Governance: transparency matters

With the financial services meltdown of 2008 still fresh in the mind, UK
boardrooms are set for a tightening of corporate governance as a new code is
brought into play. It follows a period of intense scrutiny of company boards and
a damning report by the Organisation for Economic Co-operation and Development,
where it concluded that failures and weaknesses in corporate governance
arrangements were a significant contributory factor to the crisis in the
financial services sector.

Despite some reservations among leaders of FTSE-350 companies, the Combined
Code, centrepiece of the UK governance regime, has been significantly revised
and renamed the UK Corporate Governance Code. The new code applies to accounting
periods beginning on or after 29 June 2010. The Combined Code continues to be
used for earlier accounting periods. As before, the code operates on a ‘comply
or explain’ basis.

The code represents best practice for all quoted companies, but only those
with a premium listing – formerly known as primary listing – must comply or
explain their non-compliance to shareholders. Overseas companies with a premium
listing are also now subject to the UK code. Companies with a standard listing,
and those on the AIM or PLUS-quoted markets, should also be aware of the changes
to best practice represented by the new code and the consequential effect on the
expectations of their institutional shareholders.

The structure of the code has been revised to encourage greater focus on
boards’ behaviour. In addition, some new main principles have been introduced
and some supporting principles have been upgraded to main principles. Premium
listed companies must now report on how they have applied these new main

For example, the former main principle on the balance of executive and
non-executive directors has been reduced to a supporting principle. It has been
replaced as a main principle by a requirement that the board should have the
appropriate balance of skills, experience, independence and knowledge of the
company to enable it to carry out its duties and responsibilities effectively.
This addresses concerns that there was previously too much emphasis on the
independence criteria.

Another change to the main principles makes clear the board’s responsibility
for determining the nature and extent of the significant risks it is willing to
take in achieving its strategic objectives, and for maintaining sound risk
management systems.

The principles on directors’ appointments now emphasise the benefits of board
diversity, including in relation to gender. While this has provoked much press
comment, with headlines such as “A woman’s place is in the boardroom”, it
appears as a supporting principle. Companies will not be required to report
directly on how they have applied it.
As well as changes to the principles, there are further alterations to many of
the code provisions with which premium listed companies must either comply or
explain non-compliance.

Two of the most controversial require all directors of FTSE-350 companies to
stand for re-election at each AGM, rather than every three years, and the annual
evaluation of board performance at these companies to be carried out externally
at least every three years. Bodies like the Confederation of British Industry
and the Institute of Directors have voiced concerns that annual director
elections will lead to short-termism and undermine the collective responsibility
of the board. The FRC, however, argues that it will lead to increased dialogue
with shareholders.

Another new provision means directors must include in the annual report an
explanation of the basis on which the company generates or preserves value over
the longer term – the business model – and the strategy for delivering the
objectives of the company. Companies that are properly applying the Accounting
Standards Board’s voluntary reporting statement on the operating and financial
review already provide this information.

In the short term, the move to introduce a new code will inevitably cause a
degree of uncertainty and upheaval. But increased corporate accountability and
transparency is essential to rebuild public trust in the corporate sector and
helping to avoid a repeat of the failure that contributed to the financial

Danielle Harris is a professional support lawyer in the corporate
department at Maclay Murray & Spens LLP.

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