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FRC publishes updated UK Corporate Governance Code

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17 Sep 2014

The Financial Reporting Council (FRC) has today published an updated version of the UK Corporate Governance Code (the "Code"), along with two associated guidance documents and revisions to International Standards on Auditing (UK and Ireland) ("ISAs"). The revised Code and ISAs are applicable for periods commencing on or after 1 October 2014.

This update is the final part of the FRC’s two year review of the Code and response to the Sharman report. It follows earlier consultations on directors’ remuneration and risk management, internal control and the going concern basis of accounting. The key changes to the Code cover three principal areas:

  • Going concern, risk management and internal control;
  • Remuneration; and
  • Shareholder engagement.

The updates also include some changes to the Preface to the Code, highlighting the importance of diversity on the board and setting the correct 'tone from the top' regarding standards of behaviour. In particular the Preface notes that, in addition to gender and race:

Diversity is as much about differences of approach and experience, and it is very important to ensure effective engagement with key stakeholders in order to deliver the business strategy.

As well as the updated Code itself, the FRC has also published two guidance documents:

  • Guidance on Risk Management, Internal Control and Related Financial and Business Reporting, which revises, integrates and replaces the current documents Internal Control: Revised Guidance for Directors on the Combined Code and Going Concern and Liquidity Risk: Guidance for Directors of UK Companies (the "Guidance"); and
  • Guidance for Directors of Banks on Solvency and Liquidity Risk Management and the Going Concern Basis of Accounting, which addresses supplementary considerations for the banking sector and should be read in conjunction with the above.

Furthermore, revised versions of ISA 260 Communication with those charged with governance, ISA 570 Going concern and ISA 700 The independent auditor’s report on financial statements (all links to FRC website) have been published. These reflect consequential amendments to the responsibilities of auditors as a result of the changes to the Code, in particular the fact that the auditors will now have a responsibility to state in their report whether they have anything material to add or draw attention to in relation to the directors' assessment of principal risks, the going concern statement and the statement about the prospects of the entity. 

 

Going concern

As set out in the proposals in the consultation paper issued in April 2014, going forward boards will need to provide two statements as follows:

1)     In annual and half-yearly financial statements, the directors should state whether they considered it appropriate to adopt the going concern basis of accounting in preparing them, and identify any material uncertainties to the company’s ability to continue to do so over a period of at least twelve months from the date of approval of the financial statements (Code Provision C.1.3); and

2)     The directors should state whether, taking account of the company’s current position and principal risks, they have a reasonable expectation that the company will be able to continue in operation and meet its liabilities as they fall due over the period of their assessment, drawing attention to any qualifications or assumptions as necessary (Code Provision C.2.2). 

 

Risk management and internal control

There has continued to be broad support for the FRC’s proposals on principal risks and monitoring the risk management system and, as such, there are no amendments to the April 2014 proposals.  The Code has been amended to include a new provision C.2.1 requiring the directors to:

confirm in the annual report that they have carried out a robust assessment of the principal risks facing the company, including those that would threaten its business model, future performance, solvency or liquidity.

It also requires them to describe those risks and explain how they are being managed or mitigated.

As well as this, provision C.2.3 has been amended to refer to specifically refer to a responsibility for the board to monitor the company’s risk management and internal control systems.

Although concerns were raised during the consultation process about the recommendation in the draft Guidance that the board should explain actions that have been or are being taken to remedy any significant failings or weaknesses in risk management or internal controls, this has been retained in the final Guidance document as the FRC believes that it is of legitimate stewardship interest to shareholders. However supplementary guidance has been included to make it clear that the board

would not be expected to disclose information which, in its opinion, would be prejudicial to its interests. 

 

Remuneration

Section D of the Code now emphasises that the overall objective of the remuneration policy should be to deliver long-term benefit to the company. Principle D.1 now states that

Executive directors’ remuneration should be designed to promote the long-term success of the company. Performance-related elements should be transparent, stretching and rigorously applied.

This is supported by a requirement to avoid paying more than necessary and changes to Schedule A in relation to the design of performance-related remuneration schemes. The supporting principle also emphasises the need to be cautious about using comparisons with other companies and the danger of upward ratcheting with no corresponding improvement in performance.

Provision D.1.1 has been amended to include a specific reference to recovering or withholding performance-related payments, also know as 'clawback', including the circumstances in which this is considered appropriate.

The supporting principle in provision D.2 has also been amended to remove any potential ambiguity in relation to conflicts of interest when the remuneration consults the chief executive about the remuneration of other executive directors. 

 

Shareholder engagement

Section E of the Code now includes a new provision requiring companies to explain what action they intend to take in response to situations where a significant proportion of votes have been cast against a resolution at any general meeting. This is likely to be particularly relevant to resolutions on directors' remuneration.

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