Out-Law Guide | 09 Mar 2010 | 9:25 am | 5 min. read
The Financial Reporting Council (FRC) may be the custodian of the UK Corporate Governance Code but compliance is a matter for the Listing Rules. Produced by the Financial Services Authority, these Rules regulate all companies (UK and overseas) with a premium listing on the London Stock Exchange.
The UK Corporate Governance Code does not apply to:
There is, though, nothing to stop such companies complying with the Code if they choose to do so. Shareholder pressure, or simply a wish to conform with “best practice”, may lead many “exempt” companies to follow some or all of the Code’s recommendations. Most of the Code’s principles, if not all the detailed provisions, provide a sound basis for the governance of many companies.
Indeed, the Code’s reach increasingly extends beyond its immediate “target group”. The Code has been the impetus for the development of a more formalised approach to governance in other sectors. Universities have produced their own governance code; public sector bodies have guidance from the Independent Commission on Good Governance in Public Services. And mutual life companies are expected to follow guidelines on governance produced in the wake of the Equitable Life inquiry.
The UK Corporate Governance Code does not apply to AIM companies, and there is no equivalent set of guidelines in the AIM Rules. One reason for this is that AIM is a less regulated market, attracting companies from around the world by its ‘light touch’ regime. Given this absence of regulation, the safeguard for shareholders is the broker or sponsor that acts as the company’s nominated adviser or ‘nomad’.
The nomad is in many ways the conscience of the company, checking, cautioning and advising the company on compliance with the rules and good practice. Two obligations highlight this role:
That is the limit of the governance regulation on AIM. And with many AIM companies based overseas, sometimes with large family or founder shareholdings, there is great flexibility for controls that fit the local circumstances.
For those who nonetheless want a ready-made code, there is a set of guidelines produced for AIM companies by the Quoted Companies Alliance (details and cost available from the QCA). These do not have a comply or explain format (see The comply or explain rule, below), but rather are a set of minimum standards to be followed in their entirety.
Whether you adopt the basic rules from the QCA or favour compliance with the relevant bits of the Code, best practice suggests you should describe your governance systems each year in the company’s annual Directors’ Report.
The Code is divided into “main principles”, “supporting principles” and “provisions”. The main principles are general statements of corporate life, which, at times, come close to motherhood and apple pie in their level of general acceptability. The first, for example, states: “Every company should be headed by an effective board, which is collectively responsible for the success of the company”. Supporting principles expand on the main principles and give more guidance. But it is the Code’s provisions that state the detailed requirements necessary, in the view of the Code’s authors, to make sure the principles are upheld.
The Listing Rules seek to give the principles and provisions some force by placing two requirements on companies with a premium listing:
This brings us to a key feature of the UK Corporate Governance Code, copied to an extent by other codes derived from it: its regime of “comply or explain”. Listed companies must comply with the Code’s detailed provisions or explain why they do not. Ignoring the Code is not an option; but if you have good reason to deviate from its terms, you may do so and leave it up to your members/shareholders to decide whether your reason is good enough.
So non-compliance with a term of the Code is not a breach; failure to explain is. If you can talk to shareholders and demonstrate that departures from the Code’s provisions are consistent with its principles and in the company’s best interests, then non-compliance is unlikely to become a big issue.
Shareholders have no specific sanction if they disapprove of what you are doing, short of voting against the directors’ remuneration report if the debate is over boardroom pay, or voting one or more directors off the board – a somewhat extreme step. What they can do, though, is apply pressure with the aim of persuading the board to change its mind.
As the case of the supermarket chain Morrisons shows, this can be most effective at those junctures when a company needs the support of its shareholders. (See case study below.)
If the shareholders are not big enough or well organised enough to exert pressure or if they are unwilling to take the opportunities they have to do so, then the board can decide how much it complies. The key point is that the Code and its provisions are not compulsory; they are there for guidance and represent best practice.
Some years ago, the supermarket chain Morrisons seemed unencumbered by corporate governance principles. The company, led by the septuagenarian Sir Ken Morrison as full-time executive chairman, had no non-executive directors, no audit or remuneration committees and no shame in explaining that it did not think these were necessary. It was a FTSE 100 company and very much in the public eye. Institutional shareholders might not have liked its public defiance of generally accepted principles, but Morrisons was successful, and there was little they could do about it.
Things began to change after Sir Ken decided to bid for rival chain Safeway in 2003. The chairman needed to raise the money for the bid from shareholders, and one of the conditions they imposed was that he should at least appoint two non-executive directors. Over a year later and just before the AGM, two new non-executives duly appeared (though one resigned 10 months later). One institutional shareholder group commented, recognising the uphill task they still faced: "we welcome this step towards better corporate governance and hope to see formal board meetings established in due course."
Integration of the Safeway stores did not go smoothly, profit warnings followed and the company acknowledged failures in its internal controls, all of which gave shareholders the opportunity to argue that its governance wasn’t working. Step by step, Morrisons came to have a full complement of board committees, a majority of non-executives on the board and to separate the roles of chairman and chief executive.