Regulator consults on code

The Financial Reporting Council (FRC), the UK’s corporate reporting regulator, has launched a consultation on its proposals to reform the UK’s Combined Code on Corporate Governance in the wake of the current financial crisis.

While the FRC has not found evidence of serious failings in the governance of British business outside the banking sector, it believes that the proposed changes to the Code are “sensible improvements” that would benefit governance in all major businesses. The new Code – which will be renamed “The UK Corporate Governance Code” to avoid confusion among overseas investors – will also apply to foreign companies operating in the UK if they apply for premium-listed status only available to equity securities issued by trading companies, closed or open-ended investment equities.

The main proposals put forward by the FRC are;

• The annual re-election of the chairman or the whole board. The FRC also recommends that the board should set out for shareholders why they make those recommendations, in papers accompanying a resolution to elect a non-executive director
• New principles on the leadership of the chairman
• New principles on the role, skills and independence of non-executive directors and the level of time commitment to ensure the board is well balanced and challenging. The FRC wants the Code to mandate the board to appoint a non-executive director to act as a senior independent director, providing a sounding board for the chairman and to serving as an intermediary for the other directors when necessary
• Evaluation of the board to be externally facilitated at least every three years, while the chairman should hold regular development reviews with each director
• The FRC proposes that the board is “responsible for defining the company’s risk appetite and tolerance” and that the board “should maintain a sound system of risk management and internal control to safeguard shareholders’ investment and the company’s assets”. However, the regulator wants to add a new provision based on the Turnbull guidance, which states that the board “should satisfy itself that appropriate systems are in place to identify, evaluate and manage the significant risks faced by the company”
• An emphasis that performance-related pay should be aligned to the long-term interests of the company and its policy on risk.
  

In line with Sir David Walker’s report on the corporate governance of banks and financial institutions, the FRC has proposed a number of other changes to the code extending its remit, including:

• The FRC taking responsibility for a Stewardship Code for institutional investors, as recommended by Sir David Walker;
• Considering options for producing practical guidance on good practice engagement between companies and investors;
• Carrying out during 2010 a limited review of the Turnbull Guidance on Internal Control, on which there will be separate consultation, while
• The FRC has commissioned Institute of Chartered Secretaries and Administrators to work with others on its behalf to update the good practice guidance from the 2003 Higgs Report which addresses, for example, the roles of the chairman and non-executive directors.
  

In addition, the FRC may propose limited changes to its existing guidance to audit committees, depending on the outcome of work being undertaken by the FRC’s Auditing Practices Board on the provision of non-audit services and audit partner rotation.

Well received
The FRC’s proposals have been largely welcomed, though with some reservations.

Margaret Cassidy, director of corporate governance at PricewaterhouseCoopers, says the FRC “has introduced a welcome change to the focus of the code, away from the box-ticking approach driven by provisions to a more thoughtful one centred around enhanced principles.”

She adds that the proposals “cast a spotlight on the pivotal role of the chairman, whose leadership style can be expected to come under greater challenge from investors in future. In addition, greater clarity around the board’s responsibility for risk management should lead to a more rigorous application of the existing Turnbull guidance for directors on internal controls.”

Richard Wilson, audit partner and leader of the independent director programme at Ernst & Young, says he very much welcomes the introduction of a Stewardship Code, which he believes “should help to improve further the engagement of shareholders in influencing the governance of companies”.

Peter Montagnon, director of investment affairs at the Association of British Insurers, says the proposed amendments “highlight some important issues, including director accountability, board evaluation and risk management”. However, he adds that the institutional investor “has expressed reservation about the annual election of chairmen alone, because this can be too-blunt an instrument.”

Consultation on the draft revised Code ends on 5 March 2010. Subject to the outcome of consultation and the necessary changes to the London Stock Exchange Listing Rules, the FRC intends that the revised Code should apply to all listed companies with a premium listing for financial years beginning on or after 29 June 2010.

Useful links
Copies of the FRC’s report, the consultation document containing the draft revised code and other documents relating to the review are available at www.frc.org.uk/corporate/reviewCombined.cfm

Responses to the consultation on the draft revised code are requested by 5 March 2010 and should be sent to codereview@frc.org.uk