Governance & Compliance Update - Issue 136

Included in this issue of the Governance & Compliance Update: FRC to publish Wates Principles on 12 December 2018; ESMA updates MAR Q&As; ICSA poll: 70% oppose idea of workers on boards and more...

Corporate Governance Reform

BEIS publishes revised Q&A on Companies (Miscellaneous Reporting) Regulations 2018

The government has updated the Q&A document it first published in June 2018 which provides guidance on the forthcoming reporting requirements under the Companies (Miscellaneous Reporting) Regulations 2018, SI 2018/860 (Reporting Regulations). By way of reminder, the Reporting Regulations impose obligations on UK incorporated companies of a certain size:

• to provide a section 172, Companies Act 2006 statement in their strategic report setting out how directors have had regard to stakeholder and other interests when discharging their section 172 duty;
• to set out their governance arrangements in their director's or strategic report; and
• for "quoted" companies, to disclose certain CEO focused pay ratio information.

Further detail on the Reporting Regulations can be found in our previous Governance & Compliance update. The Reporting Regulations were approved by Parliament in July 2018 and the majority of the requirements apply to companies with financial years beginning on or after 1 January 2019.

The key changes in the Q&A document include:

Part A – Overview

• An exception to the implementation timetable has been included such that the requirement for companies to illustrate the impact of share price increases on executive pay outcomes will apply to any remuneration policies introduced on or after 1 January 2019.

Part B - Scope

• Qn.1(ii) clarifies that, for the purposes of Regulation 13 which requires a statement of how directors have engaged with employees and taken account of their interests, where a company is a parent company it is the number of employees in the group and not just the company itself that is used for determining whether a company has more than 250 UK employees.
• New Qn.4 deals with the potential sanctions for non-compliance with the Reporting Regulations.

Part D - Section 172(1) statement

• Qn.11 deals with the approach that a UK subsidiary company could take to its own section 172 statement in circumstances where policies are set by the parent company and applied throughout the group.

Part E - Corporate governance arrangements in large private / unlisted public companies

• Qn.2 clarifies that the corporate governance statement can be included in a company's strategic report as well as in its directors' report.
• New Qn.3 deals with the ability to publish the statement by making the entire annual report or the whole directors’ report available on a website.
• Qn.6 underlines that the government hopes that the Wates Corporate Governance Principles for Larger Private Companies (Wates Principles) will be "widely adopted".
• A new Qn.8 states that where a UK company chooses to refer to a foreign corporate governance code in its corporate governance statement, it must make an English translation freely available on its website.
• Qn.9 clarifies that while subsidiary companies that meet the threshold criteria must report, the detail of that report will depend on the nature of their relationship with their parent company.
• A new Qn.11 states that a UK subsidiary of a listed overseas parent which applies an overseas code will have to prepare a corporate governance statement.
• A new Qn.13 clarifies that the employee threshold and the turnover and balance sheet thresholds should be calculated at an individual company level only—no consolidation across a group is required. A new Qn.14 explains the "smoothing provision" to the extent that a company meets the threshold conditions in one year but not the next.

Part F - Executive pay - Pay ratio reporting

• A new Qn.3 clarifies that where a UK-incorporated and quoted company is a subsidiary of a non-UK incorporated parent, it must still report its pay ratio. In such a case, the pay ratio reporting would relate to the pay and benefits of the CEO of the UK-incorporated and quoted subsidiary, rather than to the pay and benefits of the CEO of the non-UK incorporated parent and cover only UK employee pay and benefits at the UK incorporated and quoted subsidiary and any subsidiaries beneath it.
• A new Qn.20 on whether pay of employees on leave for some or all of the year should be included – ultimately this is a matter for the company to decide and will depend on the option chosen for the calculation.
• A further new Qn.20 (which should be Qn.21) on whether companies using option B or C for the calculation should use the full-time equivalent of gender pay gap or other data to identify the ‘best equivalents’ of the 25th, median and 75th percentiles – the answer states that "it may be sensible to do so" as pay and benefits for the relevant financial year must be calculated on a full-time equivalent basis (step 2 in the process outlined in Qn. 20).

Part G - Executive pay - Share price impact reporting

• Qn.5 has been amended to suggest that companies consider providing an explanation of how share price growth may have enabled directors to meet a target in their remuneration package, and the impact of this on the variable pay awards.

FRC to publish the Wates Principles on 12 December 2018

The Financial Reporting Council (FRC) has stated that it will publish the final version of the Wates Principles on 12 December 2018, following the consultation it launched in June 2018.  

