Revised UK Corporate Governance Code published
Financial Reporting Council publish a revised Code with a focus on internal controls published by Eversheds Sutherland
Why should I read this?
The Financial Reporting Council (FRC) have published a revised UK Corporate Governance Code (Code). Under the Financial Conduct Authority’s Listing Rules, premium listed companies must make a statement in their Annual Report as to how they have applied the Principles of the Code. Such companies must also set out their reasons for any non-compliance with a Code Provision.
As expected following their policy update in November 2023, the FRC have made fairly minimal amendments to the Code, opting against the inclusion of ESG expectations and primarily focusing on revisions in relation to risk management and internal control frameworks. The existing expectations in the Code in relation to internal controls will remain. The main substantive change is that boards will have to explain through a declaration in their annual reports the effectiveness of their material internal controls.
Other more minor and clarificatory revisions have been made, including relating to malus and clawback provisions for director remuneration and audit committee minimum standards. The FRC have published a two page summary to highlight the key changes to the Code.
The revised Code will apply to accounting periods beginning on or after 1 January 2025, other than the new declaration regarding internal controls, which will come into effect one year later on 1 January 2026.
What are the key changes?
Most of the revisions relate to Section 4 of the Code, which covers audit, risk and internal control frameworks. Revisions to Principle O make boards responsible not only for establishing, but now also for maintaining the effectiveness of, the risk management and internal control frameworks of listed companies.
The key change relates to Provision 29. This has been expanded to provide that in addition to monitoring the company’s risk management and internal controls framework (covering financial, operational and compliance controls), and carrying out an annual review and reporting on that review in the annual report, the board is specifically required to provide in the annual report:
a description of how the board has monitored and reviewed the effectiveness of the framework;
a declaration of effectiveness of the material controls as at the balance sheet date; and
a description of any material controls which have not operated effectively as at the balance sheet date, the action taken, or proposed, to improve them and any action taken to address previously reported issues.
The FRC consider this approach to be a “targeted, proportionate and balanced response” to addressing expectations for better governance reporting around risk management and internal controls. The FRC note that this is a principles-based approach that relies on boards making their own judgment, and is better suited to the UK commercial and governance framework than more prescriptive approaches in other jurisdictions, such as the Sarbanes-Oxley requirements in the US. It will be for boards to determine to what extent they obtain third party assurance in respect of this declaration.
Minor amendments have also been made to this section of the Code to reflect the publication of the FRC’s Minimum Standard for Audit Committees and External Audit published in May 2023 (Minimum Standard). Whilst the Minimum Standard is expressed to apply to companies that are included in the FTSE 350 index (the FRC suggests smaller cap companies may wish to apply the Minimum Standard on a voluntary basis), this distinction is not drawn within the revised Code, although non-FTSE 350 companies could choose to explain departure from relevant provisions.
What else is changing?
Reporting
In Section 1, Board leadership and company purpose, the FRC has reframed Principle C, which now states that companies should, when reporting on their governance activity, focus on board decisions and their outcomes in the context of the company's strategy and objectives. Where the board reports on departures from Code provisions, it should provide a clear explanation. In a separate ‘Mythbuster’ document, the FRC set out what they mean by “outcomes-based reporting” – ie providing stakeholders with information on how board decisions have and will impact strategy, objectives and long-term viability. The need for better quality explanations of non-compliance with Code provisions has been highlighted by recent FRC reviews into reporting against the Code.
Remuneration
While the 2018 Code already refers to remuneration schemes and policies enabling the use of discretion, and allowing for the recovery or withholding of sums/share awards as a matter of good practice, the 2024 Code has been amended to provide specifically that executive directors’ contracts or other remuneration documents should include malus and clawback provisions. This is accompanied by a new annual reporting requirement for companies to provide a description of the malus and clawback provisions, including the circumstances in which they could be used, a description of the selected period for application of malus and clawback, why that period is suited to the organisation, and whether the provisions were used in the last reporting period. If they were used in the last reporting period, a clear explanation of the reason should be provided. This disclosure applies to executive directors, not all employees subject to malus and clawback.
