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At its meeting today, the FRC agreed the final text of a new Combined Code. The new Code will come into effect for reporting years beginning on or after 1 November 2003.
The new Code is based on the draft revision of the existing Code that Derek Higgs suggested in his report on non-executive directors published in January, which also incorporated the recommendations of Sir Robert Smith’s report on audit committees. The agreed final text reflects extensive consultation by the FRC since January.
The Code’s overall aim is to enhance board effectiveness and to improve investor confidence by raising standards of corporate governance. Its main features are:
- new definitions of the role of the board, the chairman and the non-executive directors;
- more open and rigorous procedures for the appointment of directors and from a wider pool of candidates;
- formal evaluation of the performance of boards, committees and individual directors, enhanced induction and more professional development of non-executive directors;
- at least half the board in larger listed companies to be independent non-executive directors, with a definition of independence of non-executive directors;
- the separation of the roles of the chairman and the chief executive to be reinforced;
- a chief executive should not go on to become chairman of the same company;
- closer relationships between the chairman, the senior independent director, non-executive directors and major shareholders; and
- a strengthened role for the audit committee in monitoring the integrity of the company’s financial reporting, reinforcing the independence of the external auditor and reviewing the management of financial and other risks
As with the existing Code, in order to meet their obligations under the Listing Rules, listed companies will have to describe how they apply the Code’s main and supporting principles and either confirm that they comply with the Code’s provisions or provide an explanation to shareholders. The new Code emphasises that companies and institutional investors should enter into dialogue based on trust and mutual understanding. Companies should give helpful and informative explanations, and institutional investors should take a considered approach when evaluating them.
FRC Chairman Sir Bryan Nicholson said:
“The Code agreed today represents a positive and sensible advance in corporate governance in the UK and gives us a leading position internationally. It will foster far-reaching changes in British boardroom practice and help to develop further the professionalism of non-executive directors.
Boards will need to ensure that non-executive directors are appointed on merit after a rigorous selection process. There will be a new emphasis on continuing professional development and on regular evaluation of the performance of boards and individuals. There will for the first time be a single definition of what constitutes independence for a non-executive director. I expect to see non-executive directors better able to make their full contribution within the unitary board.
The Code encourages open dialogue between company boards and institutional shareholders. All have to play their part in ensuring that the dialogue is productive. I believe that, beyond the Code, there is a need for more action on this and I am exploring with those concerned how best to take this forward.
After the FRC’s wide consultation over a period of six months, I am confident that the new Code will command broad support.
I would welcome it if companies were to report early on steps they are taking to implement the new Code, rather than waiting till their reporting year end.
The longer-term effect will be better boards, better-run businesses, greater investor confidence and a more competitive British economy.”
The Code published today incorporates the substance of Derek Higgs’ and Sir Robert Smith’s proposals. The detailed drafting reflects the consultation process. The main areas of difference are:
- modification of the Code’s structure to include not only main ‘principles’ and ‘provisions’ but also ‘supporting principles’, allowing companies greater flexibility in how they implement the Code;
- the board chairman to be able to chair the nomination committee;
- clarification of the roles of the chairman and the senior independent director (SID), emphasising the chairman’s role in providing leadership to the non-executive directors and in the communication of shareholders’ views to the board;
- for smaller listed companies below the FTSE 350, relaxation of the rule on the number of independent non-executives to 'at least two' instead of 'at least 50%'; and
- particularly rigorous review rather than special explanation when non-executive directors are re-elected beyond six years
The intention is that provisions should be as clearly defined and verifiable as possible, so that companies can report unambiguously whether or not they have followed them. The supporting principles are cast in more general terms and leave the detailed method of implementation for companies to decide. Companies will be required, as at present, to make a statement on how they have applied the main principles, and this requirement will extend to the supporting principles as well.
- The new Code is available free on the FRC website, www.frc.org.uk. For the convenience of readers, this includes all the relevant formal texts associated with the Code: the text of the Code itself, the text of the new guidance on audit committees (the Smith guidance) and the text of the Turnbull guidance on internal control, as well as several pieces of informal guidance from the Higgs report (see para 10 of the preamble to the Code).
- The same material will shortly be available in a single printed volume ‘The Combined Code on Corporate Governance, July 2003’, from CCH Information, tel 0870 777 2906, fax 020 8247 1184, email customerservices@cch.co.uk. Orders may be taken immediately.
- Also available on the website is the FRC’s Regulatory Impact Assessment, which sets out in broad terms the rationale for introducing the new Code, together with some discussion of the likely costs to companies.
- Derek Higgs’ report “Review of the Role and Effectiveness of Non-Executive Directors” and Sir Robert Smith’s report “Audit Committees – Combined Code Guidance” were both published on 20 January 2003. The Higgs report included a suggested revised Combined Code to supersede the 1998 Hampel Combined Code. It incorporated proposals from both the Higgs and Smith reports. On the same day, the FRC invited comments on the proposed new Code, with a closing date of 14 April. 181 responses to the consultation were received. The responses of those who have given their consent, and a summary, is available on the FRC website.
- FRC Press Notice 74 of 14 May announced the outcome of that consultation and the formation of a working group of FRC members to work on the draft Code in the light of the public consultation and further consultation with the main representative bodies.
- The Financial Services Authority (FSA)'s Listing Rules underpin the Code by requiring listed companies to make a statement in their annual report on how they have applied its principles, and to comply with its provisions or to explain in their annual report why they have not done so. As explained above, the requirement to state how the Code’s principles have been applied will extend to the supporting principles. The FSA has said that it will replace the 1998 Code that is annexed to the Listing Rules with the revised Code and will seek to make consequential Rule changes. There will be consultation on the necessary Rule changes but not further consultation on the Code principles and provisions themselves.
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Press Enquiries: Charles Bridge, Assistant Secretary to the FRC, (020) 7611 9706.
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