Included in this issue: BEIS Select Committee publishes report on Corporate Governance; McGregor-Smith Review on race in the workplace; Announcements of regulated information to require further information from October 2017 and more...
BEIS Select Committee publishes report on Corporate Governance
The Select Committee (Committee) of the Department of Business, Energy and Industrial Strategy (BEIS) has published its report on Corporate Governance (Report) having launched an inquiry in September 2016 following the high-profile governance failings in BHS and Sports Direct and in light of the Prime Minister's commitment to bring forward measures to tackle corporate irresponsibility. The Financial Reporting Council (FRC) has welcomed the Report, as has the Institute of Directors (IoD). Once the Government has responded to it, the FRC intend to commence a review of the UK Corporate Governance Code (Code) to "simplify and shorten it and set it on its course for the next 25 years".
The Committee believes that the UK's strong corporate governance regime remains a considerable asset which enhances the reputation of the UK as a place to do business. It believes that the Government should be very cautious about making changes that risk this position purely because of a small number of highly damaging examples of corporate governance failure; it does not believe that a radical overhaul is required. However, the Committee states that there is scope for significant improvement in the governance framework in order to address the changing nature of company ownership in a globalised economy.
The most significant of the Committee's recommendations are:
- More effective measures are required to ensure that directors demonstrably take seriously their duties to have regard to other stakeholders and the long-term consequences of decisions.
- The FRC should amend the Code to require informative narrative reporting on the fulfilment of Companies Act 2006 section 172 duties. Boards must be required to explain precisely how they have considered each of the different stakeholder interests and, where there have been failures to have due regard to any one of these interests, these should be addressed directly and explained.
- The Government should legislate to give the FRC the additional powers it needs to engage and hold to account company directors in respect of the full range of their duties. Where engagement is unsuccessful, the FRC should report publicly to shareholders on any individual or collective failings and be given authority to initiate legal action for breach of section 172 duties.
Rating annual reports
- The FRC should develop appropriate metrics to inform an annual rating exercise for annual reports. This should publicise examples of good and bad practice in an easy to digest red, yellow and green assessment. Companies should be obliged to include reference to this rating in their annual reports.
- Companies should consider establishing stakeholder advisory panels. The Code should be revised to require a section in annual reports which sets out how companies engage with stakeholders.
- The Government should also consult on new requirements for listed and large private companies to provide full information on advisors engaged in transactions above a reasonable threshold, including on the amount and basis of payments and on their method of engagement.
- The FRC should include best practice guidance on professional support for non-executive directors when it updates the Code. Companies should include training of board members as part of reporting on their people or human resources policy.
- The Code should be updated to provide guidance on how companies should identify clearly and transparently the roles of non-executive directors where they have particular responsibilities and how they should be held to account for their performance. NEDs should be required to demonstrate more convincingly that they are able to devote sufficient time to each company when they serve on multiple boards.
- The FRC, IoD and Institute for Family Business should develop, with private equity and venture capital interests, an appropriate code with which the largest privately-held companies would be expected to comply.
- Those same bodies should contribute to the establishment of a new body to oversee and report on compliance with that code.
- Any new code should include a complaint mechanism, under which the overseeing body could pursue complaints against a company.
The Committee believe that executive pay is causing damage to the generally good reputation of British business and undermining public trust in it. Too often pay awards appear impossible to justify in relation to performance and when set against pay levels lower down an organisation.
If the measures outlined below and more responsible shareholder engagement do not have the desired effect, Government may have to consider more direct intervention, including annual binding votes on pay levels.
The Committee recommends:
- the alignment of bonuses with broader corporate responsibilities and objectives as well as ensuring that targets are genuinely stretching. Any policy in this respect should be considered by the FRC in their corporate governance rating system.
- LTIPs should be phased out as soon as possible. No new LTIPs should be agreed from the start of 2018 and existing agreements should not be renewed.
- Deferred stock rather than LTIPs should be best practice in terms of incentivising long-term decision making. Executive pay structures should have the following features:
- a simpler structure based primarily on salary plus long-term equity, divested over a genuinely “long-term” period, normally at least five years, without large steps;
- limited use of short-term performance-related cash bonuses, which should be aligned, where possible, to wider company objectives or corporate governance responsibilities;
- clear criteria for bonuses: they should be genuinely stretching and be aimed to provide incentives rather than just reward.
- The FRC should revise the Code to include a requirement for a binding vote on executive pay awards in the year which follows a vote against awards of over 25 per cent of votes cast. This requirement should be included in legislation at the next opportunity.
- The Code should recommend employee representation on remuneration committees as this would send a powerful signal on company culture and commitment to fair pay.