In making these amendments, the FRC has moved the expectation of using malus and clawback from the “Guidance for Board Effectiveness” into the Code itself, which will make it a higher priority for companies to report on. It is also perhaps part of the FRC’s general intention to allow less scope for boilerplate, general language about recovery and withholding provisions, which the FRC noted in its 2023 review was used by many companies, and, in its view, reflected lower quality information for shareholders and less transparency. The FRC has referred to the new provisions on malus and clawback as being part of minor changes to the Code which “aim to better streamline the expectations or clarify the language”.
The Code has been slimmed down in various areas. With regard to remuneration, this has resulted in the removal of the list of factors a remuneration committee should address when determining executive director remuneration policy and practices.
Diversity and Inclusion
The original proposed changes to the Code included giving equal weight to all protected and non-protected characteristics when considering appointments to the Board and succession planning instead of limiting it to the 2018 Code wording: “diversity of gender, social and ethnic backgrounds, cognitive and personal strengths”. Whilst it seemed in November last year that a change to this wording was being dropped entirely, the 2024 Code now states that both appointments and succession plans should “promote diversity, inclusion and equal opportunity” so that it is not limited to specific groups. However, other more detailed provisions which had been proposed to report more widely on D&I in appointments and succession planning have not been included.
Other changes
Other proposed revisions that were set out in the consultation published in May 2023, including the role of audit committees in relation to environmental, social and governance (ESG) issues; over-boarding provisions; expectations on Committee Chair’s engagement with shareholders and the inclusion of a resilience statement in the annual report have not been taken forwards (the latter following the government’s withdrawal of the draft Companies (Strategic Report and Directors’ Report) (Amendment) Regulations 2023).
Impact and next steps
These changes come in response to a number of high-profile company and audit failures over the last several years which have dented confidence in UK plc and, along with other geopolitical and macroeconomic factors, adversely impacted the performance of the UK public markets.
The FRC has tried to go some way to restoring confidence in the UK for investors and others, whilst, at the same time, striking an appropriate balance that recognises the increasing regulatory and administrative burdens to which listed (and indeed other) companies are subject to (and which may also be seen as potentially damaging to the competitiveness of the UK as a destination for business and investment).
Recognising the more proportionate and flexible principles (as opposed to rules)-based approach that the FRC has adopted, the revisions have been broadly welcomed by the issuer and investment community, including by the government-backed Capital Markets Industry Taskforce, the Association of Investment Companies and the IoD. The FRC have also reiterated the “comply or explain” regime of the Code, following recent criticism that the Code was effectively becoming “comply or else”.
However, at the same time, there may be disappointment voiced in some quarters that not taking forward proposals posited in its 2023 consultation paper to strengthen ESG and sustainability reporting represents a missed opportunity by the FRC to further challenge ‘greenwashing’ and to hold UK plc to greater account for its contribution to achieving UK and global environmental, climate and sustainability goals.
The FRC will publish associated guidance to accompany the Code on 29 January. The FRC emphasis that the guidance is not part of the Code and should not be seen as a requirement of the FRC.
The revised Code applies to accounting periods beginning on or after 1 January 2025, with the exception of the requirement for a board declaration on internal controls (revised Provision 29). In response to stakeholder feedback that boards need more time to develop their approach around internal controls, this Provision will apply to accounting periods beginning on or after 1 January 2026.
Further reading on the UK Corporate Governance Code
UK Corporate Governance Code (January 2024)
FRC press release
Feedback Statement
FRC webpage
If you would like to discuss what the revised Code means for your company reporting, please get in touch with our team, who can assist from both a corporate governance and HR perspective.
Stephen Nash Partner
stephennash@eversheds-sutherland.com
Elizabeth Graves Partner
elizabethgraves@eversheds-sutherland.com
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