The Association of British Insurers published on 12 December 2012 a report on the “comply or explain” approach to corporate governance as practised in the UK. From the executive summary:
“The ABI has developed six key criteria to assist companies in preparing Code explanations. These have been designed with the intention of providing investors with the information necessary to consider whether the alternative approach a company has chosen in particular circumstances remains aligned with their interests. These should not be viewed as a rigid set of rules that provide a new set of requirements for companies to follow. The intention is simple: to improve the operation of the UK principles-based system – underpinned by ‘comply or explain’ – for the mutual benefit of companies and investors.
In summary, the criteria are:
1. Company specific context and historical background
2. Convincing and understandable rationale
3. Mitigating action to address any additional risk
5. Specify deviations from the provisions as well as from main principles
6. Explain how the alternative is consistent with the Code principles and contributes to the objective of good governance.
The ABI reviewed a sample of Code explanations based on these criteria to understand the current quality of explanations and to highlight best practice and areas requiring improvement. Many company disclosures are failing to meet investor needs:
• 38% of the explanations detailed the company specific context and historical background;
• 27% provided a convincing and understanding rationale;
• 25% indicated whether the Code breach was time-bound;
• 20% described mitigating actions taken to address any additional risk;
• 25% explained how the alternative was consistent with the principles and contributed to good governance; and
• 16% met none of the criteria.”
And the report makes the following recommendations:
“• ABI members strongly support the role of Code explanations. We attach as much importance to good quality explanations as to basic compliance with Code provisions.
• It is important for companies to consider carefully and articulate both why they have complied with and deviated from the Code: in a sense, a move towards ‘apply and explain’.
• Where companies deviate from the Code, they are strongly encouraged to explain in detail the reasons. Current Code explanations are not meeting investors’ current expectations and are some way from meeting the new Code explanation requirements coming into effect shortly.
• The increasing trend towards Chairmen providing introductory corporate governance statements is positive. Those companies with Chairmen’s statements were correlated with better corporate governance disclosures in the wider sense. Chairmen should therefore be encouraged to provide introductory statements.
• Investors must adopt a more active approach to overseeing and scrutinising Code explanations. This should also help broaden the nature of engagement and increase focus on a wider range of corporate governance risks.
• Although we accept that smaller capitalised companies face a bigger burden meeting high standards of corporate governance, we particularly encourage them to make improvements in their Code explanations. They may well have good reasons for departing from the Code given the nascent development of their business or uniqueness of products or services. They would derive significant benefit from enhancing disclosures to improve investor understanding.”