UK: Directors Face Annual Re-Election Under New Corporate Governance Code

Last Updated: 7 June 2010
Article by Sean Watson and James Parkes

All directors of FTSE 350 companies will soon be expected to submit themselves for re-election annually, under new best practice guidelines on corporate governance published last week. For financial years beginning on or after 29 June 2010, all companies with a Premium Listing of equity shares on the Main Market of the London Stock Exchange will be expected to report against their compliance with the 2010 version of the Combined Code on Corporate Governance – which has been renamed the UK Corporate Governance Code – published by the Financial Reporting Council on 28 May.

Under the 2010 Code:

  • All directors of FTSE 350 companies (but not smaller listed companies) will be expected to stand for re-election every year. (Currently annual re-election is required only for NEDs with more than nine years' service, although a few very large companies have chosen to put the whole board up for re-election every year.) The FRC decided to introduce this requirement despite strong arguments being made against it by some companies and business organisations, and despite the fact that even among ABI and NAPF members opinions are divided on whether it is a good idea. The FRC believes that the requirement creates "a strong incentive to understand and respond to shareholders' concerns before the AGM". Some companies and other organisations have claimed that activist, short-term or single-issue investors may use the threat of a vote against one or more directors to drive forward their own agenda, or that individual directors may be blamed unfairly for decisions taken collectively by the board, but the FRC considers these concerns to be overstated. Empirical evidence also suggests that most investors will use the power to vote against a director sparingly.
  • FTSE 350 companies will be expected to arrange externally-facilitated board reviews at least every three years. (At present, board reviews should be conducted annually, but there is no requirement to use external facilitators.) However, scepticism about the effectiveness of external facilitators, and the fact that presently there are only a few organisations with sufficient quality and experience to perform such a role, could mean that companies are slow to comply with this new requirement.

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All directors of FTSE 350 companies will soon be expected to submit themselves for re-election annually, under new best practice guidelines on corporate governance published last week.

The new guidelines, which are contained in the UK Corporate Governance Code (2010 Code) – previously called the Combined Code on Corporate Governance – were published by the Financial Reporting Council on 28 May. All companies with a Premium Listing of equity shares on the Main Market of the London Stock Exchange, whether they are incorporated in the UK or overseas, must report each year in their annual report and accounts on how they have applied the Main Principles of the Code and the extent to which they have complied with its Provisions, explaining the reasons for any non-compliance (known as "comply or explain"). The Code in its current form was first published in 2003, following recommendations made by Sir Derek Higgs, and revised versions were published in 2006 and 2008. It is the 2008 version that companies are currently required to report against.

After conducting an extensive review of the effectiveness of the existing Code, and considering the recommendations made by Sir David Walker about corporate governance in banks and other financial institutions, the Financial Reporting Council (FRC) concluded that generally the Code is fit for purpose, and that no radical changes are needed. In particular:

  • no changes should be made to the criteria for assessing whether a non-executive director is independent (even the much-criticised assumption that a NED ceases to be independent after nine years);
  • no significant changes should be made to the role of the remuneration committee or the principles it should follow in setting the remuneration of executives. For more detail about the changes that were proposed click here ;
  • companies should not be required by the Code to have a separate risk committee or a Chief Risk Officer (although some may do so voluntarily; and large banks and insurers are likely to be required to do so by new FSA rules expected to come into force later this year).

The most important changes that have been made are:

  • All directors of FTSE 350 companies (but not smaller listed companies) will be expected to stand for re-election every year. (Currently annual re-election is required only for NEDs with more than nine years' service, although a few very large companies have chosen to put the whole board up for re-election every year.) The FRC decided to introduce this requirement despite strong arguments being made against it by some companies and business organisations, and despite the fact that even among ABI and NAPF members opinions are divided on whether it is a good idea. The FRC believes that the requirement creates "a strong incentive to understand and respond to shareholders' concerns before the AGM". Some companies and other organisations have claimed that activist, short-term or single-issue investors may use the threat of a vote against one or more directors to drive forward their own agenda, or that individual directors may be blamed unfairly for decisions taken collectively by the board, but the FRC considers these concerns to be overstated. Empirical evidence also suggests that most investors will use the power to vote against a director sparingly. (The alternative proposed in the FRC's consultation paper, that only the chairman of the company should face annual re-election, was rejected.)
  • FTSE 350 companies will be expected to arrange externally-facilitated board reviews at least every three years. (At present, board reviews should be conducted annually, but there is no requirement to use external facilitators.) However, scepticism about the effectiveness of external facilitators, and the fact that presently there are only a few organisations with sufficient quality and experience to perform such a role, could mean that companies are slow to comply with this new requirement.

In addition, a large number of structural changes have been made, so that many Principles and Provisions now have a different number, and in various places the emphasis, although not the substance, has been altered.

The 2010 Code will apply to financial years beginning on or after 29 June 2010. For companies with a calendar year-end, this means that they will need to explain how they have applied the Main Principles, and the extent to which they have applied the Provisions, in the 2010 Code for the first time in their annual report for 2011, which will be sent to shareholders in the first quarter of 2012 and approved at the AGM around May 2012. Most Main Market companies will therefore want to take steps between now and the end of 2011 to bring their corporate governance arrangements into line with the 2010 Code. Directors of Main Market companies in the FTSE 350 are likely to face re-election at the 2012 AGM (or possibly even the 2011 AGM) and every year afterwards.

For financial years beginning prior to 29 June 2010, the 2008 edition of the Code will continue to apply.

In October this year the ICSA expects to publish revised guidance to accompany the 2010 Code (based on the Good Practice Suggestions from the Higgs Report relating to NEDs). The FRC has indicated that it will be conducting a limited review and consultation on the Turnbull Guidance on internal control later this year, and that it expects to announce the outcome of its consultation on a Stewardship Code for institutional investors at the end of June 2010.

Click here for the 2010 Code and here for the FRC's report explaining the changes.

Click here for the FRC's consultation on a proposed Stewardship Code for institutional investors.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 04/06/2010.

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