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European Commission enhances ‘comply or explain’ principle

10 April 2014 by Jonathan Minter

The European Commission (EC) has published a recommendation aimed at improving the way listed companies apply the 'comply or explain' principle contained in corporate governance codes.

As the EC pointed out, the comply or explain principle gives companies flexibility as they are not obliged to comply with parts of their applicable corporate governance codes provided they explain the reason for doing so.

In the recommendation, the EC said there are shortcomings in the way it is applied, in particular with regards to the quality of these explanations.

To address this, the recommendation suggests companies that diverge from their applicable codes should state which parts they have diverged from and why, how the decision to diverge was taken, and also say in what manner the company has diverged.

Where the departure for the code is limited in time, the company should state when the company envisages complying with it, and where applicable describe what measures were taken as an alternative.

The EC also recommended that national corporate governance codes make a clear distinction between the parts of the governance codes which cannot be diverged from, the parts which apply on a comply or explain basis and those which are purely voluntary.

The UK Financial Reporting Council (FRC) chief executive officer Stephen Haddrill said he welcomes the recognition of the 'comply or explain' principle as a truly European mechanism, one it has been championed by the FRC in the UK.

In particular, Haddrill said the FRC endorses the Commission's focus on explanations.

"There will at times be legitimate reasons for departures from the requirements of corporate governance codes, but such departures must be considered and well explained. In this context, the FRC considers that outlining the elements required for explanations may be helpful in encouraging better reporting," Haddrill said.

The Association of Chartered Certified Accountants (ACCA) head of technical John Davies welcomed the recommendation and said it doesn't restrict the freedom for companies to choose not to comply with a standard provision of a non-mandatory corporate governance code.

"Instead calls on them to be forthcoming about why they decide to do so. This will allow shareholders to make their own judgments about whether a company's action merits support or not," Davies said.

EU shareholders rights

The EC also put forward a proposal to amend the EU shareholders rights to make it easier for shareholders to use their existing rights over companies and enhance those rights where necessary.

This includes a "say on pay" rule being introduced which would oblige companies to disclose remuneration policies.

Davies said the ACCA supported these measures, and described the "say on pay" rule as a step towards increasing transparency.

Related links

EU Commission

UK Financial Reporting Council

Association of Chartered Certified Accountants