FRC to consult on a review of the UK Corporate Governance Code
October 12, 2022
The FRC (soon to become ARGA) is about to review the provisions of the UK Corporate Governance Code, which is applicable to companies having a premium listing on the London Stock Exchange. An informal consultation process, which will include organisations like the QCA, is scheduled to commence at the end of this month. This will be followed by a formal consultation in Q1 or, possibly, Q2 next year. However, the FRC is mindful of a potential clash with the 2023 AGM season, which might affect timing.
The FRC has indicated it is not planning a wholesale review but intends to concentrate on what it considers to be the weaker areas of the Code. No doubt, the consultation process will highlight areas regarded as important (and requiring attention) by users of the Code, if not identified by the FRC.
The FRC is clear that the core objectives of the review are to improve the quality of reporting, not to require additional reporting, and to move companies away from reporting on process to reporting on outcomes. We support those aims.
Areas of the Code on which the FRC review is likely to focus include:
• ESG reporting and influence of proxy agents: The FRC’s focus on outcomes over process is relevant to ESG reporting. In our experience, reporting on ESG can be more aspirational (what we are planning to do) than facts-based (this is what we have achieved). This may be owing to the perceived need to demonstrate, to investors and other stakeholders, the existence of an ESG policy. Some companies are at an early stage on their ESG journeys and there has not been sufficient time to demonstrate the outcomes of their policies.
Investors and other stakeholders use ESG research by proxy agents to help them make decisions about whether to invest, join or otherwise do business with a company. Companies use proxy agents’ research to keep an eye on the market. However, the role of proxy agents has been called into question recently. “ESG Ratings A Compass Without Direction” published in August this year by the Corporate Governance Research Institute at the Stanford Graduate School of Business, the Hoover Institution at Stanford University and the Rock Center for Corporate Governance at Stanford University, casts doubt on the reliability and consistency of ESG research produced by proxy agents. The paper identifies differing views of what ESG ratings are intended to measure. Are they measuring how ESG factors affect the business or how the business affects ESG factors, e.g., employees, society, its customers and the environment? Unless the answer to this question is known and understood, ESG ratings obtained from proxy agents might cause companies and their stakeholders to reach erroneous conclusions about a company’s ESG credentials.
Our view is that ESG is important. What should be measured and assessed is the effect of each business on ESG factors, the mechanisms adopted to mitigate those effects and the success of those mechanisms. Approaches to improving ESG credentials may differ widely. Not all businesses will affect the same ESG factors or will not affect them to the same degree. Good communication and engagement with stakeholders are essential. A good starting point for companies would be to ensure that, as is the case for remuneration committees, sustainability/ESG committees include relevant expert knowledge and experience, disclosed in the annual report.
• Remuneration: As has been foreshadowed, the revised Code is likely to contain tighter provisions about malus and clawback, principally to identify with greater clarity the behaviours and events which justify exercising malus or clawback clauses in incentive plans.
There is, otherwise, no present indication that the FRC is minded to amend Code provisions on remuneration. That said, it has been commented that Code remuneration provisions lean towards value protection and not value creation.
We can see arguments for both approaches, as value protection and value creation will be important to stakeholders but are likely to be given different weightings, depending on a stakeholder’s philosophy and objectives. Perhaps the consultation process will provide an opportunity to expand upon the arguments.
An aspect of remuneration that might force its way into the FRC’s review of the Code is the Government’s initiative to look into the case for equity participation by NEDs. This is a complex issue, which raises a number of questions, including questions about independence, commitment, the role of NEDs and the ability of (especially early stage) companies having limited resources to attract experienced NED talent. We have commented on the issue of equity participation by NEDs and the importance of taking a proportionate approach, in earlier editions of our Newsletter:
- Government proposals to review NED pay have caused shareholder unrest. A proportionate approach holds the key – July 2022.
- UK investor guidance opposes participation by NEDs in share schemes. The UK approach is out of kilter with the US. Maybe now’s the time to revisit this guidance – November 2021.
• Nomination Committees: Referred to by some as the “poor relation” of the Audit and Remuneration Committees, the FRC recognises that Nominations Committees have an important role to play in management succession planning and Board composition. In the latter connection diversity and inclusion are topics which would benefit from expert knowledge. We have commented in earlier versions of our Newsletter about the case for combining Nominations and Remuneration Committees, which may be considered as part of the FRC’s consultation process.
• Internal controls: The FRC has indicated that a revised Code is unlikely to go so far as to set out a specific framework within which to develop internal controls. It is more likely to include guidance on the types of mechanisms companies might adopt to set up internal controls appropriate for their businesses.
• Audit tendering: The FRC is planning informal discussions on Audit Committee standards, what should be retained in the Code and what should be contained in standards.
MM&K will keep a close watch on the FRC review of the Code and on the consultation process, in which we would wish to participate. In the meantime, please contact Paul Norris to discuss any points arising from this article.