29 March 2021
The Financial Reporting Council (FRC) has published its findings on the application of the 2018 UK Corporate Governance Code (the Code) together with advice on how to report transparently and effectively when departing from certain provisions.
The FRC’s monitoring suggests companies are more focused on process rather than reporting meaningfully on their application of the Code and explaining any departures from it. The FRC’s review highlights a need to improve how companies report on their purpose and culture, stakeholder engagement, diversity policies and succession planning.
The most insightful reporting not only described the initiatives that were being introduced and the processes that were followed, but also discussed their outcomes and what impact they had on the business and board decisions.
Reporting expectations for the year ahead
The FRC expects companies to:
- have a well-defined purpose and show the progress towards achieving it clearly;
- discuss the issues raised, topics considered, and feedback received during engagement with shareholders and employees;
- clearly show the impact of engagement with stakeholders, including shareholders, on decision-making, strategy and long-term success;
- increase their focus on assessing and monitoring culture, including consideration of methods and metrics used;
- have increased attention on, and better reporting of, succession planning, diversity and board evaluation;
- clearly show the impact of engagement with shareholders on remuneration policy and outcomes; and
- clearly show the impact of the engagement within the workforce in relation to executive remuneration policy.
Companies should also:
- strive for transparency, clarity and integrity;
- use signposting, avoid boilerplate and ensure cohesion;
- tell a story about the company;
- clearly and comprehensively explain departures from the Code; and
- disclose the impact of actions via use of examples.
Next year the FRC will evaluate how well companies responded to the coronavirus pandemic.
- A good explanation of compliance sets the context and background and gives convincing rationale for the approach taken, describes mitigating actions and considers risks.
- Companies should be clear and transparent about any provisions of the Code they have not complied with. They should name these provisions, explain why the approach taken is right for the company, and what actions have been taken to mitigate the impact of not following the Code.
- Clear and meaningful explanations should be given on how a company’s actual practices achieve good governance standards in line with the flexibility offered by the Code, even if the company has not fully complied with a Provision of the Code.
Culture, purpose and values
- Companies should demonstrate further improvements in the quality of disclosures to articulate clearly how purpose, value, and strategy are connected.
- The description of a company’s purpose should be clear about why the company exists, its market segment, USP and how its purpose will be achieved, and describe any social or stakeholder dimensions.
- Companies should take a more rigorous approach to culture and set up effective ways of monitoring and assessing both the culture and its alignment with purpose, value and strategy, including setting out any actions taken in line with Provision 2.
Tenure, Succession planning and Board evaluation
- Clear explanations should be provided of how companies have determined a Non-Executive Director (NED) to be independent if they fall under one of the criteria in Provision 10 and why the Chair has remained in post for more than nine years.
- All companies need to pay closer attention to the issue of overboarding by their directors, as well as the size and membership of committees. More frequent board meetings have often been introduced due to the Covid-19 pandemic.
- Reporting on succession planning needs to be improved, including disclosure of the scope and frequency of reviews and how internal talent is managed.
- Reporting on board evaluations should set out recommendations, actions, and a time period for review of progress.
- Enhanced reporting should consider:
- how the board works together as a unit;
- the tone set by the chair and the chief executive; and
- the relationships between board members, particularly chair/chief executive, chair/senior independent director, and executive /non-executive directors.
Diversity & Directors’ remuneration
- Companies should describe or link to their board and workforce diversity policies.
- All companies should promote and recruit on merit. Those who use this as a justification for not actively pursuing diversity policies should demonstrate how their approach brings about diversity in the boardroom and workforce.
- Companies are encouraged to set appropriate diversity targets, describe their progress against those targets, and include senior management alongside the board.
- Remuneration policies should elaborate on the Remuneration Committee’s discretionary powers.
- Companies should demonstrate the steps taken to engage with their employees on their remuneration policies, including two-way communication, feedback and follow-up actions.
- All companies should move to full alignment of executive director pension contributions with those available to the workforce, or provide a clear and specific rationale and define a timeline for when this will be rectified.
- The FRC expects to see clear descriptions of how each element of Provision 40 (clarity, simplicity, risk, predictability, proportionality, and alignment to culture) has been accounted for when determining remuneration policy.
- Companies should genuinely engage with a wide spectrum of shareholders and try to address their concerns, particularly if 20 per cent or more of votes are cast against the remuneration report, the remuneration policy or a proposed share scheme.
Stakeholder (including shareholder) engagement
Companies should identify key stakeholders and explain their relevance in the context of their strategy. Companies should also identify key issues relating to each stakeholder group.
Companies should report on how the company has engaged with its key stakeholders and also the steps it has taken to understand the views and needs of its stakeholders, in line with Provision 5 of the Code.
The outcomes of stakeholder engagement should be reported, including why key decisions were taken, how stakeholder feedback helped inform decisions, future implications, and planned actions arising from feedback.
Companies should report a coherent narrative on the approach to measuring the performance of its stakeholder engagement strategies. When reporting on the performance of decisions, evidence should be given to support the statements made, which may be quantified (eg the decision generated x new jobs).
Companies should report on how the board oversees stakeholder engagement including how, and on what basis, stakeholder information is passed to the board, as well as how often the board reviews stakeholder engagement methods.
There should be meaningful engagement with suppliers and reporting on such engagements. The FRC encourages boards to regularly review prompt payment policies and address the supply chain dimension of the Modern Slavery Act.
- In general, further clarity is required to ensure that investors and stakeholders are aware of how companies engage with their workforce.
- The role and the impact of the workforce NED on workforce engagement should be clearly set out.
- Companies should adopt an effective method of workforce engagement to deliver meaningful and regular dialogue with the workforce and aim to strengthen the employee voice in the boardroom. Such dialogue needs to be explained clearly and effectively for Code Provision 5 to be met.
- Companies should provide full explanations of why their method of employee engagement is effective.
- Outcomes from employee engagement should be illustrated within the corporate governance report, alongside views and workforce concerns that ought to be taken on board. Management should provide feedback on how the situation has been dealt with.
Environmental, Society and Community matters
- The FRC expects companies to report how climate and environmental issues are considered at board level and the impact this has on decision making, taking into account any reporting against the Task Force on Climate-related Financial Disclosures (TCFD) and the Sustainability Accounting Standards Board (SASB).
- It should be clear how consideration of climate-related issues has informed key decisions and the business model or the company’s strategy.
- Companies should report on issues discussed with community members and provide examples of specific community engagements.
Reporting non-compliance with the Code
- The FRC recognises that companies vary and so offers flexibility through its ‘comply or explain’ approach to reporting. In its report: Improving the quality of ‘comply or explain’ reporting, the FRC highlights that it is important for companies to:
- Embrace the flexibility offered by the Code and develop bespoke governance processes and practices which raise standards; make it easy to identify which Provisions of the Code they have departed from in their annual report; and
- Ensure that they provide full, clear, and meaningful explanations for any such departures.
For further information please speak to Lee Marshall.