2018 UK Corporate Governance Code - FAQs
Who does the Code apply to?
The Code is applicable to companies with a premium listing, regardless of where they are incorporated.
When will the 2018 Code come into force?
The Code applies to accounting periods beginning on or after 1 January 2019. Therefore, unless companies decide to adopt all or part of the new Code early, reporting will not be seen until 2020.
Do any parts of the 2018 Code need to be reported sooner?
Provision 4, which relates to reporting on significant votes at shareholder meetings, will be appropriate to report on during 2019. Likewise, future remuneration policies and changes to existing ones should be developed with reference to the Code and the Guidance on Board Effectiveness.
When does the Code apply to a company?
The Code applies from when a company becomes premium listed. However, we recommend companies explain any differences between their governance practices and the Code, including if steps are intended to bring them back in line with the Code.
How should the Principles be reported on?
Companies are required to state how they have applied the Principles in a manner that would enable shareholders to evaluate how the Principles have been applied. This will involve reporting on how the board has set the company’s ‘purpose and strategy’, met objectives and achieved outcomes through the decisions it has taken. Companies should articulate actions taken and resulting outcomes and cross-reference to those parts of the annual report that describe how the Principles have been applied.
What is the status of the revised Guidance?
The revised Guidance on Board Effectiveness supports the new Code. It is not intended to instruct companies on their governance practices but to stimulate thinking. The Guidance will be updated periodically to take account of developments in governance practice. If further clarification is needed following the introduction of the 2018 Code, we will address this through these FAQs and by updating the Guidance.
Does the ‘comply or explain’ approach extend to how companies use the Guidance on Board Effectiveness?
The ‘comply or explain’ approach only applies to the 41 Provisions of the Code, not the Guidance on Board Effectiveness. The purpose of the Guidance is to encourage thinking on how boards carry out their role and improve their effectiveness. It is not mandatory nor prescriptive; it contains suggestions of good practice to support directors and their advisors in applying the Code. When preparing a corporate governance statement, boards may find it helpful to refer to how they have used the guidance, but there is no requirement to do so.
How will the 2018 Code be monitored?
During 2019 we will be considering the approach early adopters take with the new Code and making a public statement about progress in late 2019. We can learn from the transparency and reporting in some companies and we want to put this to good use and drive forward best practice. Full reporting on the new Code will covered in the annual reports published in 2020. Future decisions about the nature of monitoring will be taken in light of the outcome of Sir John Kingman’s’ review.
What does ‘comply or explain’ mean in practice?
As explained in the 2018 Code’s Introduction an alternative to complying with a Provision may be justified in particular circumstances based on a range of factors, including the size, complexity, history and ownership structure of a company. Explanations should set out the background, provide a clear rationale for the action the company is taking, and explain the impact that the action has had. Where a departure from a Provision is intended to be limited in time, the explanation should indicate when the company expects to conform to the Provision. Explanations are a positive opportunity to communicate, not an onerous obligation.
The Code is not a rulebook – it sets out good practice. Where a company has explained non‑compliance with a Provision, investors should judge whether this explanation is satisfactory. A good explanation should be seen as being Code compliant. Where reporting and explanations are weak, it is the responsibility of investors to engage with companies and hold directors to account in order to improve governance practices.
Does the Code cover subsidiaries in Code-applicable group companies?
The Code applies to premium listed companies on the London Stock Exchange, and while we do not have separate guidance on how it applies to group companies, there is nothing to stop subsidiaries of these Code companies extending their corporate governance practices throughout the group. As the 2018 Code states in the ‘Application’ section:
For parent companies with a premium listing, the board should ensure that there is adequate co-operation within the group to enable it to discharge its governance responsibilities under the Code effectively. This includes the communication of the parent company’s purpose, values and strategy.
The Government’s secondary legislation on corporate governance for large private companies (see here for more information), may be of interest as subsidiaries meeting certain prescribed size criteria will need to meet this new reporting requirement.
Board Leadership and Company Purpose
Does Provision 4 capture both board proposed resolutions and shareholder requisitioned resolutions?
Provision 4 applies to all resolutions at general meetings, whether proposed by the board or shareholders. The ‘board recommendation’ reference is to how the board recommended shareholders vote on a resolution, i.e. a vote “for” a board resolution, or a vote “for” or “against” a shareholder resolution.
Who does ‘workforce’ refer to when used in the Code?
The term ‘workforce’ is broader than ‘employees’, as used in Section 172, i.e. those with a direct contract of employment with the company. Instead it might include agency workers, contractors and people with ‘zero hours’ contracts. This will depend of course on the particular circumstances of the company which should decide who is included within the definition and explain why it has reached its conclusions. We explain this further in Paragraph 50 of the Guidance (PDF), but this is not a legally defined term. [For the Remuneration section please see Paragraph 131 for a description of workforce in this context.]
Given UK companies already need to comply with conflicts of interest requirements in the Companies Act 2006 and the Listing Rules is Provision 7 intended for non-UK incorporated entities?
Provision 7 is designed to emphasise the board’s collective responsibility for dealing with conflicts of interest in a transparent way in order to enable it to be an effective decision-making body. It is associated with Principles B and E and linked to Provision 8. The aim is to ensure that the board has an agreed process in place for identifying and dealing with conflicts rather than addressing them on an ad hoc basis. Further guidance is given in the decision-making section on pages 9-10 of the Guidance on Board Effectiveness. As such, this Provision is not primarily intended for non-UK incorporated entities only, but we acknowledge that UK companies are subject to the requirements of the Companies Act 2006 and Listing Rules.
