UK Governance Code – the next 25 years

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By Stephen Haddrill – Chief Executive Officer of the Financial Reporting Council

 

 

Since its inception 25 years ago, the UK Corporate Governance Code has been a major force for good and it makes an important contribution to the high regard in which the UK business framework is held globally, which in turn is a key reason why global investors commit their capital to the UK.

In short, the Code has made a significant and important contribution to sustainability in the UK economy and the creation of jobs, growth and prosperity. Nonetheless, after a quarter of a century and with the apparent decline in public trust in business it is time to review the Code and its framework to ensure it is fit for the future.

The Cadbury Report was published in 1992 as a response to corporate scandals at the time involving BCCI, Polly Peck and Maxwell, and was followed by the creation of the UK’s Corporate Governance Code. A key aspect of the Code from the onset has been the ‘comply or explain’ approach. This has allowed companies to respond confidently and effectively to evolving market circumstances, because it offers flexibility in how companies apply the principle to their own particular situations and business models. Hard rules don’t cope easily with the variety of British business and are inevitably more difficult to change.

As well as the ‘comply or explain’ approach, the strength of the unitary board and strong shareholder rights are important planks of the framework. These factors have long delivered economic success and must be preserved. But more can be done. While compliance with the Code’s provisions is high, our monitoring shows that some explanations when boards choose not to follow provisions are of poor quality. We have called on shareholders to challenge companies where they do not believe that explanations given are sufficiently persuasive.

Evolving framework

As we look to the next 25 years, it is important that our framework of corporate governance continues to evolve. The demands on business and the expectations of stakeholders are growing.

Inevitably, we are looking at the risks and opportunities presented by Brexit. If we maintain the advantages gained over the last quarter of a century, investors will continue to look to the UK as a destination of choice for their capital. Businesses will continue to see the merit in being listed in the UK. A proportionate, principles-based framework for corporate governance will help to achieve these outcomes.

Codes put forward principles for best practice that make bad behaviour less likely to occur; and public reporting can make it harder to conceal such behaviour. But, on its own, a code does not prevent inappropriate behaviour, strategies or decisions. The commitment of people, particularly the leaders within a business is required.

Our report Corporate Culture and the Role of Boards and our work to tier the signatories to the Stewardship Code are good examples of fresh thinking. There are certain principles mentioned earlier that underlie corporate governance in the UK and which we feel must be retained. The law holds all directors equally responsible for the decisions of the board. But their responsibility now needs to be more closely aligned to the broader factors in section 172 of the Companies Act and should be reported on and effectively monitored.

Our report on promoting good corporate culture helps them in this regard and sets out several key observations as well as case study examples, some of which I will highlight. In particular, it encourages boards to:

■ Recognise the value of culture

A healthy corporate culture is a valuable asset, a source of competitive advantage and vital to the creation and protection of long-term value. It is the board’s role to determine the purpose of the company and ensure that the company’s values, strategy and business model are aligned to it. Directors should not wait for a crisis before they focus on company culture.

■ Demonstrate leadership

Leaders, in particular the chief executive, must be seen to live the desired culture, embedding it at all levels and in every aspect of the business. Boards have a responsibility to act where leaders do not deliver. Remuneration decisions must be consistent with the desired culture. This includes decisions on appointments and remuneration incentives, and disincentives.

■ Be open and accountable

Openness and accountability matter at every level. Good governance means a focus on how this takes place throughout the company and on those who act on its behalf. It should be demonstrated in the way the company conducts business and engages with and reports to stakeholders.

■ Seek to measure behaviours

Metrics should be tailored to the behaviours and include external as well as internal stakeholder views.

Another observation from the report calls on investors to exercise stewardship. Increasingly investors, in looking at the long-term, have recognised the importance of culture and are asking questions about it in their stewardship meetings with companies. They and we are finding that reporting of culture is an area where more can be done.

To further encourage good stewardship, we have recently categorised signatories to our Stewardship Code into tiers.

“Twenty-five years after Sir Adrian Cadbury’s report, the UK remains in a good position globally with high levels of trust and confidence among investors”

The tiering exercise was undertaken to improve the quality of reporting against the Code, encourage greater transparency in the market and maintain the credibility of the Code. It distinguishes between signatories who report well and display their commitment to stewardship, and those whose reporting needs further improvement. Code signatories were encouraged to improve their statements and thereby reaffirm their commitment to stewardship.

There are nearly 300 signatories to the Code. More than 120 are in Tier 1 – the top tier, representing nearly 90 per cent of assets under management by members of the Investment Association. Asset owners are now better able to discuss with asset managers their different approaches to stewardship and ensure that these best meet their needs. Signatories will be encouraged to engage in continuous improvement of their reporting and stewardship activities.

Consultation process

With all this considered and after a programme of engagement with many stakeholders from many different sectors, we will issue a consultation on reforms to the UK Corporate Governance Code later this year. This consultation will broadly look at whether the Code should be amended to encourage boards better to take account of a wider group of stakeholders, whether we can do more to encourage engagement on remuneration issues and whether more needs to be detailed in the Code about culture.

Looking at the guidance on board effectiveness, which we released in 2011, we will again assess if it is addressing the issues relevant to board and company governance and how it could be amended to raise standards. We will also look at how the guidance could be amended to take account of the role of boards in setting, assessing and embedding a company culture.

Reputation in business is also key to this success, and corporate governance
can help to instil this in an organisation. Business has a duty to its stakeholders to be transparent, true and fair, because without it, our economy will not thrive.

Twenty-five years after Sir Adrian Cadbury’s report, the UK remains in a good position globally with high levels of trust and confidence among investors. Corporate governance must help to maintain that trust. At a time when geopolitics and world economics look less certain, both are ever more important.

 

About the Author:

Stephen Haddrill has been the Chief Executive Officer and Director of Financial Reporting Council Ltd since November 2009. Haddrill served as Director General at Association of British Insurers (ABI) from May 2005 to November 2009. Previously, he served as Director General at Fair Markets Group at the Department of Trade and Industry (DTI) since January 2002, where he was responsible for the development of the framework within which business operates.