This report from the UK Financial Reporting Council (FRC) provides good inspiration for boards of directors of listed European companies, on why and how to move away from treating governance reporting as simply a compliance exercise, using it instead to build transparency and stakeholder trust.
For the 2nd year, the FRC reviewed how a random sample of UK premium listed companies reported on their application of the 2018 UK Corporate Governance Code. The purpose was to point out where reporting could be improved, as well as promote and support good practice by using concrete examples and showing clear FRC expectations.
One key finding was that companies are still failing to disclose departures from the Code (i.e., too many forget that a company can comply with the code even if they do not follow the recommendations, as long as they provide a good, detailed, convincing explanation of why they have chosen to do something different).
The FRC’s overall conclusions are that there is still room for improvement in relation to both disclosure of departures and the quality of explanations.
“There continues to be a need for greater clarity as to how a company is applying the Code’s principles as well as clearer explanations where there are departures from the Code so that shareholders and stakeholders have greater confidence of the quality of governance… Unfortunately, companies continue to use boilerplate or declaratory statements. These statements are seldom substantiated by actions or examples, and therefore do not offer insight into company governance”.
According to the FRC, improved use of the “comply or explain” reporting should include a list of departures from the Code, with a detailed explanation for each departure. The FCA Listing Rules require companies to include in their annual reports:
1) a statement of how the company has applied the Principles set out in the UK Corporate Governance Code, in a manner that would enable shareholders to evaluate how the principles have been applied.
2) a statement as to whether the listed company has:
a. complied throughout the accounting period with all relevant provisions set out in the UK Corporate Governance Code; or
b. not complied throughout the accounting period with all relevant provisions set out in the UK Corporate Governance Code and if so, setting out:
i. those provisions, if any it has not complied with;
ii. in the case of provisions whose requirements are of a continuing nature, the period within which, if any, it did not comply with some or all of those provisions; and
iii. the company’s reasons for non-compliance.
(Source: Improving the Quality of Comply or Explain Reporting)
The annual report should clearly demonstrate:
1) The action taken by the company: What Provision it has departed from and what alternative approach it has chosen.
and
2) The outcome: How is that alternative approach more efficient and appropriate than that prescribed by the Code, and how is it helping the company to achieve good governance?
Here are two FRC examples: a good overall statement and a solid explanation:
“Throughout the financial year ended 31 December 20XX, the company fully complied with all
the provisions of the Code, except for provision 9 and we have provided a full explanation.”
Based on our European client experiences and reading various annual reports on code compliance, our opinion is that the same conclusions are true for non-UK listed companies – there is still room for improvement when reporting on departures from the Code, and these improvements will be worth the time spent, as they will lead to increased transparency and stronger stakeholder confidence.
See the full FRC report at this link.
See also this interesting report with good learnings, published by the FRC in Feb. 2021: Improving the Quality of Comply or Explain Reporting.
If you’d like to discuss ways to improve your annual reporting about how your company has applied the Governance Code, don’t hesitate to contact us here:
