UK Corporate Governance

Corporate governance reforms

UK Government consultation on corporate governance: On 29 November 2016, the Government published a Green Paper on corporate governance which "focusses on ensuring that executive pay is properly aligned to long-term performance, giving greater voice to employees and consumers in the boardroom, and raising the bar for governance standards in the largest privately-held companies."

The Green Paper sets out the problems that the Government wants to tackle and various potential options for solving the problems. The Government states that, at this stage, it does not have preferred options. The responses to the Green Paper will be used to help the Government understand the strengths and weaknesses of the different options and build a better evidence base before deciding which of them to develop further.

The Green Paper states that its aim is "to consider what changes might be appropriate in the corporate governance regime to help ensure that we have an economy that works for everyone." It focusses on three specific aspects of corporate governance:

• executive pay
• strengthening the employee, customer and supplier voice, and
• whether the UK’s largest privately-held companies - where they are of similar size and economic significance to public companies - should be expected to meet certain minimum standards of corporate governance.

Comments were due by 17 February 2017.

Committee inquiry on corporate governance: on 16 September 2016, the BIS House of Commons Select Committee launched an inquiry on corporate governance. This focusses on executive pay, directors’ duties and boardroom composition, including worker representation and gender balance in executive positions.

The Committee’s terms of reference include:

• whether company law is sufficiently clear on the role of directors and non-executive directors, and whether those duties are the right ones
• whether companies should have additional duties to promote greater transparency eg around the role of advisers
• whether there is an effective voice and challenge to boardroom decisions
• how executive pay should take account of companies’ long-term performance and whether it should reflect the value added by executives relative to more junior employees
• whether there is any evidence that executive pay is too high and how (if at all) the Government should seek to influence to control it
• what more should be done to increase the number of women in executive positions on boards, and
• whether there should be worker representation on boards and/or remuneration committees.

Submissions were requested by 26 October 2016.

UK Corporate Governance Code: on 16 February 2017, the Financial Reporting Council (FRC) announced that it will carry out a fundamental review of the UK Corporate Governance Code which is 25 years old this year. The review will take account of the FRC's work on corporate culture and succession planning, as well as the issues raised in the Government's Green Paper on corporate governance reform and the BEIS Select Committee inquiry on corporate governance referred to above. It will also consult on revisions to the Guidance on Board Effectiveness and on the Strategic Report.

The FRC will seek input from stakeholders for its review, including from its recently established Stakeholder Advisory Panel.

The FRC expect to consult on proposals later in 2017, taking into account the outcome of its review and the Government's response to its Green Paper. The FRC will consider the appropriate balance between the Code's principles, provisions and guidance but believe that the unitary board, strong shareholder rights, the role of stewardship and the 'comply or explain' approach should be preserved.

ICSA paper on corporate governance: on 16 February 2017, ICSA published a thought leadership paper on corporate governance in the UK. This is the first in a series of papers whose purpose is to encourage reflection; consider the issues dispassionately and then look at what really needs to be done to address them.

FRC Report on developments in corporate governance and stewardship: on 14 January 2017, the FRC published its annual report on developments in corporate governance and stewardship. This report has four purposes: to give an assessment of corporate governance and stewardship in the UK; to report on the quality of compliance with, and reporting against, the UK Corporate Governance Code and the Stewardship Code; to give the FRC's findings on the quality of engagement between companies and shareholders; and to indicate to the market where the FRC would like to see changes in corporate governance behaviour or reporting.

The report states that in 2017 the FRC will, in addition to its revisions to the UK Corporate Governance Code and associated guidance, monitor how companies adhere to the proposals on corporate culture set out in its report (see below) and how boards are discussing culture in the boardroom. The Culture Coalition ( a collaboration with CIMA, the City Values Forum, IBE, IIA and CIPD ) is also considering areas of future focus, including reporting on values, behaviours and the benefits of having a company purpose wider than profit; and the changing nature of leadership.

Corporate culture: on 20 July 2016, the FRC published its report on corporate culture and the role of boards (following its invitation to participate published in October 2015). The FRC’s key observations are:

