Archive for the ‘financial reporting council’ Tag

FRC Annual Report on Developments in Corporate Governance and Stewardship 2015

In the Introduction and Overall Assessment to its Annual Report ‘Developments in Corporate Governance and Stewardship 2015’ (https://www.frc.org.uk/Our-Work/Publications/Corporate-Governance/Developments-in-Corporate-Governance-and-Stewa-(1).pdf), the UK’s Financial Reporting Council (FRC) highlighted that 2015 was a year of consolidation for the UK Corporate Governance Code (the Code) which had some significant changes made in 2014. Companies’ explanations improved in quality and there was a high level of compliance with the Code ‘with 90 per cent of FTSE 350 companies reporting compliance with all, or all but one or two, of its provisions’. The FRC’s ongoing strategy for 2016/19 is to give time for recent changes to embed and not to consider further changes – other than those arising from the implementation of the EU Audit Regulation and Directive – to the Code until 2019.

The importance of culture is recognised as the Code makes it clear that there is a role for the board in ‘establishing the culture, values and ethics of the company’ and in setting ‘the tone from the top’. The FRC plans to publish findings of a study looking at the role of boards in shaping and embedding a desired culture in the summer of 2016.

In relation to the Stewardship Code, the FRC intends to make a public assessment of the reporting of signatories – again in the summer of 2016 – as it is of the view that ‘the reporting of too many signatories does not demonstrate that they are following through on their commitment [to the Stewardship Code]’.

The next section of the Annual Report on the Governance of Listed Companies details how the UK Corporate Governance Code has been implemented during 2015 and provides an assessment of the quality of reporting on corporate governance. There is an interesting summary of the top 10 areas of non-compliance and ‘Code provision B.1.2, which states that at least half the board (excluding the chairman) should be independent, remains the lowest rated in terms of compliance among FTSE 350 companies’. In 2015, 42 FTSE 350 companies did not comply with this provision although the FRC note that ‘as with last year just under half had returned to having more than 50 per cent of the board as independent non-executive directors at the time their annual report and accounts was published. On the whole non-compliance was usually as a result of retirements rather than a specific wish not to comply.’ As well as overall compliance rates, this section of the Annual Report covers the quality of explanations for non-compliance; Code changes in 2012 including audit tendering, audit committee reporting, boardroom diversity, the ‘fair, balanced and understandable’ aspects of the company’s annual report and accounts; and Code changes in 2014 relating to risk management and internal control, remuneration, and shareholder engagement.

The following section of the Annual Report covers Stewardship and Engagement. The FRC points out that the quality of signatory statements varies considerably and that they would like to see improved reporting by all signatories across the seven principles of the Stewardship Code. The FRC will be contacting signatories individually to outline where their statements need to improve and will tier signatories publicly: ‘Tier 1 signatories will be those that meet our reporting expectations and provide evidence of the implementation of their approach to stewardship. We will pay particular attention to information on conflicts of interest disclosures, evidence of engagement and the approach to resourcing and integration of stewardship. Tier 2 signatories will be those where improvements are needed.’ As mentioned earlier, they will announce the outcome in the summer of 2016. This section of the Annual Report also covers engagement in the 2015 AGM season; company and investor expectations and reporting; collective engagement; proxy advisors; and voting and ownership.

The penultimate section of the Annual Report covers Other Corporate Governance and Stewardship Developments including Audit Regulation and Directive; Lord Davies Report on diversity (highlighting that FTSE 100 companies now have over 26% of the directorships held by women, and that whilst in 2011 there were 152 all male boards in the FTSE 350, now there are only 15 companies left with all male boards, all within the FTSE 250); the European Commission’s recommendation on the quality of corporate governance reporting (the ‘comply or explain principle’); the review of the OECD’s Principles of Corporate Governance; the European Commission’s Shareholder Rights Directive; the European Securities and Markets Authority (ESMA) Call for Evidence; fiduciary duties; the ICGN Global Stewardship Code consultation; other Stewardship initiatives; and the Capital Markets Union.

The final section of the Annual Report summarises the Corporate Governance and Stewardship Work for 2016/17. As well as mentioning the main activities, the FRC points out that its work in the ‘areas of governance and stewardship overlaps with that of many others, and we continue to work closely with market participants, representative organisations, service providers, regulators and Government departments.’

