What is happening and when?

Following a lengthy consultation period, the Financial Reporting Council (the "FRC") recently unveiled its revised UK Corporate Governance Code (the "Code"). As expected from its policy statement in November 2023, the FRC has dropped many proposals that were originally floated, in light of both the Government's withdrawal of the Companies (Strategic Report and Directors' Report) Amendment Regulations 2023 and feedback received during the consultation. As a result, the revised Code is, in the FRC's words, a "limited revision", with the key changes focusing on internal controls.

The revised Code will apply to accounting periods beginning on or after 1 January 2025 except for the new requirement for a board declaration on internal controls, which will apply to accounting periods beginning on or after 1 January 2026 - please see below for further details.

Key change: New board declaration on internal controls

  • The revised Code clarifies that boards will be responsible for not only establishing, but also crucially for maintaining, the effectiveness of the company's risk management and internal control framework (Principle O). This emphasises the continuing focus on risk management and internal controls and ties in with the new requirement for an annual board declaration (see below).
  • In addition to the existing responsibility of boards to monitor companies' risk management and internal control framework and review its effectiveness, Provision 29 has been expanded so that, going forward, boards will also be required to provide in the company's annual report:
    • a description of how they have monitored and reviewed the effectiveness of the framework;
    • a declaration of effectiveness of the material controls as at the balance sheet date; and
    • a description of any material controls which have not operated effectively as at the balance sheet date, together with:
      • the action taken, or proposed, to improve them; and
      • any action taken to address previously reported issues.

Describing this change as a "small but significant enhancement", the FRC sees this as building upon existing Code expectations, rather than introducing a new workstream. That said, it acknowledges that more time is needed for boards to develop their approach to internal controls and, in response to feedback received, is allowing companies an additional year for this transition. This change has been scaled back from the original proposals and is now less onerous on companies. The FRC has made clear that it is for individual boards to decide whether external assurance is required over controls, and to what degree. In its updated Technical Q&A, the FRC has confirmed that (i) "what is a 'material control' is for each individual board to determine", and (ii) such material controls will be "different for every company depending on their features and circumstances, including for example size, business model, strategy, operations, structure and complexity".

Provision 29 has also been amended to expressly include "reporting controls" within the types of material controls that the board should monitor and review – a change which the FRC's consultation document had explained was in order to recognise the importance of narrative reporting to investors.

In addition, Provision 28 has been slightly amended to provide that the board should explain what procedures are in place not only to identify but also to manage emerging risks.

These changes build on the theme of greater board accountability against the wider background of ECM reforms. As part of the listing regime reforms, it is proposed that companies wanting to join the new listing category for equity shares in commercial companies will have to provide a declaration on the company's systems and controls and record-keeping arrangements.

Other changes

Clarifying leadership expectations

  • A new Principle C has been introduced to clarify that (i) governance reporting should focus on board decisions and their outcomes in the context of the company's strategy and objectives, and (ii) a clear explanation should be provided in respect of any departures from the Code. The FRC has clarified that "outcomes-based reporting means providing your stakeholders with information on how decisions taken by the board have, and will, impact the company's strategy, objectives and long-term viability". It wants companies to demonstrate how governance decisions have delivered change. In the updated Technical Q&A, the FRC notes that a "clear explanation" for the purpose of Principle C "should set out the background, provide a clear rationale for the action the company is taking, describe any risks and mitigating actions to address them, and set out when the company intends to comply (timescales)" and "it must be understandable and persuasive for those reading the annual report"
  • As well as requiring boards to assess and monitor the company's culture, going forward the Code will require them to look at how the desired culture has been embedded (Provision 2).

Broader look at D&I

  • The Code has been amended to reflect the fact that companies may have other initiatives in place alongside their diversity and inclusion policy (Provision 23).

