Where does UK corporate governance go from here?

November 28, 2023

The story so far ….

2023 was going to be the year of major reform to UK corporate governance and specifically, the UK Corporate Governance Code (Code). The Government promised legislation to pave the way for reforms to restore trust in company audits and their auditors, following the collapse of Carillion and Thomas Cook. The FRC launched an extended consultation period on proposed changes to the Code, to which MM&K and many other interested parties submitted detailed responses.

In addition to restoring trust in audit, those proposals were designed to encourage clearer corporate disclosures, particularly with regard to internal audit and controls and the management of risk. Lurking in the background, was the London Stock Exchange’s very real concern that the UK had lost its position as the market of choice for new listings. Revisions to the UK corporate governance framework were seen as being a necessary step towards making London listings a less daunting prospect, for overseas companies as well as home-grown businesses.

Things have not gone according to plan.

We reported last month that on 16 October, the Government, in a u-turn, shelved plans to introduce proposed legislation upon which many of the FRC’s proposed revisions to the Code had been based. On 7 November, the FRC published a statement that it will not take forward over half of its original 18 proposals, including those relating to diversity, over-boarding and shareholder engagement, and extending the role of audit committees to encompass ESG. In addition, proposals relating to an audit and assurance policy, reporting on distributable profits and a resilience statement will not be implemented.

Instead, there will be a small number of changes that ‘streamline and reduce duplication associated with the Code that were overwhelmingly supported by stakeholders in the interests of reducing burdens’. The principal revisions to the Code will now be focused on companies’ internal controls.

In addition to the Government’s u-turn and the FRC’s statement watering down its proposals for changes to the Code, the Government has now confirmed that plans to create the Audit, Reporting and Governance Authority (ARGA) will not go ahead. ARGA was intended to be a more assertive replacement for the FRC, with greater powers to sanction auditors who failed to maintain high standards – part of the overall plan to restore trust and confidence in audit.

It has been reported that the reason for this change of direction, which follows wide-ranging engagement with companies, is to reduce ‘unnecessary burdens’ faced by companies. Similar reasoning was given by the FRC for shelving more than half of its proposed changes to the Code.

Whilst all this has been going on, the Quoted Companies Alliance (QCA) published its revised corporate governance code on 13 November. The QCA code, designed primarily for smaller quoted companies and those whose shares are traded on AIM, is based on 10 principles. Its objectives are similar to the objectives of the UK Corporate Governance Code. But the QCA code is less prescriptive, although it requires companies to explain if they choose not to comply with its principles and leaves it to companies to tell their story. The QCA estimates that more than 90% of AIM companies have adopted their code.

What is likely to happen next?

The wheels may have come off the wagon but the FRC remains committed to publishing a (limited) revised Code in January 2024, following which it will start a consultation on the Stewardship Code. The effect of shelving the creation of ARGA is yet to be assessed. That said, a General Election is due, probably in 2024. It is not surprising, therefore, that the Government, trailing in the polls, is perhaps nervous about alienating business.

It is proposed that changes to the Code will apply to accounting periods starting on or after 1 January 2025. Therefore, it is unlikely that any such changes will have a material effect before the date of the next General Election.

When analysing the FRC’s proposed changes to the Code during the consultation period prior to making our submission, we observed and commented on a shift in the UK’s approach to corporate governance. The Government’s proposed (now shelved) legislation created a clear separation of and a specific focus on the largest companies. Yet proposed changes to the Code sought to apply legislation aimed at the largest companies to all Code companies, thereby both diluting the principle of proportionality and increasing the burden of governance for many Code companies ill-equipped to bear it.

There remains a need to restore trust and confidence in audit, to revise the Code and to reinstate London as the market of choice for new listings. We would hope that the period to the next General Election will be seen and used by the regulators as an opportunity to present, or at least develop their thinking about, a new Code that recognises the distinction between the largest companies, that pose the greatest risk to the economy, and other Code companies.

That could result in two Codes. Whilst possibly unthinkable to some, that might be considered by others to be a reasonable cost of maintaining the principle of proportionality and ensuring that the equally important principle of ‘comply or explain’ is applied by reference to size-appropriate criteria. If the Government and regulators thought it necessary to draft and propose legislation aimed specifically at the largest companies, it should not be a great leap to recognise that one size does not fit all in terms of regulation.

It is unlikely that any corporate governance code can achieve a state of corporate governance that will satisfy all. In addition to an appropriate and proportionate governance framework, clear communication and engagement with shareholders and other stakeholders is fundamental to a successful business in the long-term and to the successful implementation of corporate governance codes. Sustained success requires those communication channels to function in both directions.

The direction and progress of the FRC’s proposed consultation on the Stewardship Code will be important in that connection, as will the view the FRC takes towards proxy advisers. Proxy advisers are not regulated, are not shareholders and do not vote. That said, they are an influential presence and are likely to be relied upon increasingly as the burden of governance grows heavier. We would urge the FRC to consider and report on the role of proxy advisers in the UK and whether it thinks there is a case for their activities to be regulated.

To discuss any of the points raised in this article, please contact Paul Norris.

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