UK corporate governance regulation is accelerating so what are the key things that boards need to consider in 2014?
Since the 1992 Cadbury Report, corporate governance has been evolving – and accelerating. This year will see new guidance on Risk Management, Internal Control and Going Concern Basis of Accounting and the FRC will be undertaking a revision to the UK Corporate Governance Code (the Code). These revisions are made every two years but can often be very significant.
Based on our latest FTSE 350 Corporate Governance Review [ 9907 kb ], we believe the following will be key areas for the board in 2014.
1. The nominations committee
Regulators have been less focused on the nominations committee in the past than the other board committees, however there are signs that the work of the nominations committee is increasingly coming under the spotlight.
In 2011, the FRC published board effectiveness guidance and since 2012 it has been mandatory to have an externally facilitated effectiveness review every three years – the nature and quality of these reviews, and transparency about the findings, will be a focus of attention as good practice emerges.
Companies are now required by law to make disclosures about gender diversity and FTSE 350 companies are striving to achieve the targets set by Lord Davies for 25% women by 2015 – but gender is the tip of the iceberg that is boardroom diversity. Skills, attributes, and experience of relevant sectors and international markets are also highly relevant to a board's composition.
The nominations committee has a key role in assessing the composition of the board against the business needs. From our research we know that an adequate complement of non-executive directors (NEDs), and combining of the CEO and chairman role, are the biggest areas of non-compliance with Code provisions.
There is evidence that this is a result of poor succession planning, and the FRC intimated in their introduction to our 2013 Corporate Governance Review [ 9907 kb ] that this is an area where they will seek to encourage companies to improve.
2. Executive remuneration
Following recent changes in the regulations covering directors' pay disclosures, companies are required to include more detail about executive remuneration in the annual report, and the remuneration policy is now subject to a binding shareholder vote.
Institutions such as Fidelity have already outlined that they are willing to exercise their 'no' vote – in Fidelity's case if share-based long-term incentive plans (LTIPs) do not extend for a minimum of five years. This suggests that remuneration will continue to be in the spotlight in 2014 and high on the list of investors' priorities.
3. Audit committee’s extra responsibility
The latest revisions to the Code have made additional work for the audit committee. The audit committee is now required to comment on its work in relation to the financial statements and to give more detail on how it has evaluated auditor performance. It may also have to agree the content of the new enhanced auditor report with its auditors.
The European Commission will debate draft legislation for mandatory auditor rotation in February. Our research identified that some audit committees have responded by increasing both the number of members and the level of financial expertise. The changes should prompt board members to reflect on the current composition and terms of reference of the audit committee, and consider whether it remains appropriate.
4. Risk and internal control
Risk Management, Internal Control and Going Concern Basis of Accounting guidance will be published in 2014 and incorporated into the 2014 Code revisions.
Our research supports the FRC's view that current disclosures are uninformative. Insight into strategic risks and how they have been managed is key information for investors. Where disclosures are weak, it creates the impression – rightly or wrongly – that the organisation's ability to manage risk is also poor. While there is some debate about whether disclosing risk mitigation should be mandatory, we advise companies to voluntarily adopt this good practice approach.
Download the FTSE 350 Corporate Governance Review
These four issues are just some of the areas where we feel there will be increased focus in 2014. For more detail on corporate governance trends in the FTSE 350, download our latest Corporate Governance Review 2013 [ 9907 kb ].