The Annual Report therefore provides both an interesting position paper in terms of where we are now in UK corporate governance and also highlights areas which the FRC will be focussing on for improvement.

As the AGM season is upon us, it will be interesting to see how companies deal with corporate governance hot topics such as the perennial executive remuneration issues – now very much in the headlines at BP and WPP – and how investors respond in terms of their stewardship role.

Chris Mallin, April 2016

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Corporate governance by principle or rule

Recent developments in corporate governance policies and practices

Since the third edition of Tricker – Corporate Governance: Principles, Policies, and Practices published in February 2015, the subject has continued to evolve in regulation, policy, and practice. Some of the more significant developments include:

Corporate governance by principle or rule

In its drive to create a single capital market, the European Commission (EU) has continued its quest to harmonize corporate governance rules across member states. Inevitably, it has had to face the dilemma (3E, p477) of whether corporate governance practices should be based on principles, as in the UK’s ‘comply or explain’ approach, or determined by rules backed by law, as in Germany and many other EU states.

This is not a new problem: in 1972, the draft 5th directive, from what was then the European Economic Community would have required major companies in all member states to adopt the German two-tier board system of corporate governance, with employee directors on the supervisory board. It failed, not least because of British commitment to their unitary board system. The EU is now working on a shareholder rights directive that would apply across all member states. If enacted, it would have to be enshrined in the laws of each member state.

Around the world, if any trends can be seen, they are towards corporate governance by rules backed by legislation; for example in the Sarbanes-Oxley and the Dodds-Frank Acts in the United States. Nevertheless, the UK remains strongly committed to the principles not rules approach. In other words, companies should comply with the corporate governance code or explain why they have not done so. Britain is trying to extend this approach to the rest of Europe.

Sir Winfried Bischoff, chairman of the UK’s Financial Reporting Council (FRC), wrote (September 2015): ‘The UK Corporate Governance code recognizes the collective role of the board and makes specific mention of board members and their responsibilities – chief executives, chairmen, and non-executive and executive directors. This is the UK approach and one that Europe is now coming round to. In the last 20 years corporate governance codes have emerged across Europe as public perceptions of boardroom behaviour has widened and come under increasing scrutiny. These codes set out best practice principles for boards and generally operate on a ‘comply or explain’ basis, on the assumption that good corporate behaviour can be accomplished through transparency rather than through hard rules and unnecessary (bureaucratic) burdens.’

The FRC wrote formally to the EU on 26 June 2015 explaining that the FRC sets the framework in the UK of codes and standards for corporate reporting, accounting, auditing, and actuarial and investor communities, including the corporate governance and stewardship codes. It explained how the stock exchange listing rules for major listed companies required them to follow the codes, under the supervision of the Financial Conduct Authority. Details of the work of the FRC and their latest report is available at www.frc.org.uk/About-the-FRC.aspx

Bob Tricker, January 2016

UK reporting on ‘going concern’ taking risk into account

Recent developments in corporate governance policies and practices

Since the third edition of Tricker – Corporate Governance: Principles, Policies, and Practices published in February 2015, the subject has continued to evolve in regulation, policy, and practice. Some of the more significant developments include:

UK reporting on ‘going concern’ taking risk into account
Following the global financial crisis, the UK’s Sharman Report called for companies to give greater clarity to assurances that their company was a ‘going concern’, by identifying liquidity and solvency issues existing in potential long-term risks. In September 2014, the FRC updated the UK corporate governance code to take account of these recommendations, and issued guidance information. See www.frc.org.uk/getattachment/591a5e2a-35d7-4470-a46c-30c0d8ca2a14/Sharman-Inquiry-Final-Report.aspx and www.frc.org.uk/Our-Work/Codes-Standards/Corporate-governance.aspx

The code now calls for companies to monitor risk management and internal controls and, at least annually, to carry out a review of their effectiveness, and further to report on that review in the annual report. Since boards are unlikely to want to report on their exposure to risk, it is likely that external auditors will include such reviews in their audit programmes.

