A New Corporate Governance Code: What the FRC’s Position Paper Means for Financial Services Firms

Governance and Board Effectiveness has been an increased are of focus and scrutiny for regulators in recent years. The Financial Reporting Council (“FRC”) has recently published its Position Paper, “Restoring Trust in Audit and Corporate Governance”, that outlines its next steps towards strengthening the Audit and Corporate Governance framework within UK audit and corporate firms.

The Paper follows on from the Government’s Response to the consultation on enhancing the UK’s Corporate Governance, Corporate Reporting and Audit Systems. This Response led to the creation of the Audit, Reporting and Governing Authority (“ARGA”), which will take over from the FRC. It is expected that ARGA will created by April 2023. In its announcement, the FRC noted that the Paper should provide “advanced clarity for stakeholders on how work of reform will be delivered ahead of government legislation”. The Paper also details how the FRC intend to support the Government’s reforms during the transition to ARGA.

The FRC has noted that it intends for the revised the Corporate Governance Code (“CGC” or “the Code”) and implementation to be from “periods commencing on or after 1 January 2024” and will consult on the Code and supporting material from Quarter 1 of 2023. In setting the deadline, the FRC noted that this was “to allow sufficient implementation time”.

As such it is paramount that firms start to consider the implications of the revised Code and plan accordingly.

Which firms are affected?

The Code is highly regarded as the “gold standard” of corporate governance. Firms that fall under the Financial Conduct Authority’s (“FCA”) Listing Rules must adhere to the Code as a requirement and will therefore have to adhere to the proposed changes by 1 January 2024.

However, it is not uncommon for other corporate firms to adhere to the CGC requirements and guidance as a means of best practice. It therefore may be prudent for such firms to also consider their current governance arrangements to ensure they are aligned with the proposed implementation dates.

What are the key new changes and requirements?

The CGC will remain principle-based and flexible, but the key enhancements will include:

• The need for a framework of “prudent and effective controls to provide a more stronger basis for reporting on and evidencing the effectiveness of internal controls” for end of year reporting;
• Revisions to “the wider responsibilities of the Board and Audit Committee for expanded Sustainability and ESG reporting” including requiring improved assurance in this area;
• Additional disclosures in relation to corporate governance reporting including remuneration arrangements such as malus and clawback;
• To enhance existing Code provisions where reporting is “weaker” as outlined in the FRC’s Creating Positive Culture report (December 2021);
• Adding a provision for boards to consider how audit tendering undertaken accounts for the need to expand market diversity; and
• The need for post-implementation governance internal audit reviews to provide assurance that the revised Code has been implemented adequately.
   

What does this mean for firms?

The proposed changes cover a broad spectrum of governance arrangements and as such it may be beneficial for firms to review their entire governance structure. Governance arrangements are expected to be appropriate for the “nature, size and complexity” of a firm’s activities and business model (FCA Handbook, SYSC 3.1.1R). This can often be an elusive term, but key questions for firms to consider are:

• Are all governance arrangements clearly documented so that employees could outline the relevant reporting lines if questioned?
• Does our current suite of governance documentation, including organisational charts, Management Responsibilities Maps (“MRM”), role and responsibilities descriptions and committee/board Terms of Reference (“TORs”), reflect the current allocation of responsibilities and approval processes currently in practice?
• Are there any potential conflicts of interest or “bottlenecks” within the current governance structure? For example, a lack of independent challenge in key areas such as risk and compliance, remuneration and incentive arrangements or strategic business decisions?
• Are there any “key man risks” where adequate succession planning has not been accounted for?

In addition, whilst arrangements and structures in theory and on paper may be “by the book”, this does not necessarily mean that they are operating effectively. As such, whilst assessing the design of governance arrangements and underlying framework, firms should consider conducting effectiveness assessments. These assessments may be in the form of board effectiveness reviews, testing of the reporting and escalation mechanisms or gaining insights from employees around key issues such as conducting culture surveys.

For boards and committees in particular, firms should consider:

• Is the Board adequately comprised and diverse with regards to experience and background (including, key metrics such as gender, ethnicity, and social mobility)? Is the Board reflective of the workforce it overseas and customers it serves?
• Is there evidence of robust challenge and discussion from all members or is there a tendency for one individual to lead and dominate the conversation? Is there a risk that some members do not feel comfortable voicing their opinions within the forum?
• How is challenge to opinions and contested votes handled in meetings? Would the firm benefit from the appointment of Non-Executive Directors or Independent Non-Executive Directors?
• Do the boards and committees currently receive the information and reports that they need to properly assess issues within their jurisdiction and oversight? For example, do reports include trend analysis, root cause analysis and key risk indicators to allow the members to identify systemic weaknesses?
• Are there appropriate feedback mechanisms within the firm for engagement with employees and understanding of grievances or concerns?

If the answer is no to any of the above questions, it is likely that the firm’s governance arrangements are not embedded effectively. More importantly, if a firm is unable to evidence how these question and issues have been addressed, the firm should review its current arrangements to ensure that this has been appropriately documented.