A - Chapter 2 - Corporate Governance in the UK

Question 1

In the late 1990’s, due to number of high profile company collapses, the Cadbury Committee was formed. This then led to the publication of the Cadbury Report in 1992.
What were some of the common themes which emerged from this committee?

Answer 1

1. Investors were not kept informed about what was really going on in a company.
   2.The published financial statements were misleading.
2. External auditors were accused of failing to spot the warning signs.
3. The companies had self-seeking powerful chiefs, who lacked business ethics.
4. Board members were unable to restrain management from acting improperly.
5. Risk management systems were inadequate or ineffective.

Question 2

Many of the recommendations of The Cadbury Report still form the foundations of corporate governance in the UK today. List some of these foundations which are now incorporated into the UK Combined Code.

Answer 2

1. Board of Directors
2. Non - Executive Directors
3. Executive Directors
4. The Audit Committee
5. A going - concern statement
6. Internal Financial Controls

Question 3

What were the key points incorporated from Cadbury around Board of Directors?

Answer 3

The Cadbury committee agreed that the balance of power between directors and shareholders was appropriate but that there should be more accountability by directors to shareholders.

Control of the company should be exercised by the board as a whole rather than one dominant individual.

There should be a separate Chair and CEO and both should have clearly defined roles.

The board should have reserved matters which should not be delegated to management.

The board should meet regularly and monitor the performance of the exec. team.

Individual board members should be able to seek professional advice at the company’s expense. This recognised the risk that some directors might not have the necessary experience or skills in a particular area to plan an effective role in a particular discussion.

Question 4

What were the key points incorporated from Cadbury around Non Executive Directors?

Answer 4

At the time of the report, non executive directors were not common. The ones which did exist were major shareholder appointments or former execs. Cadbury recommended that there should be sufficient non exec directors to carry weight and most should be independent.

Independent non exe directors should be bale to bring judgement and experience to the deliberations of the board that exe directors on their own might lack.

Non Exec directors should be selected through a formal process overseen by a nominations commitee. recommendations are then made to the board who formally appoint.

Appointments would be for a fixed term and reappointment should not be automatic. Although not stated implicitly, it implied that through time, non exec directors became less indepdent.

Question 5

What were the key points incorporated from Cadbury around Executive Directors?

Answer 5

Cadbury recommended that directors service contracts should not exceed three years without shareholder approval. This was to reduce large pay outs for poor performance.

The committee also recommended that directors’ remuneration should be decided by a remuneration committee consisting wholly or mainly of non exec.

Question 6

What were the key points incorporated from Cadbury around The Audit Committee?

Answer 6

The committee recommended that all listed companies should have an audit committee and set out its remit.

The audit committee should comprise of at least 3 non exes and should be the main relationship with the external auditors. Previously the external auditors’ main relationship had been with the exe management.

The audit committee should also review the interim and annual financial statements before their submissions to the full board for approval.

Question 7

What were the key points incorporated from Cadbury around A Going Concern Statement?

Answer 7

The committee recommended that companies should include a #going concern# statement in their annual report and accounts.

An implication of this recommendation is that before approving the reports and accounts, each directors is under a personal responsibility to reassure themselves that the company is a going concern and is not on the brink of insolvency.

Question 8

What were the key points incorporated from Cadbury around Internal Financial Controls?

Answer 8

Directors should also report to shareholders on the company’ system of internal financial controls.

The report introduced for FTSE 350 companies the requirements for non exec directors, independent directors, audit, nominations and remuneration committees, evaluation of performance and reports on the internal controls of a company. These requirements have evolved since the Cadbury Report leading to more detailed requirements and guidance.

Question 9

What are some of the more detailed guidance and reports published since the initial Cadbury report?

Answer 9

1. The Greenbury Report on director’s remuneration (1995)
2. The Hampel report (1998)
3. The Turnbull Report on internal controls (1999)
4. The Higgs report on the role and effectiveness on non-executive directors (2003)
5. The Smith Report on audit committees (2003)
6. The Tyson Report on the recruitment and development of non-executive directors (2006)
7. The Davies Report on women on boards (2011)
8. The Parker Report on ethnic diversity on UK boards (2016)
9. The Hampton - Alexander Report on representation of women on boards (2016)

Question 10

Give a summary of the publication of the UK Corporate Governance Code by the FRC.