However, these changes applied only to companies coved by the code. In October 2015, the FRC issued a further consultation paper for all companies, including those not covered by the corporate governance code, on the assessment and reporting of the ‘going concern’ basis of accounting, taking solvency and liquidity risks into account (3E, p194 onwards).

Bob Tricker, January 2016

UK Stewardship Code – Compliance

As reported in an earlier blog post (5th July 2010), the Financial Reporting Council (FRC) issued the UK Stewardship Code in the summer of 2010 with the aim of enhancing ‘the quality of engagement between institutional investors and companies to help improve long-term returns to shareholders and the efficient exercise of governance responsibilities’.

The principles of the UK Stewardship Code are:

 Principle 1: Institutional investors should publicly disclose their policy on how they will discharge their stewardship responsibilities.

 Principle 2: Institutional investors should have a robust policy on managing conflicts of interest in relation to stewardship and this policy should be publicly disclosed.

 Principle 3: Institutional investors should monitor their investee companies.

 Principle 4: Institutional investors should establish clear guidelines on when and how they will escalate their activities as a method of protecting and enhancing shareholder value.

 Principle 5: Institutional investors should be willing to act collectively with other investors where appropriate.

 Principle 6: Institutional investors should have a clear policy on voting and disclosure of voting activity.

 Principle 7: Institutional investors should report periodically on their stewardship and voting activities.

 To what extent have asset managers, asset owners and service providers complied with the recommendations of the Stewardship Code?  Several reports have been produced which detail the level of compliance.

Level of compliance

The FairPensions (2010) survey analysed 29 of the largest asset managers and found that 24 of these had published a formal statement/response with respect to the Stewardship Code. An additional four (Insight, Invesco, Morgan Stanley and State Street) had posted short statements on their website referring to the Code. FairPensions reviewed the 24 compliance statements to assess the quality of disclosures made with respect to the Code.

They were disappointed as they felt that the investors’ statements often gave ‘tick-box’ responses to the Stewardship Code principles whereas it was an opportunity to “tell their story” as to how they monitor companies and incorporate stewardship activity into their wider investment process. http://www.fairpensions.org.uk/sites/default/files/uploaded_files/whatwedo/StewardshipintheSpotlightReport.pdf

The Investment Management Association (IMA) (2011) survey of adherence to the Stewardship Code analysed the questionnaire responses from 41 asset managers, seven asset owners and two service providers. The questionnaire was developed with the oversight of a Steering Group chaired by the FRC’s Chief Executive.  The IMA (2011) survey covered the period to 30 September 2010 and showed widespread adherence by 50 UK institutional investors to the best practice set out in the FRC’s Stewardship Code. The IMA reported:

“Over 90% of major institutional investors now vote all or the great majority of their shares in UK companies; nearly two thirds now publish their voting records.

At the time the survey was conducted, 43 out of 50 respondents had published a statement on adherence to the Code, and another six did so subsequently.

Over 1,300 people focusing on stewardship activities are employed by 43 of the respondents to the survey.”

http://www.investmentfunds.org.uk/research/stewardship-survey

The FRC (2011) published Developments in Corporate Governance 2011, The Impact and Implementation of the UK Corporate Governance and Stewardship Codes, FRC, London.

http://www.frc.org.uk/images/uploaded/documents/Developments%20in%20Corporate%20Governance%2020117.pdf

They reported that, as of December 2011 the Stewardship Code had attracted 234 signatories, including 175 asset managers, 48 asset owners and 12 service providers23. This level of take-up indicates that the concept of stewardship is being taken seriously.  Importantly there has been a wide base of support for the Stewardship Code including from both large and small institutional investors.

There seems to be rather mixed evidence as to whether institutional shareholders are engaging more with their investee companies since the Stewardship Code was introduced. However over time it is to be expected that overall there will be a higher level of engagement.

Reasons for non-compliance

Organisations not complying with the Stewardship Code tend to fall into two groups: (i) those not signing based on their specific investment strategy, and (ii) those who do not commit to codes in individual jurisdictions.

