Box-tickers beware: FRC’s 2020 review of UK Governance Code reporting

The Financial Reporting Council (FRC) has published its annual review of reporting against the 2018 UK  Corporate Governance Code (Code). Overall the FRC is disappointed with the response to the new Code. If it were an end of term report for Corporate Britain, the FRC marks would be '4 out of 10' and the comment (in red) would be 'Could do better: try harder'.

What's our view?

Who recently said "The quality of governance is tested in a crisis. Maintaining integrity in board decision-making, the management of risk, and effective engagement with all stakeholders, are essential for maintaining the trust which attracts the investments on which our economy relies. Learning from the corporate decisions and actions taken during the pandemic will much better enable us to build a sustainable and resilient economy in the future".... "box-ticking compliance, at the expense of effective governance and reporting..... is a disservice to the interests of shareholders and wider stakeholders, and ultimately is not in the public interest; it undermines trust".

Was it the PRA or the FCA? Or, was it the FRC? Could it have been a joint statement by all three? Are the references to 'public interest' and 'trust' clues?

In fact, the author of that quote was Sir Jon Thompson, CEO of the FRC. But, it could equally have been Sam Woods from the PRA.

But, there is potentially a disconnect. On the one hand when it comes to collective accountability - through compliance with the Code - the FRC say that: "overall, we are disappointed with the response to the new Code". On the other hand when it comes to individual accountability, the PRA say in their recent 'Evaluation of the Senior Managers and Certification Regime' that the SMCR with its focus on individual accountability has had "a broadly positive start" (see PRA Report: Evaluation of the SMCR). Leaving aside that Code compliance goes broader than financial services firms, the tone is strikingly different. The FRC use multiple references to 'surprising' and 'disappointed'. 

In the case of the FRC their disappointment reflects a strongly held determination to move Corporate Britain (at least the listed portion adopting the Code) onto a model of governance founded on purpose, the alignment of that purpose with culture, values and strategy, effective, two-way engagement with stakeholders, and companies making a wider contribution to society. The same determination is reflected in the FRC's approach to s172 'directors' duties' statements: (see Section 172 statement -- further guidance on how to prepare it). Sir Win Bischoff, when introducing the FRC's report on Corporate Culture as long ago as 2016 said: "There needs to be a concerted effort to improve trust in the motivations and integrity of business". Sir Jon's alignment of trust with the 'public interest' and references to 'integrity' are the language we can expect to hear much more from the FRC as it readies itself to become the Auditing, Reporting and Governance Authority, or ARGA.

What is the overview?

Sir Jon says in his Forward to the report:

"I am very proud of the UK's international reputation for good corporate governance. This must not lead to complacency; the events of this year have reminded us of that. The quality of governance is tested in a crisis. Maintaining integrity in board decision-making, the management of risk, and effective engagement with all stakeholders, are essential for maintaining the trust which attracts the investments on which our economy relies. Learning from the corporate decisions and actions taken during the pandemic will much better enable us to build a sustainable and resilient economy in the future."

The FRC:

• saw some examples of excellence in reporting;

• recommend better quality engagement with shareholders and wider stakeholders, making sure that dialogue is effective so as to build a better understanding of different company approaches and trust;

• say overall -- reporting does not demonstrate the high quality of governance that the FRC expects;

• comment that too often the objective of reporting appears to be to claim strict compliance with the Code concentrating on achieving box-ticking compliance, at the expense of effective governance and reporting. This approach, it says, is a disservice to the interests of shareholders and wider stakeholders, and ultimately is not in the public interest as it undermines trust;

• criticises much of what it has analysed as formulaic, saying that worryingly, while some companies have sought to claim full compliance, it found that this was not the case;

• overall, are disappointed with the response to the new Code; and

• where appropriate will call out poor behaviour.

What are the FCA' expectations?

This is the first year in which all UK premium listed companies reported on their application of the Code.

The FRC:

• has stated that: "effectively applying the Principles is much more important than a 'tick box' approach";

• are looking for a high standard of reporting which demonstrated that boards had considered matters beyond process and reassessed issues such as company purpose, culture, and strategy, in order to set them at the heart of governance.

What were the FRC's findings based on?

The FRC's research assessed a sample of up to 100 companies (including both FTSE100 and 250 companies, as well as Small Cap companies), considered third party reports on governance, drew on statistics from external sources and referred to the FRC commissioned reports on diversity, remuneration policies and workforce engagement.

What did the FRC find?