Equity Capital Markets

ESMA updates MAR Q&As

The European Securities and Markets Authority (ESMA) has published a further update to its Q&A on the EU Market Abuse Regulation (MAR) which includes a new question (Q7.10) which deals with whether the prohibition on PDMR dealing in a closed period in Article 19(11) MAR encompasses transactions of the issuer relating to its own financial instruments. The response clarifies that Article 19 of MAR prohibits PDMRs within an issuer, but not the issuer itself, from conducting ‘any transactions on its own account or for the account of a third party, directly or indirectly, relating to the share or debt instruments of the issuer […] during a closed period of 30 calendar days’ before the announcement of a financial report.

However, any transaction undertaken by the issuer during a closed period should be treated carefully, because the issuer remains subject to Article 14 of MAR (the prohibition of insider dealing). Accordingly, where an issuer possesses inside information regarding its own financial instruments, it will be prevented from trading in them unless it had established, implemented and maintained internal arrangements and procedures specified in Article 9(1) of MAR (legitimate behaviour). 

Company Law

Government publishes measures to tackle late payments

The government has published measures to tackle the issue of late payment of sums owed to small businesses. The call for evidence will be open until 29 November 2018. It seeks views on the best way company boards can put in place responsible payment practices throughout their supply chain, including, for example, giving a non-executive director specific responsibilities for the company's prompt payment performance. The proposals also include measures to empower trade bodies to highlight best and worst practice in payment behaviour in order to deliver practical improvements.

Corporate Governance

ICSA poll: 70% oppose idea of workers on boards

ICSA: The Governance Institute and The Core Partnership have published a poll which reveals that 70% of companies feel that having workers on boards would not be a good idea, while only 13% think it would be a good idea. However, the poll also reveals that many companies are yet to properly consider the recommendations of the 2018 UK Corporate Governance Code for promoting "employee voice" within the boardroom and decide on their preferred method of engagement as a means of doing so.

QCA assesses role of boardroom behaviour

The Quoted Companies Alliance (QCA) has published a paper exploring the role of NEDs and examining board effectiveness from the viewpoint of small and mid-sized companies and advisory firms in the context of the QCA Corporate Governance Code (QCA Code). The paper takes four of the ten Principles from the QCA Code and uses data from the QCA/YouGov Small & Mid-Cap Sentiment Index to explore each Principle from the perspective of NEDs. 

Narrative Financial Reporting

FRC publishes thematic review of reporting by smaller companies 

The FRC has published a thematic review of reporting by smaller listed and AIM quoted companies to highlight where reporting needs to improve.  

Topics covered by the review included alternative performance measures (APMs) and strategic reports, pensions disclosures, accounting policies (including critical judgements and estimates), cash flow statements and tax disclosures. Examples of good reporting are provided throughout the review.

FRC reviews quality of corporate reporting under IFRS 9 and IFRS 15

The FRC has also published two thematic reviews to help companies improve the quality of corporate reporting in relation to IFRS 9 (financial instruments) and IFRS 15 (revenue from contracts with customers). The reviews analyse the disclosures in a sample of company interim reports from June 2018 and explain their effect, providing examples of better practice for other companies to follow when adopting these accounting standards in their upcoming annual reports and accounts. The FRC will challenge companies who fail to provide an adequate level of disclosure about the impact of IFRS 9 and IFRS 15 through their 2018 accounts review process.

FRC Financial Reporting Lab publishes guidance on the presentation of performance metrics

The FRC’s Financial Reporting Lab (Lab) has published guidance for companies on the presentation of performance metrics in their reporting. This builds on the Lab's June Report which outlined that investors want metrics to be aligned to strategy, transparent, in context, reliable and consistent. The guidance follows these principles and provides examples of current practice which "resonated" with the Lab team and investors.

Streamlined energy and carbon reporting

The Companies (Directors’ Report) and Limited Liability Partnerships (Energy and Carbon Report) Regulations 2018 (ECR Regulations) have been finalised and, as previously reported, come into force on 1 April 2019. They provide for a simplified energy and carbon reporting framework for energy-intensive businesses following the abolition of the CRC energy efficiency scheme and the introduction of increases in rates of climate change levy. The ECR Regulations make changes to reporting requirements for quoted companies and introduce new reporting requirements for large unquoted companies and large LLPs to report annually in directors’ reports on emissions, energy consumption and energy efficiency action in the UK.