• Recognise the value of culture: a healthy corporate culture is vital to the creation and protection of long-term value. The board’s role is to determine the company’s purpose and ensure that the company’s values, strategy and business model are aligned to it. Directors should not wait for a crisis before they focus on company culture.
• Be open and accountable: openness and accountability matter at every level and should be demonstrated in the way that the company conducts business and engages with and reports to stakeholders. This involves respecting a wide range of stakeholder interests.
• Embed and ingrate: the company’s values should inform the behaviours that are expected of all employees and suppliers. HR, internal audit, ethics, compliance and risk functions should be empowered and resourced to embed values and assess culture effectively. Their voice in the boardroom should be strengthened.
• Align values and incentives: the performance management and rewards system should support and encourage behaviours consistent with the company’s purpose, values, strategy and business model. The board is responsible for explaining this alignment clearly to shareholders, employees and other stakeholders.
• Assess, measure and engage: boards should devote sufficient resources evaluating culture and consider how they report on it. The indicators that are used should be aligned to desired outcomes and should be material to the business. The board has a responsibility to understand behaviour throughout the company and to challenge that behaviour where it finds misalignment with values or where better information is required.
• Exercise stewardship: effective stewardship should include engagement about culture and encourage better reporting. Investors should challenge themselves about the behaviours that they are encouraging in companies and should reflect on their own culture.

The report also contains a number of highlighted questions for boards to ask.

ICSA guidance on terms of reference for audit committees: on 31 March 2017, ICSA published a revised guidance note on the terms of reference for audit committees. This note has been revised primarily to reflect the updated editions of the UK Corporate Governance Code and FRC Guidance on Audit Committees published in April 2016.

PLSA Corporate Governance Policy and Voting Guidelines: on 18 January 2017, the Pensions and Lifetime Savings Association (PLSA) published a revised version of its Corporate Governance Policy and Voting Guidelines.

Executive remuneration

Executive Remuneration Working Group: The Executive Remuneration Working Group was established by the Investment Association as an independent panel to propose a radical simplification of executive pay as it was felt that pay structures were becoming too complex. The Working Group published its final report on 26 July 2016.

The Working Group’s core recommendation is that there needs to be increased flexibility for companies to choose the remuneration structure that is more appropriate for their business. There is concern that there is a single one-size-fits-all model for executive remuneration in the UK to the exclusion of other possible structures. The final report contains a framework of possible structures to illustrate what this flexibility might mean in practice. The framework is intended to be used to explore the practicalities of a more flexible system and help committees to consider the options that are right for their business.

The other recommendations include:

• requiring an explanation of why the maximum remuneration level is appropriate for the company
• transparency around setting bonus targets and retrospectively disclosing the performance range
• use of discretion to be clearly disclosed to investors
• the chairman and the whole board should be appropriately engaged in the remuneration setting process so that remuneration committee decisions are agreed by the board, and
• non-executive director to have at least one year’s experience on remuneration committee before being appointed as the chair.

Investment Association (IA) Principles of Remuneration: on 31 October 2016, the IA published updated Principles of Remuneration. These principles have been rewritten in line with the Executive Remuneration Working Group’s recommendations for simpler and more flexible remuneration structures. The main changes are:

• the Principles have been:
  • slimmed down to a set of high level issues and updated to reflect the recommendations of the Executive Remuneration Working Group
  • amended to acknowledge the need for increased flexibility of remuneration structures and updated so that they do not promote a single remuneration structure, and
  • updated to ensure that the level of remuneration has appropriate focus and that companies should disclose pay ratios between the CEO and median employee, and the CEO and the Executive team, to provide the context of the remuneration provided.
• the Guidance includes a new section of the importance of improving shareholder consultation, ensuring that it is based on the strategic elements of remuneration and leads to consultation rather than affirmation of the company’s position, and
• post retirement shareholding guidelines have also been encouraged.

IA letter to the Remuneration Committee Chairman of FTSE 350 companies: on 31 October 2016, the IA also published a letter highlighting the changes to its Principles of Remuneration and some issues that its members will be focusing on ahead of the 2017 AGM season. These include:

• levels of remuneration awarded to executive directors need to be adequately justified
• retrospective disclosure of bonus targets is required
• members expect companies to have a maximum limit on each aspect of variable remuneration when renewing their remuneration policy
• companies need to be clear when discretion has been exercised and fully outline the circumstances, reasons and outcomes of the use of discretion, and
• the difference between the pension contribution rates for executives and the general workforce needs to be clearly justified.

Hermes paper on its remuneration principles: on 15 November 2016, Hermes Investment Management published a paper setting out its expectations for how companies should apply the remuneration principles it published jointly with the National Association of Pension Funds (now the Pensions and Lifetime Savings Association) and others in 2013.

IA letter to FTSE chairs: on 20 May 2016, the IA wrote to chairs of FTSE companies informing them of its intention to “amber top” the re-election of non-executive directors of companies which make significant changes to profit expectations and write down the value of assets following the appointment of new management. In the IA’s view this practice which, within months of appointments being made, has in many cases impacted capital strength and led to a cut in the dividend, highlights insufficient oversight by independent directors and the audit committee. This policy comes into effect for AGMs after 01 August 2016.

