Risk

UK Corporate Governance Code focuses on long-term risk

Simon Lowe Simon Lowe

boardroomChanges to the UK Corporate Governance Code published this month are pushing large corporates to focus on long-term sustainability. But will the 2014 updates have the desired effect?

Stephen Haddrill, CEO of the Financial Reporting Council (FRC), has suggested that the recent changes to the UK Corporate Governance Code are "designed to strengthen the focus of companies and investors in the longer term and the sustainability of value creation”. 

But while many of the reforms reflect a conscious move towards long-term sustainability, we do consider the impact of certain changes as subject to interpretation by corporates. Accordingly, there is still room for the more recalcitrant to hide behind bland reporting and generic statements.

We’re encouraged, however, by further emphasis being given to the importance of culture and values to drive the right behaviours, a principle borne out by our experience of more successful strategic implementation and corporate renewal projects. ‎

Some of the key changes are likely to feature highly on boardroom agendas in the coming months (and from a wider perspective potentially impact the timing of, for example renegotiating finance agreements).

The FRC now expects comfort for going concern to be provided for a period significantly longer than the stated 12 months, which some companies fear will be treated by investors as an extension of the going concern statement. The FRC also expects a board to include in its assessment of long-term viability a more robust identification and assessment of the major risks of the business, and how any such material uncertainties will impact over this increased horizon of assurance.

We anticipate that most companies will discuss long-term prospects in the strategic report, thus coming under the scope of the safe harbour provisions of the Companies Act. While it would be unreasonable to hold companies to any discussion of such long-term prospects, preliminary research for our upcoming FTSE 350 Corporate Governance Review suggests that fewer than half of listed companies provide a meaningful discussion of the future development of the business.

Clearly a significant improvement in the quality of narrative reporting will be required if the new provisions are to result in meaningful change.

There are changes around risk reporting, too. Here, the emphasis is on acknowledging that a robust assessment has taken place with companies encouraged to show how significant risks are mitigated, and to be more transparent about risk management and internal control.

The revised Code also states that executive remuneration should be aligned to long-term performance, and encourages the use of non-financial KPIs, minimum shareholding, longer vesting periods and meatier clawback provisions. Coupled with the new Directors' Pay Regulations and the binding shareholder vote on remuneration policy, shareholders will now have far more insight into how executives are rewarded.

These proposals on executive remuneration will inevitably stir the debate about optimum remuneration packages, as companies strive to strike a balance between annual returns and alignment with long-term performance. The recent rejections by shareholders of the Kentz remuneration policy and Burberry's remuneration report, to name but two, point to an even more fundamental issue for some boards. Shareholders should be consulted on remuneration at the design stage, well in advance of the AGM. The new Code provisions on shareholder engagement seek to provide remedy where companies fail to do so.

The changes clearly seek to promote accountability‎ and to improve alignment between business decisions and shareholder interests, with a continuing emphasis on ‘tone from the top’ and a need for boards to communicate and embed strong values throughout the organisation. However, observations from previous FTSE 350 Corporate Governance Reviews suggest that the full impact may not be seen for at least five years.

Further information

Read the latest FTSE 350 Corporate Governance Review [ 4002 kb ]

If you would like to explore these issues in more detail at our upcoming debates on strategic reporting and board governance, please register your interest by email at governance.institute@uk.gt.com.

Image of boardroom: (CC) wohlford/Flickr