- 0117 918 1383
Corporate Governance Update December 2017
This update summarises the major developments in UK corporate law and regulation for listed and quoted companies since our last update in September 2017.
Quarterly Corporate Governance Update December 2017
This update summarises the major developments in UK corporate law and regulation for large companies since our last update in August 2017.
Corporate governance reform
The government has published its response to the green paper consultation on corporate governance reform. The response identifies the following headline proposals for the reform:
Executive pay - changes will be made to the UK Corporate Governance Code (the “Code”) to set out the steps a company should take when there is significant shareholder opposition to executive pay (this is generally taken as a 20% or more vote against). It has been suggested that the Investment Association (IA) keep a public register of listed companies suffering a 20% plus vote against any resolution, with a record of what the company has said it will do in response.
The notion of an annual binding vote on all or part of an executive pay package has been dropped. The Code will also require a company’s remuneration committee to demonstrate how pay and incentives align across the whole company and explain to the workforce how executive pay reflects wider pay policy. Potential remuneration committee chairs will be required to sit on a remuneration committee as an observer for at least 12 months before taking on the role of chair.
The revised Code will also include further guidance on potential outcomes for share based incentive schemes and is likely to increase the holding period for share based remuneration from three to five years.
Board engagement with employees and other stakeholders - the idea previously floated of appointing directors from the workforce has been diluted - this is now optional. As regards employee representation, premium listed companies will have three options; a designated non-executive director for employee engagement; an employee advisory council; or a board member selected directly from the workforce. The ICSA and the Investment Association have published some helpful guidance called “The Stakeholder Voice in Board Decision Making”, which aims to help company boards ensure that they understand and weigh up the interests of their key stakeholders when taking decisions. This guidance lists ten core principles that boards should follow and gives practical advice on the implementation of the principles. The guidance also includes some case studies from listed companies.
Four proposals will give a greater focus as to how boards apply section 172 of the Companies Act 2006. Section 172 relates to the duty to promote the success of the company for the benefit of shareholders as a whole, whilst having regard to certain stakeholder factors. Companies of a certain size will be required to explain how they comply with section 172 as regards employees, suppliers, customers and other stakeholders, to include disclosure as to how key stakeholders have been identified, how their views have been sought and how that has influenced board discussions and decisions. A workforce of 1,000 plus is likely to be the minimum.
The government will require changes to the Code to include a new principle to strengthen the voice of employees and other non-shareholder stakeholders in the board room.
Large private businesses - it is proposed that a voluntary set of corporate governance principles for large private companies is developed by the FRC and other interested parties. The new Code principle on engagement with employees and other stakeholders will be replicated in this new code and all companies over a certain size will also be expected to report on their corporate governance arrangements and which code, if any, they follow. It is expected that this should apply to any company (and potentially LLP) with more than 2,000 employees.
Closer co-operation between the FRC, the Financial Conduct Authority (FCA) and the Insolvency Service – the intention of which is to ensure the integrity of corporate governance reporting.
The government intends these reforms to be effective by June 2018 and to apply to company reporting years commencing on or after that date. The necessary draft legislation should be laid before Parliament by March 2018.
In response to the government’s request for the above changes to the Code, the FRC has announced that it intends to carry out a fundamental review of the UK Corporate Governance Code imminently.
In conclusion, companies should be thinking and planning now for these changes - boards need to be considering who their key stakeholders are and how their interests and views are taken into account when taking decisions. Large private companies also need to start thinking about reporting on their corporate governance arrangements in their directors’ report and on their website, whether they follow any formal code and which code is the most appropriate for their business.
