Comment

The FRC's approach in this consultation paper is a helpful one, seeking to avoid duplication and dovetail with the other reforms being implemented across company law and the Listing Rules. Some of the changes also seem to target areas where the FRC has consistently identified room for improvement in annual reports it reviews annually, such as a focus on outcomes, or where investors have expressed concern, such as regarding "overboarding". The majority of changes are linked to the Government's white paper and are proposed to be made to Section 4 (Audit, Risk and Internal Control) and the approach here seems to be practical and sensible, as is the timeframe, with companies having a good period to digest and adapt to the changes before the first reporting will be due for years starting on or after 1 January 2025.

In depth

Proposed changes

The key changes being proposed can be summarised as follows.

Section 1 - Board leadership and company purpose:

• The FRC proposes to introduce a new Principle setting out an expectation that companies should, when reporting on their governance activity, focus on activities and outcomes to demonstrate the impact of governance practices. This driven by the FRC's experience in reviewing reports - their clear view is that reporting has been lacking in this respect.
• Minor amendments have been made to the provisions in Section 1 to try to increase the focus on environmental and social matters, including in relation to climate ambitions and transition planning.

Section 2 - Division of responsibilities:

• The FRC is keen to address the concern that has increasingly been expressed by investors in relation to potential "overboarding", where investors perceive that directors can take on too many board positions, making it difficult for them to devote sufficient time to each one. The proposals in response to this are split between sections 2 and 3 of the Code.
• In Section 2, the FRC proposes expanding Provision 15 to require that annual reports include more information on director appointments, including how each director has sufficient time to undertake their role effectively in light of commitments to other organisations. 

Section 3 - Composition, succession and evaluation:

• In Section 3, Principle L (which will become Principle K) on board evaluations is proposed to be expanded by adding a requirement that the annual performance review consider each director's commitments to other organisations, and their ability to discharge their responsibilities effectively.
• The FRC also aims to facilitate a more joined-up approach to diversity and inclusion across the Code and other voluntary and mandatory regimes (including the requirement in the Listing Rules for "comply or explain" reporting against targets for women and ethnic minority representation on boards). Under the proposed changes to the Code:
  • Principle J (which will become Principle I) will include a new reference to "inclusion" and give equal weight to all protected and non-protected characteristics, to encourage companies to consider diversity beyond gender and ethnicity.
  • A statement will be added that diversity and inclusion initiatives, along with any targets set, should contribute to the succession plan.
  • The description in the annual report of the work of the nominations committee should include an explanation of how the committee has overseen the development of a diverse pipeline for succession and comment on the effectiveness of the diversity and inclusion policy, including progress towards company objectives and adherence to established initiatives.

Section 4 - Audit, risk and internal control: 

• Section 4 is where the majority of the changes to the Code are proposed to be made, including in particular to align with the Government's proposals in the white paper on restoring trust in audit and corporate governance.
• The Government is intending to introduce a requirement for certain companies to have an Audit and Assurance Policy. The FRC proposes that this requirement should extend to all companies that report against the Code and that the audit committee should have responsibility for developing, implementing and maintaining the policy.
• To avoid duplication, the FRC proposes to delete language in the provisions that overlaps with the new Minimum Standard for Audit Committees and have the Code instead refer to that Standard. Meanwhile, a new requirement is proposed for audit committees to engage with shareholders and other stakeholders on the role of the audit committee, the scope of work of the external auditor, and the approach to the audit and assurance policy.
• The proposals give the audit committee a new responsibility for monitoring the integrity of narrative reporting, including sustainability reporting. Where a company commissions assurance of environmental, social and governance metrics and other sustainability matters, this should be reported on in the annual report.
• To strengthen the provisions on risk and internal controls, boards will be required to provide in the annual report:
  • A declaration of whether the board can reasonably conclude that the company's risk management and internal control systems have been effective throughout the reporting period and up to the date of the annual report.
  • An explanation of the basis for its declaration, including how it has monitored and reviewed the effectiveness of these systems.
  • A description of any material weaknesses or failures identified and the remedial action being taken, and over what timeframe.
• The FRC will publish an updated version of its Guidance on Risk Management, Internal Control and related Financial and Business Reporting later in 2023, with the consultation paper setting out a number of the matters to be covered within that document.
• Noting the Government's plan to introduce a Resilience Statement for Public Interest Entities (PIE's), Provision 31 (which will become Provision 32 under the proposed changes), dealing with the viability statement, is proposed to be revised to avoid duplication with the Resilience Statement whilst also addressing the point for companies that report against the Code but fall outside the PIE definition. The provision will become more general, asking the board to explain in the annual report how it has assessed the future prospects of the company, but less prescriptive. Companies that have published a compliant Resilience Statement would then comply with the provision.

Section 5 - Remuneration:

• The FRC proposes to revamp the Principles in Section 5 to strengthen the link between remuneration and ESG objectives and to add a reference to workforce pay and conditions as a factor for the remuneration committee to consider when exercising discretion.
• There is a new provision proposed setting out information on malus and clawback to be covered in the remuneration report, including: 
  • The minimum circumstances in which malus and clawback provisions could be used.
  • A description of the minimum period for malus and clawback and why the selected period is best suited to the organisation.
  • Whether the provisions have been used in the last reporting period (and if so, a clear explanation of the reason).
• It is proposed that the references to pay ratios and pay gaps be removed from the Code, in the hope that this will avoid duplication of disclosure for the many companies who separately report already on gender and (in many cases) ethnicity pay ratios and pay gaps.

Appendices to consultation document

Helpfully, the consultation paper includes as appendices both clean and blacklined versions of the proposed revised Code, as well as a brief summary of the Government's proposals on new reporting requirements arising from its white paper on restoring Trust in Audit and Corporate Governance.