Included in this issue of our Governance & Compliance Update: FRC publishes Annual Review of the UK Corporate Governance Code; FCA issues first fine for notification failures by PDMR and more

FRC publishes Annual Review of the UK Corporate Governance Code

The Financial Reporting Council (FRC) has published its Annual Review of the UK Corporate Governance Code in which it sets out its expectations for governance reporting in 2020 (Review). The Review covered reporting against the 2016 UK Corporate Governance Code (2016 Code) while also assessing FTSE 100 "early adopters" of the 2018 iteration of the Code, of formal application to reporting periods beginning on or after 1 January 2019 (2018 Code). The FRC published its Annual Review of Corporate Reporting, in which it focused on the areas of reporting over which it has formal jurisdiction – the Strategic Report, Directors' Report and Financial Statements – in October 2019.

Overall assessment

In summary, the FRC believes that companies need to improve their governance practices and reporting if they are to demonstrate their positive impact on the economy and wider society, and thereby start to rebuild the public's trust in business.

While changes to the 2018 Code have raised the bar considerably and have already led to some high-quality reporting, greater focus is needed on longer term sustainability including stakeholder engagement, diversity and the importance of corporate culture. These changes are expected to take time to bed in.

The FRC’s analysis found:

• Some good examples of reporting by companies who are increasingly using incentives relating to non-financial matters and are grounded in long-term strategy.
• Many companies are grappling with defining purpose and what an effective culture means with too many substituting slogans or marketing lines for a clear purpose.
• There is insufficient consideration of the importance of culture and strategy, or the views of stakeholders. Following the FRC’s 2016 report on culture, companies should be commenting on culture and now explain how they are monitoring and assessing it.
• Limited reporting on diversity. Those companies that did report well had clear plans to meet diversity targets – beyond just gender – and understood the long-term value of diversity.
• The use of engagement surveys was portrayed by many as an effective tool to achieve insight on employee engagement and culture. While these can help, the FRC believes that they should not be used in isolation. Companies must be able to demonstrate that the engagement methods used are effective in identifying issues that can be elevated to the board and how this affects company decisions.
• There is still too much focus on compliance with Code Provisions. The 2018 Code reaffirms the importance of applying the Code's Principles in a manner that shareholders can evaluate which requires demonstrating the actions a company has taken and how these link to strategy and purpose. This is particularly the case when it comes to board effectiveness and decision-making and how this has led to sustainable benefits for shareholders and wider stakeholders. 

Reporting under the 2016 Code

The FRC found that the quality of reporting under the 2016 Code was largely unchanged. However, there are areas of reporting where improvements identified will still be relevant under the 2018 Code including in the reporting of actions taken when there has been a significant (20%+) vote against a board recommended resolution. 

Explanations for non-compliance with Code Provisions remains an area of focus given the continued unsatisfactory nature of many of them. The Review looks in detail at explanations for non-compliance where companies have a combined chair and CEO, where the chair was not independent on appointment and where board balance recommendations were not met. The FRC expect companies to take account of its views on these areas when reporting in the future and, in particular, to ensure that explanations include company specific context, historical background, and information on what mitigating actions have been taken to address additional risk. Ultimately companies must explain how an alternative approach to that recommended by the Code remains consistent with the spirit of the Code Provision being departed from. 

Viability statements have not produced the desired insights. The FRC expects two-stage reporting on long-term prospects and whether the company is expected to operate and meet liabilities over the viability assessment period and refers to the FRC Reporting Lab's Report on Risk and Viability.  In light of this and the recommendations of the Kingman and Brydon Reviews respectively, the FRC intends to update its Guidance on Risk Management, Internal Controls and Related Financial and Business Reporting.

Early adoption of the 2018 Code

In summary, while there was some good reporting in FTSE 100 reports, the FRC reports that there is significant room for improvement in 2020 as the quality of reporting was "mixed". Corporate culture and workforce engagement were the most frequently discussed areas. The Review sets out the FRC's expectations for reporting against the 2018 Code particularly in relation to company purpose, culture, workforce engagement, section 172 reporting, chair tenure, succession planning, diversity and remuneration, the highlights of which include:

• Purpose – Too many companies use marketing slogans or simply specify achieving shareholder returns and profit as the company's purpose, demonstrating insufficient consideration of purpose, its importance in relation to culture and strategy and the views of stakeholders in this regard. 
• Culture – Few companies discussed their assessment and monitoring of culture, whilst those that did placed too much reliance on employee engagement surveys that should not be used in isolation. Equally, only a small number of boards reported that they receive reports on culture or have a specific agenda item to consider the alignment of culture with values and strategy, and the possible role for the internal audit function in assessing or monitoring culture appears to have been overlooked by most companies. 
• Workforce engagement – Companies should explain how effective their chosen method(s) of engagement with the workforce has been, which will be an area of focus for the FRC when analysing reports in 2020. This should include a discussion of how information obtained from workforce engagement is shared with the board and considered in decision making. The FRC's Financial Reporting Lab has considered how companies might meet the needs of investors on the reporting of workforce-related issues and will shortly be publishing its findings.
• Section 172 reporting – Whilst most companies identified, and reported on engagement with, their key stakeholders, companies should identify the issues that were important to stakeholders, how these have been understood by the board and how consideration has been given to the impact of such issues on the long-term success of the company. 
• Chair tenure – There was reduction in the number of chairs in the FTSE 350 with tenures of nine years or more, but the FRC note with concern that c.18 companies have chairs who have been on the board for 18 years or more. Where the chair's tenure exceeds the recommended nine year maximum set out in Provision 19, companies should explain their rationale for this and their proposals for future composition of the board. 
• Succession planning – The annual report should not simply refer to the nominations committee being responsible for keeping appointments to the board under consideration, and include more detail on succession plans. AGM notices should also contain more than a biography to justify the proposed re-appointment of a director and articulate the reasons for an individual's re-election, linking their contributions to strategy, risks or other key issues. 
• Diversity – Reporting of diversity focussed primarily on gender, with some reports also commenting on ethnic diversity and setting out targets to improve this area. However, few companies set out their approach to age, disability and/or LGBT+ diversity, with the FRC noting they expect to see more detailed commentary on all aspects of diversity in future. 
• Remuneration – Very few remuneration committees reported on their engagement with the workforce and the effect of that engagement, with a majority acknowledging that this is an area that would be considered further during the year. The FRC will expect future reporting to include detail on this aspect, together with insight into how workforce pay influences pay policy and how new pay policies are communicated.

