UK: ‘Comply Or Explain’: (Currently) The Right Corporate Governance Model For The UK?

Last Updated: 30 December 2011
Article by Sean Geraghty and Amy Grammer

The Financial Reporting Council (the "FRC"), the UK's independent regulator responsible for promoting high quality corporate governance and reporting to foster investment, recently published its annual report on developments in corporate governance. The report focuses on the impact and implementation of the UK Corporate Governance and the Stewardship Codes (the "Codes") introduced in 2010.

Overall, the FRC is impressed by the positive response and steps taken by both companies and investors to comply with the Codes. Their key findings are set out below.

More generally, corporate governance has been a hot topic in 2011, both in the UK and in Europe. The European Commission has questioned the effectiveness of the 'comply or explain' approach and the willingness and ability of shareholders to hold boards to account. The FRC consider that, in the current economic times, companies and investors need to demonstrate that the principle is taken seriously and delivers strong and effective governance or risk a more prescriptive approach to regulation. Such an approach would not only hamper boards, potentially at the expense of shareholders, but could slow the flow of equity capital into the UK.

The UK Corporate Governance Code

The Board

  • Despite much controversy when the requirement for annual re-election of directors of FTSE 350 companies was introduced, 80 percent of FTSE 350 companies put all of their directors up for re-election this year.
  • There has been an notable increase in companies consulting with external advisers as to their board's effectiveness.
  • Many company chairmen and committee chairs now make a personal statement in the annual report.
  • Boards are now focusing on understanding and overseeing the main risks facing the business.


  • The FRC noted that standards of reporting remain varied. Explanations on departures from the Code (which are usually only in a few instances) are usually set out unambiguously and companies have been, on the most part, clear as to the arrangements they have put in place to provide any necessary safeguards. However, there are some companies which provide only perfunctory explanations for deviations from the Code – the FRC is working with companies on this.
  • The quality of corporate reporting is generally good and the FRC was particularly pleased to note the widespread improvement in the description of principal risks and uncertainties and the actions taken by board to mitigate their effects.
  • The FRC identified reporting by audit committees to be an area of particular weakness.

The Stewardship Code

  • Although it is early days, the initial response from investors has been positive. In December 2011, there were 234 signatories to the Stewardship Code – the majority being asset managers but also including asset owners and service providers such as investment consultants and proxy voting agencies.
  • The FRC has received feedback that the Code is not as clear as it should be on the role of owners, with particular concerns about the meaning of stewardship. The FRC is consulting as to how best to clarify this.
  • As for companies, the quality of reporting is variable. The FRC encourage investors to apply the same standards as are expected of companies. For asset managers, reporting needs to be sufficiently developed to help inform asset owners' decisions on awarding mandates. There should be a focus on reporting how conflicts of interests are managed and the use made of proxy voting agencies.
  • The jury is out on whether there has been improvements on investors' engagement with companies. Both sides should make the effort, in particular on issues as executive remuneration.

What's Next?

The FRC stress the burden is on companies and shareholders to prove that the two 'comply or explain' codes "can change behaviour and drive up standards" or they risk the replacement of the current regime with prescriptive and unwieldy legislation. On their part, the FRC propose:

  • only a limited number of changes at the next revision of the codes, to take effect from 1 October 2012. Such changes to include:
    • new requirements for disclosure of the much discussed board diversity policies (see our October 2011 DechertOnPoint "Gender Diversity on Boards: UK Corporate Governance Code to be Revised"), although companies are encouraged to disclosure their policies before then (in their next annual report);
    • extension to the remit of, and reporting by, audit committees, and to recommend that the external audit be put out to tender at least every ten years; and
    • amendments to the "going concern" provisions of the UK Corporate Governance Code, following the initial recommendations of the Sharman Panel of Inquiry; and
  • following the changes in October 2012, not to change the Codes for two years and to concentrate on "helping all participants understand where the weaknesses in execution lie, and helping to facilitate improvement".

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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