OC guide to 2014 UK Corporate Governance Code changes
Published on 9th Jul 2015
The UK Corporate Governance Code (Code) was updated in September 2014. The changes apply to financial years commencing on or after 1 October 2014, and so listed companies are now looking at these changes and what they mean for them in practice. Set out below is our practical guidance on the likely impact of the changes.
The Code applies to all companies with a Premium Listing (wherever incorporated), with some provisions – such as the annual re-election of the board – applying to those companies in the FTSE 350. In addition, the Financial Reporting Council, as well as other investor bodies, encourages other listed companies to comply with the principles of the Code, so far as is appropriate given their smaller size.
Practical impact of the key changes in the 2014 edition of the Code
| 2014 Code Reference | Code provision | Amendment or new provision? | Practical impact |
| C.1.3 | In annual and half-yearly financial statements, the directors should state whether they considered it appropriate to adopt the going concern basis of accounting in preparing them, and identify any material uncertainties to the company’s ability to continue to do so over a period of at least twelve months from the date of approval of the financial statements. | Amended to make clear the distinction between going concern accounting basis and new viability statement. | Paragraph C.1.3 is now more restrictively drafted to refer to only the going concern basis of accounting, in order to distinguish it from the (new) broader viability statement.
The FRC distinguishes between the going concern and viability statements in its Guidance on Risk Management, Internal Control and Related Financial and Business Reporting (September 2014) (the Guidance): “The board’s specific responsibility for determining whether to adopt the going concern basis of accounting and related disclosures of material uncertainties in the financial statements is a sub set of these broader responsibilities. A company that is able to adopt the going concern basis of accounting and does not have related material uncertainties to report, for the purposes of the financial statements, is not necessarily free of risks that would threaten the company’s business model, future performance, solvency or liquidity were they to materialise. The board is responsible for ensuring this distinction is understood internally and communicated externally.” (See further notes on paragraph C.2.2 below) |
| C.2.1 | The directors should confirm in the annual report that they have carried out a robust assessment of the principal risks facing the company, including those that would threaten its business model, future performance, solvency or liquidity. The directors should describe those risks and explain how they are being managed or mitigated. | New provision. | Express confirmation required in the annual report that a “robust assessment” has been undertaken. What constitutes a “robust assessment” is not defined, but paragraph 34 of the Guidance provides that:
“The design of a robust assessment process to determine the principal risks and consider their implications for the company should be appropriate to the complexity, size and circumstances of the company and is a matter for the judgement of the board, with the support of management. Circumstances may vary over time with changes in the business model, performance, strategy, operational processes and the stage of development the company has reached in its own business cycles, as well as with changes in the external environment.” Whilst the change might serve as a useful prompt to re-evaluate existing risk assessment procedures, it is unlikely that this new provision will require significant changes to those procedures for the majority of listed companies. The second sentence requiring a description of risks and management/mitigation strategies is new, but the majority of listed companies already report on this basis, so this change will be of limited practical significance for the most part. Paragraphs 48 – 50 of the Guidance provide further guidance on risk disclosure. |
| C.2.2 | Taking account of the company’s current position and principal risks, the directors should explain in the annual report how they have assessed the prospects of the company, over what period they have done so and why they consider that period to be appropriate. The directors should state whether they have a reasonable expectation that the company will be able to continue in operation and meet its liabilities as they fall due over the period of their assessment, drawing attention to any qualifications or assumptions as necessary. | New provision. | This is probably the most significant of the 2014 changes, and will require new disclosure in annual reports. The FRC intends the viability statement to provide an:
“… improved and broader assessment of long-term solvency and liquidity [than the existing going concern statement]. It is expected that this statement will look forward significantly longer than 12 months… Crucially the directors should explain their reasoning to investors.” Appendix B of the Guidance provides detailed guidance on how companies should apply paragraph C.2.2. |
| C.2.3 | The board should monitor the company’s risk management and internal control systems and, at least annually, carry out a review of their effectiveness, and report on that review in the annual report. The monitoring and review should cover all material controls, including financial, operational and compliance controls. | Amended version of paragraph C.2.1 of 2012 Code. | The amendments to the 2012 Code provision:
• seek to make clear that the requirement is to monitor risk management and internal control systems on an ongoing basis, rather than solely conduct an annual assessment (this is unlikely to require a significant change in existing practices for most companies); and • broadens the reporting requirement such that the obligation is to report on the review itself, rather than report the mere fact that the review has been undertaken. That said, the Guidance (paragraph 58) requires the board to explain what actions have been or are being taken to remedy any significant failings or weaknesses, which has not historically been required. |
| D.1 | Executive directors’ remuneration should be designed to promote the long-term success of the company. Performance related elements should be transparent, stretching and rigorously applied. | Amended version of 2012 Code provision. | Unlikely to have much practical significance, as the FRC has consistently maintained that the Code requires remuneration to deliver long-term benefit to the company. The potentially contradictory 2012 Code requirement that levels of remuneration “should be sufficient to attract, retain and motivate” directors of the requisite quality has been deleted, although this deletion is unlikely in itself to have a material impact on the company’s approach to remuneration.
Additional reference to “transparency” is designed to ensure that there is greater clarity in the design and disclosure of performance-related remuneration. |
| D.1.1 | In designing schemes of performance related remuneration for executive directors, the remuneration committee should follow the provisions in Schedule A to this Code. Schemes should include provisions that would enable the company to recover sums paid or withhold the payment of any sum, and specify the circumstances in which it would be appropriate to do so. | New provision requiring clawback. | The 2012 Code required that companies “give consideration” to the use of clawback. The 2014 code mandates clawback in performance related schemes, on the basis that companies who choose not to are required to disclose that fact under the “comply or explain” principle.
This will require new disclosure in annual reports. A related change to Schedule A to the Code is to delete the limitation of clawback to “exceptional” circumstances relating to misstatements in financial reporting or misconduct, and, whilst not being prescriptive, the FRC clearly is pointing to the possibility of clawback being appropriate in less exceptional situations. The company’s remuneration committee should therefore consider existing clawback provisions and consider other circumstances in which clawback may be appropriate. |
| Schedule A | Design of performance-related remuneration for executive directors | Miscellaneous amendments. | The principal change is a new provision requiring that the remuneration committee “should consider”, in the context of share-based remuneration, requiring directors to hold a minimum number of shares and to hold shares for a further period after vesting or exercise, including after leaving the company.
The remuneration committee should therefore reconsider existing lock-in arrangements and consider whether these remain appropriate. |
| E.2.2.2 | When, in the opinion of the board, a significant proportion of votes have been cast against a resolution at any general meeting, the company should explain when announcing the results of voting what actions it intends to take to understand the reasons behind the vote result. | New provision. | This new provision is intended to improve engagement with shareholders. Whilst originally intended to apply to remuneration resolutions, it now applies across all resolutions.
The practical significance of this new provision is that where a significant number of proxy votes received in advance of the relevant general meeting have been cast against the resolution, the directors will need to have considered and agreed what to say in the announcement of the results, which is generally made on the same day as the meeting. There is no guidance on what “significant” means, and so this is for the judgment of the directors. However, 15-20% of votes cast is likely to be “significant”, although lower levels of votes against a particular resolution (where historic levels of support have been significantly higher) might also engage this provision. |
