Included in this week's Governance & Compliance Update: Wates Principles published in final form

Wates Principles published in final form

The Wates Corporate Governance Principles for Large Private Companies (Principles) have been published in final form, together with a Feedback Statement. This follows the consultation launched by the Financial Reporting Council (FRC) on behalf of the Coalition Group[1] in June 2018 and the publication of The Companies (Miscellaneous Reporting) Regulations 2018 (Regulations) which requires companies of a certain size to report on their governance arrangements in relation to financial periods beginning on or after 1 January 2019.

Overall, the majority of consultation responses thought that the Principles covered the main governance issues and were pitched at about the right level to meet the needs of a diverse group of companies and provide them with a flexible framework to explain the application and relevance of their governance arrangements. The supporting guidance in relation to each Principle (Guidance) has been 'improved' and also includes links to other sources of potential assistance.

Crucially, the 'apply and explain' approach – whereby boards apply the Principles by considering them individually within the context of the company's specific circumstances and then explain how they have addressed them in their governance practices - has been retained. In addition, the status of the Guidance remains the same as in the consultation draft – it is meant to assist companies in explaining their approach to applying each Principle as appropriate to their circumstances but does not have the same status as a provision in the UK Corporate Governance Code with which a company must comply or explain why it has not done so.

Changes made to the Principles

The Principles have been revised as follows (additions being underlined)

Principle One: Purpose and leadership

An effective board develops and promotes the purpose of a company, and ensures that its values, strategy and culture align with that purpose.

Principle Two: Board composition     

Effective board composition requires an effective chair and a balance of skills, backgrounds, experience and knowledge, with individual directors having sufficient capacity to make a valuable contribution. The size of a board should be guided by the scale and complexity of the company.

Principle Three: Director responsibilities          

The board and individual directors should have a clear understanding of their accountability and responsibilities. The board's policies and procedures should support effective decision-making and independent challenge.

Principle Four: Opportunity and risk   

A board should promote the long-term sustainable success of the company by identifying opportunities to create and preserve value, and establishing oversight for the identification and mitigation of risks.

Principle Five: Remuneration 

A board should promote executive remuneration structures aligned to the long-term sustainable success of a company, taking into account pay and conditions elsewhere in the company.

Principle Six: Stakeholder relationships and engagement   

Directors should foster effective stakeholder relationships aligned to the company's purpose. The board is responsible for overseeing meaningful engagement with stakeholders, including the workforce, and having regard to their views when taking decisions. 

Changes in more detail

Recognising that the Principles would benefit from additional information regarding the relationship between them and the Regulations, amendments have been made to the Introduction to include relevant extracts from the Regulations, along with section 172 of the Companies Act 2006 (directors' duty to promote the success of the company) (section 172). The Introduction clarifies that the Principles neither override nor interpret section 172.

The Introduction also encourages cross-reference to reporting against other legislative requirements when reporting against the Principles. Similarly, echoing the FAQs published by the government in relation to the Regulations, the Introduction states that while relevant subsidiaries are required to report, reference to a parent company's corporate governance statement may be sufficient if it deals with the governance arrangements relevant to the subsidiary.

Principle One – Purpose and leadership

Principle One acknowledges that the board both 'develops and promotes' the company's purpose.

The Guidance now states that directors should act with integrity and set the tone from the top. It also offers suggestions on how to monitor culture and reinforces the fact that boards should be able to demonstrate how sharing of company purpose and values has impacted on the company and informed its decision-making process.

As regards strategy, the Guidance is now clearer in suggesting that the board should lead on the establishment of transparent policies in relation to raising concerns about misconduct and unethical practices.

Principle Two – Board composition

No changes have been made to Principle Two.

The Guidance has been enhanced by:

• suggesting that companies should consider separating the roles of the chair and chief executive;
• promoting the benefits of the non-executive director role while not going as far as to require them;
• in relation to diversity, referring to the characteristics within the Equalities Act 2010. The Guidance has also been updated to suggest that diversity policies should be aligned to company strategy and consideration given to reviews such as those by Hampton-Alexander; and
• stating that board performance evaluations are a useful tool to assess board effectiveness and should be regularly undertaken but without being prescriptive as to their frequency.

Principle Three – Director responsibilities

Principle Three has been amended to ensure that individual directors are aware of their accountability.

The Guidance suggests that there should be agreement on how conflicts of interest should be managed. As governance policies and practices are so important to this Principle, the Guidance now promotes a periodic review of them to ensure they are fit for purpose.

Principle Four – Opportunity and risk

No changes of note have been made to Principle Four while the Guidance has been split into sections on 'Risk', 'Opportunity' and 'Responsibilities'.

Guidance in relation to 'Opportunity' suggests there should be 'processes' for the identification and consideration of opportunities for innovation and entrepreneurship. The revised Guidance also deals with emerging risk and principal risks as described in the FRC's Guidance on the Strategic Report. Guidance on 'Responsibilities' has been expanded to deal with the systems associated with decisions in relation to material environmental, social and governance matters.

Principle Five – Remuneration

No changes of note have been made to Principle Five.

The Guidance suggests that remuneration should be linked to the achievement of company strategy, and discusses reputational risks that result from excessive rewards. It also considers the use of a remuneration committee and makes explicit reference to how subsidiary companies might explain their application of this Principle.

The Guidance is more focussed on building trust in this area and suggests consideration of increasing transparency in relation to remuneration policies.

Principle Six – Stakeholder relations and engagement

Principle Six now refers to both stakeholders and specifically the workforce (with a broad definition of the term, as noted in Principle One). This approach is mirrored in the Guidance where there is a specific section on the workforce.

The Coalition Group considered requests to propose ways of engaging with the workforce within the Guidance however a 'balanced approach' was taken by referring to the FRC's Guidance on the Strategic Report which includes reference to methods of engagement. The Guidance is also more explicit in referring to a company's development of both informal and formal channels to engage with the workforce. The Guidance also points out that regulators, governments, pensioners, creditors and community groups may also be relevant stakeholders in certain circumstances.

Next steps

The Coalition Group, supported by the FRC, will continue to meet and work to promote the Principles. In due course, it will identify good practice and make any necessary adjustments which may be required after monitoring how reporting against the Principles develops.

[1] In January 2018, the Secretary of State for Business, Energy and Industrial Strategy, the Rt Hon Greg Clark, appointed James Wates CBE as Chairman of a Coalition Group, with FRC membership and secretariat support. Membership of the Coalition Group consists of the British Private Equity and Venture Capital Association, the Confederation of British Industry, the Climate Disclosure Standards Board, the Institute of Business Ethics, ICSA: the Governance Institute, the Institute for Family Business, the Institute of Directors, the Investment Association, Mark Goyder, and the Trades Union Congress.