FRC proposals to update the UK Corporate Governance Code

Wed 26 Jul 2023

What’s the issue?

The Financial Reporting Council (FRC) has published UK Corporate Governance Code – Consultation document, which proposes a series of changes to the UK Corporate Governance Code (Code); the first changes since the 2018 revision.  This is described as a limited revision focusing on preparing for the advent of the Audit, Reporting and Governance Authority (ARGA) – the body to replace the FRC – and implementing elements of the White Paper on Restoring Trust in Audit and Corporate Governance. 

What does this mean?

The review is described as “limited”, however it includes some important areas that are proposed to be changed and also looks to bring in other areas of FRC expectation.

Some of the key changes that are proposed are as follows:

• Control and risk management systems

The Principle surrounding risk and internal control is being amended to expand the board’s responsibility to establish and maintain an effective risk management and internal control framework. The board will also have to make a declaration of whether it can reasonably conclude that the company’s risk management and internal control systems have been effective throughout the reporting period and up to the date of the annual report.  The annual report will also have to explain the basis for its declaration and describe any material weaknesses or failures identified and the remedial action being taken, and over what timeframe.

• Responsibility of the audit committee for narrative reporting

The audit committee is being made explicitly responsible for reviewing the integrity of narrative reporting, including sustainability reporting, and for describing its work in this area in the annual report (where these matters have not been reserved for the board).  Additionally, the annual report will describe, where commissioned by the board, the assurance of ESG metrics and other sustainability matters.

• Inclusion of ESG matters and transition planning

Provision 1 is being amended to include a specific reference to how environmental and social matters are taken into account in the delivery of strategy, including climate ambitions and transition planning.  This is also now explicitly referred to as a factor for alignment in remuneration objectives.

• Reporting on outcomes rather than processes

A new Principle (rather than Provision) is being added to emphasise that reporting should demonstrate the outcomes of governance activities, where possible, in an attempt to drive more informative, less boilerplate reporting. This proposal being made following the FRC’s Review of Corporate Governance Reporting, which indicated that is an area where improvement is needed.

• Diversity and inclusion, engagement and remuneration

A number of changes are being made to strengthen the Code in these three areas. In relation to diversity and inclusion, the aim being to build diverse succession pipelines and to facilitate a more joined-up approach with other mandatory requirements and voluntarily initiatives, such as the FCA’s recent new requirements set out in the Policy Statement PS22/3.

Other changes are being made to increase the level of expectation to have committee chairs engage directly with shareholders and other stakeholders on significant matters related to their areas of responsibility, and to ensure there are malus and clawback provisions in director remuneration schemes, including share award schemes, with these provisions being disclosed within the annual report, along with how the provisions have been used by the company within the last five years.

• Encouraging competition in the audit market

The main roles and responsibilities of the audit committee are being expanded to include, interalia, promoting effective competition during the tendering for an external auditor to support audit market diversity and for the audit committee to ensure the Audit Committee and the External Audit: Minimum Standards, which was published in May 2023 by the FRC, has been followed.

When is it effective?

The proposed effective date for the changes is for accounting periods beginning on or after 1 January 2025. The consultation comment period closes on 13 September 2023.

Who is it applicable to?

These proposals are to be applicable to companies with a premium listing on the London Stock Exchange, and hence are required to apply the UK Corporate Governance Code. These companies must apply the Principles of the Code and comply with, or explain against, the Provisions.