Future developments

The FRC proposes to make limited revisions to both the UK Corporate Governance Code and the Stewardship Code which, subject to consultation, will take effect from 1st October 2012. As far as the Stewardship Code is concerned, they FRC state that it is ‘not currently envisaged that new principles will be introduced but it may be helpful to clarify the language in certain places, for example on the different role of asset managers and asset owners.’

Areas where the FRC might consider strengthening the language include conflicts of interest, collective engagement, and the use of proxy voting agencies, and possibly a recommendation that investors disclose their policy on stock lending.

Finally a Stewardship Working Party has been formed consisting of Aviva Investors, BlackRock, Governance for Owners, Railpen Investments, Ram Trust and USS together with Tomorrow’s Company.  They will determine whether it is possible to devise a “scale of stewardship” which would enable institutions to differentiate themselves.

 Chris Mallin 8th March 2012

The UK Stewardship Code

The Financial Reporting Council (FRC) has issued the UK Stewardship Code which ‘aims to enhance the quality of engagement between institutional investors and companies to help improve long-term returns to shareholders and the efficient exercise of governance responsibilities’. 

The UK Corporate Governance Code has traditionally emphasised the value of a constructive dialogue between institutional shareholders and companies based on a ‘mutual understanding of objectives’.  Now, in the Stewardship Code, the FRC sets out the good practice on engagement with investee companies which it believes institutional shareholders should aspire to.

Kate Burgess and Miles Johnson in their article ‘FRC’s blueprint for investor engagement’ (FT, page 18, 2nd July 2010) describe the Stewardship Code as ‘the first of its type in the world and designed to sit side by side with the UK’s code on corporate governance recently reworked by the FRC’.

Background to the UK Stewardship Code 

The Institutional Shareholders’ Committee (ISC) is a forum which allows the UK’s institutional shareholding community to exchange views and, on occasion, coordinate their activities in support of the interests of UK investors. Its constituent members are: The Association of British Insurers (ABI), the Association of Investment Companies (AIC), the Investment Management Association (IMA) and the National Association of Pension Funds (NAPF) http://www.institutionalshareholderscommittee.org.uk/

In November 2009, the ISC issued the ‘Code on the Responsibilities of Institutional Investors’.  The ISC stated that ‘the Code aims to enhance the quality of the dialogue of institutional investors with companies to help improve long-term returns to shareholders, reduce the risk of catastrophic outcomes due to bad strategic decisions, and help with the efficient exercise of governance responsibilities’ and ‘the Code sets out best practice for institutional investors that choose to engage with the companies in which they invest. The Code does not constitute an obligation to micro-manage the affairs of investee companies or preclude a decision to sell a holding, where this is considered the most effective response to concerns’.

Further detail is available at: http://institutionalshareholderscommittee.org.uk/sitebuildercontent/sitebuilderfiles/ISCCode161109.pdf

UK Stewardship Code Principles

Following a consultation earlier this year, the FRC assumed responsibility for the oversight of the Stewardship Code. The ISC Code discussed above contained seven principles which now form the basis for the Stewardship Code and indeed the Principles were adopted with only minor amendments.  The minor amendments relate to Principle 3 about the monitoring of companies. In the Stewardship Code, institutional investors are encouraged to meet the chairman of investee companies, and other board members as appropriate, as part of the ongoing monitoring, and not only when they have concerns; attend, where appropriate and practicable, the general meetings of companies in which they have a major holding; and give careful consideration the any explanations given by investee companies for departures from the UK Corporate Governance Code, advising the company where they do not accept its stance.

The principles of the UK Stewardship Code are:

Principle 1: Institutional investors should publicly disclose their policy on how they will discharge their stewardship responsibilities.

Principle 2: Institutional investors should have a robust policy on managing conflicts of interest in relation to stewardship and this policy should be publicly disclosed. 

Principle 3: Institutional investors should monitor their investee companies.

Principle 4: Institutional investors should establish clear guidelines on when and how they will escalate their activities as a method of protecting and enhancing shareholder value.

Principle 5: Institutional investors should be willing to act collectively with other investors where appropriate.

Principle 6: Institutional investors should have a clear policy on voting and disclosure of voting activity.

Principle 7: Institutional investors should report periodically on their stewardship and voting activities.

