In some ways, corporate governance codes are completely baffling. Why demand of our companies a set of attitudes and behaviours when each organisation has its own unique culture?
This blog reminds us of the main trigger, explains the reason for the Financial Reporting Council’s (FRC) review of the UK Code and CRUF’s main responses to the consultation’s 26 questions, and provides more background in case of interest.
Carillion’s failure in January 2018 revealed significant gaps in corporate governance. Carillion’s board mismanaged just about everything, relying on its reputation to sustain a fantasy of resilience that fooled people all of the time – until it didn’t. The Government responded by commissioning three independent reviews beginning in August 2018, culminating in its policy plans on 31 May 2022.
The FRC Consultation – read here
The consultation on the UK Corporate Governance Code’s (the Code) main focus is on internal control, assurance, and resilience. The proposed changes want to make clear the board’s accountability for these, and that all forms of communication with stakeholders have to be both sound and useful. These should increase investor confidence.
The FRC also considers other factors arising since the original reviews began in August 2018. The related proposals include:
- A requirement for a resilience statement and an audit and assurance policy for Public Interest Entities (PIEs). The FRC also sets out what these mean for non-PIE companies to whom the Code applies.
- Improving transparency of malus and clawback provisions in relation to directors’ remuneration.
- Clarifying ‘comply-or-explain’.
- Enhancing the reporting on diversity and its success.
- What companies should be doing about Artificial Intelligence.
The CRUF response – read here
We are pleased to support many of the FRC’s proposals. We do have some concerns, fourteen in fact, that we spell out at the start of our response.
If the FRC said I could choose only one, it would be the FRC providing a definition for materiality. The FRC mentions ‘material’ twenty-seven times in various guises without explaining what it means. Unless we have an agreed definition, we have nothing of substance against which to measure company communications.
If I could choose up to four, I would add:
- Including a technology principle in the Code. With technology being fundamental to a company’s operations, its absence is worrying. The Government is keen that companies use the opportunities that Artificial Intelligence brings so long as there are ‘guardrails’ in place to minimise abuse. This will only work if IT governance is acknowledged as necessary.
- The overloading of the audit committee. Even though we agree with what needs to be done, too much is being asked of it than it can realistically take on.
- The removal of one of the important powers given to the Workforce in the current Principle D: “The workforce should be able to raise any matters of concern.” The proposed changes are fundamentally weaker and we want it reinstated as a principle.
Background that led to the FRC’s consultation
The reason we have corporate governance codes globally (they are all here Codes | ECGI) is a result of abuses that took place in the 1980s affecting UK companies because there was no boardroom responsibility and accountability.
They all codify the appropriate way of leading an organisation, demanding a standard of behaviour from the board (or its equivalent for other business structures across all aspects of the private, public and 3rd sectors).
The UK’s Corporate Governance Code has focused on strengthening financial oversight and reporting in response to the 1980 scandals. Things have evolved to provide more independent thinking amongst board members, better correlation between executive pay and company performance, and examining better the financial risks and controls, all of these being carried out by prescribed sub-committees of the board.
But the poor governance practices revealed by Carillion’s failure was too big for the government to ignore. Many of the public sector services provided via Carillion were disrupted, causing harm to many, often vulnerable, people as consumers of the services provided. The three reviews found weaknesses in the way audits were commissioned and conducted resulting in Audit and corporate governance reform – GOV.UK (www.gov.uk). The FRC and the audit firms both have a vital role to play and are being encouragingly nudged to improve the service they provide on behalf of shareholders and wider stakeholders.
However, the responsibility for honest corporate information falls to the company board, hence the main focus of the proposed reform being on internal control, assurance, and resilience: know what risks you face and how you manage them; and obtain independent assurance that the board’s view is a true view that will enable the company to continue to carry out its purpose. The proposed Code changes support these through:
- Improving ‘comply-or-explain’, taking account of recently published FRC research and reports.
- Making necessary revisions on board and audit committee responsibilities for sustainability and ESG reporting, and associated assurance in accordance with a company’s audit and assurance policy.
- Updating the Code to strengthen reporting on malus and clawback arrangements.
- Directors being held accountable for significant failures in their corporate reporting and audit-related duties.
- Large companies reporting more comprehensively on their resilience and on the level of independently assured reporting; this will provide more helpful information for the benefit of investors, suppliers, customers, workers and pensioners.
- Large private companies’ corporate reporting and audit will now be subject to the same scrutiny as that of listed companies.
- All of these providing a framework of prudent and effective controls for a stronger reporting basis, and evidencing their effectiveness. UK Audit & Corporate Governance Reform: Key Updates | Diligent Corporation and Restoring trust in audit and corporate governance: government response to consultation on strengthening the UK’s audit, corporate reporting and corporate governance systems (publishing.service.gov.uk)
Adjusting the Code, especially via ’comply or explain’, is weaker than the recommendations of the three original reviews but does go a fair way towards “restoring trust in audit and corporate governance”.
Sue Milton is a governance specialist, covering corporate and IT governance. Sue advises governments and organisations on how to increase corporate effectiveness and is currently involved in the UK Government’s governance, audit, and digital reforms, focusing on our reliance on information technology, on company directors taking a more proactive and granular approach to risk and control management, and on the need to integrate and demonstrate ESG (environment, social and governance needs) within the strategy and culture of the organisation.
Disclaimer: The views expressed in this blog are those of the author(s) and do not necessarily represent the views of all CRUF participants. To read more about the CRUF’s views on this and other topics, please visit the comment letters section of the CRUF website.