- The Chair of a remuneration committee should normally have served on the committee for at least one year previously and should be expected to resign if their proposals on pay do not receive the backing of 75 per cent of voting shareholders.
- Pay ratios between the CEO and both senior executives and all UK employees should be published.
Composition of boards
- While the Committee supports the Hampton-Alexander Review, it believes its aims and targets should go further and that the Government should set a target that from May 2020 at least half of all new appointments to senior and executive management level positions in the FTSE 350 and all listed companies should be women. Companies should explain in their annual report the reasons why they have failed to meet this target, and what steps they are taking to rectify the gender inequality on their Executive Committees.
- The FRC should embed the promotion of the ethnic diversity of boards within its revised Code. In accordance with the spirit of the McGregor-Smith review (of which more below), the Government should legislate to ensure that all FTSE 100 companies and businesses publish their workforce data, broken down by ethnicity and by pay band.
- Annual reports should be required to include narrative on the current position, and an emphasis on what steps the company has taken, and will continue to take to enhance the diversity of the executive pipeline, with agreed targets. This narrative should include how accurately the board mirrors the diversity of both its workforce and customer base.
- Companies should be recruiting non-executive and executive directors from the widest possible net of suitable candidates, which should include recruiting internally. Just as the drive for women directors has overcome initial doubts, it should become the norm for workers to serve on boards. However, the Committee does not go as far as to recommend compulsory worker board representation.
- The revised Code should state that the procedure for the appointment of new directors to the board should be by open advertising, and by an external search consultancy, and detailed explanations should be given if one or both of these requirements is not met.
- The FRC should be given the extra role of overseeing the rigour of board evaluation processes to ensure they are genuinely independent, thorough and consistent across companies. The FRC should also highlight best and worst practice among Nomination Committees.
ICSA revise guidance on terms of reference for audit committees
ICSA has published revised guidance on terms of reference for audit committees. The revisions primarily reflect the updated editions of the UK Corporate Governance Code and FRC's Guidance on Audit Committees both published in April 2016.
Changes of significance include:
- a new recommendation that, where possible, one member of the remuneration committee should sit on the audit committee;
- expanding or amending the various duties of the committee to include:
- that, where it is practical to do so, the committee first reviews any other statements requiring board approval which contain financial information; and
- approval of the internal audit charter (if any) and consideration of whether an independent, third party review of internal audit processes is appropriate,
- expanding on and providing greater detail in relation to the committee's role as regards recommending to the board the company's policy on the provision of non-audit services by its auditor.
McGregor-Smith Review on race in the workplace
The McGregor-Smith Review on race in the workplace and the government's response to it have been published. The review makes a number of recommendations to improve diversity, including:
- listed companies and businesses with more than 50 employees should publish five-year aspirational targets and report against them annually. They should also publish a breakdown of employees by race and by pay band both on their website and in their annual report;
- the Government should legislate to ensure that workforce data broken down by race and pay band is published and work with organisations such as the CBI and IoD to ensure that free, online unconscious bias training is available; and
- businesses with more than 50 employees should identify a board-level sponsor for all diversity issues, including race, who should be held to account for the overall delivery of aspirational targets. To ensure this happens, Chairs, CEOs and CFOs should reference what steps they are taking to improve diversity in the annual report.
In its response, the Government states that it believes that a non-legislative solution is the right approach for the time being but that it will monitor progress. It notes that companies are already required to use the strategic report to document information about their employees and social and community issues and that companies can choose to report information such as diversity of their employees as part of this. Alternatively, investors could ask for diversity information to be included or ask for it to be provided at the AGM.
Business Minister Margot James has written to the chief executives of all FTSE 350 companies calling on them to take up key recommendations from the review.
Announcements of regulated information to require further information from October 2017
The Financial Conduct Authority (FCA) has set out its response to proposed changes to Chapter 6 of the Disclosure Guidance and Transparency Rules (proposed in CP16/39) as well as publishing final rules. More detail on the proposals, which require the addition of certain information when disclosing regulated information, can be found in our Governance & Compliance update published at the time the consultation was launched. The handbook changes will come into force on 1 October 2017.
UKLA guidance notes: Primary Market Bulletin No. 17
The FCA has published its 17th Primary Market Bulletin which contains a consultation on various changes to the UKLA Knowledge Base, including amending an existing technical note relating to shareholder obligations to notify significant holdings under DTR 5 (UKLA/TN/543.3). The consultation closes on 10 May 2017. The publication also contains a link to, and guidance on, the new TR-1 form which must be used for the notification of major holdings from 30 June 2017.