Corporate governance – Key legal developments – October 2023

This article provides an overview of key corporate governance updates since July 2023, including:

• 4 July 2023 – The Chartered Governance Institute UK & Ireland ("CGIUKI") published a new Code of Practice for listed companies conducting board performance reviews.

• 8 August 2023 – The Financial Reporting Council ("FRC") consults on revisions to Ethical Standards for Auditors.

• 13 September 2023– The FCR begins to receive responses regarding its consultation on the proposed revisions to the UK Corporate Governance Code ("UKCGC") such as the City of London Law Society ("CLLS") and the Law Society, who published their joint response.

• 5 October 2023 – The FRC published its Annual Review of Corporate Reporting and set out reporting expectations amidst ongoing economic uncertainty.

• 16 October 2023 – The Government withdrew the secondary legalisation element of UK Corporate Reform.

CGIUKI: Board Performance Reviews - revision of the Code of Practice (4 July 2023)

Board performance reviews are an important tool for businesses to ensure continual improvement in board decision-making and overall improvements in effective governance for UK listed companies. However, the CGIUKI carried out a survey which found that more than 50% of FTSE companies believe that the demands on their board's time has an adverse effect on their ability to dedicate time to focus on business strategy. On 4 July 2023 therefore, the CGIUKI issued an updated Code of Practice for both board reviewers and boards who undergo such reviews. The updated Code of Practice was published, together with updated guidance notes, "Code of Good Practice for listed companies using external board reviewers” and “Reporting on board performance reviews" in recognition that it is important both for the reviewers to be sufficiently qualified to carry out the review and for the board to implement the reviewer's recommended actions.

The Code of Practice outlines four principles, relating to (1) competence and capacity, (2) independence and integrity, (3) client engagement and (4) client disclosure. Further guidance was provided per principle to those who commission external board review services, as well as to investors and other stakeholders. The principles provide guidance on how boards should engage with its reviewer to achieve the maximum gain from the review and to provide assurance to its stakeholders. The guidance for listed companies also provided information on balancing the need for stakeholders to discover information through the company's board report and the board's wish to maintain confidentiality.   

The CGIUKI intends to publish similar principles and guidelines for other entities, including non-listed companies, later in 2023.

What does this mean?

The CGIUKI acknowledges the strain on the ability of boards to meet competing demands due to increasing everyday pressures and obligations to maintain compliance; however, it also recognises the need for companies to conduct assessments on the overall performance and development of its board as an essential step towards the promotion of business success.

Although the Code is not mandatory, adherence to it is likely to demonstrate assurance as to the quality and monetary value of external board performance reviews and shows a commitment to greater transparency, accuracy and consistency of individual external board reviewers. For smaller UK companies, it is still good practice to regularly review the quality of the company's board with the aim of increasing investor and public confidence.

FRC consults on revisions to Ethical Standard for Auditors (8 August 2023)

On 8 August 2023, the FRC issued a consultation on revisions to its Ethical Standard. The proposed changes illustrate the FRC's increasing focus on ensuring that the principles of integrity, objectivity and independence remain at the forefront of auditing.

The key objectives of the proposed revisions are:

• Enhancing prohibitions aimed at addressing potential threats to an auditor's independence, for example by prohibitions on reliance on fees from specific connected entities.

• Aligning with international standards – the proposed revision to reflect the latest 2019 developments in the Intentional Ethics Standard Board for Accountants (IESBA) Code to ensure the UK's Ethical Statement is no less rigorous than the international standard.

• Timely reporting of breaches – the proposed revision includes a requirement on companies/individuals to report specific breaches to the relevant authorities as soon as possible, rather than the current requirement which requires companies/individuals to report breaches on a bi-annual basis.

• Reflecting audit inspection and enforcement findings – the proposed revision reflects expected good practice.

The FRC has requested comments on its proposals by 31 October 2023.

What does this mean?

The consultation demonstrates a forward-thinking approach by the FRC to ensure that it addresses issues identified in previous audit inspections, enforcement and to promote the timely reporting of known breaches. The proposals will provide further measures to safeguard companies in managing their ethical standards; providing a higher level of scrutiny to enhance good faith and practice, integrity, objectivity, and independence in the performance on auditing duties.

Responses to the FRC’s consultation on proposed revisions to the UK Corporate Governance Code (13 September 2023)

Following the announcement on 24 May 2023, the FRC began to receive responses in relation to the proposed changes to the UKCGC . Of those responses, the CLLS and Law Society published a joint response on 21 September 2023, dated 13 September 2023.

Within its joint response the following key comments were made:

• "Comply or explain" dilution – proposed that the UKCGC should introduce the new requirements as mandatory 'principles' rather than optional 'provisions' (against which companies have the "comply or explain option") to ensure application.

