Articles

Corporate Governance – Key Legal Developments – January 2023

Picture of Hannah Sellick

By Hannah Sellick

19 Jan 2023 | 4 minute read

There have been several corporate governance updates affecting listed companies. Although not directly affecting private companies, organisations with an appetite to improve their corporate governance would be encouraged to follow the guidelines and recommendations.  

In summary, the updates in this quarter in the backdrop of economic uncertainty, appear to focus on director remuneration to ensure pay increases for executive directors are aligned to pay increases awarded to the general workforce. Clarification has been provided to confirm that pension schemes should not be used as a tool to "top-up" salaries. There is also a continued emphasis on diversity and inclusion and climate accountability. Robust and specific reporting is required to justify any non-compliance.

FCA review of diversity and inclusion in financial services

The Financial Conduct Authority ("FCA") published the results of its review of the approach to diversity and inclusion by 12 firms. It noted the following:

Strategies were too generic and lacked focus on how their diversity goals were to be achieved. A holistic approach should also be adopted, rather than focussing on senior roles.

Diversity should extend beyond gender and ethnicity. Firms should also utilise exit interviews to extract qualitative data that can be used by companies.

Although many firms said senior management would be responsible for results, there was no evidence of tangible consequences, measured against performance and rewards.

There was lack of awareness around psychological bias and failure to welcome different perspectives in the workplace.

FRC's review

  1. General Code compliance – disclosures in certain areas should be improved (particularly those Principles of the Code that require actions by the Board). The overall quality of explanations for non-compliance with the Code should also be more specific.
  2. Purposes and culture – instead of companies simply referencing their values, companies should actually explain, in a more meaningful fashion, the alignment between culture, purpose, values and its strategy. Greater importance should be placed on the impact of how initiatives will be remedied.
  3. Stakeholder engagement – the nature and method of engagement with shareholders and stakeholders should be expanded and feedback acted on.
  4. Modern slavery – disclosures should address the outcomes of engagement on modern slavery issues and the effectiveness of policies and procedures.
  5. Environment – following the Taskforce on Climate-related Financial Disclosure ("TCFD") requirements*,the FRC expects to see improvements of the level of compliance on Environmental Social and Governance ("ESG") reporting.
  6. Diversity – explanations of diversity policies with objectives and targets should linked to the overall company strategy. Reporting should extend further than gender and ethnicity-related disclosures.
  7. Audit and risk – companies should be more specific on their disclosures regarding how audit committees assess independence and effectiveness of external audit processes, e.g. the date and the length of the audit tenure should be reported on, and how such assessments are made.
  8. Remuneration – clear and transparent narratives are required to explain how remuneration is in line with the company's strategy, purpose and values. Annual reports should provide an explanation for each performance metric.

For further information on this, please refer to the November issue.

IA principles of remuneration for 2023

The Investment Association ("IA") wrote to the chairs of remuneration committees of FTSE 350 companies on 9 November 2022 confirming the key focus points for 2023[1]. Although there were no significant amendments to the IA's overall principles, the IA highlighted the following:

  1. Salary levels for executive directors – in the context of the cost of living crisis and high rates of inflation, companies should be sensitive to the hardships experienced by their stakeholders. Executive directors should therefore not receive pay increases at a rate higher than the wider workforce.
  2. ESG metrics – noting the increasing number of companies establishing ESG metrics into their variable remuneration structures, companies should explain how its performance against these metrics is measured and how it will be disclosed.
  3. Pensions – schemes should not be used as a mechanism to increase a director's overall remuneration package. Pensions should be aligned to the contribution given to the majority of the company's employees. Remuneration reports or policies that do not comply will be "red topped".
  4. Windfall gains on long-term incentives – the IA warned companies against benefitting from the collapse in share prices as a result of the coronavirus pandemic in 2020 to grant long-term incentives awarded over a larger number of shares than usual. Investors expect companies to take preventative measures to stop executives taking advantage of windfall gains. Remuneration committees should therefore explain whether they have adjusted vesting outcomes to remove windfall gains and, if not, why not.
  5. Non-executive director remuneration - the IA has acknowledged that, recently, the role of non-executive directors has become increasingly challenging and time consuming, thus increases in their remuneration that reflects this additional layer of complexity will be supported, provided it can be properly explained. 
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Glass Lewis Policy Guidelines and ISS Proxy Voting Guidelines

Glass Lewis and Institutional Shareholder Services (“ISS“), corporate governance and responsible investment solutions providers to the financial community, have published updates to their proxy voting policy guidelines in the UK.

