Political and regulatory news

Issue 5 - 14 December 09

Corporate governance under scrutiny

The last month has seen the publication of final recommendations from the Walker Review, proposed revisions to the Combined Code and a new Code for institutional shareholders.

The economic crisis has raised serious questions about the adequacy of the corporate governance framework in the UK and has lead to reviews of existing codes and practices.  Banks have been subject to particular attention and earlier this year the Government appointed Sir David Walker to undertake a review of their governance framework.  He has called for significant cultural and organisational changes within the sector.  His findings have been welcomed by Government.  Lord Myners, Financial Services Secretary, said “We strongly support his views and will look to implement his recommendations, particularly as regards the role of institutional investors.  I regard this as Walker’s most significant contribution to the governance debate”.

One of Walker’s recommendations is the creation of a new Stewardship Code for institutional investors which is sponsored by the Financial Reporting Council (FRC).  Being overseen by the FRC would give the code greater weight and enhance its status as best practice guidance.  His conclusions also relate to the performance of boards themselves and the FRC is now considering transferring a number of them to the Combined Code for general application to listed companies.  The AIC has previously warned that it would be inappropriate to automatically broaden the application of the Walker recommendations and that careful consideration should be given to the desirability of, and manner in which, any elements might be incorporated into the Combined Code.  Nevertheless, the FRC has now published an updated version of the Combined Code for public comment which reflects its position on the Walker Review and the outcome of a consultation earlier this year (see previous article).

The FRC is proposing changes to both the structure and content of the Combined Code.  It suggests splitting its recommendations on board operation into two sections on leadership and effectiveness.  It also intends to change the title of the Combined Code to ‘The UK Corporate Governance Code’ to enhance its status, particularly for foreign investors and for overseas companies listed in the UK which will soon have to apply it under proposed changes to the Listing Rules.

The FRC also proposes strengthening the role of the chairman and non-executive directors.  For example, it wants:

• the chairman to ensure that adequate time is available to discuss strategic issues and to promote a culture of openness and debate
• the senior independent director to provide a sounding board for the chairman and serve as an intermediary for other directors
• directors to allocate sufficient time to the company to perform their responsibilities effectively, although it is not introducing minimum time commitments
• boards composition to be based on an appropriate balance of skills, experience, independence and knowledge of the company
• selection criteria for new directors not to inappropriately restrict the talent pool.

The FRC is also considering the extent to which it should incorporate Walker’s recommendations on director re-election into the Combined Code.  For the banking sector, Walker supports the annual re-election of the chairman and recommends that boards consider an annual re-election policy for all board members.  The FRC is asking for feedback on two options for the Combined Code - either the annual re-election of the chairman or the annual re-election of the whole board.  The AIC’s view is that corporate governance guidance should not be set so rigidly and individual companies and their shareholders should be allowed to decide on the best approach – there should be no hard and fast presumption in favour of annual re-election.

Another Walker recommendation which the FRC wants to adopt is for an external party to evaluate the board every three years.  This would represent a significant change for investment companies as very few currently use a third party for this purpose.  Every three years may be too frequent for this sector and the AIC would prefer the Combined Code to be more flexible on this point.

The FRC has also picked up some themes from the Walker Review in relation to risk, although it is not adopting Walker’s recommendation that companies should establish a separate risk committee.  It wants to clarify the board’s responsibility for defining the company’s risk appetite and tolerance, and for maintaining a sound system of risk management.  This is not expected to raise any significant concerns for investment companies, as their boards already devote a considerable element of time to managing risk.

The FRC has decided that it would be inappropriate to apply the detailed Walker recommendations on directors’ remuneration outside of banking sector.  However, it is proposing to clarify that all forms of performance related remuneration are discouraged for non-executive directors and not just share options as the Combined Code currently states.  It also says that performance related remuneration should be aligned with the long-term interests of the company and its risk policies.  This is unlikely to be a significant issue for externally managed investment companies.

The FRC is also reviewing where corporate governance disclosures can best be presented and is inviting views on whether to give companies more flexibility by allowing statements to be made on a website rather than in the annual report.

The proposed changes to the Combined Code are open for consultation until 5 March 2010 and the AIC will be submitting its views.  The revised Code will then apply for accounting periods beginning on or after 29 June 2010.  The FRC will also be consulting on the proposed Stewardship Code for institutional investors in due course.  These developments may also have an impact on the AIC Code of Corporate Governance and the AIC is keeping the position under review.

To view the final recommendations from Sir David Walker’s ‘A review of corporate governance in UK banks and other financial industry entities’, click here.

To view the Institutional Shareholders’ Committee’s new ‘Code on the responsibilities of institutional investors’, click here. 
 
To view the Financial Reporting Council’s consultation on the revised UK Corporate Governance Code, click here.

This is the last article in this edition.

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