Answer 10

First published in 2010, updated every 2 years with the latest version being the 2018 code.

In Jan 2020, the FRC carried out a review of the code which stated that companies needed to improve their governance practices and reporting if they are to demonstrate their positive impact on the economy and wider society. It stated that while the 2018 code raised the bar considerably greater focus was required on longer term sustainability Inc. stakeholder engagement, diversity and the importance of corporate culture.

In Nov 2020, the FRC found that reporting on the new Corporate Governance Code was a ‘mixed picture’. It stated that the revised code provided an opportunity for companies to report to stakeholders in a way that allows high quality information around corporate governance to deliver the company’s purpose and strategy. The FRC found that this was not being done consistently across the board and some companies continue to treat the code as a box ticking exercise.

Question 11

What is the aim of the UK Stewardship code?

Answer 11

The aim was to encourage institutional shareholders to:

1. Take a more active role in the governance of those companies in which they invest. It is argued that they are investing on behalf of individuals and therefore have a responsibility to make sure that the board of directors of the companies in which these individuals invest, are made properly accountable and govern their companies responsibly.
2. Have a dialogue with the companies in which they invested and to make their views known, through advisory reports and if necessary via their voting practices at shareholder meetings.

Question 12

Why is it important to know historic corporate governance developments?

Answer 12

It is important to understand how corporate governance has developed so that Company Secretaries can advise boards on their best practices.

For examples, the requirements for the division of responsibilities between the Chair and CEO is designed to counter the power of one dominant individual who runs the company for their own benefit.

If the company secretary is aware of this, they are able to advise the board wishing to combine roles what other practises should be put in place.

This could be an appointment of a Senior Independent Director.

The board would also have to look at delegation of authority to the Chairman / CEO to ensure that sufficient matters were reserved to the board to ensure effective oversight of the Chairman / CEO.

Question 13

Other than the UK Corporate Governance Code for listed companies, what other areas of UK law contain aspects of corporate governance?

Answer 13

Companies Law
Laws regulating the financial markets and financial services
Environmental laws
Health and Safety laws
Employment and pension laws
Insolvency law
Laws on money laundering and insider dealing

Question 14

The main legislations in company law is the Companies Act 2006. List some areas that are included in this regulation.

Answer 14

Shareholder rights and voting
General meetings
Disclosure of information to shareholders including information on directors’ remuneration and information required in the annual report and accounts sich as in the strategic report
Powers and duties of directors
Preparation and auditing of the annual financial statements.

Question 15

Since the introduction of CA2006, there have been several other regulations introduced. What are examples of these?

Answer 15

1. The Companies Act 2006 (Strategic report and Directors Report) Regulations 2013.
2. The Large and Medium Sized Companies and Group (accounts and reports) (Amendment) Regulations 2013.
3. The Companies (Miscellaneous Reporting) Regulations 2018.
4. Companies (Directors’ Remunerations Policy and Directors’ Remuneration Report) Regulations 2019
5. Corporate Insolvency and Governance Act 2020

Question 16

What two rules make up the Financial Conduct Authority Handbook?

Answer 16

The UK Listing Rules and The Prospectus, Disclosure Guidance and Transparency Rules (LPDTR) make up the FCA Handbook.

Question 17

Who do the UK Listing Rules apply to?

Answer 17

The UK Listing Rules require all companies, UK or non UK incorporated, with a premium listing on the London Stock Exchange to comply with the UK Corporate Governance Code or explain their non - compliance in a governance statement in the company’s annual report and accounts.

Question 18

Do companies who are listed on the AIM (Alternative Investment Market - a sub market of the LSE) have to comply with the UK Corporate Governance Code?

Answer 18

Companies listed on AIM are usually smaller companies, which require a less stringent regulatory regime than that provided by the UK Corporate Governance Code.

