Restoring trust in audit and corporate governance – consultation on the Government’s proposals

On 18 March, the Government launched a consultation on a series of wide-ranging reforms to modernise the country’s audit and corporate governance regime.  It is a beast of a document – some 230 pages in length.  And every individual involved in governance within an organisation, whether large or small, should take a look at it.  History tells us that noting that the remit of the consultation only applies to “large” companies means little – particularly as the consultation includes recommendations on extending the definition of Public Interest Entity to AIM-listed companies, large private companies and the third sector.

Does it contain provisions of note that will impact executive pay?

Not really.  At least not in a material sense when compared with the potential impact of some of the other changes under consultation.  For example, as a result of this consultation, we could see requirements for directors to confirm that any dividend payment would not threaten solvency for a two-year period post declaration.  Or the introduction of additional behavioural standards in the way they carry out their duties relating to corporate reporting and audit.  The mooted changes to executive pay are somewhat smaller in gravity.

However, there are two points worthy of mention.  First, the consultation recommends strengthening malus and clawback arrangements.  This would involve the identification of minimum clawback conditions which would apply in all cases and have a minimum two-year application period.  Note that, currently, outside the financial services sector, there are no mandatory requirements for companies to include clawback provisions in directors’ remuneration arrangements (although, of course, most FTSE 350 companies already include variations of such provisions in current remuneration policies).

These new mandatory conditions could include clawback for serious misconduct, a material misstatement of results or an error in performance calculations and failures of internal controls and risk management. Subject to consultation responses, the Government proposes to invite the FRC to implement these stronger arrangements through changes to the UK Corporate Governance Code.

Secondly, there is a section on the assurance of Alternative Performance Measures (APMs) and Key Performance Indicators (KPIs) reported within and outside the Annual Report, beyond any arising from the statutory audit requirement for the financial statements.

Annual reports are now laden with APMs and a number are, of course, linked to executive remuneration targets and pay-outs.  APMs which are linked to executive remuneration is an area in which there appears to be (limited) support for extending (or at least adjusting) the scope of the statutory audit.  The Government has also noted that companies may wish to engage a different firm to provide specific assurance on APMs or KPIs linked to remuneration, in particular non-financial KPIs for which specialist expertise is needed (e.g. employee satisfaction metrics).

Over time, as the growth in the use of ESG metrics continues, we should expect this matter to become more critical.

This article draws attention to Government consultation, which will be of interest to organisations of all sizes. To discuss any of the points raised or for more information, please contact David Ellis.

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