Stakeholder engagement

ICSA/IA guidance on board engagement with stakeholders: on 13 January 2017, ICSA and the IA announced that they are going to propose joint guidance to assist boards in improving their engagement with, and understanding of the views of, their employees and other stakeholders. This will enable companies to act now instead of waiting for the Government or the FRC to complete any actions following the Government's consultation in the green paper. The guidance will include: how companies can identify non-executive directors with relevant stakeholder experience; the process by which boards can receive the views of key stakeholders; how directors' understanding of their duties and the interests of different stakeholders can be enhanced by training and induction; options on the way companies can report on how the directors have fulfilled their duties in this area. The guidance is expected in the second quarter of 2017.

Resolutions to disapply pre-emption rights: companies should comply with the Pre-emption Group template resolutions published by the Pre-emption Group as IA members have asked Institutional Voting Information Service (IVIS) to “amber top” any company not using the template resolutions for dis-applying pre-emption rights from 01 August 2016 and to “red top” them from 01 January 2017.

Institutional Shareholder Services (ISS) Voting Guidelines: on 08 November 2016, ISS published its UK 2017 proxy voting guidelines which apply to shareholder meetings held on or after 01 February 2017 other than the policy relating to the board composition of smaller companies which will apply from 2018 to give small companies time to comply.

UK Stewardship Code: on 14 November 2016, the FRC published its assessment of signatories reporting against the UK Stewardship Code, following its announcement (on 14 December 2015), that it would introduce public tiering of signatories to the Stewardship Code to improve reporting against the principles of the Code and assist investors.

Asset managers have been categorised in the following three tiers and other signatories in two tiers (tier 1 and tier 2):

• Tier 1: signatories provide a good quality and transparent description of their approach to stewardship and explanations of an alternative approach where necessary
• Tier 2: signatories meet many of the reporting expectations but report less transparently on their approach to stewardship or do not provide explanations where they depart from provisions of the Stewardship Code, and
• Tier 3: significant reporting improvements need to be made to ensure the approach is more transparent. Signatories have not engaged in the process of improving their statements which continue to be generic and provide no or poor explanations where they depart from the provisions of the Stewardship Code.

In the FRC's report on developments in corporate governance and stewardship in 2016 (referred to above) the FRC have said that mid-2017 it will remove from the signatory list any signatories that are still in Tier 3.

As part of the FRC's wider corporate governance work, it will consider how to encourage further improvements in reporting and possible revisions to the UK Stewardship Code in 2018.

EU proposal to amend the Shareholder Rights Directive: on 09 April 2014, the EU Commission published a proposal to amend the EU Shareholder Rights Directive. Proposals include giving shareholders a right to vote on the remuneration policy and remuneration report and specifying the information to be included in a remuneration report; a related party transactions regime; obligations on intermediaries to disclose shareholders; enhanced disclosure requirements for institutional investors and asset mangers’ investment policies and strategies and obligations on proxy advisors to ensure that their voting recommendations are accurate and reliable.

On 08 July 2015, the EU Parliament plenary session adopted amendments to the proposal. The EU Parliament did not adopt the proposal at first reading. Instead the text (as amended) was referred back to an EU Parliament Commission for further consideration. The Parliament, Council and Commission subsequently entered into informal trialogue discussions to try to reach an agreement so that the directive could be formally adopted at first reading by both the Parliament and Council. On 09 December 2016, the Council of the European Union announced that an agreement had been reached.

On 14 March 2017, the European Parliament resolved at first reading to adopt, with amendments, the Commission's proposal to amend the Shareholder Rights Directive. The directive must now be adopted by the Council. Member States will have two years from the date that the directive enters into force to implement it into national law.

Trust and transparency

Small Business, Enterprise and Employment Act 2015: The Small Business, Enterprise and Employment Act received Royal Assent on 26 March 2015. The corporate aspects of the Act have been implemented in stages. The main provision which has yet to be implemented is the prohibition on corporate directors which had been due to take effect in October 2016 but has been delayed.

Register of corporate beneficial ownership information: on 03 November 2016, the Department for Business, Energy and Industrial Strategy (BEIS) published a discussion paper addressing the requirement under the Fourth Money Laundering Directive for Member States to maintain a central register of corporate beneficial ownership information. Although the UK already has a central register of this kind (under the “persons with significant control” regime), the requirements of the Directive are different from UK legislation. As such, the discussion paper outlines possible ways for amending UK requirements to meet the UK’s obligations under the Directive. The deadline for responses was 16 December 2016. BEIS is expected to issue a written ministerial statement addressing a number of issues about these requirements The new provisions are expected to come into force by 26 June 2017.

