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The “Code” Which Reaches the Parts Other Codes Don’t

By Julia Penny

The FRC issued the Wates Corporate Governance Principles for Large Private Companies on 10 December 2018. This 23 page document sets out six principles (rather than referring to it as another code) of corporate governance, described as the Wates’ principles, for the chairman of the group charged with its creation. James Wates CBE, describes the principles as “offer[ing] a structure for reporting on corporate governance that not only helps [companies] fulfil their legal requirements, but also allows them to shine”. The hope is that although the legislation only requires a corporate governance statement where the company is of a significant size, others will also adopt the principles. 

The formulation of the Wates principles result from concern around large private company failures, such as that of BHS, which left stakeholders with a justifiable concern that the governance had not been up to scratch. Underpinning the value of these new governance principles, the Government introduced secondary legislation (SI 2018/860), in June 2018 requiring all companies of a significant size to provide a corporate governance statement.

We have already seen the AIM rules change to ensure this is reflected as discussed in a previous article. The Wates principles are aimed at private companies, rather than listed ones and will allow directors to report against a set of corporate governance principles, without having to look to a full code of governance. To help all sizes of companies comply with their new obligations BEIS have also issued FAQs to clarify the amendments to the various legal requirements arising from SI 2018/860.

Which companies are affected and when?

The new reporting requirements apply to companies that meet either or both of the following conditions:
• More than 2000 employees
• A turnover of more than £200m and a balance sheet total of more than £2bn.

The legislation takes effect for financial years commencing on or after 1 January 2019.

Interaction with directors’ duties and the strategic report

The Companies Act 2006 already sets out the duties of directors in sections 170-177. In particular, s.172 includes the duty to promote the success of a company for the benefit of members as a whole, as set out below:

172. Duty to promote the success of the company

(1) A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to:
(a) the likely consequences of any decision in the long term;
(b) the interests of the company’s employees;
(c) the need to foster the company’s business relationships with suppliers, customers and others;
(d) the impact of the company’s operations on the community and the environment;
(e) the desirability of the company maintaining a reputation for high standards of business conduct; and
(f) the need to act fairly as between members of the company’.

However, various consultations indicated that greater clarity was required with regard to the extent that directors should have regard to the matters set out in s.172. It was also felt necessary to require companies to explain how the directors had fulfilled these duties. The Wates principles are intended to support directors in meeting these requirements. 

In addition to the above requirements companies that produce a Strategic Report are now required to provide a s.172(1) statement on their website, which describes how they have had regard to the matters listed in that section. The Directors’ Report has also been amended to require companies to explain how they have engaged with employees and how directors have had regard to employee interests and the effect of that regard. Large private companies are also required to explain how they have engaged with supplies, customers and others in a business relationship with the company. Useful guidance on the Strategic Report, including an appendix listing out the various requirements for different companies, is given in the FRC’s Guidance on the Strategic Report document

The six principles

The document sets out a pyramid of principles as follows*:

Each of these points is broken down into further detail in terms of the guidance given as shown below, together with a narrative statement of each principle:

  • Purpose and leadership
    • Purpose
    • Values and culture
    • Strategy
  • Board composition
    • The role of the chair
    • Balance and diversity
    • Size and structure
    • Effectiveness
  • Director responsibilities
    • Accountability 
    • Committees
    • Integrity of information
  • Opportunity and risk
    • Opportunity
    • Risk
    • Responsibilities
  • Remuneration
    • Setting remuneration
    • Policies
    • Delegating remuneration decisions
    • Subsidiary companies
  • Stakeholder relationships and engagements
    • External impacts
    • Stakeholders
    • Workforce

What needs to be done

Companies caught by the legislative requirements in SI 2018/860 as discussed above, are required to disclose their corporate governance arrangements as set out below:

Extract from The Companies (Miscellaneous Reporting) Regulations 2018
26. (1) The directors’ report must include a statement (a “statement of corporate governance arrangements”) which states:
(a) which corporate governance code, if any, the company applied in the financial year,
(b) how the company applied any corporate governance code reported under sub-paragraph (a), and
(c) if the company departed from any corporate governance code reported under sub-paragraph (a), the respects in which it did so, and its reasons for so departing.
(2) If the company has not applied any corporate governance code for the financial year, the statement of corporate governance arrangements must explain the reasons for that decision and explain what arrangements for corporate governance were applied for that year.

This means that companies of a significant size, as described above, must ensure that their directors’ report includes the above information for period commencing on or after 1 January 2019. As can be seen, the approach taken is one of comply or explain, as is familiar with the application of other codes.

Impact on auditors and advisors

These new requirements also mean that auditors will need to consider the impact this has on their audit work and final audit report. As previously mentioned, AIM companies are already required to report in respect of these requirements on their websites, as the AIM rules were changed earlier in 2018. Other companies have quite a bit of time to prepare for these changes but given these are about the way that a company governs itself it will be best to start considering the issues earlier, rather than leave it to the last minute. This will allow the company time to decide if it wants to change any aspects of its governance in light of the Wates Principles so that this is reflected when it first reports on them. Initially though, it may be important to communicate these changes to the Boards of those companies affected, if you have an advisory role, or work within an affected company.

 

*Extracted from the © FRC Wates Principles document

 

December 2018 

 

Disclaimer
This article is published with the understanding that SWAT UK Limited is not engaged in rendering legal or professional services. The material contained in this article neither purports, nor is intended to be, advice on any particular matter. This article is an aid and cannot be expected to replace professional judgment. SWAT UK accepts no responsibility or liability to any person in respect of anything done or omitted to be done by any such person in reliance, whether sole or partial, upon the whole or any part of the contents of this article.