Changing the corporate governance framework

Changing the corporate governance framework

Nick Graves, a corporate partner at Burges Salmon LLP, considers how corporate governance is having an effect on smaller listed companies

The corporate governance framework for smaller listed companies is changing.

The Financial Reporting Council (FRC) has published a new shorter and sharper UK Corporate Governance Code, and the government has introduced new corporate governance reporting requirements for UK incorporated companies.

The new Code applies to accounting periods beginning on or after 1 January 2019. The new reporting requirements come into force at the same time.

Whilst the new Code is shorter and sharper at only 15 pages, the revised Guidance on Board Effectiveness now runs to 45 pages. Companies should consider both when establishing their approach to the new corporate governance framework.

What’s new?

Smaller listed companies need to prepare for the following changes:

  • Annual re-election: all directors should be subject to annual re-election. The list of standard resolutions proposed at the AGM will need to change as a result. For each director, the AGM notice must set out the specific reasons why their contribution is, and continues to be, important to the company’s long-term sustainable success.  Previously only directors of FTSE 350 companies were subject to annual re-election.
  • Board composition: at least half the board, excluding the chair, should be non-executive directors whom the board considers to be independent. The exemption for smaller companies (that is, companies below the FTSE 350), which simply required them to have at least two independent non-executive directors, has been removed. So, all smaller companies will need to consider the composition of their board.
  • Chair limited to 9-year term: the chair should not remain in post beyond nine years from the date of their first appointment to the board.  The revised Code does contain some flexibility where this is required to facilitate effective succession planning and the development of a diverse board.  In those circumstances, the 9-year period can be extended for a limited time, particularly when the chair was an existing non-executive director on appointment.
  • Share awards – minimum vesting and holding periods: remuneration schemes should promote longer-term shareholdings by executive directors. Share awards should be released for sale on a phased basis and be subject to a total vesting and holding period of five years or more rather than three.
  • Significant votes against shareholder resolutions: if 20% or more of votes are cast against the board recommendation for a resolution, a company must, when announcing the result, explain what actions it intends to take, provide an update within six months, and provide a final summary. The FRC expects companies to report on significant votes against which occur in 2019.
  • Workforce engagement: the board must use one, or a combination of, the following methods to engage with its workforce: a director appointed from the workforce; a formal workforce advisory panel; or a designated non-executive director. If the board does not choose one or more of these methods, it should explain what alternative arrangements are in place, and why it considers that they are effective. The first step will be to identify the “workforce” for Code purposes.

Does the new Code contain any exemptions for smaller listed companies?

Smaller companies will continue to benefit from the following exemptions:

  • Independent board evaluation: companies outside the FTSE 350 are not required to have a regular externally facilitated board evaluation. However, the revised Guidance on Board Effectiveness notes that chairs of smaller companies are encouraged to consider doing this periodically.
  • Audit committee membership: the board of a smaller listed company should establish an audit committee of independent non-executive directors, with a minimum membership of two.  However, in order to reinforce the independence of the audit committee, the company chair cannot be a member of the audit committee.
  • Remuneration committee membership: the board of a smaller listed company should establish a remuneration committee of independent non-executive directors, with a minimum membership of two.

What are your options?

Smaller listed companies should review their current corporate governance arrangements against the principles and provisions contained in the new Code. Boards will then have the following options:

  • Work towards achieving compliance with all Code provisions as soon as possible after 1 January 2019.
  • Agree that compliance with all Code provisions will take longer to achieve and prepare a meaningful explanation of how the company is changing its corporate governance arrangements to reflect the new Code.
  • If the board takes the view that some provisions of the new Code are not appropriate for the particular circumstances of that company, then articulate that clearly to shareholders and stakeholders.

We anticipate that, for the first reporting year after the introduction of the new Code, many smaller listed companies will take advantage of this flexibility and will prepare meaningful explanations instead of seeking to comply with all of the Code provisions.

Is there a transitional period for smaller listed companies?

It is important to note that there is not a transitional period for smaller listed companies.

New corporate governance reporting requirements

Smaller listed companies will, if they satisfy certain tests, need to:

  • Include a “section 172(1) statement” in their strategic report.
  • Explain in their directors’ report how they have engaged with their employees, how they have had regard to employee interests, and the effect of that on their business.
  • Provide a summary of how the directors have regarded to the need to foster the company’s business relationships with suppliers, customers and others and the impact of that on their company.
  • Comply with new pay ratio reporting requirements. UK listed companies with more than 250 employees will be required to publish the pay difference between their chief executive and their average UK worker annually. Companies must also justify the gap, known as the pay ratio.

Next steps

Companies should start to develop their approach to the new Code and how they will meet the new corporate governance reporting requirements. Whilst the Code provisions operate on a “comply or explain” basis, the reporting requirements are mandatory.

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