Diversity on boards: UK measures

Hampton-Alexander review: on 07 July 2016, the UK Government announced the appointment of Sir Philip Hampton and Dame Helen Alexander to head a group to carry out an independent review on improving female representation at executive level in FTSE 350 companies and raising the target to 33% of women on boards by 2020 (as recommended in Lord Davies’ final report).

The Hampton-Alexander Review’s report was published on 09 November 2016 and makes various recommendations including that:

• FTSE 350 companies should aim for a minimum of 33% women’s representation on their boards by 2020
• FTSE 100 companies should aim for a minimum of 33% women’s representation across their executive committee and in the direct reports to that committee, and
• all stakeholders should work to ensure increasing numbers of women are appointed to the roles of chair, senior independent director and executive director positions on boards of FTSE 350 companies.

Parker review: the Parker Review interim report was published on 02 November 2016 and found that FTSE boards "do not reflect the ethnic diversity of the UK". The report makes various recommendations which can be divided broadly into three groups: increasing the ethnic diversity of UK boards; developing candidates for the pipeline and planning for succession; and enhancing transparency and disclosure. This report is the findings of the review so far and was to be the subject of consultation and debate with business leaders, regulators and lawmakers. Responses to the interim report were due by 28 February 2017.

McGregor-Smith review: on 28 February 2017, Baroness McGregor-Smith's review into issues faced by businesses in developing Black and Minority Ethnic (BME) talent in the workplace was published. The review makes a total of 26 recommendations. Those most of interest to employers include that:

• All employers with more than 50 employees should set aspirational targets to increase diversity and inclusion throughout their organisations. Notably, the review also suggests that in setting those targets organisations should consider the make-up of the area in which they operate. This means that organisations, for example, in London, would need to consider these targets against a backdrop of over 40% of the working population in London being from a BME background.
• All employers with more than 50 employees should publish a breakdown of employees by race and pay band. The review goes further and suggests that the Government should legislate to make this a mandatory requirement.
• All employers with more than 50 employees should identify a board-level sponsor for all diversity issues, including race.

Organisations within the financial services sector will recognise that many of the above are similar to the recommendations that came from the Gadhia review (Empowering Productivity). The most significant difference is that there is no recommendation that executive bonuses should be tied to achieving an organisation's internal targets on equality, which would one of the most controversial aspects of the Gadhia review.

Disclosure of board’s diversity policy: For financial years beginning on or after 01 January 2017 certain listed company's corporate governance statement must include a description of:

• the diversity policy for the board, including age, gender, educational and professional backgrounds
• the objectives of the policy
• how the policy has been implemented, and
• the results in the relevant reporting period.

If a company does not have a diversity policy, then it must explain why that is the case (DTR7.2.8R).

The rule does not apply to a listed company which qualifies as a small or medium company under the Companies Act 2006 or to certain non-UK companies.

Women on boards: EU measures

Draft directive on gender equality: On 14 November 2012, the EU Commission published a draft proposal for a directive to increase gender equality on the boards of listed companies in the EU (Directive on improving the gender balance among non-executive directors of companies listed on stock exchanges and related matters). The EU Commission decided not to introduce quotas for the number of women that need to be on boards, instead it will set a minimum objective that 40% of non-executive directors should be women.

On 20 November 2013, the European Parliament passed a legislative resolution to adopt, with amendments, the EU Commission’s proposal. A progress report was published on 27 May 2014 and a factsheet was published in June 2014. On 07 December 2015, the Employment, Social Policy, Health and Consumer Affairs Council failed to adopt the directive. Both the European Parliament and the EU Council have yet to adopt the final text of the directive. The Council has to adopt its first reading position taking the Parliament’s first reading position (which was adopted on 20 November 2013) into consideration.

On 14 March 2017, the EU Parliament issued a press release noting that the EU is only halfway towards achieving gender equality and MEPs urged the Commission and EU Member States to adopt this directive.

Latest statistics: in July 2016, the European Commission published statistics which show that the percentage of women on the boards of the largest publicly listed companies in the EU had risen to 23.3% (April 2016) up from 22.7% in October 2015.

Potential impact

See the following articles on elexica:

Government Green Paper published: the pace of corporate governance reform accelerates
Race in the Workplace: The McGregor-Smith Review published
Representation of women - focus on the pipeline
One by one, the case for ethnic diversity in the Boardroom
Corporate aspects of the Small Business Enterprise and Employment Act 2015

Look out for

Consultation on corporate governance reforms: Government’s response to its consultation in the Green Paper
Committee inquiry on corporate governance: response to the BEIS inquiry
Parker review: further report
UK Corporate Governance Code: FRC consultation on its review of the Code and associated guidance
Gender diversity on boards: EU developments on its proposal for a directive to increase gender diversity on boards of EU listed companies
Proposal to amend EU Shareholder Rights Directive: adoption by the EU Council