Modern Slavery Act - updated guidance
In early October 2017, the government published updated guidance on statements required by the Modern Slavery Act 2015 (supply chain transparency statements). The update guidance builds on experience since 2015 and includes examples of what best practice looks like. The updated guidance sets out a list of six issues on which companies “may” wish to comment and advises business to “paint a detailed picture of all the steps taken”. The guidance also provides clarity on the Board approval process and goes on to clarify the legal position that a company is required to publish a statement every year and suggests that businesses keep historic statements from previous years online so that the public can monitor progress made by a business over time. Companies who have technically fallen below the £36m threshold to report are encouraged to continue to publish a statement to demonstrate transparency. The updated guidance can be found here:
As a reminder, section 54 of the Modern Slavery Act 2015, requires commercial organisations with a global turnover of more than £36m to publish a slavery and human trafficking statement each financial year. This requirement has been covered in detail previously.
Companies approaching their second year of reporting are reminded that statements must be published six months from the end of the relevant financial year. If nothing has changed during the financial year, the organisation is still required to publish a statement for each financial year - that statements must be properly approved, signed, and dated. Given that statements must contain details of the steps taken during a particular financial year to combat modern slavery and human trafficking, it is unlikely that simply repeating a previous year’s statement will be sufficient.
Payment practices reporting
BEIS has published updated guidance to reporting on payment practices and performance. It includes practical tips on how of make a report via the government web filing portal.
Larger companies are now required to publish a report on payment practices and performance. The duty to report is required from October 2017 (depending on a company’s year-end) and must be submitted via the Government’s dedicated portal.
As a reminder, the requirement to report on invoice payment practices came into force on 6 April 2017 and applies to financial years beginning on or after that date. Entities within the scope must produce a report on their payment practices every six months, within 30 days of the end of that period and submit that report to a government-hosted website.
2017/18 Annual Reports
Companies with December year-ends will now be focusing on preparing the narrative sections of their annual reports. The FRC has written to Audit Committee chairs and finance directors outlining the FRC’s expectations of annual reports and includes changes to UK reporting requirements. These include:
- the implementation of three new accounting standards (IFRS 9, IFRS 15 and IFRS 16);
- enhancement to strategic reports to explain relationships and linkages between different pieces of information such as KPIs and remuneration policies. The FRC also launched a consultation on proposed amendments to its guidance on the strategic report in August 2017 to reflect new regulations on non-financial and diversity information. These regulations are effective for financial years beginning on or after 1 January 2017 and will therefore apply to December year-ends. The FRC aims to finalise the revised guidance for companies in the first half of 2018, although this may be too late for some December year-end companies. However, in the meantime, the FRC has published a factsheet to assist companies to determine the impact of the new regulations.
- the FRC guidance suggests that further improvements can be made in risk reporting and viability statements;
- companies should also consider how their assessment of the potential impact of Brexit has affected their business and to make appropriate disclosures to reflect their latest analysis;
- the FRC encourages more detailed reporting on the capacity to pay dividends, including the extent to which profit can be distributed by subsidiary companies (see also FRC lab report on dividend disclosures -)
- the FRC also cautions against boilerplate and generic disclosures when it comes to critical judgements and estimates.
Other considerations and reminders for 2017/18 Annual Reports are as follows:
Companies should now be familiar with the three-year reporting period as regards their remuneration report and policy. The remuneration reporting regime was introduced in 2013 and for many companies, the remuneration policy was put to a binding shareholder vote at 2017 AGMs for a further three years. However, listed companies should continually review their remuneration policies to take account of investor feedback and consider whether their remuneration policy is still fit for purpose, given the changing business landscape.
Companies are also reminded of the requirement to disclose longer-term viability in their viability statements. One of the biggest discussion points when this was first introduced was around the length of time that companies should pin their viability statements to. FRC guidance states that the period covered by the viability statement should be significantly longer than 12 months from the approval of the financial statements. It appears that the majority of companies are making three-year statements, with some stretching to five years, but best practice continues to evolve in this area. The Investment Association published guidelines setting out institutional investors’ expectations around the viability statement last year, a link to which can be found in our December 2016 update.
Turning to committee reporting, it is now common practice for listed companies to have separate sections of their annual report, describing the work of the various board committees in discharging their responsibilities. The UK Corporate Governance Code, the latest version of which was published in April 2016, usefully sets out what it would expect to see in each committee report.
