All change please? Governance reform proposals round-up

Those immersed in corporate governance are used to a shifting legal and regulatory regime. At times, it can feel like we are constantly adapting to the plethora of changes or proposals announced, consulted on, and - in what can seem like a minority of cases - actually introduced. Following a period of relative stability in the corporate governance sphere, significant changes impacting multiple aspects of the corporate governance landscape have been advanced over the past 12 months as part of three long-trailed reform programmes:

• a new UK Corporate Governance Code (Code), following the workstreams to strengthen audit, corporate reporting and corporate governance in the UK;  
• the transformation of Companies House, through the Economic Crime and Corporate Transparency Act 2023 (ECCTA), which also makes significant changes to the company administration regime; and
• an overhaul of the UK listing regime, flowing from the recommendations of the Hill Review.

Against the backdrop of ever more vocal criticism that the UK is an increasingly unappealing place for companies not least due to the burden of regulation, the government and regulators appear to be heeding these growing calls to address some of the challenges facing UK companies in a globalised world.

So what do the reforms involve, and will they achieve their aims?

Update of the UK Corporate Governance Code

In terms of changes to the Code, in many respects, it is more a matter of what the Financial Reporting Council (FRC) has not done than what it has.

In its consultation published in May 2023, the FRC proposed substantial changes to the Code to both implement a number of the audit and governance reform measures outlined by the government in its May 2022 Restoring trust in audit and corporate governance consultation response^[1] and carry out a general update of the Code since its last review in 2018. 

In terms of the audit and governance reform measures advocated by the government, the FRC's consultation duly reflected the government's proposed secondary legislation published in July 2023 and would have required companies to publish an audit and assurance policy, a resilience statement and a material fraud statement amongst other things.

However, the government's abrupt U-turn on these regulations in October 2023 necessitated a rethink by the FRC.  As did the fact that the November 2023 King's Speech did not include an audit, corporate reporting and governance bill, which amongst other things would have created the Audit, Reporting and Governance Authority (ARGA), the successor regulator to the FRC.

Against this backdrop, no doubt reading the prevailing mood music and in a welcome move, the FRC rowed back on many of its original proposals. Instead, the FRC focused primarily on streamlining certain aspects of the Code and reducing duplication – changes which were overwhelmingly supported in the consultation process.

The main substantive change to the Code is that it is more prescriptive in relation to how the board should report on their annual review of the effectiveness of the company's material internal controls (see the box below for details of the disclosures required). Having listened to the feedback received about the burden its original proposals would impose and to support "UK economic growth and competitiveness", the FRC scaled back the requirements in relation to internal control disclosures, describing the changes as "a targeted and proportionate Code revision". Whilst this is not a UK version of the US Sarbanes-Oxley regime, these changes will require companies to consider the robustness of their risk management and internal controls frameworks and in particular what level of additional information and assurance boards might need now that they are required to provide a formal declaration of effectiveness.

In light of the government's audit and governance reform agenda, in May 2023 the FRC also published a minimum standard for audit committees (Standard), which covers areas such as the external audit tender process (which the audit committee should lead), the oversight of the external auditor and the disclosures to be included in the annual report on the work of the audit committee. Companies will need to consider the Standard carefully, especially when initiating an audit tender process and when reporting on compliance with the Standard in the annual report and accounts.

The FRC has also replaced the list of specific diversity characteristics that boards should look at when appointing directors and developing succession plans, with a more generic provision to "promote diversity, inclusion and equal opportunity". The accompanying Code guidance indicates that the FRC wants to leave it to boards to decide which aspects of diversity are important in the context of their business and its needs.

Noting that the Code has the advantage of operating on a flexible, "comply or explain" basis, it will be interesting to see whether the approach of giving more leeway to companies to decide what is material and relevant to their business will be adopted in other areas of governance and reporting. 

The transformation of Companies House from letterbox to regulator  

Despite being created over 180 years ago, Companies House had a limited range of powers compared to other UK regulators and had come to be regarded as a passive recipient of information. With the ECCTA, it is expected that it will become a much more active gatekeeper of the register of companies in the UK, aiding confidence in the UK business environment and helping UK companies take advantage of technological improvements in company administration. Whilst ultimately this may help create a more stable and certain business environment, in the short to medium term, a number of changes introduced by the ECCTA will require a degree of preparatory work for companies and increase the administrative burden on them if new internal processes need to be put in place – the new identity verification requirements for directors, those filing information with Companies House and certain others, in particular.

The proof of whether Companies House will live up to these expectations will be in the implementation of the ECCTA: will Companies House use its new powers to make it easier to do business? Will it be able to move to a more efficient and streamlined electronic filing system to reduce administrative burdens on companies in future? Will it act promptly to stamp out the use of UK corporate structures which camouflage illegal activities? Initial signs have been encouraging, with indications that Companies House is proactively reacting where there are concerns about information submitted for the public register and Companies House stating that it wants to make the identity verification process very efficient and easy to understand so as not to create a burden for legitimate businesses.  Time will tell how the ECCTA is implemented in practice and whether the reforms prove to be a particular pain point for companies. This will be an area to monitor carefully.

The radical reset of the UK Listing Rules

The most significant reform of the UK listing regime since the current regime was created in 2005 is expected to come into effect later this summer. The genesis for the overhaul was the Hill Review of the UK listing regime, published in March 2021, which was undertaken to analyse, and put forward plans to tackle, the underperformance of UK equities and the continued (even widening) valuation gap between UK and foreign listed companies.

Whilst a number of the reasons for underperformance of the UK markets are realistically outside of the control of the UK government and its regulators, the Hill Review identified a number of measures which could be implemented to improve the attractiveness of the UK listed company environment.  For its part, the FCA is clearly aware of the scale of the challenges facing UK plc and the new UK Listing Rules go further than some were predicting in scaling back aspects of the listing regime that were seen as uncompetitive. In particular, replacing the need for shareholder approval for significant/Class 1 transactions with a disclosure obligation should enable UK listed companies to compete more effectively against global competitors in M&A activities. However, for most governance processionals, the status quo is maintained in terms of governance and reporting-related continuing obligations.

It remains to be seen whether the move from a more rules-based regime to a more disclosure-based one will in practice result in any significant reduction in the work involved in preparing disclosures for significant/Class 1 transactions or the scope of comfort boards seek from advisers on large transactions. UK listed companies also face a high ongoing reporting burden, which, as noted above, is proposed to remain largely the same under the new UK Listing Rules. It is a shame that the FCA did not take the opportunity as part of the overhaul to rationalise the periodic reporting requirements placed on listed companies, given the number of applicable disclosure regimes covering similar territory.