Independent board evaluation: ICSA consultation
June 27, 2019
The UK Corporate Governance Code requires, for listed companies, annual evaluation of the performance of the board. The chair should consider having a regular externally facilitated board evaluation. In FTSE 350 companies this should happen at least every three years.
The Government Department for Business, Energy and Industrial Strategy (BEIS) received responses on its Insolvency and Corporate Governance consultation paper suggesting that the standards of independent board evaluations vary considerably. BEIS invited ICSA, the Governance Institute, to convene a group of representatives from investors, governance institutions and corporations to identify ways of improving the quality of board evaluations including the development of a code of practice.
The group issued a report for consultation in May 2019 and consultation responses are required by Friday 5th July.
The report begins with defining the purpose of board evaluation. It then reviews company practice in the FTSE 350. Finally, it offers, for consultation, a draft code for external evaluation providers and a draft set of principles for companies employing them. Following the consultation, the group will publish a report with recommendations and a revised draft of the code and principles.
On receipt of the report, BEIS will decide whether and how to act.
Purpose of board evaluation
The report defines the purpose as a process of self-improvement by boards rather than providing an assessment of board effectiveness for quality assurance. The group believes this is more realistic. It will also demonstrate to shareholders and other stakeholders the board’s commitment to achieving high standards for themselves and the company.
Analysis of current practice
The report provides an analysis of current practice in the FTSE 350, using data from 2018. In that year alone, 35% of FTSE100 and 32% of FTSE 250 companies had an externally facilitated board evaluation. Over a three-year period nearly all companies are compliant with the UK Corporate Governance Code provision. This figure is contrasted with only 37.5% of companies in Continental Europe over a three-year period.
In 2018 FTSE 350 companies received evaluation services from 32 individuals or firms, a consolidation down from 51 in 2012. Just four organisations undertook 65% of the work.
There was limited data on the process of selection, although anecdotally it appeared to be getting more rigorous, with less reliance on mates of the chair. Many boards had self-imposed limits on the number of times they would work with a reviewer (usually two or three times).
In 2018 only 41% of FTSE 350 companies provided a good explanation of how the evaluation was carried out. This percentage should improve with the new provisions of the 2018 Corporate Governance Code. The same applies to a description of the outcomes and actions resulting from the evaluation. In 2018 only 47% of companies provided this.
The report emphasises the need for a share responsibility between the company board and the external evaluator. The evaluator must be prepared to challenge the board’s perception of its own performance; the board in turn must be willing to allow the reviewer to do so.
The three proposed measures from the report are:
• A voluntary code of practice for providers of independent board evaluation, who would sign up to the code, in the same way that remuneration consultants (including MM&K) sign up to the Remuneration Consulting Code. An open question for the consultation is whether the code should be underpinned by an accreditation process or a process of oversight.
• A set of voluntary principles for companies to apply in managing their board evaluation.
• Guidance to companies on disclosure of the evaluation process and outcomes, to supplement the guidance issued by the FRC to support the 2018 Corporate Governance Code.
The report includes a proposed draft for each measure and invites comments on the draft. It leaves open whether application of the code of practice should be mandated. It also raises the possibility of including shareholders in the process for appointing the evaluator.
The code for reviewers
There are three elements:
• Competency and capacity – it provides a disclosure framework of activities and attributes against which code signatories have to demonstrate their experience and capability. The group invites view on how prescriptive this framework should be. It also wants advice on establishing processes for accreditation, oversight and monitoring that are rigorous but do no set excessive entry barriers to service provision. Should the oversight body comprise mainly code signatories or be mainly independent? What should its role be in:
• Monitoring compliance
• Operating a client complaints procedure
• Reviewing the operating of the code and revising it where necessary?
• Independence and integrity – the code is more prescriptive in this area – eg in dealing with conflicts of interest. The group is particularly interested in receiving advice on how to deal with conflicts of interest.
• Client engagement – again the code is prescriptive eg in setting the terms of engagement.
Voluntary principles for listed companies
• Appointment of the evaluator will be the collective decision of the full board or the nomination committee – not the decision of a single board member.
• The company will not appoint external reviewers with which it has other current commercial relationships or that have carried out more than two previous evaluations.
• Terms of engagement will be agreed before the review commences, specifying the objectives and scope of the evaluation and the process to be followed.
• The company will provide the reviewer with direct access to the board collectively and individually, and to all board and committee papers and to management and other stakeholders as necessary to meet the agreed objectives.
• The company will provide the reviewer with an opportunity to present their findings to the full board.
• The company will identify a contact with whom the reviewer can discuss in confidence any concerns about the management of the process (usually on of the independent board members).
• In the annual report, the company will state whether it has followed these principles and whether the board reviewer is a signatory to the code. The report advises against making it mandatory for companies to employ a code signatory as the reviewer.
• The reviewer will be asked to confirm the accuracy of the description of the findings and findings in the annual report.
Draft disclosure guidance for listed companies
The report also includes what is in effect an elaboration of the guidance provided with the 2018 Corporate Governance Code plus a description of the appointment and terms of reference of the independent reviewer. It suggests:
• How the evaluation has been conducted – objectives, scope, who involved, processes.
• The evaluator, selection process, previous involvement, whether a signatory to the code, whether monitoring implementation of recommendations.
• The outcomes and actions taken- the guidance recognises the commercial sensitivity of this, but encourages disclosure as far as possible to build trust.
• How conclusions will affect board composition.
For further information, contact Damien Knight