2018 has been a year of far-reaching change for UK corporate governance. Reporting requirements have grown exponentially in breadth and complexity.
With this in mind we, along with Pinsent Masons, invited the governance community to explore the changing face of reporting and compliance. At a seminar on 5 September, we brought together company secretaries, legal counsel and others involved in corporate governance to discuss the latest issues.
The growing governance burden
Martin Webster, a partner at Pinsent Masons, opened the discussion by outlining some of this year’s key developments including the revised UK Corporate Governance Code, the new QCA Code, the draft Wates Corporate Governance Principles for Large Private Companies and the updated AIM Rule 26.
Implications of these developments
Given changing governance expectations, Martin warned that UK firms must now start thinking about their reporting obligations in a number of areas:
Purpose and culture. What is your organisation’s purpose? How will you align your culture behind it? How will you measure your success in doing so? And how will you articulate all of this in your annual report?
Succession planning: How long has your chair been on the board? Do you plan to replace him/her at the end of nine years – and if so, how? If not, how will you explain your reasons for not complying with this new requirement?
Board balance: How can companies outside the FTSE 350 achieve an even balance of independent and non-independent directors ahead of 2020?
Workforce engagement: How are you talking to your workforce and taking account of their views? Do you have effective arrangements in place and how are you evidencing this?
Firms will find themselves in an impossible position if they wait until their 2020 reports are due before tackling these issues. They need to start acting on these requirements, and gathering the necessary evidence, now.
It is an opportunity to thoroughly review your approach to governance, and potentially even start afresh.
The state of reporting
As the new governance landscape takes shape, how does reporting activity in the UK currently stack up against its demands?
Simon Lowe, chair of the Grant Thornton Governance Institute, outlined some of the main findings from our 2017 analysis.
Code adoption at all-time high
Adoption of the UK Corporate Governance Code by the FTSE 350 is at an all-time high as the new version comes into effect.
The proportion of FTSE 350 companies fully complying with the Code has risen from 28% in 2005 to 66% last year.
Reporting on board effectiveness appears to be falling short. In 2017, only modest proportions of the FTSE 350 provided anything other than, at best, boiler-plated explanations in several key areas of the UK Code:
Culture and values – 39%
Shareholder engagement – 33%
Directors’ skills – 27%
Succession planning – 14%
Long-term viability – 6%
Beyond the UK Code’s stipulations, the Companies Act requires annual reports to look at future risks to businesses, and their strategies to address them.
This forward-looking perspective would appear to be a challenge for the FTSE 350. Only 14% properly fulfilled the strategic reporting requirement in 2017.
Interestingly, looking at firms’ risk disclosures since 2010 sheds a revealing light on what’s been happening in the marketplace. The number of financial related risks disclosed has fallen each year since 2010-11, when firms were still struggling with the more immediate aftermath of the financial crisis.
In their place, we’ve seen a significant rise in operational risks and, tellingly, technology risks. Despite the latter trend, many firms outside of the tech and telecoms sectors reported a lack of crucial technology skills on their boards last year.
Simon reiterated Martin’s call for firms to start preparing for the new governance requirements now – or risk reporting significant levels of non-compliance come 2020.
The AIM picture
Revised Rule 26 which is effective from 28th September this year requires AIM companies to state which code they intend to adopt and how they fare when compared to it. As AIM listed companies aren’t obliged to comply with the UK Code, the QCA code is the favoured alternate as it is seen to be more flexible, any analysis is likely to reflect low levels of compliance – particularly as some AIM firms chose to adopt some, but not all, of the Code’s stipulations.
All the same, our study of the top 50 AIM companies who at least state an aspiration to adopt aspects of the UK Code, suggests that there is much work to do:
Just 9% of the companies provided forward-looking statements in their 2017 annual reports.
Only 18% reported fully on their board succession plans (though that exceeds the 14% of the FTSE 350 currently complying with this requirement).
