On 16 July 2018, the Financial Reporting Council (FRC) published the final, revised version of the UK Corporate Governance Code (UK CGC).[1] This will apply (on a “comply or explain” basis) to all companies with a premium listing in the UK for accounting periods beginning on or after 1 January 2019.

The new UK CGC is one of a range of corporate governance reforms currently being implemented in the UK in response to the UK Government’s wide-ranging Green Paper Consultation on UK corporate governance reform.[2] Its publication concludes a seven-month consultation by the FRC, following the publication of a draft revised UK CGC in December 2017.[3] The FRC received 275 responses to its consultation from a wide range of stakeholders and has made a number of changes to its original proposals to address the feedback received. We briefly explore the most significant of these changes below.

Workforce engagement

Consistent with the UK Government’s Green Paper Consultation, an area of focus for the new UK CGC is the board’s responsibility for considering the interests of a wider range of stakeholders (beyond shareholders), with a particular emphasis on the workforce.[4] The FRC originally proposed that companies should be required to adopt one of three options for engaging with their workforces:

  • appointing a director from the workforce;
  • establishing a formal workforce advisory panel; or
  • designating an existing non-executive director to represent the interests of the workforce.

The new UK CGC makes clear that while these are the primary workforce engagement mechanisms that the FRC expects to be used (individually or in combination) in most instances, companies can choose to put in place alternative arrangements for engaging with their workforces, provided that they explain what these are and why they are effective.

Independence of non-executive directors and chairs

Under the current UK CGC, at least half the board (excluding the chair) must comprise independent non-executive directors (INEDs), with their independence being determined annually by the board. The current UK CGC includes a non-exhaustive list of disqualifying criteria (e.g. where the director has been an employee of the company during the last five years or has been on the board for more than nine years) but the board still has discretion to conclude that a director is independent notwithstanding the existence of the disqualifying criteria where appropriate. The FRC originally proposed removing this element of board discretion but very few consultation respondents supported this approach. The new UK CGC therefore maintains the existing approach, although the FRC has said that where a board uses this discretion, it expects to see a more detailed explanation in the annual report of the reasons for the board’s conclusion. We expect this to be an area of focus for the FRC’s increased compliance monitoring activities (see below).

Currently, the chair is only required to be independent on appointment. The FRC originally proposed that the independence of the chair, like other non-executive directors, should be assessed on an on-going basis. The current board composition requirement that at least half the board (excluding the chair) must comprise INEDs was therefore proposed to be replaced with a requirement that INEDs (including the chair) must constitute the majority of the board. Again, most consultation respondents objected to this proposal, often on the basis that the chair’s position requires him or her to become closely involved with the company’s management, resulting in an on-going test of independence being neither necessary nor appropriate. The new UK CGC therefore maintains the current position that chair independence is only assessed on appointment as well as the current formulation of the board composition requirement.

The combination of the FRC’s original proposals on subjecting chairs to on-going independence assessment and removing board discretion around the determination of independence was expected to impose a de facto nine-year tenure limit on company chairs for the first time. At the time of the consultation launch, approximately one fifth of current FTSE 350 chairs were expected to fall afoul of this requirement. The new UK CGC retains this proposal and, indeed, puts it on an express footing. However, in response to concerns that it would take some time to replace offending chairs in an orderly fashion, the new UK CGC provides that the nine-year period can be extended for a limited time where required for effective succession planning and the development of a diverse board. This is particularly the case where the offending chair was an existing INED before appointment to the chair (in which case, his or her time as an INED will count towards the nine-year limit).

Exemptions for smaller listed companies

The FRC originally proposed the removal of all exemptions currently available for “smaller listed companies”, which are those that were below the FTSE 350 throughout the prior year. A number of respondents felt that the removal of these exemptions would make UK CGC compliance unduly onerous for smaller listed companies. In response, the FRC has decided to retain or modify some of the exemptions, while pushing ahead with the removal of others:

  • The exemption on overall board composition will be removed. Currently, a smaller listed company is exempt from the requirement that at least half the board (excluding the chair) should comprise INEDs and, instead, is only required to have at least two INEDs. Under the new UK CGCs a smaller listed company will become subject to the same requirement as FTSE 350 companies.
  • The exemption on annual re-election of directors will be removed. Currently, the directors of a smaller listed company are exempt from the requirement to stand for annual re-election and are only required to stand for election by shareholders at the first annual general meeting after their appointment and re-election thereafter at intervals of no more than three years. Under the new UK CGC, a smaller listed company will become subject to the same requirement as FTSE 350 companies.
  • The exemptions in relation to audit and remuneration committee composition will be retained in part. The audit and remuneration committees of a smaller listed company can still comprise two (rather than three) INEDs. However, while the chair of a smaller listed company can continue to be a member of (but not chair) the remuneration committee if he or she was independent on appointment, he or she is no longer permitted to be a member of the audit committee in any circumstances.
  • The exemption in relation to board evaluation will be retained in part. The new UK CGC requires all companies (including smaller listed companies) to undergo formal annual board evaluations and encourages such evaluations to be externally facilitated at regular intervals. However, smaller listed companies will continue to be exempt from the requirement (applicable to FTSE 350 companies) to undergo an externally facilitated board evaluation at least every three years.

Extended remit of the remuneration committee

Historically, remuneration committees have only been responsible for the remuneration of the executive directors, the chair and senior management. The FRC originally proposed widening the remuneration committee’s remit by requiring it to “oversee” remuneration across the company’s whole workforce. Many respondents felt that this would be impractical, particularly in the context of large companies with global workforces. The FRC has therefore decided to amend its proposal and the new UK CGC now only requires the remuneration committee to “review” wider workforce remuneration and take this into account when setting the policy for executive director remuneration with the intention of better aligning executive pay with pay conditions across the wider company. Consistent with this aim, the new UK CGC also provides that pension contribution rates for executive directors (which are often more generous than those for other employees) should be aligned with those available to the wider workforce.

Executive share awards

Following its Green Paper Consultation, the UK Government asked the FRC to consider extending the minimum vesting and post-vesting holding period for executive share awards from three to five years in order to encourage better alignment between executive remuneration and long-term shareholder interests. Most consultation respondents were supportive of this proposal. It has therefore been incorporated into the new UK CGC, although the FRC has made a number of clarifications to the language, including to confirm that the five-year period is the minimum total period for both vesting and post-vesting holding.

Role of investors

The new UK CGC reiterates that investors should: engage constructively and discuss with the company any departures from UK CGC principles and provisions; in their consideration of explanations, pay due regard to a company’s individual circumstances; and give companies sufficient time to respond to enquiries about corporate governance.

FRC monitoring of UK CGC compliance

Finally, the FRC has said that it intends to intensify its monitoring activities. Consistent with the new UK CGC’s focus on discouraging a tick box approach to compliance, this will include the FRC carrying out more detailed reviews of annual reports to ensure that companies that depart from the UK CGC include meaningful explanations of the reasons for such departure.

[1] The new UK CGC, along with the final version of the FRC’s associated Guidance on Board Effectiveness and the consultation response document, is available here.

[2] A number of these reforms are addressed in our previous posts available here and here.

[3] The draft UK CGC originally published by the FRC was addressed in detail in our previous post, which is available here.

[4] In response to requests for clarification on the definition of “workforce” for the purposes of the UK CGC, the FRC has included guidance in its new Guidance on Board Effectiveness. This makes clear that it is for each individual company to consider, decide and explain who they have included for these purposes and, in addition to employees with formal contracts of employment (permanent, fixed-term and zero-hours), companies should consider including individuals engaged under contracts of service, agency workers and remote workers, regardless of their geographical location.