UK: Setting the Tone - A New Focus for Governance

Last Updated: 9 June 2010
Article by Deloitte Audit Group

Most Read Contributor in UK, August 2017

After much consultation the Financial Reporting Council has launched the new UK Corporate Governance Code. For the time being, the 'comply or explain' concept lives to fight another day but many boards will find the new Code challenging. There are many structural changes to the Code including four new principles, five changes to the principles, two new supporting principles and eight changes of substance to the provisions. Key differences include the following:

  • All directors of FTSE 350 companies should be up for annual election.
  • The search for board candidates should be conducted and appointments made on merit against objective criteria and with due regard for the benefits of diversity on the board including gender.
  • Board evaluation of FTSE 350 companies should be externally facilitated at least every three years.
  • The chairman should confirm to the shareholders when proposing re-election of a NED that following formal performance evaluation the individual's performance continues to be effective and to demonstrate commitment to the role.
  • The company's business model should be explained and the board should be responsible for determining the nature and extent of the significant risks it is willing to take.
  • Remuneration committees should take a robust line on reducing compensation to reflect departing directors' obligations to mitigate loss.

New elements within the Code also underline the importance of effective boardroom challenge in this time of continuing economic and political uncertainty. This should not be viewed as another compliance exercise – it is about boards taking action which leads to better long-term financial performance.

Some of the new principles stem from the work of Sir David Walker and his recommendations for improvements to the governance of banks and other financial institutions where these are deemed to be applicable to all listed companies. The majority of the Walker Report proposals fall within the remit of the Financial Services Authority (FSA) and these have been reflected in the consultation paper (CP10/3) published in January 2010. The final position is expected in a policy statement from the FSA in the Autumn. The biggest impact of these changes for financial institutions is likely to be seen through a changing focus of FSA Arrow visits as opposed to extensive detailed new rules.

The implementation date of the new Code is for periods commencing on or after 29 June 2010 but, given the nature of the changes to the Code, there is no reason why companies should not take action as soon as practicable, particularly in the area of risk management and control. Every day we see evidence of the toughening governmental and regulatory responses to issues such as environmental accidents, financial sector activities including market abuse and product recalls. Another example is the Bribery Act 2010, intended to be the toughest Act of its kind in the world and already causing boards to re-evaluate their risk and control systems.

Below we have set out below a summary of the key new areas of focus in the Code together with suggested actions and questions to ask on a practical route to implementation.

It should be noted that the new Code is not the whole story for corporate governance – there are many other important elements to consider. These include a review of the Turnbull Guidance on internal control and risk management, revisions to the Guidance for audit committees and a Green Paper on corporate governance from the European Commission. These and other relevant matters are covered at the end of this document.

Other Developments to Consider

Turnbull 3 – the FRC has committed to another review of the Turnbull Guidance on internal control later in 2010. This guidance has not been updated since 2005 and needs to reflect the new Code principles on risk. It will not be a 'back to basics' review but we will be recommending that many of the messages included in the ICAEW Foundation and Independent Audit publication "Getting it right" should be considered.

Stewardship Code – in response to a recommendation from Sir David Walker, the FRC issued a consultation document on a Stewardship Code for Institutional Investors in January 2010. The Code seeks to achieve more effective engagement between companies and investors by placing certain responsibilities on investors in terms of both engagement and disclosure. Views were sought on whether the 'comply or explain' approach should apply and what monitoring arrangements should be put in place. The consultation period closed on 19 April 2010 and the FRC aims to publish the final code by the end of June 2010.

Higgs 2 – the Institute of Chartered Secretaries and Administrators (ICSA) has been commissioned by the FRC to carry out a review of the Higgs guidance on good boardroom practice. Entitled "Improving board effectiveness", the ICSA consultation paper sought views on the general direction of the review. A further consultation draft is expected in June with completed guidance due to be given to the FRC in October 2010.

Updated Guidance for audit committees – whilst there are no changes to the Guidance for audit committees arising directly from the new UK Corporate Governance Code, we are expecting that changes will be made as a result of a review of non-audit services by the Auditing Practices Board. A key outcome of that review is likely to be that improved governance of the assignment of nonaudit services is required, together with enhanced disclosures of audit committee activity in this area.

Guidance on performance evaluation – ICSA and the Institute of Directors have launched a working group on board performance evaluation. The objective of the group is to develop 'best practice' guidance on the undertaking of externally facilitated board evaluation. It is hoped that the guidance will be available by late Summer 2010.

Operating and Financial Review – the Conservative Liberal Democrats Coalition Agreement states that the new government will "reinstate an Operating and Financial Review to ensure that directors' social and environmental duties have to be covered in company reporting, and investigate further ways of improving corporate accountability and transparency". Expect further announcements from the Department for Business, Innovation and Skills in due course.

European Commission Green Paper on governance issues – on his return from his first official visit to the United States, and following recent calls by Heads of State and Government to accelerate the pace of financial reform, Commissioner Barnier recently held a press conference setting out where the EU and the US stand on delivering G20 commitments on financial regulation reform, and the next steps to fulfill those commitments.

In relation to corporate governance a Green Paper on corporate governance in financial institutions has been published in June 2010.

Final rules from the FSA including auditor assurance aspects – as stated above the FSA is due to publish its policy statement on 'Effective corporate governance' further to CP10/3 in Autumn 2010 for companies with a premium listing of equity shares. There will also need to be an update to the Listing Rules to reflect the new Code and consideration of whether there should be a revision of the nine provisions which are required to be reported on by the statutory auditors.

Useful links

UK Corporate Governance Code

2009 Going concern guidance

Getting it right

FRC Challenges for audit committees

ICAS Report on non audit services

Bribery Act 2010

Conservative Liberal Democrats Coalition Agreement

FSA's CP 10/3 on effective governance standards

Deloitte Global Centre for Corporate Governance

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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