AIM companies do however have to adopt a set of governance standards and most choose to adopt the Corporate Governance Code for Small and Mid Sized Quoted Companies which is issued by the Quoted Companies Alliance (QCA).

From Sept. 2018, AIM companies are required to set out in a statement the details of a recognised corporate governance code that has been selected by the board, how that code has been applied and, where the company departs from its selected code, an explanation for doing so.

Question 19

Disclosure and Transparency Rules

Give a summary of DTR 2 and list what other regulations may be applicable to this.

Answer 19

DTR2 is Disclosure and control of inside information by issuers.

This rules sets out the requirement for prompt and fair disclosure of relevant information to the market. It also gives guidance on aspects relating to disclosure of such information including the circumstances in which disclosure may be delayed.

The rule should be read in conjunction with:
The Market Abuse Regulations
Part 7 of the FSA 2012 relating to misleading statements and practices
Part V of the Criminal Justice Act 1993 relating to insider dealing
The Takeover Code

Question 20

Disclosure and Transparency Rules

Give a summary of DTR 3.

Answer 20

DTR3 is Transactions by persons discharging managerial responsibilities and their connected persons.

This rule sets out the notification obligation of PDMRs and their connected persons in relation to shares, debt instruments or derivates of the company. Directors and senior executives are usually classified as PDMR’s.

Question 21

Disclosure and Transparency Rules

Give a summary of DTR 4

Answer 21

DTR4 is Periodic Financial Reporting.

This rule sets out the requirements for the content and publication of a company’s
Annual report and financial statements
Half yearly report and interim statements
Reports on payments to governments

Question 22

Disclosure and Transparency Rules

Give a summary of DTR 5

Answer 22

DTR5 is Vote Holder and Issuer Notification Rules.

This rule sets out the requirements for holders of shares in a company to disclose the percentage of their holding above certain thresholds to the company.
It also sets out the disclosure relating to a company’s share capital which are to be made by the company to enable holders to fulfil their requirements.

Question 23

Disclosure and Transparency Rules

Give a summary of DTR 6.

Answer 23

DTR6 Continuing obligations and access to information.

This rule sets out what continuing obligations the listed company agrees to comply with. The obligations include, among others:
Equality of rights of shareholders of the class
Exercise of rights by shareholders
Electronic communications
Information about dividend payments, shareholder meetings, changes in share capital.

Question 24

Disclosure and Transparency Rules

Give a summary of DTR 6.

Answer 24

DTR6 Continuing obligations and access to information.

This rule sets out what continuing obligations the listed company agrees to comply with. The obligations include, among others:
Equality of rights of shareholders of the class
Exercise of rights by shareholders
Electronic communications
Information about dividend payments, shareholder meetings, changes in share capital.

The rule also sets out the disclosure requirements for listed companies in relation to the continuing obligations.

Question 25

Disclosure and Transparency Rules Give a summary of DTR 7.

Answer 25

DTR7 Corporate Governance This rule sets out the requirements for listed companies in relation to Having an audit committee Including a corporate governance statement in its annual directors' report Rlated party transactions

Question 26

UK Corporate Governance Code 2018 The Code sets out good practices to enable boards to do what?

Answer 26

1. Establish their company's purpose, strategy and values, and satisfy themselves that these are aligned to their company's culture and aimed at achieving long - term success for the company. 2. Consider the practices and processes that need to be put in place to ensure an effective interaction with the company's employees, customers, suppliers and wider stakeholders. 3. Develop effective policies to ensure diversity (gender, social and ethnic backgrounds, cognitive and personal strengths) on the board, within the management team and in the management pipeline. 4. Ensure that appointments to boards are based on merit and objective criteria to avoid group think.

Question 27

UK Corporate Governance Code 2018 What sections are the 2018 Code split into?

Answer 27

1. Board leadership and company purpose 2. Division of responsibilities 3. Composition, succession and evaluation 4. Audit, risk and internal control 5. Remuneration Each section is further divided into a set of principles followed then by more detailed provisions. Listed companies are required to make a statement in their annual report and accounts on how they have applied the spirit of the principles and complied with, or explain why they have not complied with the provisions and supporting guidelines for the code.