The FRC found:

• examples of good reporting; but

• too many companies with the objective to claim full compliance with the Code, with 'tick-box' practices;

• too often companies who are not compliant with the Code do not declare non-compliance but offer vague explanations, and continue this pattern year on year;

• in many cases corporate governance reporting was not coherent and cohesive; and

• a thoughtful approach to corporate governance was unfortunately lacking from too many of the reports that it assessed.

This, according to the FRC, is in line with the findings of the FCA in their report on Corporate Governance Disclosures by Listed Issuers where they set out how corporate governance disclosures could be improved, especially when disclosing how the Principles have been applied.

What does the FRC regard as a far better approach?

A far better aim is to set out the approach to the company's application of the Code's Principles, explain why this approach is right for its individual circumstances and, if necessary, what actions it has taken to mitigate the impact of not following the Code.

What examples does the FRC give about its preferred approach?

Diversity and Inclusion/ LGBTQ+

For example, many companies stated the importance of diversity and diverse boards but offered little explanation in the way of evidence to support their assertions, including: a lack of targets to improve diversity at the board and executive committee levels; little or no discussion of succession planning; and minimal reporting on how board evaluations are leading to the development of diverse talent pools. Many companies discussed diversity and inclusion committees or LGBTQ+ networks but did not describe the impact of such groups on the company's long-term success.

Purpose and culture

The FRC reported in 2020 that more work was required on purpose and culture. They were pleased to see that reporting on both of these issues improved, but many companies continue to set out a purpose that is more of a marketing slogan. Many companies still appear to be considering how to define purpose and embed culture throughout the organisation. Work is required in terms of monitoring culture, with only a minority of companies setting out in detail how they plan to assess their culture beyond the use of surveys and site visits.

Stakeholder engagement

Companies were better at commenting on stakeholder engagement, but the FRC are concerned about the reliance on process and the lack of reporting on feedback received and outcomes. In many cases, it was not clear how issues were raised to board level, and how any discussions of such matters affected decision-making.

Remuneration

This lack of evidence of any feedback also manifested itself in relation to remuneration policies. The FRC were pleased to see that most companies had embraced Code changes into their new remuneration policies and many companies stated that they had considered wider (workforce) remuneration when setting executive remuneration polices. That said, the FRC were concerned to see that there was almost no discussion of how the new policies had been debated with and explained to shareholders and wider stakeholders.

COVID-19

As the impact of the COVID-19 pandemic was not captured in most of the reports that they assessed, the FRC have not commented in any detail on this significant issue in their report. Next year they will evaluate how well companies responded.

What are the FRC's expectations for the future application of the Code and reporting?

Their expectations are:

• Corporate reporting is an effective tool to communicate the company's corporate governance standards, policies and practices. It should be underpinned by the principles of transparency, clarity and integrity, and give a true overview of the company's business model and operations, structure, activities and performance.

• Companies reporting against the Code are expected to move away from boilerplate statements towards a more meaningful narrative in support of their application of the Code's Principles and to report non-compliance with Provisions. Use of examples is strongly encouraged, to demonstrate application of any non-compliance with the Code. Recognising that no one size fits all, the Code should serve as a guide to good governance practice, which companies ought to use to tell their unique story.

• To help navigation through the Annual Report and Accounts and ensure cohesion with the corporate governance statement, companies should be using signposting, linking different elements of the report, with clear reference to the Code. The report needs to be informative and understandable for all company stakeholders.

• The Code puts greater emphasis on companies' relationships with their stakeholders, in line with s.172 of Companies Act 2006 and strategic reporting requirements. The FRC expects companies to report on their engagement efforts with their stakeholders, which should be conducted in an open manner. Reporting should also include a discussion on how any received feedback has informed company decisions and strategy.

• Quality corporate reporting maintains the confidence of company stakeholders by demonstrating the resilience of the company business model, or flags the need for the model to adapt. By providing evidence and examples about statements and commitments in their reporting, companies can be more accountable and thus gain the trust of their stakeholder.

How does the FRC expect improved reporting against the Code next year?

As a result of this year’s review, the report states that the FRC expect improved reporting in the following ways:

• Companies to have a well-defined purpose and to clearly show the progress achieving it.
• Discussion of the issues raised, topics considered, and feedback received during engagement with shareholders and employees.
• Clearly show the impact of engagement with stakeholders, including shareholders on decision-making, strategy and long-term success.
• Increased focus on assessing and monitoring culture, including consideration of methods and metrics used.
• Increased attention and better reporting of succession planning, diversity and board evaluation.
• Clearly show the impact of engagement with shareholders on renumeration policy and outcomes.
• Clearly show the impact of the engagement within the workforce in relation to executive renumeration policy.