In the United Kingdom's corporate governance, a development recently emerged with the introduction of the UK Corporate Governance Code and its accompanying Guidance. This change aims to provide more transparent, accessible and user-friendly instructions for companies to apply and comply with the Code. It signifies a step towards fostering constructive dialogue between companies and investors. However, compared to the ambitious intentions of the previous draft, the new update trimmed many of the suggestions to a more relaxed set of principles, leaving out environmental and social topics.
The Guidance, as consolidated by the Financial Reporting Council (FRC), deliberately refrains from prescribing specific frameworks or standards for assessing the effectiveness of material controls. The FRC opts for a non-prescriptive approach, meaning companies must decide the most suitable methods for reviewing and reporting on the efficacy of their controls. Therefore, market participants, rather than regulatory bodies, must now determine the standards, fostering a dynamic and responsive governance environment. Whether this more relaxed approach will be effective remains to be seen.
Smarter regulations
As articulated in the Guidance, the updated regulation amalgamates previous FRC guidelines into a single, user-friendly document linked to the Code and other relevant materials. The FRC underscores the discretion of boards to tailor governance arrangements to their company's circumstances while adhering to the Code's principles. It also encourages boards to thoughtfully explain any justified departures from the Code's provisions, emphasizing the intent to stimulate boards' thinking rather than enforce robust compliance.
In addition, the FRC's approach is now less about creating a checklist but about sparking thoughtful consideration. The Guidance includes cross-references to prior FRC work and guidelines from industry bodies, such as The Chartered Governance Institute and the Investment Association. It underscores the need for proportionate and appropriate reporting tailored to the reporting company's size, complexity and maturity.
While the FRC is in the process of a substantial review of its stewardship code, the aim is to establish a principles-based framework where companies and investors collaborate to ensure governance and reporting arrangements are proportionate and appropriate. This collaborative effort seeks to create a renewed relationship between companies and investors, grounded in trust, mutual respect, and transparent disclosure, ultimately contributing to better value discovery and improved market dynamics in the UK equity markets.
Risk management and internal controls
A significant aspect of the Code pertains to risk management and internal controls. Boards are mandated to monitor their company's risk management and internal control framework annually reviewing its effectiveness. The annual report and accounts must detail how the board has monitored and reviewed the framework's effectiveness, accompanied by a declaration of effectiveness for material controls. Material controls, unique to each company, encompass policies, culture, organization, behaviors, processes, and systems that impact the company, its shareholders and stakeholders.
Notably, the Guidance does not prescribe a specific framework for reviewing effectiveness but suggests considerations for boards to form their views. It reaffirms that seeking external advice or assurance is a board decision. However, companies are likely to seek guidance from their advisors, especially accountants, to navigate the intricacies of maintaining and monitoring their risk management and internal controls framework.
The FRC deliberately leaves it to the market to determine appropriateness, envisioning a scenario where existing frameworks prevail. If not, industry initiatives may need to create new frameworks through bodies like the Institute of Chartered Accountants in England and Wales (ICAEW). In areas where reporting frameworks may not cover certain aspects, boards are encouraged to design review processes, leveraging internal audit functions and third-party professional advice to ensure sufficient comfort.
Additional findings
The Guidance also draws attention to emerging risks and technology, urging boards to align their strategy, risk management, and internal controls with technological changes, including artificial intelligence. Additionally, while climate change and environmental factors aren't standalone discussions, they are recognized as crucial elements relevant to strategy, opportunities, and risk, emphasizing their integration into a company's systems.
Furthermore, the Guidance introduces new recommendations for board committees, emphasizing the need for clear responsibilities and effective communication between committees to enhance overall governance effectiveness. This approach underscores the evolving nature of corporate governance in the UK, highlighting the interconnectedness of strategy, risk management, technology and environmental considerations within the framework of the Code and its guiding principles.
Overall, the introduction of the UK Corporate Governance Code and its accompanying Guidance marks a certain milestone in transforming corporate governance practices in the United Kingdom. The move towards a more transparent, accessible, and user-friendly framework reflects a commitment to fostering constructive dialogue between companies and investors.
However, it is debatable whether the more relaxed updates, leaving regulations and self-assessment to the market in absence of FRC enforcement powers against boards, will result in better outcomes. Certainly, this development creates less of a challenge for companies, but it also shows the regulator’s shift from a regulating ambition to a mere facilitating one.
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