None are yet reporting on their long-term viability or culture and values.
The smallcap and AIM perspective
As noted, the QCA also revised its governance code this year.
The QCA represents the interests of quoted small and medium-sized enterprises (SMEs) in the UK. Its members include what chief executive Tim Ward called “the entire small-cap ecosystem”: investors, fund managers and advisers, as well as listed SMEs.
In Tim’s words, the QCA code is a “standard-setter, not a regulator”, devised by the listed SME community for the community.
Tim described the code as “practical, proportionate, flexible and outcomes-oriented”. It is less prescriptive than the UK Code, and isn’t restricted by government regulation – though in some areas, it demands a greater level of disclosure.
The code is based on 10 principles – reduced from 12 in the recent revision – which are grouped under three basic tenets of good governance:
Delivering growth in long-term shareholder value
Maintaining a dynamic management framework
Building trust and confidence between companies and stakeholders
The Code includes guidance on how to apply each principle, what to disclose and where.
Tim stressed the importance of ‘signposting’ – making clear where stakeholders can find governance information, eg annual report or website. This is particularly key for private investors, who don’t have the resources to interact regularly with companies.
These additional requirements around communication reflect the more direct relationships smaller listed firms have with their stakeholders. In this context, it’s all the more important to consider the needs of shareholders, employees and others.
And from a liquidity perspective, it’s imperative that retail investors can easily find the information they need. “If they can’t see it, they won’t have confidence in you, and they won’t invest,” Tim warned.
Response to the revision
Initial feedback on the revised QCA Code is that it’s succinct and easy to follow with QCA surveys suggesting that 80% of AIM firms intend to adopt it. At least one investor has recommended it to all of the companies she has a stake in.
Investors have also welcomed the healthy discussion on governance that the code is generating in the boardroom.
Purpose and culture
Our seminar concluded with a panel discussion, led by Martin Webster and featuring speakers Simon Lowe and Tim Ward. They were joined by:
Pauline Egan, NED & external board member at Pinsent Masons
Tony Hunter, company secretary to Just Eat
Alison Halsey, audit chair for Credit Suisse and Aon
Much of the conversation focused on the purpose and culture reporting requirements in the UK Code, which are an entirely new obligation. Martin posed the question: “Where do boards start with this?”.
Pauline described ‘purpose’ as “the reason you’re in business.” Not just in terms of making a profit, but also driving long-term sustainability, and meeting the needs of all your stakeholders. She described it as “the big idea everyone can engage behind”.
In her view, the process of defining a company’s purpose should begin by asking four fundamental questions:
Which stakeholders are most important to your business?
What do they think your organisation stands for?
What do you want it to stand for in their eyes?
How can you bring that to life?
Then once you’ve identified your purpose, every decision you take, and every aspect of your culture, must reflect it.
Alison added that everybody in the organisation must understand what your purpose and culture are. However, culture isn’t just a factor of what you communicate. It also comes down to how you listen. And it has to be inclusive. She gave the example of Aon, where staff are always referred to as ‘colleagues’, and never as ‘employees’.
Culture also needs to be measured, Alison stressed – using indicators such as pulse surveys, reportable incidents, absenteeism, whistleblowing, and so on.
Rounding off the culture discussion, Simon pointed out the challenge of embedding your culture once it’s been defined. Leaders need to be rigorous about driving it throughout the organisation and recognise that this can take years to achieve.
Martin finished up by asking if the additional governance requirements facing firms will create better companies, more effective boards, and ultimately, greater shareholder value.
Simon’s view was that for the new Codes to be worthwhile, practice has to be embedded into the fabric of a company. Improving disclosures are a good indicator that attitudes to compliance are changing within which has to be a positive measure. He told the audience: “this is a great opportunity to bring about a step change in governance practices”.
If you would like to talk to us about any of the issues raised, please contact Simon Lowe or Sarah Bell.
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