Question 28

UK Corporate Governance Code 2018 What was the aim from the amendments and introduction of required statements made by the changes in the 2018 revision of the code?

Answer 28

The aim from the publication of statements was to allow shareholders to evaluate the application of the code. This was to move away from a box - ticking exercise or boilerplate responses. It was hoped that the statements would provide the basis for positive and constructive dialogue with shareholders. Shareholders have responsibilities under the stewardship code to engage with companies on their corporate governance practices especially where they have provided an explanation for non- compliance with a code provision. The 2018 Code applies to accounting periods beginning on or after 01 January 20198 for ALL PREMIUM LISTED COMPANIES.

Question 29

FRC Guidance To assist companies in developing their corporate governance practices based on the requirements of the UK Corporate Governance Code, the FRC has published a series of guidelines. List these.

Answer 29

1. Guidance on Board Effectiveness (2018) Based on the Higgs report of 2003, the purpose of the guidance is to stimulate boards thinking on how they can carry out their role and encourage them to focus on continually improving their effectiveness. It covers sections 1,3 and 5 of the code. 2. Guidance on Audit Committees (2016) Previously known as the Smith Report, this guidance provides more details on the role and responsibilities of audit committees. 3. Guidance on Risk Management, Internal Control and Related Financial and Business Reporting (2014) This guidance replaced the Turnbull guidance. It aimed to encourage boards to consider: How to discharge their responsibilities in relation to existing and emerging principal risks of the company; and To embed risk management and internal control systems into the business processes of the company. It introduced the concept of cultures of risk. 4. Guidance on the Strategic Report (2018) An enhancement to the 2015 version, the 2018 revised guidance has been enhanced to recognise the increasing importance of non-financial reporting.

Question 30

Guidance from investors Where can institutional investors and shareholders find additional guidance?

Answer 30

Institutional Investors and their representation bodies have issued a series of guidelines on corporate governance issues, such as directors pay and stakeholders engagement for listed companies. From 2014 onwards, these have been issued and managed by the the Investment Association.

Question 31

QCA Corporate Governance Code 2018 The QCA is a body that represents smaller quoted companies. They publish a QCA code which are similar to the UK Corporate Governance code but are not quite as rigorous. What are the 10 principles?

Answer 31

1. Establish a strategy and business model which promotes long term value for shareholders. 2. Seek to understand and meet shareholders needs and expectations. 3. Take into account wider stakeholder and social responsibilities and their implications for long-term success. 4. Embed effective risk management, considering both opportunities and threats throughout the organisation. 5. Maintain the board as a well-functioning balanced team led by the chair. 6. Ensure that between them, directors have the necessary up - to - date experience, skills and capabilities. 7. Evaluate board performance based on clear and relevant objectives, seeking continuous improvement. 8. Promote a corporate culture that is based on ethical values and behaviours. 9. Maintain governance structures and processes that are fit for purpose and support good decision - making by the board. 10. Communicate how the company is governed and is performing by maintaining a dialogue with shareholders and other relevant stakeholders. Companies adopting the QCA Code are required to issue an annual statement on how the comply with the code and where they depart, provide a justification for doing so.

Question 32

Corporate Governance and Unlisted Companies Following scandals involving large private companies (such as BHS), the Green paper published in November 2016 raised issue relating to the UK Corporate Governance Framework of large private companies. This then led to publication of The Companies (Misc. Reporting) regulations of 2018. Summarise what these regulations are.

Answer 32

The Companies (Misc. Reporting) Regulations 2018 provide that large private unlisted companies defined as those with more than 2000 employees or with a turnover of more than £200 million and a balance sheet of more than £2 bn, will have to include a statement as part of their directors' reporting statement. The statement should report: 1. Which Corporate Governance Code they are following 2. If they have deviated from their chosen code, an explanation as to why 3. If they have not adopted a code, an explanation as to why not and what arrangements for corporate governance have been applied instead. The statement must be published online. and in addition, large private companies will have to provide within their strategic reports, a s172 describing how the directors have had regards to the matters set out in s172 when performing their duty under s172 to promote the success of the company.