Who the UK Stewardship Code applies to

The Stewardship Code is to be applied on a ‘comply or explain’ basis.  The UK Stewardship Code is ‘addressed in the first instance to firms who manage assets on behalf of institutional shareholders such as pension funds, insurance companies, investment trusts, and other collective vehicles’.  The FRC expects such firms to disclose on their websites how they have applied the Stewardship Code or to explain why it has not been complied with.

However it has been pointed out that it is not the responsibility of fund managers alone to monitor company performance ‘as pension fund trustees and other owners can also do so either directly or indirectly through the mandates given to fund managers’.  Therefore the FRC encourages all institutional investors to report whether, and how, they have complied with the Stewardship Code.

The FRC plans to list on its website all investors who have published a statement indicating the extent to which they have complied with the Stewardship Code.  This list will be made available from October 2010.

Monitoring and review of the application of the Stewardship Code will be in two phases.  As an interim measure, the Investment Management Association (IMA), will carry out its regular engagement survey which will also cover adherence to the Stewardship Code in 2010. The first full monitoring exercise will then take place in the second half of 2011.

 

Other issues

The FRC points out that there are a number of significant issues which were raised during the consultation phase which are not addressed in the UK Stewardship Code.  These include disclosure by institutional investors of their policies in relation to stock lending; arrangements for voting pooled funds; and the information to be disclosed in relation to voting records.  The FRC will undertake additional work in relation to these areas prior to the monitoring exercise in 2011.

A recent EU Green Paper ‘Corporate governance in financial institutions and remuneration policies’ (June 2010) may also have ramifications for the UK Stewardship Code as in section 5.5, the Green Paper mentions that the Commission intends to carry out a review centred around, inter alia, ‘institutional investors adherence to ‘stewardship codes’ of best practice’. http://ec.europa.eu/internal_market/company/docs/modern/com2010_284_en.pdf

Concluding comments

It is apposite to conclude with a comment from Bob Campion in his article ‘Managers on alert to comply or explain’ (FTfm Page 5, 5th July 2010) ‘The new code is a timely opportunity for pension trustees to finally get to grips with their role as institutional shareholders.  If they do, it will be up to fund managers to demonstrate their own expertise in this area or risk losing business’.

The UK Stewardship Code, together with a report on its implementation, can be found at:

http://www.frc.org.uk/images/uploaded/documents/UK%20Stewardship%20Code%20July%2020103.pdf

http://www.frc.org.uk/images/uploaded/documents/Implementation%20of%20Stewardship%20Code%20July%2020103.pdf

Chris Mallin 5th July 2010

UK Corporate Governance Code

The Financial Reporting Council (FRC) has issued an updated corporate governance code for UK companies. Formerly known as the Combined Code, the newly issued UK Corporate Governance Code is a response to the financial crisis which caused shock waves around the world.

The FRC traces the roots of the UK Corporate Governance Code to the Cadbury Committee Report (1992) http://www.ecgi.org/codes/documents/cadbury.pdf and its successor reports. They recognise that ‘The Code has been enduring, but it is not immutable. Its fitness for purpose in a permanently changing economic and social business environment requires its evaluation at appropriate intervals’.

The UK Corporate Governance Code (hereafter ‘the Code’) continues to have at its heart the ‘comply or explain’ approach which was introduced in the Cadbury Committee Report. Sir Adrian Cadbury in his seminal book ‘Corporate Governance and Chairmanship, A Personal View’(2002) stated ‘The most obvious consequences of the publication of the 1992 Code of Best Practice was that it put corporate governance on the board agenda. Boards were asked to state in their reports and accounts how far they complied with the Code and to identify and give reasons for areas of non-compliance’. The flexible approach provided by the ‘comply or explain’ approach is a great strength and has been adopted in many countries.

Code structure

The Code has five sections being Section A: Leadership; Section B: Effectiveness; Section C: Accountability; Section D: Remuneration, and Section E: Relations with Shareholders. There is also currently a Schedule in the Code (Schedule C) ‘Engagement Principles for Institutional Shareholders’. This schedule contains three principles: dialogue with companies; evaluation of governance disclosures; and shareholder voting. However it will cease to apply when the Stewardship Code for institutional investors which is being developed by the FRC comes into effect.

