code to be more specific about the steps that listed companies should take when they encounter shareholder opposition to executive pay; and
   • Invite the Investment Association to maintain a public register of listed companies encountering shareholder opposition to pay awards of 20% or more to executive pay and other resolutions, along with a record of what the companies are doing to address concerns.
      
2. More responsibility for rem committees: The FRC will be invited to consult on a revision to the Code to give remuneration committees broader responsibility for overseeing pay and incentives across the company and require them to engage with their workforce to explain the company’s pay policy (using pay ratios where appropriate)
   
   
3. Pay ratio: Legislate to require listed companies to report annually the ratio of their CEO’s pay to the average pay of their UK workforce, along with a narrative explaining changes to that ratio from year to year.
   
   
4. Clearer disclosures: Legislate to require listed companies to provide a clearer explanation in remuneration policies of the range of potential outcomes from complex, share-based incentive schemes.
   
   
5. Increased vesting periods: The FRC will be invited to consult on changes to the Code to increase the minimum holding period for share-based remuneration from 3 to 5 years.

 2. Strengthening the employee, customer and stakeholder voice

1. New reporting requirement for directors to explain how the board has identified the views of stakeholders, considered and acted on these.
   
   
   • Section 172 of the UK Companies Act imposes a duty to promote the success of the company) requires that directors act in good faith to promote the success of members as a whole and in doing so have regard to (amongst other matters) the long-term, interests of employees, relationships with customers, suppliers and others, impact on environment, reputation of the business and fairness.
   • New laws will require companies (the threshold still to be set) to report on how they have fulfilled this duty. Most likely, this will apply to firms with >1,000 employees, and be included in the Strategic Report.
                                          
2. Employee engagement mechanism: The FRC will be invited to consult on a new Code principle strengthening the voice of employees and other non-shareholder interests at board level. This will include a Code principle requiring companies to adopt, on a ‘comply or explain’ basis, one of three employee engagement mechanisms:
   
   • a designated non-executive director;
   • a formal employee advisory council; or
   • a director from the workforce.
      
3. Practical guidance on engagement: The government will ask the Institute of Chartered Secretaries and Administrators and the Investment Association to publish joint guidance on practical ways in which companies can engage with their employees and other stakeholders at board level.
   
   
4. Practical guidance on section 172 directors’ duty: The government will invite the GC100 (ie FTSE 100 general counsels) to publish new advice and guidance on the practical interpretation of the directors’ duties in section 172 of the Companies Act 2006.

3. Corporate governance in large privately-held firms

1. Voluntary code for large pty: The government will invite the FRC to work with the Institute of Directors and others to develop a voluntary set of corporate governance principles for large private companies.
   
   
2. Disclosure of corporate governance arrangements: New legislation will require all companies of a significant size are to disclose their corporate governance arrangements in their Directors’ Report and on their website, including whether they follow any formal governance code. 

4. Other measures

Regulator co-ordination in sanctioning directors: The FRC, the Financial Conduct Authority and the Insolvency Service are to conclude or revise letters of understanding with each other to ensure the most effective use of existing powers to sanction misbehaving directors and ensure the integrity of corporate governance reporting.

5. Boardroom diversity

Although not specifically canvassed in the Green Paper, the government responded to calls for greater action on board diversity by:

1. Supporting the existing voluntary target of 33% female executives in FTSE100 firms and 33% female directors in FTSE 350 boards by 2020;
   
   
2. Supporting voluntary targets for ethnic diversity on boards in principle (pending the outcome of the Parker review, currently recommending ‘one by 2021’ directors of colour on FTSE100 boards);
   
   
3. Not supporting any further legislated reporting on diversity at this time. 

The proposed reforms have received wide coverage, some criticising the dilution of proposals for worker representation and binding annual votes on executive remuneration and others arguing that new and potentially onerous reporting requirements (extending to private companies) will add to compliance costs without delivering real change. Reforms seen as ‘beefing up’ director duties and policing them have been generally welcomed. The Government intends to take forward its proposals by June 2018 and for the new requirements to apply to company reporting years commencing on or after that date.