Until now, in the UK only publicly quoted companies have had to select and report against a corporate governance code. Not so, unquoted companies. However, that looks set to change in January next year. Largely as a result of the fall-out from recent high profile corporate collapses, draft regulations, if enacted, will require our very largest companies to "comply or explain" against a chosen code in their annual reporting. A coalition of experts, chaired by James Wates CBE (of family construction business Wates) and with support of the Financial Reporting Council, has now published a draft code (the "Wates Corporate Governance Principles for Large Private Companies") for consultation. While only the very largest private companies will be required to "comply or explain" against a corporate governance code, the regulations will also introduce other new reporting requirements, which will apply to a far greater number of private companies. So what is the justification for this and what are the requirements?
Corporate governance reporting for quoted companies has historically been primarily aimed at increasing transparency and accountability of the board to current (and future) shareholders. Where a company's shares are not in public hands, a company's management is accountable to its shareholders privately, so why should they be faced with making their internal governance (including management pay) structures public? An answer is possibly found in the perceived decline in public trust following a string of high profile corporate failures. As the introduction to the Wates principles points out, they have highlighted "severe risks to wider stakeholders including the workforce, suppliers and customers when big business fails". A House of Commons select committee commissioned to look at what could be done noted in its Corporate governance report that "while no law or set of principles could remove the risk of serious corporate failings, a code of corporate governance for large private companies can serve to raise awareness of good practice and, over time, help to improve standards of private governance in private companies, large and small".
Which companies will the "comply or explain" requirement apply to?
As currently drafted, the regulations require a "corporate governance statement" to be included in an annual report and published on its website by any private company which in the reporting year had: (1) more than 2,000 employees; or (2) turnover of more than £200 million and a balance sheet total of more than £2 billion (in each case globally).
What does it comprise?
The corporate governance statement must state: the code, if any, which the company has applied; how it has applied it and, if it has departed from it, the reasons for doing so. If it has not applied a code, the company must also give reasons. This is very similar to the reporting language recently introduced under the AIM rules for AIM quoted companies - see further new AIM requirements and QCA Code. With the requirements to report applying to financial years commencing on or after 1 January 2019, we are unlikely to see the first reports until September 2020. However, those companies which are large enough to possibly meet either of the two above criteria, should nevertheless be preparing for implementation.
What do the Wates principles cover?
Not so much a code as a set of guiding principles for boards, the six principles cover: (1) corporate purpose; (2) composition of the board; (3) board responsibility and accountability; (4) the creation and preservation of value and mitigation of risk; (5) executive remuneration aligned to sustainable long term success and pay elsewhere in the company; and (6) stakeholder engagement, including with the work force.
While some guidance is given, the principles are designed to allow flexibility and avoid a "box ticking" approach. Companies are asked not merely to "comply or explain" but "apply and explain". The principles are not supported by specific provisions, like the full UK Corporate Governance Code for quoted companies. They are designed to be "outcomes" focussed and allow companies to apply them in different ways. An example of this is given in relation to principle 2 (board composition). This principle sets out that "Effective board composition requires an effective chair and a balance of skill, backgrounds, experience and knowledge, with individual directors having sufficient capacity to make a valuable contribution….." The code explains that, while a large family owned company might seek to appoint an independent director to its board for independent challenge, a large subsidiary of a UK listed company may establish an advisory committee to seek independent objective advice as to the board effectiveness. Both should explain in their reporting how this has improved director decision-making. This is quite distinct from the FRC's 2018 UK Corporate Governance Code for listed companies, which provides that at least half of the directors on the board be independent non-executive directors and sets out circumstances which are likely to impair independance.
What is a "corporate purpose"?
It is noteworthy that the first principle is to "promote the purpose of a company, and ensure that its values, strategy and culture align with that purpose". This "corporate purpose" is described in the code as a "rationale for existence" to be agreed between key shareholders and the board. A purpose should make it "easier for companies to engage with their customers, workforce and the wider public" and is specifically also mentioned in the sixth principle – which requires "fostering good stakeholder relationships based on the company's purpose". No examples are given of what a corporate purpose might be, but it appears to be more fundamental and assume a wider impact on society than merely what a company manufactures or its core values (though it informs the latter). Perhaps some inspiration might be taken from the Wates corporate website which describes James Wates as "having the ultimate goal of creating a higher quality built environment, stronger communities and a better society". Might that be reflected in the company's purpose too?
What about other private companies?
The Wates principles state "it is hoped that the principles will provide a useful tool for a wide range of companies (not just those covered by the reporting requirement) to understand and adopt good practice in corporate governance". This is interesting: particularly so, given that the regulations introduce other new reporting requirements which overlap with the Wates principles. Boards of private companies qualifying as large for accounting purposes (a much wider category than the very large companies described above) will be required to include:
- a directors' duties statement explaining how they have had regard to specified factors (including to take account the needs of employees, the environment etc.) when performing their duty to "promote the success of the company"; and
- a stakeholder statement summarising how the directors have had regard to the need to foster the company's business relationships with suppliers, customers and others.
Furthermore, boards of companies with more than 250 employees will be required to make a detailed "employee engagement statement" covering the board's action to engage with employees.
Conclusion and more information
Private companies should start by assessing which set of rules, if any, are likely to apply to them and prepare a gap analysis to assess what, if any, changes they need to make. Many companies will already have sound corporate governance structures. However the new requirements will doubtless act as a catalyst for review and, if necessary, realignment. Further guidance is available in the draft Companies Miscellaneous Reporting Regulations 2018 and the BEIS Q&A.