Sustainability is increasingly important as we look for ways to reduce carbon emissions and our impact on the environment and communities around us. This is particularly crucial when it comes to companies, who are responsible for more than their fair share of carbon emissions. And while laws and regulations are increasingly requiring accountability and the adoption of policies in support of sustainability, companies need to go further than this and incorporate sustainability factors into the core of their business runnings.
The 2018 UK Corporate Governance Code encourages company directors to consider sustainability in their decision making processes and requires certain disclosures with regards to this. However, many wonder if the Code goes far enough or if it leaves too much discretion to directors who often favour shareholder gains over environmental or sustainability concerns (ie. shareholder primacy).
👉 In this article we’ll explore the UK’s Corporate Governance Code in more detail and examine the Government’s plans for an updated version in the near future.
Firstly, what is corporate governance?
Corporate governance is a system of rules, practices and processes used to direct and control a company.
Corporate governance provides the structure for reaching a company’s objectives, it encompasses all aspects of management and defines a company’s power structure, accountability structure and decision-making process’. It ensures that the company is run in a way that allows it to meet its objectives while also balancing the interests of its stakeholders - ie. shareholders, employees, suppliers, clients and customers, and the wider community.
🇬🇧 What is the UK Corporate Governance Code?
The 2018 UK Corporate Governance Code provides a set of principles of ‘good corporate governance’ for companies listed on the London Stock Exchange. Though it should be noted that many smaller companies who are not listed also choose to follow the guidance and its best practice principles.
The first corporate governance code in the UK was published in 1992 and it has been updated several times since to ensure relevancy and best practice guidance. The latest version of the code was published in July 2018.
👉 It should be noted that the UK Corporate Governance Code isn't actually law. It asks companies to ‘comply or explain’ - ie. companies need to either follow the code or explain why they don’t.
The 2018 Corporate Governance Code in detail
The revised 2018 Corporate Governance Code is an updated set of principles that emphasise the importance of good corporate governance and sustainable growth. It sets higher standards of corporate governance with the ultimate aim of promoting transparency and integrity in business across the UK, while also attracting investment and benefiting the economy and wider society.
Companies who choose to apply the Corporate Governance Code principles and follow the detailed guidance will be better positioned to report on how their governance structure contributes to the long-term success of the business.
The Corporate Governance Code applies to all companies with a ‘premium listing’, regardless of whether or not they are incorporated in the UK. A premium listing means that the company is listed on the London Stock Exchange, but instead of having a standard listing they have a premium listing - this is often applied to larger companies. It means that the company is expected to meet the UK’s highest standards of regulation and corporate governance.
Let’s take a closer look at what changes the Code introduced:
Stakeholders - the 2018 Corporate Governance Code aims to improve the relationship of the company with a wider array of stakeholders by enhancing company board responsibility when it comes to policies that promote a healthy workplace culture. This includes the appointment of a director, a workforce advisory panel or non-executive director who will engage with the workforce on behalf of the board as well as the adoption of a mechanism allowing the workforce or company directors to raise concerns resulting in an effective enquiry.
Boardroom - the Corporate Governance Code aims to promote the diversification of UK company boards and foster greater transparency by requiring higher quality board evaluations to be carried out by an external evaluator.
Remuneration - the Corporate Governance Code adopts more stringent remuneration policies and practices, including more transparent reporting when it comes to remuneration policies.
Sustainable governance - the Corporate Governance code asks that companies demonstrate how the governance of the company contributes to its long-term sustainable success. It encourages the alignment of the company’s purpose, strategy, values and corporate culture. Specifically, the Corporate Governance code requires that annual reports include a description of how opportunities and risks to the future success and sustainability of the business model have been considered and addressed.
What about environmental sustainability?
Although the updated 2018 Corporate Governance Code didn’t expressly mention ‘climate change’ or ‘environmental sustainability’ it does emphasise the importance of healthy relationships between shareholders and stakeholders (employees, the wider community etc.). It’s argued that this also infers that the environment should be considered as a stakeholder. In its 2020 Annual Review of the UK Corporate Governance Code, the FRC actually stated that the Code is intended to encourage directors to create sustainable value and benefit the environment to mitigate environmental issues.
Alongside the 2018 Corporate Governance Code itself, the FRC also published guidance, this included the recommendation that companies adopt a voluntary framework for the consideration of its environmental impact. Additionally, the FRC encourages the inclusions of climate change mitigation and other ESG matters when establishing a company’s purpose.
