The Financial Reporting Council published on 19 December 2012 its annual report monitoring developments in corporate governance. The report is here and the accompanying press release is here.
From the press release:
“The Stewardship Code has been a catalyst for greater engagement between companies and their shareholders in 2012. Introduced in 2010, there are now over 250 signatories to the Code, including most major institutional investors.
This is one of the conclusions in the Financial Reporting Council’s annual report on its monitoring of developments in corporate governance, published today.
The FRC also found strong take-up by companies of the recommendations introduced to the UK Corporate Governance Code in 2010. Ninety-six per cent of FTSE 350 companies now put all directors up for re-election every year, and the majority of those companies will have the effectiveness of their board independently reviewed at least every three years. Overall compliance with the Code among listed companies of all sizes remains high.”
From the Introduction to the report:
“Promoting long-term growth is an objective which underpins many of the FRC’s activities and many of the recent changes to the UK Corporate Governance and Stewardship Codes. Our mission is to foster investment through high quality corporate governance and reporting. Providers of risk capital want to be assured that their interests will be promoted by a good board and that they will receive clear and honest reports on the company’s performance; the absence of either deters long-term investment in the company.
The need for boards and investors to take a longer term view in order to benefit companies andsavers and strengthen capital markets is a message that has been repeated frequently in 2012. It comes through strongly in the recommendations of the Kay review, and in Lord Sharman‘s review of how companies assess their going concern status. The European Commission has also identified its importance in promoting growth and will shortly set out its views on the issue in a Green Paper.
A long-term perspective is also necessary when assessing the impact of governance codes and regulation. Changes in process or practice can be brought about relatively quickly; for example, just two years after the UK Corporate Governance Code first recommended that FTSE 350 companies put all directors up for re-election annually, nearly all of those companies and a good many smaller ones now do so. Changes in culture and behaviour, which are ultimately what determine good governance, take longer. Instilling those changes is one of the primary responsibilities of a company’s board.
This report focuses on corporate governance and stewardship over the last twelve months, and there are encouraging developments to report. Our feedback sessions with company chairmen and senior investors indicate that both sides have been trying to raise their game, and that communication between them has increased at senior level. Companies and investors have responded positively to the changes the FRC made in 2010, of which the most significant was the establishment of the Stewardship Code.
Aggregate compliance with the UK Corporate Governance Code across FTSE 350 companies stands at 97 per cent, and we now have over 250 signatories to the Stewardship Code. The more recent changes to both codes, introduced in October, build on solid foundations.
But it is important also to look further back to where we have come from, and ahead to the challenges we face. The UK Corporate Governance Code celebrated its twentieth anniversary this year. Over that period it has made a big difference to corporate governance standards and practice in the UK. It has a history of success in pushing out the boundaries of best practice, such as the separation of the chairman and chief executive, the independence of audit committees and the practice of regularly reviewing the board’s effectiveness. It is the flexibility inherent in the “comply or explain” approach that has enabled those boundaries to be pushed, and the FRC believes it is important that flexibility is retained if the Code is to continue to do so. We are pleased that the European Commission has recognised the important role that national “comply or explain” codes have to play in raising governance standards across the EU.
Not all governance problems have been solved by any means. Two that have been highlighted this year are the perennial question of how to set executive remuneration in a way that is seen as fair reward for good performance, and wider concerns about governance in the banking sector. In both instances the UK Corporate Governance Code operates alongside regulation which the Government is in the process of reforming.
The FRC will consider during 2013 whether changes are needed to how the Code addresses remuneration, and will consult on this question once the Government’s legislation has been finalised. The FRC is also contributing to the debate on the governance of banks. We believe that the Code itself should continue to be applicable to all companies and that, as a general rule, any governance issues specific to the financial sector are best addressed through the existing framework for regulating that sector.
There have also been significant changes in ownership structure since 1992 that have created some challenges that might not have been anticipated when the “comply or explain“ approach was first devised. One of these is the increase in recent years in the number of Premium listed companies with controlling shareholders. The pure “comply or explain” approach can be less effective in these cases, where the majority shareholder is in effect reporting to themselves, and for this reason the Financial Services Authority is currently consulting on proposals to give greater protection to the minority shareholders of such companies.
While this is a relatively recent development, underlying changes in the ownership of listed companies in the UK – and in particular the declining share held by UK-based long-term investors – go back much further. The impact of these changes has been significant in many respects, as Professor Kay has identified in his report. In terms of corporate governance, it means that the critical mass of investors with along-term perspective who are willing and able to engage with boards has to be established internationally, not just within the UK. Establishing a critical mass that enables the chain of accountability from companies through to savers to work as it should, in a difficult economic environment, is possibly the greatest challenge, and is the over-arching objective of the Stewardship Code.
The events of the so-called “Shareholder Spring” indicated a greater willingness on the part of investors to challenge boards. This is welcome in many ways, but will not in itself create a stewardship culture where all parties work together to deliver sustainable returns to savers. Indeed, genuine stewardship may suffer if public confrontation becomes the default mode of engagement. As well as the implications for the relationship between individual boards and their shareholders, it may deter exactly those sorts of investors – particularly international investors – that should be encouraged to engage more.
The development of a stewardship culture among investors is not something that happens overnight. It requires cultural and behavioural change rather than prescription. Looking back over the first two years of the Stewardship Code it is clear that much has changed, and the recent changes to that Code will hopefully moves things on another stage. Stewardship is firmly on the investment agenda and the evidence suggests that leading investors are taking their responsibilities seriously, and looking to engage more effectively both individually and collectively. Stewardship needs to develop further, however, if we are to reach the critical mass needed. As emphasised in the revised Stewardship Code, it is not something that can be delegated to proxy advisors or other third parties; and just as the quality of governance within companies is determined by the board, it needs senior management within institutions to provide leadership and commitment.”
