The New Corporate Governance Rules for Large Private Companies
The Financial Reporting Council (FRC) has recently published a consultation paper on a new set of corporate governance principles aimed at large private companies following the Government's Green Paper Consultation on Corporate Governance Reform in 2016 and the BEIS Select Committee's corporate governance report in 2017. in support for action to "encourage high standards of corporate governance in the UK's largest private companies" and the need to boost trust, fairness, accountability, responsibility and transparency for the benefit of stakeholders (such as shareholders, lenders, customers, suppliers, employees and the general public).
The publication of the consultation paper also coincided with the new legislation laid before Parliament on 11 June 2018, which will place new reporting obligations on large private companies.
Which companies do the new corporate governance rules apply to?
'Large' private companies, which must report on their corporate governance arrangements, are those with:
- over 2,000 employees, and/or
- a turnover of over £200 million and a balance sheet total of over £2 billion.
Certain companies will be exempt from reporting on stakeholder considerations. These are companies which meet two of the following three criteria:
- a turnover below £36 million;
- a balance sheet total of below £18 million; or
- fewer than 250 employees.
However, as we will explore below, corporate governance is an increasingly important consideration for private companies of all sizes, with further changes anticipated in the near future.
What are the new corporate governance principles?
In January 2018, the Government appointed James Wates CBE to chair an industry group to develop the corporate governance principles in relation to large private companies.
The consultation paper sets out the following draft six voluntary principles (the Wates Principles):
- Purpose – an effective board should promote the purpose of the company and ensure that its values, strategy and culture align with that purpose;
- Composition – effective board composition should comprise of an effective chair and a balance of skills, backgrounds, experience and knowledge, with individual directors having sufficient capacity to make a valuable contribution;
- Responsibilities – a board should have a clear understanding of its accountability and terms of reference;
- Opportunity and Risk – a board should promote the long-term success of the company by identifying opportunities to create and preserve value, and establishing oversight for the identification and mitigation of risks;
- Remuneration – a board should promote executive remuneration structures aligned to the sustainable long-term success of a company, taking into account pay and conditions elsewhere in the company; and
- Stakeholders – a board has a responsibility to oversee meaningful engagement with material stakeholders, including the workforce, and have regard to that discussion when taking decisions.
Whilst the Wates Principles may be attractive in their simplicity, private companies will be free to choose other governance codes to apply (such as the UK Corporate Governance Code or the QCA Corporate Governance Code) if they are deemed more suitable.
'Apply and Explain'
The Wates Principles function on an 'apply and explain' basis. Large private companies should explain how they have applied the principles to achieve their desired outcomes. This is where the reporting requirements (see below) come into play.
The purpose of the reporting requirements is for stakeholders in the company to be able to make an informed decision as to whether the company is achieving good governance outcomes. The explanation also helps encourage company directors to see corporate governance not as a set of prescriptive list of actions or a box ticking exercise but as being 'about fundamental aspects of business leadership and performance, which every company must interpret and apply for itself' (J Wates CBE).
The principles are accompanied by guidance which aims to help large private companies put the principles into practice. In reality, different companies will apply the Wates Principles in different ways because there is recognition that outcomes are not the same for every company.
How to report your corporate governance arrangements
The Government have tabled new secondary legislation which, from 1 January 2019, will oblige large private companies to state in their directors' report and on their website:
- which corporate governance code the company follows, if any;
- how precisely that corporate governance code is followed and applied; and
- whether the company has departed from that corporate governance code in any way and, if so, how and why.
Most UK companies will also be required to state how their directors comply with their statutory duty to consider stakeholder interests. All UK companies with at least 250 employees in their UK group must also report on employee engagement.
In this way, many private companies will be bound by minimum reporting standards in a similar way to public limited companies whose shares are traded on a major stock market.
What about the cost?
In applying the 'best practice' standard of the Wates Principles, some private companies might take certain actions which may attract additional costs.
For example, the guidance recommends amending policies and constitutional documents to set out "policies and procedures that govern the internal affairs of the company". Such amendments, which may include amending the company's articles of association or introducing a shareholders' agreement, may require companies to seek professional advice and guidance.
Companies may also wish to appoint a director-representative for key stakeholders, such as an employee-director. This may lead to additional costs in the appointment process, or fees payable under any new service contracts.
What about corporate governance for smaller private companies?
The consultation paper states that it wants the new principles to serve as a demonstration of 'good practice' to all private companies. Smaller private companies, particularly those looking to grow in the future or those considering listing on a major stock market may therefore consider adopting the Wates Principles, despite not being obliged to under the new law. This would help the company to prepare for such growth and also to demonstrate that it is operating within the standard requirements of good corporate governance.
What happens next?
The consultation will end on 7 September and the draft Principles will be finalised by December 2018 in time for implementation by January 2019. This is subject to Parliamentary approval of the secondary legislation, which the Government intends to implement around the same time, but it is clear that corporate governance is becoming an increasingly important focus for all private companies.