The Financial Reporting Council (FRC) has issued today an updated version of the UK Corporate Governance Code (the Code). This significantly enhances the quality of information investors receive about the long-term health and strategy of listed companies, and raises the bar for risk management.
The FRC has confirmed proposals for boards to include a ‘viability statement’ in the strategic report to investors. This will provide an improved and broader assessment of long-term solvency and liquidity. It is expected that this statement will look forward significantly longer than 12 months. The Code has also been changed in relation to remuneration. Boards of listed companies will now need to ensure that executive remuneration is designed to promote the long-term success of the company and demonstrate how this is being achieved more clearly to shareholders.
Commenting on the UK Corporate Governance Code, FRC CEO Stephen Haddrill said:
“The changes to the Code are designed to strengthen the focus of companies and investors on the longer term and the sustainability of value creation. The changes on going concern implement the reforms proposed by Lord Sharman whose work has stimulated a sea change in thinking about the assessment and reporting of risk and business prospects.
The changes also reflect and have benefitted from extensive consultation. Recognising the different circumstances for business, companies are allowed to choose the period over which they look forward but we are clear this should be more than a year and reflect the nature of the business. Crucially the directors should explain their reasoning to investors. If included in the Strategic Report their statements will be subject to a safe harbour in accordance with companies’ legislation.
The changes on remuneration also focus companies on aligning reward with the sustained creation of value.
The Code will continue to operate on the principle of ‘comply or explain’, which has served investors and the UK corporate sector well for over 20 years.”
The revised Code will apply to accounting periods beginning on or after 1 October 2014.
The key changes to the Code include:
Going concern, risk management and internal control
Companies should state whether they consider it appropriate to adopt the going concern basis of accounting and identify any material uncertainties to their ability to continue to do so;
Companies should robustly assess their principal risks and explain how they are being managed or mitigated;
Companies should state whether they believe they will be able to continue in operation and meet their liabilities taking account of their current position and principal risks, and specify the period covered by this statement and why they consider it appropriate. It is expected that the period assessed will be significantly longer than 12 months; and
Companies should monitor their risk management and internal control systems and, at least annually, carry out a review of their effectiveness, and report on that review in the annual report.
Companies can choose where to put the risk and viability disclosures. If placed in the Strategic Report, directors will be covered by the “safe harbour” provisions in the Companies Act 2006.*
Greater emphasis be placed on ensuring that remuneration policies are designed with the long-term success of the company in mind, and that the lead responsibility for doing so rests with the remuneration committee; and
Companies should put in place arrangements that will enable them to recover or withhold variable pay when appropriate to do so, and should consider appropriate vesting and holding periods for deferred remuneration.
The FRC has also highlighted the importance of the board’s role in establishing the ‘tone from the top’ of the company in terms of its culture and values. The directors should lead by example in order to encourage good behaviours throughout the organisation.
In addition the FRC has emphasised that key to the effective functioning of any board is a dialogue which is both constructive and challenging. One of the ways in which such debate can be encouraged is through having sufficient diversity on the board, including gender and race. Nevertheless, diverse board composition in these respects is not on its own a guarantee. Diversity can be just as much about difference of approach and experience. The FRC is considering this as part of a review of board succession planning and will consider the need to consult on these issues for the next update to the Code in 2016.
Notes to editors:
The FRC is responsible for promoting high quality corporate governance and reporting to foster investment. We set the UK Corporate Governance and Stewardship Codes as well as UK standards for accounting, auditing and actuarial work. We represent UK interests in international standard-setting. We also monitor and take action to promote the quality of corporate reporting and auditing. We operate independent disciplinary arrangements for accountants and actuaries; and oversee the regulatory activities of the accountancy and actuarial professional bodies.
The updated Code is issued today with three related documents:
a. Guidance on Risk Management and Internal Control and Related Financial and Business Reporting (the Risk Guidance) is an amalgamation of the 2005 Turnbull and 2009 Going Concern guidance notes and has now been revised to reflect the finalised requirements of the Code and in the light of comments from earlier consultation in November 2013 and April 2014.
b. Guidance for Directors of Banks on Solvency and Liquidity Risk Management and the Going Concern Basis of Accounting provides supplementary considerations for the banking sector, and should be read in conjunction with the Risk Guidance.
c. Revised Auditing Standards (extracts) – ISAs (UK and Ireland) 260, 570 and 700 draws attention to related changes to the standards that were made following consultation in 2012, to require auditors to consider and report on narrative disclosures, including risks. Accordingly auditors will need to consider the going concern basis of accounting (and material uncertainties relating thereto) and the longer term viability statement and the risk management disclosure.
*Further detail on “safe harbour” provisions:
The provision means that, provided that directors do not make a deliberately or recklessly untrue or misleading statement or dishonestly conceal a material fact by way of an omission, they will not be liable to compensate the company for any loss incurred by it in reliance on the report.