FCA issues first fine for notification failures by PDMR

The Financial Conduct Authority (FCA) has published a Final Notice imposing a fine of £45,000 on Kevin Gorman, formerly a member of the Executive Committee at Braemar Shipping Services plc (Braemar).  Braemar is listed on the main market of the London Stock Exchange.  Mr Gorman had been a person discharging managerial responsibilities (PDMR) at Braemar at the relevant time.

The FCA found that Mr Gorman had not notified to it three trades he made in Braemar’s shares (which took place in August and November 2016, and January 2017) within the three business days required by Article 19 of the Market Abuse Regulation (MAR), resulting in Braemar not being able to announce the transactions to the market in the manner required by MAR.  The FCA also found that Mr Gorman had failed to seek prior authorisation from Braemar for the trades, a requirement of Braemar’s internal policies.

From a practical perspective, the decision of the FCA (the first against a PDMR for breach of Article 19 of MAR since it came into force in July 2016), underlines the importance of PDMRs being aware of, and complying with, internal policies and procedures concerning the handling of inside information and personal account trading.  

In its decision, the FCA reviewed not only the requirements of MAR, but Braemar’s policies, procedures, and the manner in which they had been published to Mr Gorman (see in particular section 4 of the Final Notice).  Mr Gorman stated to the FCA during its investigation that although he had received by email a pack of relevant paperwork about MAR (including the company's share dealing policy), and signed a memorandum acknowledging it, he did not read or check the documents and consequently was not aware of his obligations at the relevant time. The FCA stated in its reasoning: “The [FCA] does not consider a claim of ignorance of the obligations outlined in MAR to be a defence for a breach”, and asserted that it was reasonable in the circumstances to expect Mr Gorman to have read the materials he had been sent and had acknowledged.

CIIA publishes new Internal Audit Code of Practice

The Chartered Institute of Internal Auditors (CIIA) has published a new Internal Audit Code of Practice (Audit Code). The Audit Code contains principles-based guidance that represents the final recommendations of the independent Internal Audit Code of Practice Steering Committee following a public consultation process. It is intended to be applied by all organisations in the private and third sectors that have an internal audit function and an audit committee, with an acknowledgement that the Code should be applied proportionately depending on the size and complexity of the organisation. 

The guidance in the Audit Code is divided into the following areas:

• Role and mandate of internal audit
• Scope and priorities of internal audit
• Reporting results
• Interaction with risk management, compliance and finance
• Independence and authority of internal audit
• Resources
• Quality Assurance and Improvement Programme
• Relationship with Regulators
• Relationship with External Audit

Reporting discrepancies about beneficial owners on the PSC register

To coincide with the entry into force of the Fifth Anti-Money Laundering Directive (MLD5) in the UK, by virtue of the Money Laundering and Terrorist Financing (Amendment) Regulations 2019, on 10 January 2020, Companies House has published guidance on how to report a discrepancy about beneficial owners on the PSC register of a UK company, limited liability partnership, or Scottish limited or qualifying partnership. 

MLD5 requires "obliged entities", including credit and financial institutions, auditors, accountants, tax advisers and legal professionals, to inform Companies House of material differences between the information that they have on a beneficial owner and the information that appears on the PSC register of the relevant undertaking. Typographical errors or information that goes beyond that required for the PSC register does not constitute a "material discrepancy". 

A report, to be submitted as soon as reasonably possible using a prescribed online form, is required if an obliged entity identifies a discrepancy when setting up a new business relationship with a customer on or after 10 January 2020.

ESMA publishes report on issuers' use of APMs

The European Securities and Markets Authority (ESMA) has published a report on EU issuers’ use of Alternative Performance Measures (APMs) and their compliance with ESMA's 2015 Guidelines (2015 Guidelines). The report covers:

• the use of APMs in management reports, ad hoc disclosures and primary financial statements; and
• compliance of issuers with the APM Guidelines in management reports, ad hoc disclosures and prospectuses.

Of the 123 issuers whose management reports were reviewed by ESMA, only 16 complied fully with all principles of the 2015 Guidelines (with a similar compliance rate applying to the ad hoc disclosures that ESMA reviewed). Whilst there was a good level of compliance with the 2015 Guidelines in relation to comparatives, consistency and the unbiased nature of APMs reported, compliance with the principles regarding explanations, reconciliations and definitions was more limited. Issuers are encouraged to improve the transparency of their disclosures in relation to APMs, with ESMA setting out recommendations to assist.