UK: How Small And Mid-Cap Firms Can AIM Higher

Last Updated: 17 May 2018
Article by Tim Ward

The QCA has updated its code to help small and mid-cap companies improve governance and encourage growth

Given public and government pressure following recent examples of corporate failure, corporate governance and the disclosure of governance is firmly on the agenda of market operators, investors and companies.

It is a subject, perhaps even a discipline, that companies on the Alternative Investment Market (AIM) can no longer ignore.

That said, in the 'Mid & Small-Cap Investor Survey 2018' by the Quoted Companies Alliance (QCA) and broking firm Peel Hunt, there was a marked positivity from investors toward corporate governance in small and mid-size quoted companies.

Many of the fund managers surveyed stated that they see signs that governance disclosure is improving. 'In the last two or three years I think it has improved ... We are seeing more companies, more willing to engage on corporate governance issues than five years ago,' one respondent said.

Another stated: 'We do spend quite a bit of time having conversations with boards on governance issues, working quite closely with the likes of the QCA to try and educate on governance issues. Where we do not like what we are seeing we are not scared of helping to make changes.'

Rule changes

Alongside this, in March 2018, the London Stock Exchange announced that the rules for companies on AIM were changing.

Under the new AIM Rule 26, as of September 2018, companies will have to follow and apply what is described as a 'recognised corporate governance code' and publicly state how they meet that code's requirements on their website, explaining any divergence, should it exist.

The information should be reviewed annually and the date on which it was last reviewed should be included.

"Although many AIM companies already voluntarily choose to follow a corporate governance code, there are plenty that do not"

This marks a significant change in the way investors can benchmark companies against corporate governance guidelines. Departures from recognised practice – good and bad – can more easily be detected.

This is especially helpful for individual investors who do not get to meet management teams, in contrast to institutional investors who typically hold large stakes in small growth companies.

Although many AIM companies already voluntarily choose to follow a corporate governance code, there are plenty that do not. But the rules that previously allowed them to opt out of this will no longer apply from September.

This will mean many companies revealing their approach to governance for the first time. As a result it will place more responsibility on the shoulders of the non-executive directors (NEDs), particularly the chair, to ensure that a company is meeting this new requirement.

Recognised codes

Although the AIM rules state that companies must apply a 'recognised' corporate governance code, there is no definitive list of codes that have this status.

We undertook research in early 2018 and found that around half of the 900+ companies on AIM currently apply or refer to the QCA Corporate Governance Code on their websites. Of the remaining companies on AIM that do not refer to the QCA code:

  • A significant proportion state that they do not follow any code due to their size and stage of development
  • Some state that they follow the Financial Reporting Council (FRC) UK Corporate Governance Code, or at least some aspects of it
  • A small number follow the corporate governance code of their home country, for example, the code of the Australian ASX Corporate Governance Council
  • A small number follow other codes that are tailored for their sector, for example, from the Pensions and Lifetime Savings Association.

Of course, large companies listed on the main market of the stock exchange are required under the Listing Rules to follow the FRC UK Corporate Governance Code, but most small and mid-size companies on AIM find that this is unsuitable for their size and stage of development and, as a result, are more likely to adopt the QCA code.

'Companies benefit from adopting appropriate governance measures, but [we] recognise to be effective these measures should be tailored to a company's individual requirements given its stage of growth and developed through considered engagement with key stakeholders,' explained Marcus Stuttard, head of AIM and head of UK primary markets at London Stock Exchange Group.

Revising the QCA code

The QCA Corporate Governance Code is tailored to meet the needs of small and mid-size quoted firms. It is used by a substantial number of AIM companies on their websites and also by a number of privately-owned companies.

Since its initial release in 2013, it has become a valuable reference for growing companies wishing to follow good governance practice. It serves as a practical outcome-oriented approach to corporate governance for those quoted companies not obliged to follow the UK Corporate Governance Code.

This April we have released an updated version of the QCA code. It now includes 10 corporate governance principles that companies should follow and step-by-step guidance on how to effectively apply these principles.

It has been written by the QCA's Corporate Governance Expert Group and a standalone working group, comprising leading individuals from across the small and mid-size quoted company sector.

The new edition of the code builds on existing concepts, as well as introducing new structures and tools to provide a more user-friendly approach to applying the principles.

"In comparison to the FRC's code, the QCA code is more flexible and outcome-oriented for smaller, growing companies"

We have brought the principles and the necessary disclosures sections together to facilitate a more straightforward approach to the correct application of the code. Companies are able to identify how each principle can be linked with its correct application and the disclosures that can demonstrate it.

This is while allowing flexibility and for companies to focus on the correct application of the principles, their interaction with the disclosures and how each company can apply the code, bearing in mind its own individual circumstances.

The 2018 QCA code is a shorter, leaner document than the previous edition. The 10 principles emerged after revisiting the 12 principles of the previous version and considering their application in practice.

Although the principles have been consolidated, there is an increase in the number of suggested disclosures.

There are now 32, up from the previous 20. Roles and responsibilities have been revised and expanded and a new description of how a board is typically composed, how it works and what key challenges it faces regarding its directors' independence is now included.

In comparison to the FRC's code, the QCA code is more flexible and outcome-oriented for smaller, growing companies. Despite the increase, it still has fewer disclosures (32 compared to 41 in the UK Corporate Governance Code), which are also less prescriptive in nature.

An important choice

As Gervais Williams, senior executive director at Miton Group Plc and QCA chairman, said in an article for Governance in April/May 2018: 'An accurate assessment of each company's corporate governance standards is becoming more important.

'The higher profile of corporate governance codes like the QCA's should continue to help investors correctly pick out the quoted companies with the best internal cultures and hence ensure our limited amounts of risk capital generate attractive returns.'

Choosing the right code to adopt is an important decision for a business. It involves ensuring that the chosen code has sufficient flexibility and rigour in requirements, allowing a company to tailor the outputs to the nature and substance of the company's business.

An overbearing code – even if it is comply or explain in nature – can lead to a plethora of negative statements describing why certain requirements are not appropriate.

We firmly believe that good governance creates shareholder value by improving corporate performance; it helps to reduce or mitigate the risks a company faces as it seeks to create sustainable growth over the medium to long-term.

Serious business

We saw evidence that companies were taking corporate governance more seriously even before the impending AIM rule changes.

In the last edition, from December 2017, of the QCA's biannual 'Sentiment Survey' of small and mid-size quoted companies, we see a notable increase in the number of companies wanting their non-executive directors to contribute more on corporate governance, with 28% saying this was a priority in 2017, up from 11% in 2015.

But this same survey also showed a mismatch between what companies and their advisors felt about their corporate governance.

"Choosing the right code involves ensuring that it has sufficient flexibility and rigour"

Only a small proportion of companies surveyed felt their boards lacked corporate governance knowledge, but for advisors this category was the second most significant skill lacking on small and mid-size companies boards – beaten only by risk management expertise.

Companies join public markets to access capital, to benefit from the kitemark of being a well-regulated, transparent, communicative and financially sound organisation – this encourages trust.

Without trust, there will be no appetite from shareholders to invest further or remain shareholders. As the risk is reduced, so the cost of capital is reduced.

The release of our revised QCA Corporate Governance Code is our contribution in encouraging small and mid-size companies to improve their governance practices. We offer it in a manner that is proportionate to their stage of development.

Most companies in this bracket are focused on growth and investing the right amount of time and resources in governance practices can take time to perfect.

The AIM rule changes will of course be a trigger for many companies to change and we look forward to working with them to help them get it right. Good governance helps to create great companies.

Tim Ward is CEO of the Quoted Companies Alliance

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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