Authors
Key takeaways
- The Financial Reporting Council (FRC) has published the 2024 edition of the UK Corporate Governance Code (Code). The Code applies to companies with a premium listing on the UK’s Official List, on a “comply or explain” basis.
- The new Code follows a consultation launched in May 2023 in which the FRC proposed to make significant changes to the Code. Many of the proposals were driven by the UK government’s own plans for major reforms to the UK’s audit and corporate governance regimes.
- However, following the government’s announcement that it was withdrawing its proposed legislation, the FRC announced in November 2023 that it intended to reduce significantly the scope of its changes to the Code. The 2024 Code reflects that decision.
- Key reforms that have survived the consultation process include new reporting obligations in relation to a company’s material controls (including a board declaration on their effectiveness). More disclosure is also expected on malus and clawback arrangements, with the Code now specifying these provisions should be built into contracts and other directors’ remuneration documents.
- The FRC has also published new Corporate Governance Code Guidance to the 2024 Code, which consolidates and updates its previous guidance on different aspects of the Code in one place.
- The 2024 Code will apply to financial years beginning on or after 1 January 2025, with the exception of the changes to risk management and internal control monitoring and reporting, which will apply to financial years beginning on or after 1 January 2026.
Key changes to the Code
The main changes to the Code (in comparison to the current, 2018 version) include the following.
Board leadership and company purpose
- A new Principle C requires governance reporting to focus on board decisions and their outcomes in the context of the company’s strategy and objectives, with the board required to provide a clear explanation when it reports on any departures from the Code’s Provisions. This reflects the FRC’s renewed emphasis on the “comply or explain” approach to Provisions in the Code, and on meaningful reporting on outcomes. There is a corresponding expectation in the Introduction to the new Code that investors and proxy advisers will consider explanations for departures from the Code thoughtfully, taking full account of a company’s circumstances.
- The board’s assessment and monitoring of culture should also extend to how the desired culture has been embedded in the group (Provision 2).
Composition, succession and evaluation
- While Principle J requires board appointments and succession plans for the board and senior management to promote diversity, inclusion and equal opportunity, the FRC has removed the list of diversity characteristics, to indicate that diversity policies can be wide ranging. In the annual report’s description of the nomination committee’s work, disclosures on the diversity and inclusion policy should also include any initiatives in this area (Provision 23).
- The chair should commission (rather than “consider having”) a regular externally facilitated board performance review (Provision 21). The change from “evaluation” to “performance review” is intended to indicate the need for a continual process of self-improvement for boards, rather than a backwards-looking assurance process.
Audit, risk and internal control
- The FRC has updated Provisions setting out the roles and responsibilities of the audit committee and related annual report disclosures to reflect and cross-refer to the obligations in the Audit Committees and the External Audit: Minimum Standard, and to remove duplicative language (Provisions 25 and 26). As indicated by the FRC in its consultation paper, although the Standard is intended to be mandatory for FTSE 350 companies (once the necessary legislation is in place), non-FTSE 350 companies will be able to continue to approach the Standard on a “comply or explain” basis.
- Amendments to Principle O underline the pervasive obligation on the board to maintain an effective risk management and internal control framework. Replacement Provision 29 states that the board should monitor the company’s risk management and internal control framework and, at least annually, carry out a review of its effectiveness. The monitoring and review should cover all material controls, including financial, operational, reporting and compliance controls. The board should provide in the annual report:
- A description of how the board has monitored and reviewed the effectiveness of the framework;
- A declaration of effectiveness of the material controls as at the balance sheet date; and
- A description of any material controls which have not operated effectively as at the balance sheet date, the action taken, or proposed, to improve them and any action taken to address previously reported issues.
The FRC has been keen to emphasise that the inclusion of a specific board declaration on the effectiveness of material controls, as requested by the government, does not result in a UK reporting and liability regime equivalent to that in the U.S. Sarbanes-Oxley Act. In particular, the FRC does not have the power to sanction directors, unless they are members of the professional accountancy or actuarial bodies (although this could change, if the government eventually goes ahead with some of its original proposals). The FRC’s Corporate Governance Code Guidance also confirms that, when making these statements, boards should not be held to a higher standard of care than generally applies to directors in the exercise of their duties, and the flexibility provided by the “comply or explain” regime can be used where a control system is less established or mature, or its effectiveness unproven. Additionally, the Code does not require companies to obtain specific external assurance on their frameworks or effectiveness statements (although auditors already have certain obligations under ISA (UK) 720). The FRC’s guidance suggests that external assurance may not be necessary where a company has an effective internal audit function that is appropriately resourced to provide assurance over the effectiveness of the framework. However, clearly, any such decision would need careful consideration by the board.
As noted above, the revised Provision 29 does not apply until financial years beginning on or after 1 January 2026, in order to give companies further time to prepare for the change in their reporting obligations.
Remuneration
- As requested by the government, the revised Code seeks greater transparency around malus and clawback arrangements that enable the company to recover or withhold directors’ pay and share awards where there has been wrongdoing by directors. Director contracts and other documents covering director remuneration should include malus and clawback provisions and set out the circumstances in which these would apply (Provision 37). The annual remuneration report should describe these provisions, including the circumstances for their use, the period they apply (and why this is best suited to the company) and any use of them in the last reporting period and the reason for this (Provision 38).
Although the changes to the Code are considerably less wide-ranging than the FRC’s original proposals, all companies will need to review their procedures, controls and reporting systems to ensure they are able to address the new requirements once they become effective. The FRC’s revised Corporate Governance Code Guidance, while non-mandatory and non-prescriptive, is designed to inform this process. Companies will also need to review their director contracts and other remuneration documents to ensure they contain appropriate malus and clawback provisions.
Further changes can still be expected, as the government has said that it remains committed to wider audit and corporate governance reform, including establishing the FRC’s replacement, the Audit, Reporting and Governance Authority. However, although the government’s stated intention is to deliver a “targeted, simpler and effective framework”, the substance of this remains uncertain at this stage.
Client Alert 2024-028
Authors