In June 2018, two draft documents were published which will impact on the corporate governance and reporting obligations of large companies going forward : the Wates Principles for large private companies and the Companies (Miscellaneous Reporting) Regulations 2018 (the "Regulations").
What is changing?
Subject to Parliamentary approval, the Regulations will introduce new requirements for public and private companies, in respect of financial years starting on or after 1 January 2019. Most of the requirements apply to large companies, the definition of which differs between the various requirements, whilst some apply only to quoted companies. Please see our table summarising the scope of each of the requirements here.
What are the key changes?
Section 172 Companies Act 2006 statement
Large companies (both public and private) will be required to state in their strategic reports (in a separately identifiable statement) how the directors had regard to the matters set out in section 172(1) of the Companies Act 2006 when performing their duty to promote the success of the company. The matters include the interests of the company's employees, the need to foster the company's business relationships with suppliers, customers and others, and the impact of the company's operations on the community and the environment. For this purpose, "large" is defined under the Companies Act 2006 as companies who meet at least two of the following criteria in the relevant financial year : (i) turnover of more than £36m; (ii) balance sheet total of more than £18m; or (iii) more than 250 employees.
This statement will also need to be published on the company's website. Quoted companies will not need to take any extra steps to comply with this as they already have to make their annual report (of which the new statement will form part) available on a website. For unquoted companies, however, this will be a change and they will need to ensure that the section 172 statement is available on a website.
The requirement will apply to all group companies which individually meet the definition, and not just the parent company.
Corporate governance statement
Large companies (both private and public) will have to make a corporate governance statement in their annual report. "Large" for this purpose means companies with either (i) more than 2,000 global employees and/or (ii) a turnover of more than £200 million globally and a balance sheet of more than £2 billion globally. Listed companies which currently make a corporate governance statement under DTR 7 will be exempt, but this requirement will apply to their subsidiaries which meet the test.
The Regulations would require such companies to state in their annual report:
- which corporate governance code, if any, they had applied in the relevant financial year;
- how they had applied the code; and
- if they departed from the code, how and why. Private companies will be able to adopt the Wates Principles (see below) in complying with this requirement.
Disclosure of engagement with UK
Companies with 250 or more UK employees will be required to report on employee engagement in their directors' report, including action aimed at:
- providing employees systematically with information on matters of concern to them as employees;
- consulting employees or their representatives on a regular basis so that their views may be taken into account in making decisions which are likely to affect their interests;
- encouraging the involvement of employees in the company's performance through a share scheme or by some other means; and
- achieving a common awareness on the part of all employees of the financial and economic factors affecting the company's performance.
Engagement with suppliers, customers and others
This requirement applies to large companies as defined under the Companies Act (see the section 172 statement section above). The new duty requires additional reporting on the company’s engagement with its suppliers, customers and others in a business relationship.
Remuneration (including pay ratios)
- Quoted companies (i.e. Official List companies or companies whose shares are listed on the New York Stock Exchange, NASDAQ or a recognised stock exchange in the European Economic Area) with more than 250 UK employees will be required to report pay ratio information comparing the remuneration of the CEO with the 25th, 50th and 75th percentiles of the full-time equivalent remuneration of the company’s UK employees. These companies will also have to publish supporting information, including the reasons for changes to the ratios from year to year and, in the case of the median ratio, whether, and if so why, the company believed this ratio to be consistent with the company’s wider policies on employee pay, reward and progression. For a parent company, the information will need to relate to the group.
- All quoted companies will also need to include further additional information in their directors' remuneration report, including information with regard to the exercise of discretion by the remuneration committee in awarding directors' remuneration.
- All quoted companies must report how much of a director’s pay award was attributable to share price growth and specifically address whether discretion had been exercised as a result of changes in share price.
- All UK quoted companies must include in their Remuneration Policy, in relation to multi-year performance measures or targets, the maximum remuneration.
At the same time as publishing the Regulations, the Government also published a Q&A to help companies and interested stakeholders understand how they will be affected by the new corporate governance reporting requirements in the Regulations. The Q&A provides guidance on matters such as:
- the scope of the Regulations;
- the timing of reporting obligations;
- the duty to report on matters in section 172 of the Companies Act 2006 (including the type of information and level of detail required);
- pay ratio reporting (including an illustration of pay ratio methodology in the Annex); and
- share price impact reporting.
Consultation on Wates Corporate Governance Principles for Large Private Companies
What is changing?
On 13 June 2018, the FRC published for consultation draft corporate governance principles to help companies comply with the new Regulations: the Wates Corporate Governance Principles for Large Private Companies (the "Principles"). The FRC issued the guidelines on behalf of a coalition group chaired by James Wates CBE and whose members include (amongst others) the FRC, BVCA, ICSA, the Institute of Directors and the Investment Association. Input was sought from various stakeholder groups, as well as senior business leaders of large private companies in the UK.
Which companies are caught?
The Principles are intended to assist private companies in complying with the new corporate governance statement requirement, as well as to help private companies of all sizes adopt good practices in corporate governance. Accordingly, the Principles do not state which companies are within scope.
How will the principles apply?
Companies may voluntarily adopt the Principles, which will operate on an "apply and explain" basis. Companies which do adopt the Principles will have to demonstrate, through a written explanation in the directors' report and on their website, how the application of the Principles has resulted in improved corporate governance outcomes during the reporting period. The Principles aim to provide a high-level approach to good corporate governance, while allowing sufficient flexibility for companies to explain the application and relevance of their corporate governance arrangements. To illustrate this flexible approach, the consultation contains an example of how different types of company (i.e. a large family owned company; a private equityowned company, and a large subsidiary of a UK listed company) may apply and explain the Principles in different ways.
What are the principles?
There are six Principles, as follows, with non-exhaustive guidance in relation to each Principle:
- Principle One - Purpose: An effective board promotes the purpose of a company, and ensures that its values, strategy and culture align with that purpose.
- Principle Two - Composition: Effective board composition requires an effective chair and a balance of skills, backgrounds, experience and knowledge, with individual directors having sufficient capacity to make a valuable contribution. The size of a board should be guided by the scale and complexity of the company.
- Principle Three - Responsibilities: A board should have a clear understanding of its accountability and terms of reference. Its policies and procedures should support effective decision-making and independent challenge.
- Principle Four - Opportunity and risk: A board should promote the long-term success of the company by identifying opportunities to create and preserve value, and establishing oversight for the identification and mitigation of risks.
- Principle Five - Remuneration: A board should promote executive remuneration structures aligned to the sustainable long-term success of a company, taking into account pay and conditions elsewhere in the company.
- Principle Six - Stakeholders: A board has a responsibility to oversee meaningful engagement with material stakeholders, including the workforce, and have regard to that discussion when taking decisions. The board has a responsibility to foster good stakeholder relationships based on the company’s purpose.
The consultation on the Wates Principles closes on 7 September 2018. The aim is to finalise the Principles in December 2018 to align with the introduction of new reporting requirement outlined above.
Why are these changes being introduced?
Following the reports on Sports Direct and BHS in the summer of 2016, BEIS undertook to conduct an inquiry looking at any systematic problems in relation to the operation of corporate governance. The Government's 2016 Green Paper on corporate governance reform looked at three key issues, namely executive pay; engagement with stakeholders; and corporate governance for private companies. In the subsequent BEIS response paper, the FRC, Institute of Directors and Institute for Family Business were invited to develop together, with private equity and venture capital interests, an appropriate voluntary code of corporate governance with which the largest privately-held companies would be expected to comply.