Just ahead of new reporting obligations taking effect from January, the Financial Reporting Council has published the Wates Corporate Governance Principles for Large Private Companies. Until now, in the UK only publicly quoted companies have had to select and report against a corporate governance code. However, from January regulations will also require our very largest private companies to state which corporate governance code, if any, has been applied and how. The Wates principles, which have been prepared by a coalition of experts, chaired by James Wates CBE (of family construction business Wates) with support of the Financial Reporting Council, are designed to be capable of adoption by those companies. However, in the introduction, James Wates states "My hope is that a wide range of companies – and not just those included in the new legislative requirement to report on their corporate governance arrangements - will use the Wates Principles. Accordingly, we have kept them flexible and high-level, with guidance provided not as requirements, but to help companies understand how they can apply the Principles." So what is the background to this, what are the reporting requirements, what do the principles cover and, importantly, what should companies do next?
Corporate governance reporting has historically been primarily aimed at quoted companies in order to increase 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 until recently there has been little emphasis on private companies making their internal governance structures public. However, this has changed following a string of high profile corporate failures. These have highlighted the risk to wider stakeholders, including the workforce, suppliers and customers when big businesses fail. The House of Commons select committee which was 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". Further, the government response to its Green Paper on Corporate Governance Reform, noted that it is in the interests of business to have strong corporate governance stating: "It provides confidence not just to shareholders but to other key stakeholders including the workforce, customers, suppliers pensioners and the environment that a company is being well run."
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).
The company must publish a "corporate governance statement" in its annual report and on a website. The company must state: the code, if any, which the company has applied; how it has applied the code 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. 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.
Not so much a code as a set of guiding principles for boards, the six principles cover: (1) corporate purpose and leadership; (2) board composition; (3) director responsibilities; (4) opportunity and risk; (5) remuneration (including executive remuneration structures aligned to long term sustainable success); and (6) stakeholder relations and engagement.
While some guidance is given, the principles are designed to allow flexibility and avoid a "box ticking" approach. Companies are asked to "apply and explain" i.e. by considering each principle within their own particular circumstances and explain how it has been addressed in their governance practices. The principles are not supported by specific provisions, like the full UK Corporate Governance Code for quoted companies. By way of example, principle 2 (board composition) 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 gives guidance, including suggesting that board appointments "promote diversity in line with the protected characteristics within the Equalities Act", and that consideration should be given to "separating the roles of the chair and chief executive" and to "the value of appointing independent non-executive directors to offer constructive challenge". However, unlike the FRC's 2018 UK Corporate Governance Code there is no formal provision to separate the roles of chairman and chief executive or providing that at least half of the directors on the board be independent non-executive directors.
It is noteworthy that the first principle is "An effective board develops and promotes the purpose of a company, and ensures that its values, strategy and culture align with that purpose". It is clear from the code that this is meant to underpin delivery and is specifically also mentioned in the sixth principle – which requires "fostering good stakeholder relationships based on the company's purpose". In the consultation on the principles, earlier this year, the "corporate purpose" was described as a "rationale for existence" to be agreed between key shareholders and the board (although that statement has now been dropped). 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 the service it provides and its core values (though it informs the latter).
As noted in our article "Greater accountability for boards in 2019", the "corporate governance statement" is not the only new reporting requirement. As a result of the regulations, companies that are large (and some medium-sized) for accounting purposes are faced with other new reporting statements relating to stakeholder (including work force) engagement. These companies should be mindful of the wider framework set out in the Wates principles and may, for stakeholder engagement reasons, chose to voluntarily apply and even include a more general corporate governance statement in their reports.
If they haven't already, companies should look to see which reporting requirements will apply to them in their next reporting year commencing after January – see our Corporate governance reporting checker for a questionnaire to help with that. Companies should then prepare a gap analysis to assess what, if any, changes they need to make before the financial year begins. 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. At Mishcon de Reya we have experience of advising companies on the types of corporate governance arrangements covered by the Wates principles. We are, for example, experienced in advising on board and shareholder structures and documentation, arrangements for managing conflicts of interest, training on directors' duties and corporate governance, board and executive remuneration and gender pay, stakeholder engagement structures and whistle-blowing policies.
If you would like to know more about corporate governance and how it might affect your business, please speak to your usual Mishcon contact or a member of our Corporate governance team.