Alert December 27, 2018

New UK Corporate Governance Reporting Requirements

Summary

The UK has introduced an enhanced corporate governance and reporting framework which imposes on public and private companies new reporting requirements on directors’ duties, engagement with stakeholders, and corporate governance issues.

What is changing?

New legislation in the form of The Companies (Miscellaneous Reporting) Regulations 2018 (the 2018 Regulations) introduces new reporting requirements for public and private companies for accounting periods beginning on or after 1 January 2019 (so actual reporting will in most instances only start in 2020). Most of the requirements apply only to large companies (whether public or private) - large which is defined differently for different requirements, whilst some of the requirements apply only to quoted companies.

What are the new reporting obligations for large companies (public or private)?

  1. Section 172 Statement

    Large companies must now produce a “Section 172 Statement” by including in their strategic report a separate section to explain how its board of directors has had regard to the matters specified in section 172(1) of the Companies Act 2006 (the Act) in discharging their duty thereunder. This directors’ duty is to promote the success of the company for the benefit of its shareholders, including having regard for the likely consequences of their decisions in the long term; the interests of employees; the need to foster relationships with suppliers, customers and others; and the impact of operations on the community and the environment.

    Large companies for this purpose are defined in the Act as those who meet at least two of the following criteria in the relevant financial year: turnover in excess of £36m, balance sheet total in excess of £18m, and employees in excess of 250 (each calculated at an individual company level).

    The requirement applies to every company in a corporate group which meets the definition, not just the parent, and even if the parent is required to produce a consolidated strategic report. A parent cannot report on behalf of its subsidiary. If a parent and its subsidiaries fall below the threshold, but through consolidation the parent meets the threshold, it must prepare the statement.

    In terms of its content, the statement must explain the factors the directors considered relevant to discharging their duty and their rationale for them; how the directors engaged with stakeholders with regard to the factors they consider relevant; and how having regard to these affected their decisions.

    Companies must publish the statement on their website, either by posting their entire annual report or just the statement in a format which can be read on a standalone basis. Companies can publish the statement on their own website, or one maintained on their behalf (such as that of the parent) provided that the reporting company is identified and the statement is freely accessible. Quoted companies already have to publish their annual report on their website.

    Government’s Department for Business, Energy and Industrial Strategy has issued a Frequently Asked Questions guide on how and when companies will be affected by the new corporate governance reporting requirements which can be accessed here.

    The GC100 Group recently published helpful Guidance to give boards practical examples of how they can foster a culture where the wider interests of stakeholders are considered whilst making decisions and running the business. Importantly, the guidance emphasizes that directors need “not try to balance the interests of the company and those of other stakeholders" but instead to “weigh up all the relevant factors and then to ask themselves which course of action they consider best leads to the success of the company, having regard to the long term”. Further, it says that “this can sometimes mean that certain stakeholders are adversely affected, but this does not call into question decisions made".

    The Guidance focuses on five specific things which can help a board embed section 172 in making decisions for the company:

    • Strategy: Reflect the section 172 duty when setting and updating the company’s strategy – practically, this necessitates clearly identifying who the company’s stakeholders actually are, what the relationship between their interests and the company’s goals is, and setting aside sufficient time despite having to continuously deal with short term urgent issues to consider the impact the company is having on its stakeholders.
    • Training: Establish and attend training courses on induction to the board, with ongoing updates on the section 172 duty in the context of wider duties and responsibilities – practically, this includes providing induction and refresher training for managers and subsidiary directors on their duties as directors, and also appropriate skills and career development training to extend their skills and enhance their effectiveness.
    • Information: Consider and arrange to receive the information needed on appointment and going forward to help discharge the directors’ role and duty – practically, this includes really thinking about what information is needed to consider the impact on stakeholders, whether the actual information flows meet that, whether sufficient input from others are received where actual knowledge is lacking, and whether the metrics and scope of current information packs sufficiently reveal stakeholder information.
    • Policies and process: Put in place policies and processes appropriate to support the company’s operating strategy and to support its goals in the light of the section 172 duty – practically, this includes at board level explicitly referencing directors’ duties in making appointments, having discussions, and taking and documenting decisions. At management level this includes training on writing effective board papers which makes clear to directors the impact of decisions, and implementing specific policies around section 172 issues.
    • Engagement: Consider what should be the company’s approach to engagement with employees and other stakeholders, whether through board engagement or wider corporate engagement – at a practical level it should be borne in mind that engagement involves not just the actions of directors but also managers and employees, engagement comprises not just formal channels set up for that purpose but the ongoing experience of a company through smaller interactions, and feedback should be effectively shared to ensure it eventually reaches the board.

       

  2. Statement of Engagement with UK Employees

    This new statement must be produced by large companies which, for this purpose, are defined as companies with an average of more than 250 employees in the UK during the relevant financial year. For parent companies, this would be the average number of employees in the group.

    To ensure that companies specifically report on the employee aspect of the section 172 duty (as set out in 1 above), in-scope companies must summarise in the directors’ report (in addition to the usual statement describing how the company engaged with employees) how the directors have engaged with employees and had regard for employees’ interests, and the effect that such regard has had on their decisions. The statement can be made in the company’s strategic report instead, if the directors consider the matters to be of strategic importance, and state in the directors’ report that this has been done.

  3. Statement of engagement with suppliers, customers and others

    Large companies as defined in the Act (see 1 above) must now summarise in the directors’ report how the directors have had regard to the need to foster relationships with suppliers, customers and others; and the effect that such regard has had on their decisions during the year. The statement can be made in the strategic report instead if the directors consider the matters to be of strategic importance and state in the directors’ report that this has been done.