Main changes to the Code

The FRC identifies six main changes http://www.frc.org.uk/press/pub2282.html as follows:

(i)     ‘To improve risk management, the company‘s business model should be explained and the board should be responsible for determining the nature and extent of the significant risks it is willing to take.

(ii)    Performance-related pay should be aligned to the long-term interests of the company and its risk policy and systems.

(iii)   To increase accountability, all directors of FTSE 350 companies should be put forward for re-election every year.

(iv)   To promote proper debate in the boardroom, there are new principles on the leadership of the chairman, the responsibility of the non-executive directors to provide constructive challenge, and the time commitment expected of all directors.

(v)    To encourage boards to be well balanced and avoid “group think” there are new principles on the composition and selection of the board, including the need to appoint members on merit, against objective criteria, and with due regard for the benefits of diversity, including gender diversity.

(vi)   To help enhance the board’s performance and awareness of its strengths and weaknesses, the chairman should hold regular development reviews with each director and FTSE 350 companies should have externally facilitated board effectiveness reviews at least every three years.’

Contentious changes?

The changes that seem most likely to be contentious and attract most debate relate to the annual re-election of directors and the move to encourage boards to consider diversity, including gender, in board appointments.

 

Annual re-election of directors

According to Rachel Sanderson and Kate Burgess, in their article ‘Directors must be re-elected annually’ (FT, page 17, 28th May 2010), the annual re-election of directors in FTSE 350 companies is the most controversial aspect of the Code. They state ‘Critics, including the Institute of Directors, have said it will encourage short-termism and be disruptive. Those in favour have said it will make boards more accountable to shareholders’.

The widespread concern about the underperformance of some UK board directors prior to, and during, the recent financial crisis no doubt led to increased support for the idea of the annual re-election of directors.

Diversity

Another potentially contentious change is the fact that boards are now encouraged to consider the benefits of diversity, including gender, to try to ensure a well-balanced board and avoid ‘group think’. Similar provisions may be seen in the German Corporate Governance Code (2009) ‘The Supervisory Board appoints and dismisses the members of the Management Board. When appointing the Management Board, the Supervisory Board shall also respect diversity’ (5.1.2) and the Dutch Code of Corporate Governance (2008) ‘The supervisory board shall aim for a diverse composition in terms of such factors as gender and age (111.3).

The UK has not gone as far as Norway which has, since 2008, enforced a quota of 40% female directors on boards of all publicly listed companies. Similarly Spain introduced an equality law in 2007 requiring companies with 250+ employees to develop gender equality plans which clearly has implications for female appointments to the board.

Whilst it is fair to say that the number of females with experience at board level in large UK companies is relatively limited, non-executive directors can be drawn from a much wider pool including the public sector and voluntary organisations. Their experience can bring new insights to the board, maybe challenging long-accepted views and hence adding value.

Institutional shareholders

As mentioned above, the Code currently contains Schedule C ‘Engagement Principles for Institutional Shareholders’ but this will be withdrawn when the Stewardship Code becomes operational. The Stewardship Code is being developed separately by the FRC and will set out standards of good governance for institutional investors, the FRC hopes to publish it by the end of June 2010.

Andrew Hill in the FT Lombard column (FT, page 18, 28th May 2010) ‘New code sets the high-water mark for governance’ discussed the new Code. He points out that ‘Now it is up to shareholders, encouraged by their own forthcoming stewardship code, to rise to the challenge……the FRC has set a new high watermark for post-crisis governance standards. The test will be whether investors use it responsibly and maintain sensible pressure on boards, as recession turns to recovery and chief executives’ and directors’ risk aversion dissipates’.

Concluding comments

The FRC has produced a robust UK Corporate Governance Code, building on the earlier Codes and retaining the flexibility of the ‘comply or explain’ approach. Future success will be measured by companies following the substance, or spirit of the Code, and not just its form and by institutional shareholders and boards engaging more fully.

The new edition of the Code will apply to financial years beginning on or after 29 June 2010. The Code, and a report explaining the main changes, can be found at: http://www.frc.org.uk/corporate/ukcgcode.cfm

Chris Mallin 28th May 2010