Insights

Code section

Summary of proposed changes

Implications for firms

Section 1 – Board leadership and company purpose

Proposed changes to this section are limited but include:

• New principle setting expectation that, when reporting on governance activities, there is focus on outcomes to demonstrate impact of governance practices.
  
  
• Amendments to provisions to:

o   describe how ESG matters are taken into account in the delivery of company strategy, including climate ambitions and transition planning.

o   not only assess and monitor culture, but also report on how effectively the desired culture has been embedded.

o   report on the outcomes of shareholder engagement during the reporting period.

Governance outcomes

Firms should carefully consider how they can demonstrate, and report on, governance outcomes. Although it is relatively easy for firms to describe their governance process and practices, it is harder to demonstrate their impact. One way is to report on some case studies or key topics considered by the Board during the year, how they have been dealt with through governance process, the decisions taken and outcomes / impact on company objectives and stakeholders. To simplify this reporting, Boards could keep a log of key topics discussed and their outcomes so there is a clear record to refer to.

ESG

Firms need to focus more on ESG in their reporting. This requires a clear explanation and understanding of how ESG supports the overall company strategy, a definition of climate ambitions, and a  transition roadmap. Whilst most firms are considering ESG, the Code changes may require firms to be more definitive in their ESG strategy and the public commitments they make in this area. It will also increase accountability, as stakeholders will want to see progress year-on-year.

Culture

Firms need to introduce mechanisms and metrics to be able to assess and report on the effectiveness of embedding the desired culture. For example, the use of staff culture surveys or HR data / metrics to show how behaviours and culture are achieved at the firm.

Shareholder engagement

The chair will need to report, in greater detail, on shareholder engagement and outcomes. This may mean increasing the formality of the shareholder engagement process, so that shareholder views are captured and fed back into the governance process and decision-making. The outcomes will need to be tracked and monitored so they can be readily reported in the annual report.

Section 2 – Division of responsibilities

In response to investor concerns over the number of Board positions held by directors and their time commitment, there is a new requirement proposed to list all significant director appointments in the annual report and describe how each director has sufficient time to undertake their role effectively.

Most firms have a process to identify and record other directorships, but it may need improving in response to the proposed Code changes. For example, through a better understanding and record of the time commitment of other directorships and their impact.

It may also be necessary to (re)define time commitment expectations for each director and monitor more closely expected versus actual time to improve reporting in his area.

Section 3 – Composition, succession and evaluation

Proposed changes to this section aim for a more joined-up approach to diversity and inclusion. Among them are amendments to principles to set the expectation that appointments and succession plans will promote equal opportunity and diversity, and inclusion of protected and non-protected characteristics. In support, provisions would state that diversity and inclusion initiatives and any targets set should contribute to succession plans.

There are also additional reporting requirements for nomination committees e.g. on succession planning, Board and senior management appointments and the effectiveness of the diversity and inclusion policy.  

Another amendment suggests that annual performance reviews should consider each director’s commitments to other organisations and ability to discharge responsibilities.

Succession plans

As set out in the consultation document, the FRC continually sees poor reporting on approaches to succession planning, so firms must improve in this area. The Code changes require a clear link between succession plans and diversity and inclusion, which means consideration beyond gender, social and ethic backgrounds. Depending on the maturity of firms’ diversity and inclusion policies, this may require a lot of proactivity in development of succession plans and greater clarity in how they support diversity and inclusions initiatives / targets.

Nominations committee reporting

The proposed changes to nominations committee reporting are likely to require greater oversight of the development of succession plans, how diversity and inclusion is promoted in the appointments process, and the overall effectiveness of diversity and inclusion policies. This may need more scope and time commitment for the nominations committee, and additional MI to achieve effective oversight. In particular, this could mean extra metrics / MI so that the nominations committee can assess progress towards diversity and inclusion objectives, targets and initiatives.

Annual performance reviews

The scope and rigour of annual performance reviews will require more time commitment from each director. This could ultimately lead to changes in Board composition or size.

Section 4 – Audit, risk and internal control

Proposed changes to this section are largely in response to the Government’s consultation Restoring Trust in Audit and Corporate Governance. For example:

• Additional roles and responsibilities of the audit committee, such as:

o   monitoring integrity of narrative reporting, including sustainability matters, and reviewing significant reporting judgements.

o   developing, implementing and maintaining an audit and assurance policy (AAP) (currently in draft legislation).

o   following the Audit Committees and the External Audit: Minimum Standard.

• Additional audit committee reporting e.g. in respect of the Audit Committees and the External Audit: Minimum Standard, any assurance of ESG metrics and sustainability matters and the AAP.

On risk management and internal controls, there are proposed changes to provisions for the Board to:

• explain the procedures in place to identify and manage emerging risks, and describe these.
  
  
• declare in the annual report whether risk management and internal control systems have been effective throughout the reporting period and up to the date of the annual report.  They should provide the basis for this declaration, including how the Board has monitored and reviewed the effectiveness of these systems. Also included should be any material weaknesses or failures and remedial actions, and their timeframe.

Audit committee role, responsibilities and reporting

Most critically, firms reporting against the Code will need to develop and implement a triennial AAP and report on this annually. This will require significant involvement from the audit committee, and engagement with other Board committees and stakeholders. Also needed will be ongoing compliance and monitoring against the AAP, as well as the Audit Committees and the External Audit: Minimum Standard.

With the additional responsibility for narrative reporting, including on sustainability matters, firms will see increased scrutiny from audit committees. This means greater audit committee oversight of ESG disclosures, controls and processes, and of assurance obtained from third parties.

Risk management and internal controls

Not only may the Board need to tighten risk management processes around emerging risk, but it will also need to implement mechanisms to declare the effectiveness of risk management and internal controls. This is likely to include the results of first-line risk/control self assessments, results of second-line reviews, consideration of risk events/control breaches, and results of internal audit reviews or obtained external assurances. Critically, the requirement to report on material weaknesses or failures will require careful consideration to include sufficient detail of remedial actions / timeframe to demonstrate effective management.

Section 5 –  Remuneration

Overall, proposed changes to this section are designed to strengthen the links between remuneration policies and outcomes and corporate performance, including ESG objectives.

Other proposed changes include:

• additional reporting requirements on malus and clawback provisions. This aims to increase the accountability of directors by adhering to their statutory duties in corporate reporting and audit, and also increase transparency for investors.
  
  
• additional emphasis on workforce pay and conditions when determining executive director remuneration. The annual report will also need to describe the remuneration committee’s engagement with shareholders and the workforce and its impact, including alignment with executive remuneration and the overall company pay policy.

The main challenge for firms is to set clear ESG objectives and show how they drive director and senior management remuneration. Firms should consider how they incorporate ESG into remuneration assessments and decisions.

They must also identify and report on malus and clawback provisions (whether set out in director contracts and/or other remuneration agreements/documents). Firms should maintain a central register of these, that includes all details they will need to disclose following proposed changes to the Code.