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 are 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.

Corporate culture: on 20 July 2016, the Financial Reporting Council (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. The FRC stated in the report that it would be monitoring company and investor reporting culture over the next year and will review its Guidance on Board Effectiveness in 2017, taking into account any feedback received on the report.

Succession planning: on 23 May 2016, the FRC published its feedback statement to its discussion paper on UK board succession planning for companies which are subject to the UK Corporate Governance Code. The feedback statement includes suggestions for improvements in the six key areas covered: board strategy and culture; nomination committee; board evaluation; pipeline; diversity and constitutional investors. It stated that for the reporting season in which the statement was published, the FRC would review and analyse nomination committee disclosures (including board evaluation reported for the FTSE 350) and will comment on its findings in the 2016 Developments in Corporate Governance and Stewardship report. The FRC will consider providing nomination committee guidance as part of the revision of its Guidance on Board Effectiveness.

Executive remuneration

Executive Remuneration Working Group: the Executive Remuneration Working Group was established by the Investment Association (IA) 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
  • 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.

Investment Association 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.

Shareholder engagement

Pre-emption Group Guidelines: the Pre-emption Group has published template resolutions to be used for the disapplication of pre-emption rights resolutions which it expects companies to use for all meetings held after 01 August 2016

Revised share capital management guidelines: on 04 July 2016, the IA published a revised version of its share capital management guidelines. These guidelines state that 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 will be applied to shareholder meetings taking place 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.

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 provisions which have yet to be implemented are the prohibition on corporate directors which had been due to take effect in October 2016 but has been delayed and the payment practices and policies statement which is expected to apply to financial years beginning on or after 06 April 2017 - see "Narrative reporting - recent developments".

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.

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.

EHRC guidance: on 23 March 2016, the Equality and Human Rights Commission (EHRC) published guidance for companies which includes how to improve the diversity of company boards within the frameworks of the Equality Act 2010 and the UK Corporate Governance Code. On 23 July 2016, the EHRC published guidance on appointments to boards and equality law. 

Parker review: the Parker Review 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 will be the subject of consultation and debate with business leaders, regulators and lawmakers and a final report, incorporating the output of this consultation, is due to be published at the end of February 2017.

Disclosure of board’s diversity policy: an EU directive on disclosure of non-financial information includes a requirement for certain listed companies to include a description of the board’s diversity policy in its annual report. On 09 November 2016, the government published its response to its consultation which asked for views on the best approach to implement this directive. The requirement to include a board’s diversity policy in the annual report will be introduced through amendments to the Disclosure Guidance and Transparency Rules. The narrative reporting changes required by the directive will be introduced in new regulations - see “Narrative reporting - recent developments”.

On 04 November 2016, the FCA published its response to its consultation (CP16/17) with amendments to the Disclosure Guidance and Transparency Rules that require companies to include a diversity policy in their corporate governance statement unless they fall within certain exemptions. This applies to financial years beginning on or after 01 January 2017.

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 the same date, the UK Business Secretary announced that the Government welcomed the Commission's decision not to impose mandatory quotas for women and that the Government believes that the self-regulatory model, as set out in the Davies Review, is the best approach for the UK.

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.

Latest statistics: On 24 September 2014, the European Commission published statistics which showed that the percentage of women on the boards of the largest publicly listed companies in the EU had risen to 18.6% (April 2014) up from 17.8% in October 2013. On 20 January 2015, the European Commission published new statistics which showed that on average 20.2% of board members of the largest publicly listed companies in the EU were women.

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.

On 09 December 2016, the Council of the European Union announced that the Permanent Representative Committee of the Council (COREPER) had endorsed an agreement between the Slovak presidency of the Council and European Parliament representatives on amendments to the EU Shareholder Rights Directive. The agreement was formally approved by COREPER on 16 December 2016 and is expected to be adopted by the Council and European Parliament in 2017. Member States will then have two years to incorporate the provisions into domestic law. 

Potential impact

See the following articles on elexica:

Government Green Paper published: the pace of corporate governance reform accelerates

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: response to the Green Paper

Committee inquiry on corporate governance: response to the inquiry

Parker review: further report

Corporate culture and Succession planning: FRC review of its Guidance on Board Effectiveness.

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 and Parliament.