A new item for all companies last year, whether listed or unlisted, was the disclosure of related undertakings. All related undertaking information must now be disclosed in the annual report and cannot be appended to confirmation statements.
Preparers of accounts are also reminded about disclosures around the use of alternative performance measures (APMs), an update on which was provided in our March 2017 update.
Be prepared for institutional investor feedback by taking account of their latest voting guidelines, including the IA, PLSA and ISS. Visit their websites to download their latest voting guidelines.
Preparers of accounts should also take account of the FRC’s latest review into corporate reporting covering the period 2016/17. The FRC have stated that the standard of corporate reporting remains good, but it continues to encourage improvement, especially where a compliance focused approach leads to a report that lacks balance.
For those of you not familiar with the FRC review, it reviews both the financial statements, including accounting policy disclosures and judgements made, as well as a review of the narrative sections of the annual report. It is certainly a useful report, and will help with the drafting of your 2017 year end reports.
We will signpost trends and expectations for 2018 AGM resolutions in our next update (due early 2018).
Rio Tinto plc – breach of DTRs
The FCA has fined Rio Tinto plc £27m for failing to write down the value of its Mozambique mines. Rio Tinto failed to carry out an impairment test, as required by international accounting standards, and recognise an impairment loss on the value of mining assets in the Republic of Mozambique acquired in August 2011 for US$3.7 billion when publishing its 2012 half-yearly financial report. As a result, they continued to value the assets at their original acquisition price until 17 January 2013 when they announced an impairment of more than $3 billion. A few years later, the mining assets were ultimately sold for $50 million, billions of dollars below their original acquisition price.
The FCA considers that this demonstrated a serious lack of judgement. Had Rio Tinto complied with its obligation to carry out the test, a material impairment would have been required to have been disclosed. Rio Tinto’s financial reporting was therefore inaccurate and misleading in breach of DTR 1.3.4R(1). The Authority therefore has decided to impose a financial penalty on Rio Tinto in the amount of £27,385,400 pursuant to section 91 of the Financial Services and Markets Act 2000.
Companies are reminded that new rules applying to announcements of regulated information by listed companies came into force on 1 October 2017. A new DTR 6.2.2 AR requires an issuer to notify the following to the FCA when filing regulated information under DTR 6.2.2 R:
- its Legal Entity Identifier (LEI), a 20-character reference code to identify legally distinct entities that engage in financial transactions; and
- the OAM classification relevant to the announcement, which are new. These do not map necessarily to the London Stock Exchange headline and category codes set out in DTR 8 annexed 2 R, which still apply.
- The London Stock Exchange now requires AIM listed companies to have an LEI, to ensure compliance with the obligations under Markets in Financial Instrument Directive (MiFID II) and Market Abuse Regulations. Existing AIM companies must register for an LEI by 30 November 2017.
The final report into ethnic diversity on UK boards has been published (known as the Parker Review). The key findings of the report are that the board rooms of the UK’s leading plcs do not reflect the ethnic diversity of the UK, nor the stakeholders they seek to engage and represent. The final recommendations of the report make various recommendations relating to the composition of FTSE 100, FTSE 250 and FTSE 350 boards.
The European Securities and Markets Authority (ESMA) has updated its Q&A document on Market Abuse Regulation (MAR).
The Insolvency Service has announced that it is seeking to disqualify all of the directors of the failed Kids Companycharity, including the chief executive, who was not an appointed board member, but is alleged to have been a de-facto director.
The London Stock Exchange has published its 2018 dividend procedure timetable giving guidance for main market and AIM companies on the timing of their ex-dividend, record dates and announcement dates for their interim and final dividends.
We reported in our last report about the General Data Protection Regulation, which becomes applicable across all EU member states with effect from 25 May 2018. This effectively replaces the Data Protection Act 1998 as the primary source of data protection legislation for most organisations. The Data Protection Bill was published in September 2017 and paved the way for implementation of GDPR within the UK. Further guidance on this can be found here.
If you would like our assistance in navigating through any of the issues mentioned in this publication, we would love to hear from you.
The Specialist Corporate Governance Team