Consultation launched on latest version of UK Corporate Governance Code

The Financial Reporting Council (FRC) yesterday launched a public consultation on the latest iteration of the UK Corporate Governance Code (Code). The full consultation can be found here, including a marked-up version of the proposed Code against the current version.

Publication of this consultation begins to fulfil one of the main proposals set out in the Government white paper (titled “Restoring trust in audit and corporate governance”), issued in 2021. For further background on that paper and the context to this latest revision of the Code please see our previous briefing here.

The Code applies (on a “comply or explain” basis) to companies with a premium listing on the London Stock Exchange but many other companies without a premium listing also use the Code as a yardstick for their governance aspirations, including many AIM and privately-owned companies. Separately, the Financial Conduct Authority (FCA) is currently also consulting on proposals to simplify the existing UK listing regime, including removing the distinction between premium and standard listing segments. If those proposals are implemented, the Code could become directly applicable to a wider group of companies, including those currently with a standard listing.

The consultation will be open for comments until 13 September 2023 and the FRC has said that it intends that the revised Code will apply to accounting years commencing on or after 1 January 2025. This is a year later than previously advised and means that most affected companies should have time to consider any prospective changes to remuneration arrangements before the new Code begins to apply.

Several significant changes to the Code are proposed, including expanded responsibilities for audit committees and enhanced reporting on risk management and internal control systems. However, in this briefing we have focused on the proposed new aspects in the revised Code that will be relevant to those responsible for executive remuneration. The following is a summary of those new aspects and our initial comments on their significance.

Malus and clawback

As expected, the FRC has proposed that the revised Code will strengthen reporting on malus and clawback arrangements, to include disclosure of:

• the minimum circumstances in which malus and clawback provisions could be used;
• the minimum period of application for malus and clawback and why the selected period is best suited to the organisation;
• whether the provisions have been used in the last reporting period and a clear explanation of the reason for application; and
• any use of malus and clawback provisions in the last five years.

In addition, the revised Code sets an expectation that malus and clawback provisions should be incorporated into the employment contracts of executive directors (in addition to remuneration policies and relevant incentive documentation such as plan rules), in order to improve enforceability.

FIT comment: As the consultation document acknowledges, some of these disclosures have been standard for listed UK companies for several years, as the UK directors’ remuneration reporting regulations already require an explanation of malus and clawback provisions. However, the revised Code will go further and require additional disclosures including details of the application of malus and/or clawback provisions going back up to five years. This extends the continuing trend of including ‘lookback’ reporting on various aspects of UK executive remuneration which will further expand the length of directors’ remuneration reports. 

The consultation acknowledges the risk in prescribing a one-size-fits-all approach and the FRC has not (yet) stated which triggers might be expected for application of malus and clawback. The supporting guidance to the 2018 Code included a set of recommended triggers which included payments based on erroneous or misleading data, misconduct, misstatement of accounts, serious reputational damage and corporate failure. An updated version of that guidance is not expected until the final Code is published (probably in late 2023 or 2024). It therefore remains to be seen if the FRC will provide guidance on what ‘minimum’ compliance looks like.

ESG objectives

The remuneration principles of the revised Code will be reworded to set an expectation that remuneration outcomes are aligned with corporate performance in the wider sense, including ESG objectives. In addition, remuneration committees will be required to explain how executive director remuneration policies support “company strategy and environmental, social and governance objectives”.

FIT comment: The introduction of explicit references to ESG objectives is unsurprising given the increased focus on this topic since the Code was last updated in 2018. Most remuneration committees will already be aware that this is an area of particular and growing focus from many institutional investors, some of whom have begun to mandate inclusion of ESG metrics into executive incentive arrangements, e.g. LGIM. This also dovetails with other regulatory initiatives to improve ESG reporting and the link to incentive arrangements. For example, earlier this year the FCA issued a discussion paper regarding how sustainability‑related objectives can be linked to the design and operation of incentive plans for financial services firms.

Increased emphasis on workforce

The list of considerations that a remuneration committee should take into account when authorising remuneration outcomes will be expanded to include explicit consideration of “workforce pay and conditions” (although this has long been a factor for directors to have regard to under section 172 of the UK Companies Act). Companies will also be required to disclose any engagement with the workforce (as well as shareholders) and the resulting impact on executive remuneration and overall company pay policy.

FIT comment: The current Code already includes an expectation of workforce engagement and consideration by remuneration committees. However, the proposed changes to the Code appear to have changed the emphasis of those requirements. Under the draft Code, remuneration committees will need to be ready to take into account and explain the impact of workforce engagement/ pay and conditions, on executive remuneration, including outcomes. Companies will remain free to disclose that there is no impact but some will feel that the bar has been raised regarding the expected level of disclosure and justification.

Replacement of Provision 40

Provision 40 will be replaced with a new requirement that a remuneration policy should be “clear, identify and mitigate risks associated with remuneration, and ensure outcomes are proportionate and do not reward poor performance".

FIT comment: The current provision 40 sets out a list of areas that remuneration committees should address when determining executive directors’ remuneration policy and practices (clarity; simplicity; risk; predictability; proportionality; and alignment to culture). Recent FRC corporate governance reporting reviews have noted the tendency of companies to echo the language in the Code, instead of providing tailored content. Under the revised Code the onus will now be on companies to ensure their disclosures reflect their own specific circumstances. In our view this is a good change.

There are other changes and deletions proposed in the revised Code, including removal of the current reference to pay gaps and pay ratios (in order to prevent duplication with disclosures elsewhere in annual reports). It is also worth noting the aspects of the existing Code that are not expected to change. In particular, some commentators have recently queried whether the opposition to non-executive directors receiving share incentives or performance related remuneration should be removed. However, no changes have been proposed to this in the consultation.

The FRC has also said that it is working on supporting guidance, including an update of the ‘Guidance on Board Effectiveness’, which will be made available when the new Code is published following this consultation. The supporting guidance has historically been crucial because it has included detailed guidance such as expected malus and clawback triggers; the 2018 Code guidance listed five triggers (noted above) which have since become very common in many UK listed company remuneration policies and incentive arrangements.

FIT comment:

Compared to previous iterations of the Code, the changes proposed in this revision are arguably relatively modest and not dissimilar to the existing expectations of some institutional investors and proxy advisory firms. However, in several places the tone and emphasis of the Code has noticeably changed. For example, the consultation generally emphasises the need for “transparency” and the new aspects of the remuneration provisions will extend the required disclosure and rationale from remuneration committees when justifying remuneration outcomes, e.g. alignment with ESG objectives, taking account of workforce pay and conditions.

Taken together, these changes will modestly increase the expected levels of disclosure, justification, and scrutiny that companies can anticipate for remuneration reports published from early 2026 onwards. The FRC has a difficult role and some interested parties will consider that the changes do not go far enough, whereas others will complain that they go too far. Given the background to this iteration of the Code, we take the view that the proposed changes are at the lower end of what might have been expected. 

This consultation arrives at an interesting time for UK executive remuneration. In recent months a broader debate has been taking place regarding the burden of legislative and governance requirements for UK listed companies (set in the context of a number of UK businesses choosing to list or move their listing outside the UK, especially to the US). Our last Executive Briefing discussed Julia Hoggett’s recent call for a “constructive discussion” about the approach to executive pay in the UK (please see our briefing on the debate here). While the proposals could have gone further, it should be noted that they reflect a further tightening of what is already the most onerous regime globally.

If you wish to discuss anything arising from this briefing, please ask your usual contact at FIT or email us using the links below.