26.Sep.2018

New corporate governance requirements for public and private companies

Background

The Government announced last year, in response to its green paper on corporate governance reform, that new legislative measures would be introduced to improve and strengthen the existing corporate governance regime in the UK.

To that end, the Companies (Miscellaneous Reporting) Regulations 2018 (Regulations) were published on 17 July and provide us with both a clearer picture of some of the new reporting requirements and also the companies that will be subject to these measures. 

In addition to the Regulations, a question and answer paper was published in June providing further guidance on the new requirements (FAQ Paper).

From when do the Regulations apply?

The new reporting requirements will apply for financial years beginning on or after 1 January 2019 (so companies will report on the relevant requirements from 2020).

Which companies will be subject to the new reporting requirements?

Different exemption thresholds apply to the various reporting requirements and so a company may be subject to some, but not all, of the new measures.

This table sets out, at a glance, the companies that will fall within the scope of each new reporting requirement and where it must be addressed.

New reporting requirement

Relevant report for new requirement

Companies subject to the new requirements

Section 172(1) statement

Strategic report

A company that meets at least two of the following criteria:

  • turnover of more than £36 million
  • balance sheet total of more than £18 million
  • more than 250 employees

Statement on engagement with employees

Directors’ report

All companies with on average more than 250 UK employees during the financial year

Statement on engagement with suppliers, customers and others in a business relationship with the company

Directors’ report

The same criteria as for a section 172(1) statement above

Statement of corporate governance arrangements

 

Directors’ report

A company that meets either one or both of the following criteria:

  • it has more than 2,000 employees; and/or
  • it has a turnover of more than £200 million and a balance sheet of more than £2 billion

Pay ratio reporting

Directors’ remuneration report

A company is required to provide pay ratio information if:

  • it is quoted on the UK Official List, the New York Stock Exchange, NASDAQ or a recognised stock exchange in the EEA (and excluding companies listed on AIM); and
  • the average number of UK employees is more than 250

 

Section 172(1) statement

Section 172(1) of the Companies Act 2006 (the Act) sets out that a director must act in the way he considers would be most likely to promote the success of the company for the benefit of its members as a whole.  In fulfilling this duty, a director should have regard to a number of factors, including the interests of the company’s employees and the need to foster the company’s business relationships with suppliers, customers and others.

Under existing measures, subject to exemptions most companies are already required to provide a strategic report that is designed to “inform members of the company and help them assess how the directors have performed their duty under section 172 of the Act”. 

Notwithstanding this, the Government concluded that there was merit in introducing formal reporting requirements on how directors have had regard to the requirements of section 172(1) to both ensure that directors think carefully about how they take account of these matters and to reassure stakeholders that companies are being run with a view to their longevity.

Under the Regulations, companies subject to the new requirement will need to include a new section 172(1) statement in the company’s strategic report setting out how the directors have had regard to the matters set out in section 172(1) when performing their duties.   This new statement must be provided in a separately identifiable statement within the company’s strategic report.

The FAQ Paper provides that, whilst the information companies should include in their section 172(1) statement will depend on the individual circumstances of each company, companies will likely want to include information on:

  • the issues, factors and stakeholders the directors consider relevant in complying with section 172(1);
  • the main methods the directors have used to engage with stakeholders and understand the issues to which they must have regard; and
  • information on the effect this has had on the company’s decisions and strategies during the relevant financial year.

The Financial Reporting Council has included further guidance on how companies should report on the new section 172 requirement in its revised Guidance on the Strategic Report.

The section 172(1) statement must be made available on a website maintained by or on behalf of the company (so, for example, the statement for a subsidiary could be published on the website of its parent as long as it clearly identifies the subsidiary).

Statement on engagement with employees

A company that meets the qualifying criteria must include a statement in its directors’ report setting out the action that has been taken by the company to introduce, maintain or develop arrangements designed to:

  • provide employees with information on matters of concern to them;
  • consult employees or their representatives on a regular basis so that the views of employees can be taken into account in making decisions that are likely to affect their interests;
  • encourage the involvement of employees in the company’s performance through an employees’ share scheme (or by other means); and
  • achieve a common awareness on the part of all employees of the financial and economic factors affecting the performance of the company.

The statement must also set out how the directors have engaged with employees, how the directors have had regard to employee interests, and the effect of this including on principal decisions taken by the company during the financial year.

The statement need not include any information about “impending developments or matters in the course of negotiation” if the disclosure would be seriously prejudicial to the interests of the company.

Statement on engagement with suppliers, customers and others in a business relationship with the company

For companies within the scope of this requirement, the directors’ report must contain a new statement summarising how the directors have had regard to the need to foster the company’s business relationships with suppliers, customers and others, and the effect of this (including on the principal decisions taken by the company during the financial year).

Statement of corporate governance arrangements

Until now, the UK corporate governance and reporting regime has applied solely to public companies but, in its response to the green paper, the Government concluded that the case had been made to strengthen the corporate government requirements for some of largest UK private companies.

For qualifying companies, the directors’ report must include a statement of corporate governance arrangements that identifies which, if any, corporate governance code the company applied during the financial year and how the company applied it.

If the company departed from any aspect of the relevant code applied by the company, the statement must also include details of this together with the reasons for the departure. 

Finally, if the company did not apply any corporate governance code during the relevant financial year, the statement should set out why that is the case and what alternative arrangements for corporate governance the company applied instead.

The statement of corporate governance arrangements will form part of the directors’ report of a qualifying company and must be available on a website maintained by or on behalf of the company.

What corporate governance code will qualifying companies apply?

The Government appointed James Wates at the beginning of the year to chair a coalition of various industry bodies and other organisations to develop a set of corporate governance principles specifically for private companies.  

The Financial Reporting Council published for public consultation the Wates Corporate Governance Principles for Large Private Companies (the Principles) shortly after the draft Regulations were laid before Parliament. 

Whilst the Regulations allow a qualifying company to choose which, if any, corporate governance code it will apply, companies may elect to use the Principles as an appropriate framework when reporting on its corporate governance arrangements. 

The consultation on the Principles has closed with final Principles due to be published in December.

We have published a separate briefing note on the Principles which is available here.

CEO pay ratio reporting

One of the proposals put forward by the Government in its green paper was to require quoted companies to publish ratios in its directors’ remuneration report comparing the remuneration of a company’s CEO to that of the rest of its UK workforce. 

Companies within the scope of the new reporting requirements must include a new pay ratios table in its directors’ remuneration report.  

We have published a separate briefing note on the new pay ratio reporting requirement together with other financial reporting obligations set out in the Regulations which is available here.

Commentary and next steps

It is clear that some of the UK’s large companies will need to review carefully the Regulations and which, if any, new reporting requirements will apply.

Qualifying companies will also need to ensure they have the necessary arrangements in place to meet the requirements set out in the Regulations next year in order to report in 2020.

The three core aims of the green paper on corporate governance reform were to address concerns around executive pay, strengthen the voice of employees and other stakeholders and look to extend the corporate governance framework to the largest privately-owned UK companies.  The Regulations address these issues and will provide greater transparency on each of these areas of reform. 

The Regulations are one aspect of implementing the Government’s corporate governance reforms.  A range of other measures are being introduced including the recent changes to the corporate governance code, which we will report on separately.

Please contact your usual Shepherd and Wedderburn LLP contact for advice in relation to the Regulations and new reporting requirements.

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