Remuneration – greater transparency on malus and clawback

  • Going forward, there will be a requirement for directors' contracts and/or other agreements or documents which cover director remuneration to include malus and clawback provisions (Provision 37). While malus and clawback provisions are common in director remuneration policies and incentive arrangements, companies should review such provisions to ensure they are fit for purpose and also dovetail with directors' service contracts.
  • A new Provision 38 will require companies to include in their annual report on remuneration a description of their malus and clawback provisions, including:
    • the circumstances in which malus and clawback provisions could be used;
    • the period for when the malus and clawback provisions will apply and why that is suitable for the organisation; and
    • whether malus and clawback was used during the year and the reason for doing so.
  • In the Technical Q&A, the FRC confirms that the disclosures under Provision 38 should focus on executive directors and not all those that are subject to malus and clawback.

Removal of Provision 40 (factors to be considered by remuneration committee)

  • The current Provision 40, which sets out specific factors to be addressed by the remuneration committee when determining executive director remuneration policy and practices, has been dropped from the revised Code. This is in response to the FRC's observations that this Provision often results in lengthy and boiler-plate reporting, as well as support received during the consultation for this proposed simplification.

Changes to reflect FRC's Minimum Standard on external audit

  • The FRC's publication entitled Audit Committees and the External Audit: Minimum Standard(the "Standard"), which applies to FTSE 350 companies, contains several sections that are identical to some of the current Code provisions in relation to external audit. The FRC is therefore deleting these provisions to avoid duplication and referring instead to the Standard. This will bring into scope non-FTSE 350 companies that that are subject to the Code but would not otherwise be caught by the Standard.

Terminology

  • References to "board evaluation" have been replaced with "board performance review" to reflect the Corporate Governance Institute's findings (set out in its Review of the effectiveness of independent board evaluation in the UK listed sector) that the use of the term "evaluation" had contributed to the erroneous perception that externally facilitated reviews are intended as a backwards-looking assurance function, whereas the value of such reviews is in informing a continual process of self-improvement for boards.

"Comply or explain": here to stay

The FRC has taken this opportunity to reiterate the value it sees in the "comply or explain" approach and emphasises that providing a cogent explanation is a viable and preferable option where strict adherence with the Code's detailed provisions may not be the right approach for a particular company.

New guidance and other accompanying documents

The FRC has revamped and restructured some of its guidance to provide a much more user-friendly and interactive product. The new guidance incorporates the existing Guidance on Board Effectiveness, Guidance on Audit Committees and Guidance on Risk Management and Related Financial and Business Reporting and structures this in the order of the Code. The guidance will be regularly reviewed to ensure it is relevant and up to date. As the above guidance is now all in one place, it is much easier to map across to the relevant Code provisions.

The FRC has also published a couple of other useful documents: "Key changes" and a "UK Corporate Governance Code 2024 mythbuster", as well as an updated Technical Q&A (as noted above).

Changes that have been dropped

Amongst the proposals that were not taken forward (please see our briefing Consultation on changes to the UK Corporate Governance Code for further details of what was originally proposed) are new provisions relating to:

  • expansion of the role of audit committees, in particular as regards ESG issues;
  • expansion of diversity and inclusion expectations;
  • overboarding; and
  • expectations of committee chairs on engagement with shareholders.

Checklist of suggested actions

  • Ensure the board is briefed on the revised Code.
  • Think ahead to processes which may need to be put in place in order for the board to be able to give the new annual declaration on internal controls. Although this requirement will not apply until financial years beginning on or after 1 January 2026, companies will need to plan ahead to make sure the necessary checks can be made and appropriate record-keeping procedures established.
  • Consider whether and to what extent external assurance is required over internal controls.
  • Review directors' service contracts and incentive arrangements specifically in relation to malus and clawback, but also seeing this as an opportunity for a more general review to make sure these documents are up-to-date and fit for purpose.
  • Review the committee terms of reference and board reserved matters to ensure they reflect the revised Code, e.g. the new board declaration on internal controls, the focus on outcomes-based governance reporting, the revised terminology and the deletion of Provision 40.
  • Update internal documents to reflect the change in terminology, referring to the concept of "board performance review

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.