The Financial Reporting Council (FRC) has published a consultation paper on proposed changes to the UK Corporate Governance Code (the Code). The consultation closes on 13 September 2023, with changes to the Code expected to apply for reporting periods beginning on or after 1 January 2025.
The consultation focuses on areas highlighted by the Government in its response to its consultation on restoring trust in audit and corporate governance in May 2022 (see More PIEs in the ARGA) and the FRC’s position paper in response which focussed on areas within its remit. It is not a wholesale review of the Code (unlike the one which took place in 2018) and therefore the Code (with its approach of having principles which must be applied and provisions, to which a comply or explain approach is taken) will remain structurally the same. The FRC is currently working on updating the guidance which applies to the Code, including the Guidance on Audit Committee and Guidance on Board Effectiveness. The FRC has indicated where relevant in the consultation some of the key changes it intends to make to the guidance and has asked for input.
The main proposals relate to amendments to Section 4 (Audit, risk and internal control) of the current Code:
Risk management and internal controls – the proposals include a new principle requiring the board of a company to establish and maintain an effective risk management and internal control framework, together with a new provision requiring the board to provide a declaration in the company’s annual report regarding the effectiveness of the company’s risk management and internal controls throughout the last financial year. This declaration must also include a description of any material weaknesses in such controls. The consultation notes that, although revised guidance will discuss what constitutes a material weakness, it will be for the boards of individual companies to determine which weaknesses are material to their specific situation and similarly it will be up to companies to decide whether they need to obtain external assurance.
Audit and Assurance Policy (AAP) – the Government has confirmed that it will introduce a new statutory requirement for public interest entities (PIEs) to produce an AAP relating to internal and external audit assurance. Whilst the legislation is awaited, the FRC states that in its view all companies reporting against the Code should consider producing an AAP on a “comply or explain” basis, using the legislation as a guide as to what should be included.
Sustainability reporting – an addition to provision 26 requiring the audit committee to monitor the integrity of narrative reporting (including sustainability reporting).
Further proposals include amending Section 5 (Remuneration) of the Code to require disclosure of a company’s malus and clawback provisions (and whether they have been used during the last five years) in its annual report, together with strengthening the Principles and Provisions around diversity and inclusion in the current Section 3 (Composition, succession and evaluation).
In relation to diversity, the FRC is proposing to remove the reference to gender and social and ethnic backgrounds in new Principle I (formerly Principle J) and instead to insert a reference to appointments to the board promoting equal opportunity and diversity and inclusion of protected characteristics and non-protected characteristics including cognitive and personal strengths. The stated intention here is to encourage board diversity beyond gender and ethnicity. We note that the UK Financial Conduct Authority (FCA) only recently amended the Listing Rules to mandate gender and ethnicity reporting at board level and that its latest consultation paper on reforms to the UK listing regime (CP23/10) does not indicate any intention to amend the Listing Rules. As such, the FRC and FCA currently appear to be diverging somewhat in relation to diversity.
We are awaiting draft legislation reflecting the Government’s proposals, particularly in relation to establishment of the Audit, Reporting and Governance Authority (ARGA) (the replacement for the FRC) and the requirement for PIEs to produce a resilience statement.
Minimum standard for FTSE 350 Audit Committees
Following an earlier consultation in November 2022, the FRC has now published “Audit Committees and the External Audit: Minimum Standard”. The consultation was in response to the Government’s response statement in May 2022 (see above) and the earlier White Paper from 2021 which set out the Government’s intention to grant statutory powers to ARGA to mandate minimum standards to audit committees in relation to the appointment and oversight of external auditors.
The minimum standard will apply to audit committees of all FTSE 350 companies. It will take effect immediately and will operate on a voluntary comply or explain basis until such time as ARGA is created with the power to mandate compliance. It covers responsibilities such as requiring the company manages non-audit relationships with audit firms to ensure that it has a fair choice of suitable external auditors at the next tender, conducting the tender process and making recommendations to the board concerning the appointment of the external auditor and reviewing the effectiveness of the external audit process.
Non-financial reporting review: call for evidence
The Department for Business and Trade has issued a call for evidence as part of the review it is conducting, alongside the FRC, of the non-financial reporting requirements that UK companies need to comply with. The Government recognises that the demand for non-financial information has grown as more investors and stakeholders are looking beyond financial return to long term value creation when making investment decisions. The review is being conducted to ensure that the UK’s non-financial reporting framework remains fit for purpose and delivers the information that investors and stakeholders need to make decisions.
The review of non-financial reporting will consider:
the costs and benefits of current non-financial reporting requirements and what opportunities there may be to streamline those requirements;
the thresholds used to determine whether companies and LLPs must comply with certain requirements, including whether they are set at appropriate levels; and
the future of the UK’s non-financial reporting framework (including the potential integration of the sustainability reporting standards being developed by the International Sustainability Standards Board).
The call for evidence is the first phase of the non-financial reporting review and will close on 16 August 2023. The Government will use the information gathered to develop detailed proposals for public consultation next year.