Composition, Succession and Evaluation
Do chairs who have been on the board for over 9 years have to resign in 2019?
No – the Code is ‘comply or explain’. There may be reasons to keep a chair in post, but boards must think very carefully about their composition, refreshment and succession planning, and offer an explanation.
Why have you set a tenure period for chairs but not non-executive directors?
The independence criteria in Provision 10 have and will continue to act as a recommended tenure period for non-executive directors. The new period for chairs ensures that there is careful consideration after 9 years. Where there is an extension this should be supported by comprehensive explanations which will help investors and other stakeholders better understand the long-term succession planning strategy of companies.
Is the clock reset when a non-executive director is appointed chair or does the nine-year test of independence start when they first join the board?
In respect of board chairs, the recommended nine-year tenure period starts when the person first joins the board. Nevertheless, the 2018 Code offers flexibility on this issue. Principle K refers to the combination of skills, experience and knowledge needed on a successful board and that consideration should be given to the overall length of service of the board. This recognises that an effective board will benefit from a mix of lengths of service.
In addition, Provision 19 says that the nine-year period “can be extended for a limited time, particularly in those cases where the chair was an existing non-executive director on appointment”. The provision explains that this is “to facilitate effective succession planning and the development of a diverse board”.
The Code is of course based on setting a high standard of good practice and the principle of ‘comply or explain’ and we expect high quality explanations in cases where companies depart from the Code Provisions.
How does the Code’s definition of ‘senior management’ (including for Hampton‑Alexander reporting) fit with the Companies Act (s.414c) definition of ‘senior managers’?
In terms of Code reporting, we would not expect companies to list all their senior management by name. Nevertheless, good practice would be to indicate the size and scope of senior management, for example – an Exco/Executive Board of XX (with XX direct reports – for the purposes Hampton Alexander reporting). This could be done by use of a footnote.
The definition of ‘senior manager’ in s414c (see below) is based more on function rather than seniority, so some companies may have different disclosures under the legislation than for the Code. Where this is the case companies can explain why the two disclosures are different, but some may wish to use the definition which covers both requirements.
(8) In the case of a quoted company the strategic report must include—
- a description of the company’s strategy,
- a description of the company’s business model,
- a breakdown showing at the end of the financial year—
(i) the number of persons of each sex who were directors of the company;
(ii) the number of persons of each sex who were senior managers of the company (other than persons falling within sub-paragraph (i)); and
(iii) the number of persons of each sex who were employees of the company.
(9) In subsection (8), “senior manager” means a person who—
- has responsibility for planning, directing or controlling the activities of the company, or a strategically significant part of the company, and
- is an employee of the company.
Audit, Risk and Internal Control
Why does the Code not specifically refer to cyber risks?
Both the Code and the Strategic Report asks directors to consider the situation of the company and identify its emerging and principal risks (and their materiality to shareholders), and how they are managed and mitigated.
For many companies cyber/IT security will be amongst these risks, but the Code does not provide a list of risks for directors to consider as this is a matter for their judgement and particular to the company’s activities. Of course, having expertise on the board in this area will be one way of mitigating this type of risk.
The purpose of the Code disclosures is to give investors an understanding of the directors' consideration of risks and the actions that have taken. Investors can then engage with the company as appropriate.
When will the Guidance on Audit Committees be updated?
We intend to update the 2016 version with consequential changes needed to reflect the 2018 Code and a new version will be published in due course.
Are changes likely to Provision 31 – the ‘viability statement’?
As noted in the Feedback Statement we will be making consequential changes to the Guidance on Risk Management, Internal Controls and Related and Financial Business Reporting. We will also assess whether further amendments are required in relation to internal controls and the viability statement in light of the completion of the various investigations into the collapse of Carillion.
What does Provision 36 mean in terms of how long shares should be held before they can be sold?
The intention of Provision 36 is to encourage a phased approach so that not all shares vest at the same time as is currently the case in Schedule A of the 2016 Code which states, “grants under executive share option and other long-term incentive schemes should normally be phased rather than awarded in one large block.” Phased awards should encourage a continuous focus on performance over the long-term. This sets out well-established market practice, enforced by clear and robust institutional investor expectations. Provision 36 is intended simply to indicate that LTIP award shares should be granted on a phased basis and should vest in grant order.
What difference will the changes on executive remuneration make? Will the changes stop excessive pay packages?
The role of remuneration committees will be broader. They will be asked to set remuneration for senior executives, exercise discretion, and to review pay and incentives across the workforce. They will be expected to take that broader context into account when setting policy for director remuneration and to explain decisions to the workforce.
This will encourage remuneration committees to reflect on their approach and be more accountable for their decisions. The changes are also designed to emphasis long-term company performance and sustainability and to create conditions in which executive pay policy is aligned to long-term thinking. They encourage remuneration committees to keep schemes simple and transparent, with predictable outcomes.
Additional key changes include:
Provision 36 asks remuneration committees to consider whether executives should be required to continue to hold shares for a period after their employment ends.
Provision 37 encourages boards to exercise discretion to override remuneration outcomes that ‘don’t feel right’ because they are not a true reflection of individual performance.
We have also clarified expectations on pension contribution rates for executives – Provision 38 says they should be aligned with what is available to the workforce.
It is expected that the changes will empower remuneration committees in their discussions with executives. They should also:
strengthen the link between the delivery of strategy and performance,
foster greater accountability; and
require a more considered approach to executive pay.