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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

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