• Duplication risks confusion –the proposed changes to the UKCGC have been  addressed in pre-existing legislation, for example best practice concerning 'Environmental and Social Governance' disclosure, and therefore the proposed changes to the UKCGC may become too onerous on companies and create uncertainty as to which provisions apply, therefore undermining effective compliance.

• Proportionality – given the wide scope to which the UKCGC applies (from large corporates to smaller companies with fewer resources), there was an emphasis on the importance of the requirements remaining proportionate and suggested that the FRC considers conducting impact assessments in relation to the proposed changes.

• The risks of specifics – expressed concern regarding the increased specification of the proposals and greater detail from companies, potentially resulting in the adoption of "formulaic boilerplate disclosure". For example, the FRC's proposal that all significant director appointments are listed in the annual report to include a description of how each director has enough time to effectively carry out their duties alongside commitments to other businesses, which is arguably variable information and would place an unduly burdensome task on directors where their time could be better spent elsewhere.

• Guidance – highlighted that some of the proposals would benefit from enhanced (yet consolidated) guidance to ensure that the relevant requirement is achieved rather than amendments to the UKCGC.

• Further guidance for all companies – given that there is a focus on the application of the UKCGC applying to large UK companies, it would be helpful if additional guidance was provided for smaller UK companies who are not within the FTSE350 and any non-UK companies listed in the UK.

What does this mean?

The responses are under consideration and the FRC has yet to provide a further statement addressing the responses made. However, it can be deduced that the proposals will retain its emphasis on the interests of shareholders (with a focus on the governance, ESG, diversity and further stakeholder interests).

The heightened focus of the FRC suggests that although regulatory trends have emerged in response to the "crisis of trust", it is important for companies (listed and non-listed) to ensure compliance not only from a regulatory perspective but from the need to ensure the maintenance and/or increase of their investment potentials.

It is anticipated by the FRC that proposed Code will come into effect on or after 1 January 2025.

FRC reporting expectations (5 October 2023)

On 5 October 2023, the FRC published its Annual Review of Corporate Reporting outlining its findings from its review of UK corporate reporting conducted from a period 12 months ending on 31 March 2023. The Annual Review urges companies to consider the impact on their corporate reporting of the high levels of inflation and increases in interest rates, alongside the growing uncertainty surrounding the current economic market. This is due to its concern about errors found in cash flow statements for companies and auditors. The Annual Review also identified the need for improvement in reporting on financial instruments and deferred tax assets.

Some of the findings included in the Annual Review were:

• Quality of Reporting: FRC found that TSE 350 companies maintained their quality of reporting and that reporting had improved in areas such those relating to alternative performance measures.
• Judgments and Estimates: Concerns related to judgements and estimates increase as a consequence of economic uncertainty.
• Climate Reporting: the FRC found that there was a wide breadth of maturity in the stages of companies reporting on climate related matter.

What does this mean?

Despite the impact of uncertainty surrounding the ongoing cost-of-living crisis, the FRC emphasises its expectation on accurate reporting and urges companies to focus on providing clear and transparent disclosures regarding the material risks and changes arising from the above uncertainties. Specific focus and care should be taken by companies to explain the realistic impact on their performance, estimates and prospects.

Withdrawal of the secondary legislation element of UK Corporate Reform (16 October 2023)

On 16 October 2023, the Government withdrew the secondary legislation element of UK Corporate Reform. This decision arose following a series of consultations with companies in which concerns were raised regarding the burden of additional reporting requirements.

The draft statutory instrument intended to introduce the following new reporting requirements for large UK companies – the proposed requirements were:

• an annual Resilience Statement – this statement would have set out how the company manages risk over the short, medium, and long term;
• a triennial Audit and Assurance Policy Statement – this statement would have detailed how the company proposes to assure non-financial reporting over a three year period; in addition to an annual update on the implementation of the policy;
• an annual statement about distributable profits and the company’s policy on distributions; and
• an annual statement on steps taken to prevent and detect material fraud.

Instead, the Government has announced that a new reform package will be devised to provide a more certain, "targeted, simpler and effective framework for both business and investors" in an effort to ensure the UK is one of the best placed to business in the world.

What does this mean?

The Government's publication of the draft statutory instrument on corporate reporting, to be considered alongside the proposed changes to the Corporate Governance Code in July 2023, will no longer be put into effect.

Therefore, the additional reporting requirements will not be implemented for UK companies (including public and private companies but excluding limited liability partnerships, charities, third sector organisation and public organisations if they are mot incorporated under the Companies Act 2006) that surpass the threshold of 750 employees or more and an annual turnover of £750 million or more for a financial year. These wider reporting requirements would have incurred additional time and costs for companies and therefore this news has been greatly welcomed by officers as a step towards proportionate corporate governance.

However, despite the Government withdrawal of the draft new reporting regulations, the proposed changes to the UK Corporate Governance Code are still under review by the FRC, with the final changes expected to be published by end of this year.