Criticisms of the 2018 Corporate Governance Code
Even though the 2018 Corporate Governance Code was lauded as being shorter and sharper than ever before, there are those who levelled criticisms at the Code. Principle points of concern include that ‘comply or explain’ machism (whereby a company must comply with the code or submit a written explanation as to why they’re not complying) isn’t effective at encouraging participation and it is little more than a tick-box exercise.
Other concerns with the existing code include that the stakeholder protection mechanism is flawed. Enforcement of the mechanism depends on shareholders lobbying for change, and while some shareholders might be stakeholder friendly, many would rather prioritise their return on investment. This is also of particular concern when it comes to weighing up environmental concerns with financial gains. Often, it’s the company's financial priorities that take precedence.
In fact, there are those who believe that the Corporate Governance Code should be abolished altogether and replaced with new disclosure requirements under the Financial Conduct Authority’s Listing Rules.
The main policy reform is the creation of a body called the Audit, Reporting and Governance Authority (ARGA), which will replace the existing regulatory body (the FRC - Financial Reporting Council). The UK Government plans to give ARGA more powers to oversee corporate reporting and auditing, as well as the ability to sanction directors for any breach of duties.
Alongside the creation of this new public body, the UK Government also proposed changes that will see a strengthening of internal controls contained within the UK Corporate Governance Code, as well as an expanded scope of application which will result in an additional 600 companies being subject to the Code.
Another notable change is the mandate that companies ‘have regard’ for ‘the impact of the company’s business model of climate change’. Unlike the 2018 Corporate Governance Code which doesn’t actually refer to climate change, the proposed reform will require that climate change is taken into consideration when it comes to their Resilience Statement, which forms part of the company’s strategic report. The UK Government intends for this statement to complement the soon to be published Sustainability Disclosures Requirement regime which will require disclosures in line with International Sustainability Disclosure Standards, as well as disclosures on a company’s environmental impact.
In response to the UK Government’s plans to update legislation to strengthen the UK’s corporate governance, the Financial Reporting Council (FRP) published the Position Paper which outlines how it plans to help the UK Government achieve its new aims.
The paper establishes the FRP’s position in relation to sustainability, and includes proposed updates to the Corporate Governance Code, Strategic Report Guidance, and non-financial reporting. This reflects a shift towards integrating and strengthening sustainability-related considerations when it comes to company reporting and corporate governance. Specific proposals include:
Update to the UK Corporate Governance Code - proposed changes reflect the expanded responsibilities of the board of directors and Audit Committee with regards to sustainability and ESG reporting.
Update to Strategic Report Guidance - once the UK Government has finalised its intentions for adopting the International Sustainability Disclosure Standards into UK law, the FRC will also update its Strategic Report Guidance in line with this.
Sustainability reporting - the FRC supports the establishment of an international baseline when it comes to sustainability reporting and has said that it will work closely with international bodies to establish a global standard.
Streamlining reporting - the FRC will work with the Department for Business, Energy and Industrial Strategy to help streamline current non-financial reporting requirements, without compromising on quality.
Strengthened review capabilities for the new ARGA - they will be able to review not only the directors report but also the annual report and accounts of the company, including corporate governance statements, directors remuneration, and audit committee reports. Sustainability reporting is also likely to be included.
If the proposed changes are approved they will come into force in 2024 (subject to legislation).
👀 Looking forward
Companies are slowly waking up to their responsibilities when it comes to environmental concerns and the societal impact of their company operations. It’s no longer possible for companies to ignore these elements when it comes to their corporate governance. Those who do, risk losing out on investment opportunities, clients and potentially also losing employees - stakeholders across the board have come to expect more from companies, and sustainability practices are now the norm as opposed to the exception.
The proposed changes to the UK’s Corporate Governance Code will help to strengthen internal governance and improve the quality of company reporting, including sustainability reporting. This aligns with the direction of sustainability reporting more generally. Many other countries and international bodies have introduced requirements that sustainability-related information is verifiable and have adopted more stringent assurance processes.
What about Greenly?
At Greenly we can help you to assess your company’s carbon footprint, and then give you the tools you need to cut down on emissions. Why not request a free demo with one of our experts - no obligation or commitment required.
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