The UK Financial Reporting Council (FRC) has updated the UK Corporate Governance Code (the Code) with changes regarding going concern, risk management, internal control, remuneration and shareholder engagement.
"The changes to the Code are designed to strengthen the focus of companies and investors on the longer term and the sustainability of value creation," FRC chief executive officer Stephen Haddrill said.
The revised Code promotes the inclusion of a ‘viability statement’ in the strategic report to investors, aimed to provide an improved and forward-looking assessment of long-term solvency and liquidity.
With regard to going concern requirements, risk management and internal control the updated Code stipulates that companies:
- state whether they consider it appropriate to adopt the going concern basis of accounting and identify any material uncertainties to their ability to continue to do so;
- state whether they believe they will be able to continue in operation and meet their liabilities taking account of their current position and principal risks, and specify the period covered by this statement and why they consider it appropriate;
- robustly assess their principal risks and explain how they are being managed or mitigated;
- monitor their risk management and internal control systems and, at least annually, carry out a review of their effectiveness, and report on that review in the annual report; and
- can choose where to put the risk and viability disclosures. If placed in the strategic report, directors will be covered by the "safe harbour" provisions in the Companies Act 2006.
"The changes on going concern implement the reforms proposed by Lord Sharman whose work has stimulated a sea change in thinking about the assessment and reporting of risk and business prospects," Haddrill explained.
Haddrill referred to an inquiry led by Lord Sharman aimed at examining and foreseeing the challenges faced by directors, management and auditors where companies face going concern and liquidity risks.
The inquiry was launched by the FRC in March 2011. After the results were handed down in June 2012, the UK accounting watchdog launched a public consultation period on the Sharman findings that ended in April 2013. The changes reflect and have benefitted from the consultation, Haddrill said.
RemunerationWhen it comes to the issue of remuneration, the updated Code promotes that:
- greater emphasis be placed on ensuring that remuneration policies are designed with the long-term success of the company in mind, and that the lead responsibility for doing so rests with the remuneration committee; and
- companies should put in place arrangements that will enable them to recover or withhold variable pay when appropriate to do so, and should consider appropriate vesting and holding periods for deferred remuneration.
"The changes on remuneration also focus companies on aligning reward with the sustained creation of value," Haddrill added.
The updated Code also addresses shareholder engagement and the board’s internal communication.
First, it stipulates that companies should explain when publishing general meeting results how they intend to engage with shareholders when a significant percentage of them have voted against any resolution.
Second, it advises the companies’ boards to lead by example in order to encourage good behaviour throughout the organisation. According to the FRC, the boards should establish a dialogue which is both constructive and challenging.
The revised Code will apply to accounting periods beginning on or after 1 October 2014. "It will continue to operate on the principle of ‘comply or explain’, which has served investors and the UK corporate sector well for over 20 years," Haddrill concluded.
ReactionsICAEW executive director Robert Hodgkinson said the new code presents big challenges for boards, and it will take a great deal of work for them to ensure they are compliant, particularly in two fronts.
"Firstly, to work out what they need to change in their risk management and reporting to satisfy the new guidance. Secondly, they will need to decide over what period they consider their company to be viable so they can be ready to issue their new viability statement," Hodgkinson said.
On the issue of remuneration Hodgkinson noted that executive pay remains a hot topic for shareholders and added that the changes to the Code link remuneration to long-term performance rather than attracting and retaining talent.