Detailed guidance on how to comply with the new obligations to disclose emissions, energy consumption and energy efficiency action in directors’ reports or energy and carbon reports as applicable for financial years starting on or after 1 April 2019 is expected to be published by the government in January 2019. This will build on the current guidance on mandatory greenhouse gas reporting.

Audit

BEIS Committee examines the future of audit

The Department of Business, Energy and Industrial Strategy Select Committee (BEIS Committee) has launched an inquiry into the future of audit alleging that the current audit market is "broken" and that failings in audits, including at Carillion, have helped to undermine public trust in business. As a consequence, the BEIS Committee believes that Parliamentary involvement is needed to give voice to public and shareholder concerns about ineffective corporate governance and ensure that future proposals, including from the Competition and Markets Authority (CMA) market study of the UK statutory audit market and the independent review of the FRC, led by Sir John Kingman, are swiftly acted upon.

The FRC has also announced a strategic programme of work that aims to ensure that audit better serves the public interest. The programme encompasses work on auditor independence, audit quality, the future needs of investors and corporate viability. In light of recent company failures, the FRC will create proposals to strengthen requirements on auditors when considering if an organisation is a going concern, including whether the responsibilities of auditors in assessing companies’ statements on longer-term viability should be increased and whether auditors should publicly report their views of the realism of assessments made by companies. 

Brexit

UK government publishes further technical notices on 'no deal' Brexit

The Department for Exiting the EU has published the fourth tranche of technical notices which focus on the implications of exiting the EU should there be 'no deal' in place. The technical notices follow the issue of the Government’s White Papers: The future relationship between the United Kingdom and the European Union and Legislating for the Withdrawal Agreement between the United Kingdom and the European Union, both of which were published in July 2018.

The latest documents cover a range of subjects, including:

• Business structures - there will be no change in who can be an owner, senior manager or director of a UK company but the requirements for EU companies that operate branches in the UK will change. UK businesses that own or run business operations in EU Member States may face additional requirements or additional approvals to operate, depending on the sector and EU Member State. UK companies and limited liability partnerships that have their central administration or principal place of business in certain EU member states may no longer have their limited liability recognised in jurisdictions that operate the ‘real seat’ principle of incorporation.
• Cross-border mergers involving UK companies - mergers involving UK companies will no longer be able to take place under the relevant EU Directive and EU Member States will no longer be required to give effect to cross-border mergers that do not complete prior to the UK exiting the EU.
• Treatment of "EU" companies - European Economic Interest Groupings (EEIGs), Societas Europaea and European Groupings of Territorial Cooperation will no longer be able to be registered in the UK. Societas Europaea and EEIGs registered in the UK that do not make alternative arrangements before exit will be automatically converted into a new UK corporate structure.
• Accounting and audit - parents of EU businesses and UK incorporated subsidiaries will continue to be subject to the UK's corporate reporting regime. Companies with parents or subsidiaries incorporated in the EU will not be able to benefit from certain exemptions in the Companies Act 2006 relating to the preparation of individual accounts. UK businesses with a branch operating in the EU will become third country businesses and will be required to comply with the specific accounting and reporting requirements in the Member State in which they operate, and UK companies listed in an EU Member State may be required to provide additional assurance to the relevant listing authority that their accounts comply with IFRS. 
• Free trade agreements - the government will seek to bring into force bilateral UK-third country agreements from exit day. If that is not possible, trade would then take place on a ‘Most-Favoured Nation’ basis, or ‘World Trade Organization Terms’, until any such new arrangements have been implemented.

Accounts and reports post-Brexit—draft regulations published

In light of the above, draft Accounts and Reports (Amendment) (EU Exit) Regulations 2018 (Exit Regulations) propose to make amendments to legislation in the field of accounts and reports required of certain types of business undertakings, namely companies, building societies, friendly societies, certain types of partnerships, LLPs and overseas companies.

The Exit Regulations make a number of amendments to CA 2006, Pt 15 in relation to the preparation and filing of accounts by UK companies. These amendments address a number of issues arising from the UK’s exit from the EU, including substituting references to the Accounting Directive with references to domestic legislation, as well as making changes which have more significant impacts, such as limiting the scope of certain exemptions so that they apply only to UK registered companies with UK parents. Where appropriate, similar amendments have been made to legislation which effectively mirrors CA 2006, Pt 15, such as the legislation relating to qualifying partnerships, LLPs, friendly societies and building societies.