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The new UK Corporate Governance Code: will Australia follow?

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This article was written by Tim Bednall

The first thing to note about the new UK Corporate Governance Code, published in July and applying to listed companies for accounting periods beginning on or after 1 January 2019, is that it is mercifully short: only 15 pages, compared to the 58 pages of the proposed 4th edition of the ASX Corporate Governance Council's Principles and Recommendations.

The second thing to note is that s172 of the UK Companies Act, unlike any Australian equivalent, requires directors to consider the interests of a broad range of stakeholders in the discharge of their obligations. In Australia, shareholder primacy still applies, although consideration of the interests of other stakeholders will often be in the interests of shareholders.

The third preliminary note is that the UK Code consists of Principles and Provisions. UK companies must explain how they are applying the Principles in the company's circumstances (with no option to explain why not), and must also comply with the Provisions, or explain why they have not. Under the Australian regime of Principles and Recommendations, there is no requirement to report against the Principles, just a requirement to disclose whether companies have complied with the Recommendations, and if not, explain why they have not.  

The fourth and final preliminary note is that the UK Corporate Governance Code sits side by side with the UK Stewardship Code, which applies to institutional investors in listed entities.  There is no Australian equivalent: perhaps there should be.

Notable changes to the UK Corporate Governance Code

The following notable changes have been made to the previous edition of the UK Code. (Only relevant sections are mentioned.)

Listed companies will now be required to report on the application of the Principles by the company.

Leadership and purpose

  • The Board must be satisfied that the company's culture is aligned with its purpose, values and strategy.
  • If more than 20% of votes are cast against a resolution recommended by the board, the company must explain how it proposes to consult with shareholders, and report on feedback and actions taken.
  • As part of stakeholder engagement, companies must engage with the workforce by doing one or more of the following: appoint a director from the workforce, or establish a formal workforce advisory panel, or designate a non-executive director to engage with the workforce.

Board composition, succession and evaluation

  • All directors are required to be subject to annual re-election.
  • The Chair should not remain in office for more than 9 years from first appointment to the board.
  • There should be a "formal and rigorous" annual board evaluation, with an external facilitator at least every 3 years.
  • The annual report should describe succession planning, including development of a diverse pipeline, and gender balance of senior management and their direct reports.

Remuneration

  • Remuneration schemes and policies should include discretions to over-ride formulaic outcomes. (This sits with the ability to withhold payments or share awards.)
  • Pension contribution rates for executive directors should be aligned with rates applicable to the workforce.

Commentary

The increasing focus on culture and diversity evident in the new UK Code is consistent with the proposed changes to Principles 2 and 3 of the ASX CGC's Principles and Recommendations, without the contentious imposition of requirements relating to "social licence to operate" and "social responsibility", or the impractical suggestions for extremely diverse representation at all levels of a company.

The requirement to respond to a 20% "rump" of shareholders who oppose a resolution recommended by the board sets a threshold even lower than the 25% threshold for a "strike" on the rem report in Australia. On one view, this places too great a burden on directors who have proposed a resolution, won the support of the vast majority of shareholders, and yet remain obliged to appease the minority. It is difficult to understand why this should be so, particularly why boards should be obliged to take action to do so which is unlikely to have majority support.

The formalisation of mechanisms for engagement by the board with the workforce represent another step in the evolution of the role of the board to include obligations and expectations to engage directly with executives and employees other than the CEO. Time will tell whether this trend leads to a blurring of the roles of board and management that undermines the effectiveness of the board and the authority of senior management.

The requirement for all directors to stand for re-election each year creates an obvious risk of the loss of board continuity and "corporate memory". Again, it is difficult to see why this measure is preferable to a rotation requirement with maximum three-year terms.

We will wait with interest to see whether any of these measures are included in the final form of the fourth edition of the ASX CGC's "Principles and Recommendations".

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