A new U.K. Corporate Governance Code will require directors to look beyond shareholders’ interests

business man sitting at his desk working on a tablet

The long-awaited consultation by the Financial Reporting Council (FRC) on revisions to the U.K. Corporate Governance Code was published in December 2017. The Code has been revised many times since it was first introduced in 1992, but these changes are among the most extensive made. The good news for those of us who have come to expect that regulation will only become longer and more complex, is that this proposed structure of the Code is in fact shorter and more concise than the current version.

The current Code consultation ends on February 28 and the proposed Code is due to take effect on January 1, 2019. Of particular interest, apart from the structural changes, are the FRC’s proposals relating to directors’ duties under section 172 of the Companies Act. (See my previous post on corporate governance reform as it affects U.K. listed companies.)

Proposed structural changes to the Code

Dealing with the structure first, it’s no exaggeration to say that the FRC has, in effect, recast the entire Code. The 17 new core principles, together with their 41 related provisions, are just 13 pages long. They are organized into four sections:

Section 1 – Leadership and purpose
Section 2 – Division of responsibilities
Section 3 – Composition, succession and evaluation
Section 4 – Audit, risk and internal control

Some of the most interesting changes are in the first three sections, which broadly correlate to Sections A (Leadership) and B (Effectiveness) in the existing Code. The current provisions relating to audit, risk and internal control seem to have remained largely unchanged.

The Section 172 duty: A toothless tiger?

Section 172 of the Companies Act 2006 imposes a duty on directors to promote the success of the company. In doing so, directors are required to consider:

  • The likely consequences of any decision in the long term
  • The interests of the company’s employees
  • The need to foster the company’s business relationships with suppliers, customers and others
  • The impact of the company’s operations on the community and the environment
  • The desirability of the company maintaining a reputation for high standards of business conduct
  • The need to act fairly as between members of the company

In mid-2017, I blogged about the House of Commons’ Business, Energy and Industrial Strategy Committee’s proposal that “… the FRC be given authority to initiate legal action for breach of Section 172 duties…” This section proved to be rather a toothless tiger in that no successful proceedings have been brought against directors for failure to comply with its principles. Whether this power will ultimately be granted to the FRC remains to be seen. However, Provision 4 states that:

“The board should explain in the annual report how it has engaged with the workforce and other stakeholders and how their interests and the matters set out in Section 172 of the Companies Act 2006 influenced the board’s decision-making.”

We should have a better idea as to what this means in practice after the GC100 Group (General Counsel to the top FTSE 100 companies) publish their guidance “on the practical interpretation of section 172,” which they have been asked to prepare as part of the U.K. Corporate Governance framework. In the meantime, companies should be prepared to articulate the ways in which they have applied these principles.

Other significant changes

Companies should also take note of the following significant changes being considered to the U.K. Corporate Governance Code:

  • Boards will be strongly encouraged to ensure they consider the importance of diversity – in gender, social and ethnic background – when making appointments, planning for board succession and managing the executive pipeline.
  • Where more than 20% of votes have been cast against a resolution, the company should explain the steps it intends to take to consult shareholders in order to understand the reasons behind the result.
  • The rules on the independence of non-executive directors and chairs will be strengthened, including the requirement that board members must meet the stated criteria for independence throughout their tenure rather than simply on appointment.

What the future holds

While these revisions to the Code are still in the form of proposals, it seems clear that the direction of travel is towards greater clarity and transparency about the ways in which company directors demonstrate that their decision making is not solely in the interests of shareholders, but instead pays due regard to broader community interests. Emphasis is also being placed on ensuring that the constitution of boards themselves is sufficiently robust and diverse to deliver these outcomes. Shareholders will be keeping a close eye on these proposals. They should welcome changes which lead to increased clarity and transparency in the decision making process but will wish to ensure that their interests are not compromised

About Francis Kean

Francis is an Executive Director in Willis Towers Watson's FINEX Global, where he specializes in insurance for Dir…
Categories: Directors & Officers, Executive Risk, Featured Post, Leadership and Talent | Tags: , , , ,

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