The New UK Corporate Governance Code

29 / 01 / 2018

The Financial Reporting Council (FRC) is the custodian of the UK Corporate Governance Code (the UK Code).  The FRC needed to refresh the UK Code, and it is now well on the way to doing this. The new UK Code will be shorter and more focussed than before, which is very welcome.

The UK Code had become rather unwieldy and over-focussed on the trophy issue of remuneration. It had started to lose the intended focus, namely to support and encourage good and effective board room behaviours.

The FRC has done a decent job with its stakeholder management because little in the new document came as a surprise. However, in seeking to be acceptable to a broad constituency, the FRC has not delivered a particularly radical or novel approach. In brief, the new document marks a significant improvement, albeit not without imperfections.

However, there is one critical area where political pressure has been placed on the FRC to use the UK Code to deliver a change which should be delivered through parliament. We have witnesses a lively debate over recent years regarding the duties of directors and to whom these duties should be owed. The UK Code is not the place to set out those duties, and particularly not the place to seek to amend them, but the FRC has sought to do so inserting the two small words “long term” and by stating that part of the functions of a successful board is to “contribute to wider society”.

Why is the FRC doing this? It is probably because in these current strange times the government wishes to see changes in governance law and practice but does not wish to dedicate any parliamentary time to achieve such ends.

Let’s be clear: we at Wedlake Bell are evangelists of good corporate governance. We firmly believe that, in most cases, the interests of shareholders are best served if the board does have a long-term vision and strategy for the company and remains a good corporate citizen, cognisant of the role the company must play within the community.  We work hard to support companies to achieve this. However, the law specifically does not require directors to look to the long term.

The general duty of directors was codified from common law into statute in 2006 and takes the form of section 172 Companies Act 2006. Section 172(1) begins “a director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members and a whole …”. This provision was hotly debated in parliament. The words “long term” do not appear. They do, however, appear later in the section, but in a subsidiary manner as one of a number of contributing factors as to how directors should discharge the duty to shareholders, considered alongside the interests of company employees, the need to foster relationships with supplier, customers and others, the impact on the community and the environment, the maintenance of high standard of business reputation and the need to act fairly as between members of a company.  The law states that directors must be cognisant of the likely consequences of any decision in the long term, which is not the same as a “long term interest”.

The FRC has been put under pressure from the government to make changes to the UK Code to reflect possible evolutions in thinking over the last 12 or so years, which is laudable, save that the UK Code cannot be used as a proxy to the amendment of primary legislation.  If, notwithstanding the current parliamentary mathematics, politicians from left and right are of a view that section 172 Companies Act 2006 and the underlying common law from which it was codified should be changed, parliament should legislate accordingly. It is not appropriate for the FRC to deliver what parliament does not wish to deliver itself. The result would be confusion and uncertainty with parliament effectively seeking to abdicate its powers to make law: a highly undesirable result. This presents an important constitutional issue. The FRC should show leadership in the evolution of progressive governance, but must also protect its independence from the changing desires of politicians. Accordingly, we are generally supporting the changes to the UK Code, bar this one.

The consultation runs until 28 February 2018 and the objective of the FRC is for the new finalised UK Code to be circulated during the summer, to take effect for financial years commencing on or after 1 February 2019.