  4. Corporate Governance Statement

    Large companies for this purpose are those who in the relevant financial year have either (a) more than 2000 employees globally, or (b) turnover in excess of £200m and a balance sheet total in excess of £2bn. These thresholds apply to each company in a group. The requirement applies to UK subsidiaries of listed overseas parents.

    In-scope companies must state in the directors’ report which corporate governance code (if any) was applied, how it was applied and, if it was departed from, how and why. If the company did not apply a corporate governance code, the statement must explain the reasons for this and what corporate governance arrangements were applied instead.

    Unquoted companies must publish the statement either on their own website or on one maintained on their behalf (such as that of the parent), in the latter case clearly identifying the reporting company and making the statement freely accessible. Quoted companies already have to publish their annual reports on their website.

    In terms of which corporate governance code a company applies, different requirements and/or options exist depending on whether the company is quoted or privately owned. In brief:

    • Companies with a premium listing will be required to comply with the new 2018 UK Corporate Governance Code (which is replacing the 2016 UK Corporate Governance Code) in respect of financial years beginning on or after 1 January 2019, whilst companies with an AIM listing have more flexibility and since September 2018 have been required to state on their website (and admission document) which recognized corporate governance code its board has decided to apply and how it does so. A number of options exist for codes to apply.
    • Large private companies now required to produce the Corporate Governance Statement can voluntarily adopt the new Wates Principles (as detailed below).

Which corporate governance codes are available for large companies in complying with their new corporate governance reporting obligations, and other private companies wanting to adopt appropriate best practice?

The Wates Corporate Governance Principles for Large Private Companies and supporting guidance (the Wates Principles) were recently published, both to help in-scope companies produce a Corporate Governance Statement pursuant to the 2018 Regulations but also to help out-of-scope private companies of all sizes adopt good corporate governance practices (hence they do not state which companies they apply to).

The Wates Principles were developed by an industry group chaired by James Wates CBE and including the Financial Reporting Council, the Institute of Directors and the British Venture Capital Association (the BVCA).

Large companies who adopt the Wates Principles must demonstrate in their Corporate Governance Statement (as set out above) how application of the Principles has resulted in improved corporate governance outcomes during the reporting period.

The Wates Principles aim to provide a high-level approach to good corporate governance, while allowing sufficient flexibility for companies to explain the application and relevance of their corporate governance arrangements to their size and type of business. The Principles comprise six elements, each with non-exhaustive guidance, and can be accessed here – briefly they are:

  1. Purpose and Leadership – An effective board both develops and promotes the purpose of a company, and ensures that its values, strategy and culture align with that purpose.
  2. Board Composition – Effective board composition requires an effective chair and a balance of skills, backgrounds, experience and knowledge, with individual directors having sufficient capacity to make a valuable contribution. The size of a board should be guided by the scale and complexity of the company.
  3. Director Responsibilities – Directors should have a clear understanding of their accountability and responsibilities, with policies and procedures to support effective decision-making and independent challenge.
  4. Opportunity and Risk – A board should promote the long-term sustainable success of the company, by identifying opportunities to create and preserve value and establishing oversights for the identification and mitigation of risk.
  5. Remuneration – A board should promote executive remuneration structures aligned to the long-term sustainable success of a company.
  6. Stakeholder Relationships and Engagement – Directors should foster effective stakeholder relationships aligned to the company’s purpose. The board is responsible for overseeing meaningful engagement with stakeholders and having regard to their views in making decisions.

To date, many of the UK’s largest private equity-backed companies have applied Sir David Walker’s Guidelines for Disclosure and Transparency in Private Equity, which were developed with the BVCA in 2007 and updated in 2014, for the requirement to produce a strategic report. The Guidelines, which are a voluntary set of rules intended to be implemented on a 'comply or explain' basis, require greater disclosure by large private equity firms and their portfolio companies (as defined in the Guidelines and summarized here) and currently cover 56 of the largest private equity-backed companies in the UK.

The Private Equity Reporting Group (the PERG), the body tasked with monitoring compliance with the Walker Guidelines, has just published its latest annual report. Notably, 100% of the companies in the sample of 15 reviewed this year have complied with the disclosure requirements in their annual report, as compared with 79% in 2017. The PERG and PwC have concurrently published the latest version of the Good Practice Reporting Guide, which illustrates how the Walker Guidelines can be implemented with real examples of good practice to aid portfolio companies with their reporting. Both reports make for useful reading, in that they set out basic and enhanced practices with many examples, and can be found here.

The BVCA has also recently produced a very useful briefing that summarises the various narrative reporting requirements for portfolio companies, including the corporate governance reforms and Wates Principles.

What are the new reporting obligations only for quoted companies?

Quoted companies (that is, UK incorporated companies who are UK Official List companies or whose shares are listed on the New York Stock Exchange, NASDAQ or a recognized exchange in the EEA) must, in brief, include in their directors’ remuneration report information on:

  1. Pay ratios – Quoted companies with an average of more than 250 UK employees must report on pay ratios, including a comparison of the CEO’s remuneration with the average pay in the wider company workforce. A UK-incorporated and quoted company that has an overseas parent, must still report its pay ratio.
  2. The impact on share price – All quoted companies must report on the possible outcomes of their long term incentive plans (LTIPs) for directors’ remuneration.

The GC100 and Investor Group recently revised their Directors’ Remuneration Reporting Guidance, mainly to reflect changes introduced by the 2018 Regulations and stakeholder feedback.