FRC issues proposed revised UK corporate governance code
Find out more about FRC’s ‘Audit committees and the external audit: minimum standard’ and proposed revised UK corporate governance code.
The Financial Reporting Council (FRC) has issued its ‘Audit committees and the external audit: minimum standard’ and its proposed revised UK Corporate Governance Code.
Minimum standard for audit committees
The standard reflects the proposals in the UK Government's consultation on Restoring Trust in Audit and Corporate Governance. This includes granting statutory powers to ARGA (Audit, Reporting and Governance Authority) for mandating minimum standards for audit committees in their role on external audits.
The Standard focuses on FTSE 350 companies and aims to enhance performance and consistency of approach across audit committees. By setting out clear expectations and guidelines, the FRC aims to support the delivery of high-quality audits and reinforce public trust in the financial reporting process. As ARGA has not yet been established compliance with the standard is currently voluntary.
ICAS shared our views on the consultation with FRC.
Proposed revisions to the UK corporate governance code
The five primary areas of focus are revisions intended to:
- Focus on a framework of prudent and effective controls to provide a stronger basis for reporting on and evidencing their effectiveness.
- Reflect the responsibilities of the board and audit committee for sustainability and ESG reporting and appropriate assurance in accordance with a company's audit and assurance policy.
- Take account of the new Audit Committee Standard (Audit Committees and the External Audit: Minimum Standard).
- Improve the functioning of comply-or-explain where reporting is currently weaker, taking account of recently published FRC research and reports.
- Align the changes to legal and regulatory requirements as set out in the Government's response to its White Paper on audit and corporate governance reform, including strengthening reporting on malus and clawback arrangements.
FRC’s key proposed changes to the UK corporate governance code are highlighted below.
Risk management and internal controls
Considerable focus will be placed on the proposed change to the wording of the principle on internal control.
The board should establish procedures to manage risk, oversee the internal control framework, and determine the nature and extent of the principal risks the company is willing to take in order to achieve
its long-term strategic objectives.
Proposed revised wording
The board should establish and maintain an effective risk management and internal control framework, and determine the nature and extent of the principal risks the company is willing to take in order to achieve its long-term strategic objectives.
The proposed revised principle is supported by the following revised provision which sets out that boards should monitor the company’s risk management and internal control systems, review their effectiveness and make a declaration on their effectiveness throughout the reporting period and up to the date of the annual report.
30. The board should monitor the company’s risk management and internal control systems and, at least annually, carry out a review of their effectiveness and report on that review in the annual report. The monitoring and review should cover all material controls, including operational, reporting and compliance controls. The board should provide in the annual report:
- A declaration of whether the board can reasonably conclude that the company’s risk management and internal control systems have been effective throughout the reporting period and up to the date of the annual report;
- An explanation of the basis for its declaration, including how it has monitored and reviewed the effectiveness of these systems; and
- A description of any material weaknesses or failures identified and the remedial action being taken, and over what timeframe.”
The objective of the proposed approach is to avoid a situation where the review of effectiveness is seen as a one-off exercise, and which only assesses the effectiveness of the company’s systems at a point in time. Additionally, the scope of the provision is wider than just controls over financial reporting and covers, operational, reporting (financial and non-financial) and controls.
FRC plans to update its guidance on risk management, internal control and related financial and business reporting later in the year once the outcome of the consultation on the code is known.
FRC expects the updated guidance to set out possible structures, responsibilities, actions and recommendations but allow companies flexibility to adapt it to their unique circumstances and characteristics (e.g. industry, size, geography etc). Ultimately the board will need to be comfortable that the internal controls framework is sufficiently effective to enable them to make the declaration.
In the consultation paper FRC highlights various matters that the guidance would likely cover including: What constitutes an effective risk management and internal control framework, and what is considered a material weakness. In this context the working definition of material weakness FRC is currently considering is: “A fault, deficiency or failure in the design or operation of the risk management and internal control framework, such that there is a reasonable possibility that the company’s ability to identify, assess, respond to or monitor risks to its strategic, operational, reporting and compliance objectives is adversely affected”.
In addition, it is anticipated that the updated guidance will provide assistance on how to report against the code’s amended requirements, including: explaining the basis for the declaration, how these systems have been monitored and reviewed during the reporting period, and how the board is content that their conclusion regarding the effectiveness of the systems is appropriate.
