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Building Blocks

11 November 2019 by Mala Shah-Coulon

Building Blocks

For the first time listed companies will soon start to report against new far-reaching UK corporate governance changes in their 2019 Annual Reports and Accounts

EY’s 6th annual review of FTSE 350 reporting ‘Annual reporting in 2018/19: Engaging stakeholders, restoring trust’, published in September 2019, benchmarks early FTSE 350 reporting practices against the new requirements.

It is encouraging to see that some FTSE 350 companies have made a head start in certain areas. The report identifies these and discusses how companies can further develop and refine their reporting in key areas of change, ultimately to help restore trust in business.

A Key Medium

The UK’s governance and reporting frameworks already had a strong reputation around the world, but recent reforms including revisions to the UK Corporate Governance Code (the 2018 Code) and new secondary legislation – The Companies (Miscellaneous Reporting) Regulations 2018 (MRR) – have raised the bar further. Boards and their committees now need to demonstrate a clear focus on creating and preserving value over the long term for a broad set of stakeholders.

Part of the solution set in these reforms is new disclosure requirements. We believe that corporate reporting is a vital cog in the wider capital market eco-system as it enables transparency and accountability. But, these new reporting requirements come at a time when there is already criticism of the length and complexity of the average Annual Reports and Accounts (ARA). There is also increasing debate about its purpose, and whether in its current form it allows companies to articulate their equity narrative in a compelling way.

However, we know from research and our conversations with investors that the ARA is still highly valued. We believe that, if approached correctly, it is a key medium by which stakeholders can hold directors to account and should remain as an important and high-profile communication channel for boards.

Our report ‘Engaging stakeholders, restoring trust’, focuses on the following five key topics where the changes have been the most far reaching:

  • articulating purpose and culture
  • stakeholder engagement and section 172
  • board evaluations and talent planning
  • emerging risks
  • broadened responsibilities of the remuneration committee.

We hope it helps December 2019 reporters who
will soon be putting pen to paper to achieve
impactful reporting.

Articulating Purpose and Culture

The 2018 Code requires boards to establish and promote a company’s purpose and values, monitor the actual culture of the organisation to assess the divergence from the desired state and ask management to take corrective action if appropriate.

These new requirements are somewhat of a revolution, not an evolution, and as such it is not surprising that meaningful reporting in this area is in its infancy.

Very few companies in our sample articulate how culture is measured and monitored or how progress is being assessed by boards. Companies need to carefully consider their use of terms such as ‘client-centric’ and ‘innovative’ to explain their culture, if they do not/cannot articulate how these cultural attributes contribute to the realisation of their strategic objectives.

Balanced narrative explaining the divergence between the desired and actual culture, together with meaningful explanations into what is being done to foster the desired behaviours, will give readers insight on how boards are discussing and discharging their duties around this important topic.

Stakeholder Engagement and Section 172

In response to regulatory, societal and political pressure, most companies are already disclosing who their key stakeholders are and are giving a flavour of their on-going engagement activities. But the changes to the 2018 Code, and the new MRR requirement to include a separately identifiable section 172(1) statement, has given this topic new emphasis.

Directors need to demonstrate how they are considering and using feedback from the broader ecosystem within which the company operates to help keep the business model current and, therefore, sustainable.

In order to achieve this, disclosures will have to explain board level engagement with stakeholders, the issues covered and, most importantly, the impact that feedback from stakeholders has had on the board’s discussions and decisions.

Board Matters

There are numerous examples of good disclosure of the board evaluation process. However, the 2018 Code shifts the focus towards reporting evaluation outcomes and the actions to address these, with the aim of improving board effectiveness.

Given the strategic importance of talent planning, investors’ continued concerns regarding the ‘over-boarding’ of some NEDs, and the broadened role of nomination committees, we expect to see more insights into senior management succession and the time directors have available to commit to their roles.

Chair tenure has been high on board and investor agendas due to the nine-year tenure limit introduced in the 2018 Code. We recommend that companies acknowledge the issue where they have long-serving chairs and provide some insights into what actions
are being taken to plan for a smooth and orderly succession.

Emerging Risks

The 2018 Code has introduced the requirement for boards to consider emerging risks and disclose the process for identifying, managing or mitigating them.

It is important that companies avoid making boiler plate, process-oriented disclosures and instead use specific examples to provide some context on how the board monitors emerging risks and assesses the speed with which they may develop. Also, as the term isn’t defined in the 2018 Code, we encourage companies to define emerging risks in the context of their organisation.

Broadened Responsibilities

The scrutiny on executive pay and the role of the remuneration committee has continued to increase, with a heightened focus on fairness in pay and the ‘gap’ between higher and lower earners in
an organisation.

Remuneration committees will have to carefully balance the views and expectations of their wider stakeholders with ensuring that their pay practices align with business strategy, while also enabling them to attract and retain the best talent. We expect to see greater focus on the narrative explaining pay ratios and ensuring messaging is consistent with the wider ‘pay story’.

Grasp the Spirit

We hope our report provides December reporters with some food for thought, not only on what they need to convey in their ARAs but also in how they operate and govern.

We strongly believe business must rise to the challenge of demonstrating how it is grasping the spirit of the reforms and holding itself to account. Failure to do this risks the imposition of further regulation as future governments look for new ways to restore public trust in business and the capital markets. A far better course is to strive now to achieve the highest standards of corporate governance and reporting – using the ARA as the high-quality communications channel it can be. 

Mala Shah-Coulon is an associate partner at EY Corporate Governance

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