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FRC responds to EC recommendation on ‘comply or explain’ reporting

25 September 2015

The quality of corporate governance reporting has been in the spotlight recently, with the Financial Reporting Council (FRC) in the UK issuing a response to the European Commission's Recommendation on the quality of corporate governance reporting (focusing on ‘comply or explain’ reporting).

In 2014, the European Commission issued a Recommendation on ‘comply or explain’ reporting, with a requirement that member states advise the Commission on progress with the Recommendation by mid-2015.

The objectives of the Recommendation were:

  • to provide guidance on how listed companies should explain their departures from the recommendations of relevant corporate governance codes, and specifically, Article 20 of the Accounting Directive (2013/34/EU); and
  • to encourage European listed companies to report on how they follow the relevant corporate governance codes on the topics of most importance for shareholders, in order to improve transparency and the quality of corporate governance reporting in general.

Specifically, the Recommendation outlined that in each departure from an individual recommendation, companies should:

  • explain in what manner the company has departed from a recommendation;
  • describe the reasons for the departure;
  • describe how the decision to depart from the Recommendation was taken within the company;
  • where the departure is limited in time, describe when the company envisages complying with a particular recommendation; and
  • where applicable, describe the measures taken instead of compliance, and explain how those measures achieve the underlying objective of the specific recommendation or of the code as a whole, or clarify how it contributes to good corporate governance of the company.

The FRC has recently responded to the Recommendation:

  • the 'comply or explain' method of adherence has given companies flexibility and made it possible to set more demanding standards than can be done through hard rules;
  • experience has shown that the vast majority of companies attain these standards – in 2014 the Grant Thornton survey of compliance by FTSE 350 companies found that 94% of companies complied with all, or all but one or two, of the 54 provisions in the UK Corporate Governance Code; and
  • by requiring companies to report to shareholders rather than regulators, the decision on whether a company's governance is adequate is taken by those in whose interest the board is meant to act.

The FRC went on to say that it has commenced a communications exercise to raise standards and promote the flexibility of ‘comply or explain’. This will include a reminder to both companies and investors that simply complying without giving due consideration to what is appropriate and relevant reduces the flexibility that this approach aims to achieve.