The New UK Corporate Governance Code
Following the review by Sir David Walker of corporate governance in UK banks and other financial institutions and his final recommendations which were published in July 2009 (the “Walker Report”), the Financial Reporting Council (the “FRC”) has now implemented some of these recommendations in a revised version of the Combined Code under the new name of “UK Corporate Governance Code” (the “revised Code”). This update looks at the ten key points you need to know about the new corporate governance regime.
Single code for all companies
The FRC decided to maintain the integrity of a single corporate governance code for all companies rather than introduce sector-specific provisions, and adopted some of the recommendations of the Walker Report that it considered appropriate for all companies.
New Main Principles
Greater emphasis on chairman and nonexecutive director responsibilities
The revised Code brings together under new Main Principles the existing Supporting Principles describing the chairman's role and responsibility for leading the board and the role of non-executive directors to constructively challenge and help develop proposals on the company's business strategy, thereby giving them greater prominence.
In addition, the FRC has asked the Institute of Chartered Secretaries and Administrators to update the "Suggestions for Good Practice from the Higgs Report" which were last reissued in June 2006. We understand that this updated guidance should be available by the time the revised Code comes into effect at the end of June 2010.
Appropriate mix of director skills, experience and independence
The FRC recognised in its 2009 review of the Combined Code that the wording of the provisions governing board balance and independence may have encouraged the (unintended) perception among companies and investors that independence was the primary consideration when assessing the board composition. However, it is the FRC's view that the over-riding consideration should be that the board is fit for purpose. Accordingly, the existing Main Principle has been amended to emphasise the need for the board and its committees "to consist of directors with the appropriate balance of skills, experience, independence and knowledge of the company to enable it to discharge its duties and responsibilities effectively".
Expected time commitment
As indicated in the FRC's final report of its 2009 review of the Combined Code, the revised Code does not introduce indicative minimum time commitments for the chairman and non-executive directors. Instead, the existing requirement relating to directors' availability has been given greater prominence in the revised Code by upgrading it to a new Main Principle stating that all directors must allocate sufficient time to discharge their responsibilities effectively. Focus on risk management but no board risk committee
The FRC decided not to extend the recommendation made in the Walker Report with a view to banks and other financial institutions to require all companies, including non-financial companies, to establish a board risk committee. Instead, the board's responsibility for risk is made more explicit in the revised Code through the introduction of a new Main Principle which requires that the board determine "the nature and extent of the significant risks [the company] is willing to take in achieving its strategic objectives", and maintain a system of risk management.
The FRC is further planning to conduct a limited review later in 2010 of the Turnbull Guidance on Internal Control to ensure that it adequately addresses specific issues raised in its 2009 review of the Combined Code.
New "comply or explain" provisions
Annual re-election of directors
To increase accountability to shareholders, all executive and non-executive directors of FTSE 350 companies will be subject to annual reelection. Previously, the Combined Code required that directors be re-elected at least every three years. The three year re-election rule has been maintained for directors of non-FTSE 350 companies provided, however, that non-executive directors who have served longer than nine years should also be subject to annual re-election. The FRC recognises the concerns that have been raised against the introduction of annual director re-election during the consultation and emphasises that companies are of course free to explain rather than comply if they believe that their existing arrangements ensure proper accountability or if they need a transitional period before introducing annual re-election.
Disclosure of business model and financial strategy
The revised Code contains a new provision requiring companies to set out in the annual report, preferably in the same part as the business review, an explanation of their business model and overall financial strategy. This provision has been adopted by the FRC to help shareholders and potential investors understand how the company has "made (or lost) its money and what the main future risks are judged to be" 1 and aims to address concerns that risk reporting by companies is widely seen by investors as being unsatisfactory.
Regular director development reviews
The revised Code introduces a new requirement for the chairman to agree and regularly review a personalised approach to training and development with each director.
External board review
The revised Code recommends in a new provision that the performance of the board of FTSE 350 companies be reviewed and evaluated by external advisers at least every three years. Where external advisors are used, the company should disclose whether they have any other connection with the company. The form of such an external review is not prescribed by the revised Code so it will be up to the individual company to decide which form would be most suitable to them.
The quality of external board reviews, and therefore their value to investors, will depend on the standards that apply to the evaluation process. The FRC is in talks with providers of board evaluation services in this regard. The external board review requirement is at present restricted to FTSE 350 companies due to concerns about the availability of board evaluation services. However, in its May 2010 Final Report, the FRC states that, as part of its 2013 review of the Code, it will consider whether to extend this position to smaller listed companies.
No performance-related remuneration for non-executive directors
The key substantive change to the current remuneration provisions is a clarification that all forms of performance-related remuneration are discouraged for non-executive directors, not only share options.
A clearer statement in a new Supporting Principle further emphasises the need for performance-related elements of executive directors' remuneration to be aligned to the longterm interests of the company. Although in most instances, this will already be the case in practice, the new Supporting Principle signifies a change in the Code's tone and focus.
Application to overseas companies
With effect from 6 April 2010, the Financial Services Authority introduced a new two-tier listing regime which provides for "premium" and "standard" listings on the Official List. All premium listed companies, including overseas companies, are required to "comply or explain" against the revised Code. This is new. Under the previous listing regime, different rules applied to UK companies and overseas companies. Only UK companies with a primary listing were required to "comply or explain" against the Combined Code; overseas companies with a primary listing were only required to disclose whether or not they complied with the corporate governance regime of their country of incorporation and set out the significant ways in which their corporate governance practices differed from those set out in the Combined Code.