The European Commission published its Recommendation on the role of non-executive directors in February 2005. Member States were invited, but not required, to promote the application of the Recommendation's principles by 30 June 2006. With this date almost upon us, the following is a summary of the current position. The principles are applicable to listed companies, although Member States are allowed to extend the ambit to unlisted companies. The Recommendation endorses the "comply or explain" approach of the UK Combined Code. The UK will most likely preserve this approach, which the Commission notes is often more efficient than the binding legislation Member States can opt for as an alternative.
The Recommendation is unlikely to have any significant effect on non-executive directors in the UK. The Combined Code already broadly encompasses the Recommendation's provisions, and the UK government is not expected to introduce any further regulation as regards compliance.
To recap, in brief, the Recommendation outlines the following:
- Non-executive directors should be appointed for a specific term and should have "the right background and sufficient time for the job" to ensure they can properly undertake the role.
- All new board members must have a specifically tailored induction programme outlining their role and the company's structure and organisation.
- The scope, operation and transparency of remuneration, nomination and audit committees and their relationship with the supervisory board. These committees make recommendations to the board which retains authority to make the final decision.
- Supervisory boards should include a balance of executive and non-executive directors, precluding a minority from dominating decision-making. There should be a sufficient number of non-executive directors to ensure their efficacy where there is a high risk of conflict of interest.
- The roles of the Chairman and the CEO could, it is suggested, be separated in a unitary board as one possible option for ensuring the chairman's objective judgement. This is a marked relaxation of the previous draft's provision, which provided that the roles should normally be separate.
- The board should annually review its capability to meet the expectations of shareholders, with regard to each director individually and the board as a whole. Furthermore, it should incorporate an evaluation of the performance of the board committees. The company's report should consider whether the review has prompted any material changes.
- The role of non-executive directors in detail with the aim of ensuring their efficacy. Provisions are made regarding appointment and removal, commitment, qualifications and ability to be independent. They are deemed independent where they are free from material conflict of interest.
The Recommendation includes two Annexations which further detail committee structures and criteria for determining non-executive directors' independence. Following criticism by Member States and companies these provisions were removed from the main body of the Recommendation and now merely constitute "further guidance".
Although the Commission outlines that it has no intention to create a European Corporate Governance Code, it contends that the EU should pursue a common approach regarding certain fundamental rules and should ensure that Member States' corporate governance codes co-ordinate effectively. Whilst Member States are not obliged to implement the Recommendation, their response will be crucial in determining whether there is to be subsequent formal legislation in this field.