Glass Lewis

On 17 November 2022, Glass Lewis’s updated guidelines included:

  1. “Overboarding” – a director will be considered to have an excessive commitment level if they serve in an executive office of any public company whilst also serving on any other one external public company board (this has reduced from the two offices previously allowed).
  2. Director accountability for climate-related issues – if companies have increased climate risk exposure and they have failed to provide sufficient disclosures in accordance with the TCFD, Glass Lewis may recommend voting against a responsible board member.
  3. Employee representatives (“ER“) – ERs will no longer be included in whether the board is considered independent.
  4. Cyber risk oversight – recommendations will be made against appropriate directors where cyber attacks have resulted in a material risk to shareholders and disclosure is insufficient.
  5. Pensions – should be aligned with the majority of the wider workforce.
  6. Combined incentive plans – generally, omnibus plans should have a minimum vesting period of three years, part of the award should be applied to deferred awards, and there should be some rationale provided for the plan.
  7. Specific authority to issue shares – considered on a case-by-case basis.

ISS - On 13 December, ISS's updated guidelines, which are generally effective for meetings held on or after 1 February 2023, noted the following for good market practice:

Directors’ annual salary increases are lower proportionately than the general pay increases across the broader workforce.

For companies in the Climate Action 100+ Focus Group, ISS has extended its disclosure requirements e.g., emission reduction targets should cover 95% of the company’s operational emissions.

At least one woman should be on the board.

At least one member of the board should be from a minority ethnic background.

Note where there have been four or fewer audit committee meetings for FTSE 350 companies, and three or fewer meetings for FTSE All-Share companies.

The policies in relation to issuing new shares with and without pre-emption rights have been updated in line with the Pre-Emption Group Principles.

ISS - On 13 December, ISS's updated guidelines, which are generally effective for meetings held on or after 1 February 2023, noted the following for good market practice:

Directors’ annual salary increases are lower proportionately than the general pay increases across the broader workforce.

For companies in the Climate Action 100+ Focus Group, ISS has extended its disclosure requirements e.g., emission reduction targets should cover 95% of the company’s operational emissions.

At least one woman should be on the board.

At least one member of the board should be from a minority ethnic background.

Note where there have been four or fewer audit committee meetings for FTSE 350 companies, and three or fewer meetings for FTSE All-Share companies.

The policies in relation to issuing new shares with and without pre-emption rights have been updated in line with the Pre-Emption Group Principles.

Key takeaways

Following these updates, Boards should consider:

  1. Reviewing the FCA's review to ensure the company is adopting a clear strategy towards diversity and inclusion, with specific measurable targets.
  2. Reviewing the FRC's annual review to improve the quality of disclosures made in annual reports. This is useful for companies where compliance with the Code is not mandatory, e.g., if they do not meet certain thresholds, but nevertheless wish to demonstrate to investors a drive towards transparency and governance best practice. 
  3. Seeking approval from members for their remuneration policy. Remuneration committees should clearly justify any increases in executive director salary, particularly where it is not in proportion to salary increases of the wider team, and be specific when disclosing.
  4. Generally being more specific when reporting and making disclosures.
  5. Improving diversity and inclusion policies by taking a holistic approach and being specific in how such targets will be achieved.

On the horizon…

Clamping down on "greenwashing"

Due to the increasing number of companies using "green" initiatives as an important part of their marketing campaigns, the FCA is seeking to impose new restrictions to eliminate misleading and unsubstantiated sustainability claims. The results of the FCA's consultation are expected to be published in the first half of 2023. Boards should therefore review any marketing material and ensure they can support any green credentials.

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