FRC unveils finalised private company corporate governance principles

Out-Law News | 12 Dec 2018 | 2:00 pm | 4 min. read

The UK’s Financial Reporting Council (FRC) has published the final version of new corporate governance principles for private companies.

The UK’s Financial Reporting Council (FRC) has published the final version of new corporate governance principles for private companies.

The six principles (28 page / 751KB PDF) are largely unchanged from the consultation released in June and deal with the same areas: purpose and leadership, board composition, board responsibilities, opportunity and risk, remuneration, and stakeholder relationships and engagement.

The principles are set out in a pyramid format in the final document, with 'purpose and leadership' as the 'North Star'. Board composition and responsibilities are defined as characteristics of governance, with the remaining three principles under the heading of 'specific matters'.

They are designed to help companies comply with new corporate governance disclosure requirements introduced in June, under the Companies (Miscellaneous Reporting) Regulations 2018. These apply for accounting periods starting on or after 1 January 2019 to all UK-incorporated companies with more than 2,000 employees, or a turnover of more than £200 million and a balance sheet of over £2 billion, assessed for the individual company rather than on a consolidated basis. It does not apply to listed companies that are already subject to similar legal corporate governance requirements. Affected companies must explain which corporate governance code they apply and how, or if they apply no such code must describe their own corporate governance arrangements.

The aim was to design principles which enabled a diverse range of companies to explain their corporate governance arrangements, without being too prescriptive. However they do not override directors' duties as set out in section 172 of the Companies Act 2006 and this has been clarified in the final document.

Corporate governance expert Tom Garbett of Pinsent Masons, the law firm behind, said: "The final Wates Principles remain largely the same as the version put out to consultation in the summer of 2018, with the exception of an emphasis on the board's responsibility not only for the promotion of a company’s purpose, but also its development."

"Making clear the importance of a mid to long term approach, references to sustainability and long-termism in the risk and remuneration principles, respectively, reflect the direction of travel in UK corporate governance generally," Garbett said.

Each principle is supported by guidance to companies. Respondents to the consultation said the draft principles did not recognise the importance of environmental and social issues, and the final version has added guidance which advocates developing risk management systems to support informed decisions relating to such matters. The guidance now specifically refers to a company’s workforce in principle 6.

"Principle 6 - engagement with stakeholders - has been extended to specify that meaningful engagement with stakeholders should take place, in particular with the workforce which is mentioned explicitly, and that engagement should, in turn, influence the decisions of the board," Garbett said.

"Demonstrating that engagement is both sufficiently meaningful and that the consultation has impacted on the thinking of the board may require careful thought from boards adopting the principles, although careful minuting will no doubt assist," Garbett said.

Two other new reporting requirements, and an expanded version of an existing reporting requirement, will also start to apply at the same time as the corporate governance arrangements reporting requirements for which the Wates Principles were drafted. Companies which produce a strategic report will have to include in it a statement setting out how their directors have met obligations to act in good faith to promote the success of the company. They must take account of factors listed in section 172(1) of the Companies Act 2006, including the interests of employees, customers, suppliers and other business counterparties.

Large companies will also have to provide greater detail than before about how they engaged with employees. Similarly, large companies will also have to explain for the first time how they have engaged with suppliers, customers and others in a business relationship with the company.

Large private companies subject to the new corporate governance reporting requirements will also be subject to all of these other reporting requirements, as the minimum private company size threshold for those to apply is considerably smaller than the size threshold for corporate governance reporting.  

The FRC said companies adopting the Wates Principles should follow them using an "apply and explain" approach, with the result that each principle should be considered within the context of the company's specific circumstances and the approach taken explained. This provides greater flexibility than the UK Corporate Governance Code's "comply or explain" approach for premium listed companies, which requires explanation of non-compliance, and is in line with the overarching regulatory position taken by the FRC, to move beyond a tick box approach, to describing how corporate governance practice achieves the principles and demonstrates outcomes.

Garbett said the addition of detail to the guidance accompanying the principles was the most substantial change from the consultation.

"The 'apply and explain' approach taken by the principles means that the intention is for companies to explain how they have applied the principles, informed by the guidance. This means the level of flexibility promised pre-consultation remains but with the benefit of more sure-footed guidance in support," Garbett said.

Garbett said the broad approach of the principles and the relative freedom of companies to explain their application in context would be welcomed by many companies, especially those for whom formal compliance with a corporate governance code is new.

Companies will have to provide a supporting statement explaining how corporate governance policies and processes operate to achieve the desired outcome for each principle.

The principles come into force on 1 January 2019, at the same time as the new UK Corporate Governance Code.

The Wates Principles were drawn up by a coalition established by the FRC and chaired by James Wates, who heads a large UK private construction company.