01 November 2018 by Ben Harber and Kathy-Ann Pearce
Part One of our guide to corporate governance reforms and forthcoming annual reporting obligations
The recent corporate governance reforms made under the Companies (Miscellaneous Reporting) Regulations 2018 (the Regulations) and the revised UK Corporate Governance Code (the Code), have resulted in additional reporting obligations for a wider range of companies with the latter removing the smaller companies cap provisions on certain aspects of reporting.
With these reforms taking effect from accounting periods on or after 1 January 2019 and first reporting due in 2020, company secretaries should be preparing to assist their boards navigate what is in effect, a reset button on certain aspects of narrative reporting in the annual report. Over the next two issues, our aim will be to focus attention on those preparations.
The overall reforms introduced a reporting requirement with respect to S172 of the Companies Act 2006 for the facilitation of a relationship between companies and their wider stakeholder base, to encourage boards to have a better understanding of their organisations beyond its financial performance and strategic objectives. Unsurprisingly, this has resulted in additional disclosures in the strategic and directors’ reports. For the avoidance of tick-box reporting, there is a need to establish proper methods for engagement and gathering of relevant data.
The Regulations provide that the strategic report for a financial year of a company now include a statement describing how directors have regard to certain matters set out in Section 172 of the Act with respect to the performance of their duties. This also crosses over with the provisions set out in the Code, regarding the requirement to report on stakeholder understanding and workforce engagement.
The Code recommends three methods for workforce engagement. They are:
Companies are encouraged to use one, a combination of the three or a totally different mechanism, for example if appropriate, a union representative. Boards will be required to explain in the strategic report which they are implementing.
To ensure that this concept becomes embedded in the company’s culture boards will have to strive to find ways of understanding their employees and their needs and develop methods for engaging and empowering them. This may represent a step change for several boards in its approach to the business, moving away from a shareholder only approach to a wider stakeholder approach to operations.
In addition, boards will also need to consider the implementation of mechanisms for engagement with their wider key stakeholder base in order to understand their views.
The employee engagement requirement will apply to UK incorporated companies (medium and large) with more than 250 UK employees (on a group basis if they are a parent company). The wider stakeholder engagement requirement applies to UK incorporated large companies (listed and unlisted) qualifying as large under the Act.
“There is a need to establish proper methods for engagement ”
On how this will be reported, the Regulations states that a statement be published describing how directors have complied when fulfilling their duties as a director when promoting the success of the company, having regard to matters set out in s172(1) (a)-(f) of the Act.
The Regulations require the publication of a statement summarising how directors have engaged with employees when taking their interests into account. This enhances the current disclosure requirement.
The third and final part of this obligation under the Regulations is the inclusion of a summary of how directors have engaged with suppliers, customers and others engaged in a business relationship with the company. Boards will be required to identify their various stakeholders and strive to develop and implement strategies for better engagement.
Timing will also be a key factor. The methods used and results of engagement should be included in either the directors’ report or where it contains a strategic element, in the strategic report with a cross-reference.
These requirements (both legislative and non-legislative), if considered in conjunction with each other will ensure that companies comply with this over-arching obligation with respect to stakeholder and workforce engagement and make the reporting process straight forward and avoid repetition as there is the ability to cross reference where relevant. The information being disclosed should be consistent with the type and size of organisation.
Another reporting obligation introduced by the Regulations for inclusion in the directors’ report is the disclosure statement on corporate governance arrangements for large private and unlisted public companies.
All UK registered companies with either 2,000+ employees globally or with a turnover greater than £200 million globally and a global balance sheet of over £2 billion (excluding companies subject to DTR7.2R) will be subject to the requirement to include a statement in the report disclosing which corporate governance code, if any, has been applied in the companies’ operations.
Company secretaries will need to review the company’s compliance with the chosen code when preparing the disclosure statement. The statement will need to clearly explain what arrangements have been put in place with respect to compliance with their chosen corporate governance code. This will need to be published (in addition to the directors’ report) on a website maintained by or on the company’s behalf. Where companies do not comply, details setting out aspects and reasons for non-compliance together with a non-compliance statement must be included in the report.
For many Company Secretaries, this process will be reminiscent of the recent process undertaken as a result of the revised AIM Rules for the publication of a governance statement. This will require significant board consideration and the introduction of a process to ensure the statement properly considered and addressed the requirement of the adopted code. Companies are free to choose the governance code which best suites their organisations operations and it is also worth noting the addition to the Wates Corporate Governance Principles for large private companies to that list from January 2019.
There are two further provisions for reporting in the directors’ report, despite their implementation sitting under the remit of the Nominations Committee. They are the reporting on the extension of the tenure of the chair and director commitments or over-boarding and the reporting will have a wider reach as the smaller companies cap has been removed for these provisions.
Companies will need to include in the directors’ report a clear explanation for any post ten-year tenure extensions and the length of such extensions in respect to the tenure of the chair. Such extensions will need to fit in with wider succession planning (under the remit of the Nominations Committee) and major shareholder engagement (dealt with under stakeholder engagement mechanisms). Further details on succession planning will be discussed in next month’s article.
Disclosure of the board’s approval of any subsequent external appointments by directors will also be required in the report. Boards should therefore ensure that proper mechanisms are in place to ensure that directors are not overcommitting themselves and diluting their abilities to serve
It is clear from these reforms that a significant amount of time and planning will be required ahead of the upcoming reporting cycle. The BEIS (supporting FAQs) and FRC (Guidance on Board Effectiveness and Strategic Reports, both published in July 2018) have published guidance in support.