The draft revised code contains a revised provision which asks the board to explain in the annual report how it has assessed the future prospects of the company. The substance of this change is that the current viability statement is replaced with the resilience statement. Companies that have complied with the resilience statement requirement to be introduced in law will be compliant with this provision. For code companies that are not subject to the legal requirement, the board should report in a similar and proportionate way to the requirements to this or set out the basis for the assessment in the annual report.
Audit and assurance policy (AAP) statement
FRC proposes that the audit committee should have responsibility for developing the AAP due to its experience of oversight of external audit matters and wider understanding of assurance. It also proposes that the audit committee takes the lead in engaging with shareholders and other stakeholders in relation to the AAP.
It is proposed that the remit of audit committees should be expanded to include narrative reporting, including sustainability reporting, and where appropriate ESG metrics, where such matters are not reserved for the board. Additionally, it is also proposed that the annual report should describe, where commissioned by the company, the assurance of ESG metrics and other sustainability-related information.
Diversity and inclusion
It is proposed to amend the existing principle to include a reference to inclusion, and to give equal weight to all protected and non-protected characteristics, to encourage companies to consider diversity beyond gender and ethnicity. This is intended to support the Financial Conduct Authority (FCA)’s policy without introducing additional, duplicative targets or regulations. Other amendments are proposed in order to provide improved clarity on company approaches to succession planning and board and senior management appointments.
Governance – focus on activities and outcomes
The proposal is to introduce a new principle which sets out FRC’s expectation that companies should, when reporting on their governance activity, focus on activities and outcomes to demonstrate the impact of governance practices.
Opportunities and risk
When describing how opportunities and risks to the future success of the business have been considered and addressed, it is proposed that specific reference is made to how environmental and social matters are taken into account in the delivery of the company’s strategy, including its climate ambitions and transition planning.
A board should report on how effectively the desired culture has been embedded.
Engagement with major shareholders
The board should report in the annual report on the outcomes of the engagement which has taken place with them during the reporting period.
All significant director appointments should be listed in the annual report, describing how each director has sufficient time to undertake their role effectively in light of commitments to other organisations. This should describe any actions taken as a result of this assessment.
Board performance review
FRC is proposing that the term ‘board performance review’ be adopted instead of ‘board evaluation’ as use of the term ‘evaluation’ has apparently contributed to the erroneous perception that externally facilitated reviews are intended as a backwards-looking assurance function, whereas the value of such reviews is in informing a continual process of self-improvement for boards. Additionally, it is proposed that the chair should commission, rather than consider having, a board performance review.
New principles have been included to strengthen the links between companies’ remuneration policies and corporate performance in the wider sense, including ESG objectives new principles. These set out the overarching expectations of directors’ remuneration policies, including an emphasis on the importance of transparency and a link to long-term sustainable success. The importance of remuneration outcomes being clearly aligned to company performance, purpose, and values and a specific mention of ESG objectives, and the inclusion of a specific reference to company and workforce pay and conditions as a factor which remuneration committees should have regard to in determining executive pay.
Malus and clawback
The proposed revisions include a specific mention of malus and clawback and set out a requirement for additional information to be included in companies’ remuneration reports. This includes a statement on whether the company has malus and clawback arrangements in place, the minimum conditions in which these would apply, the minimum period for applying them and why the selected minimum period is best suited to the organisation, as well as whether they have been used in the last financial year.
Quality of reporting on remuneration
To help improve the quality of such reporting, FRC proposes to remove the existing detailed content which is often used by companies as template language in annual reports and instead list the factors which remuneration committees should address. The aim is for companies to report on these factors in a way that is specific to their own circumstances.
FRC notes that in March 2023, the government published a white paper on artificial intelligence (AI), setting out its vision for an AI-enabled country. In which it proposes that existing regulators will implement a new AI regulatory framework underpinned by five values-focused cross-sectoral principles. FRC therefore welcomes views from stakeholders as to whether any code changes would be needed to support progress in this area, were the government to implement its proposals.
FRC will also review the existing guidance which supports the code: guidance on audit committees, guidance on board effectiveness, and guidance on risk management, internal control and related financial and business reporting,
Due date for responses and applicable date
The deadline for responses to the consultation is Wednesday 13 September 2023 and the intention is that the revised code will apply to accounting years commencing on or after 1 January 2025 to allow sufficient time for implementation.
Email ICAS if you have any comments on the UK corporate governance code consultation.