An update on the introduction of the Wates Principles and corporate governance in large private companies
There has been an on-going initiative by the UK government to develop a set of corporate governance principles for large private unlisted companies as part of the package of measures to improve the UK’s corporate governance framework. The development of the Wates Corporate Governance Principles for Large Private Companies (the Wates Principles) is part of such initiative.
What is corporate governance?
As a reminder, the original definition contained in the code produced by the Cadbury Committee in 1992 set out below remains the classic definition:
"Corporate governance is the system by which companies are directed and controlled. Boards of directors are responsible for the governance of their companies. The shareholders' role in governance is to appoint the directors and the auditors and to satisfy themselves that an appropriate structure is in place. The responsibilities of the board include setting the company's strategic aims, providing the leadership to put them into effect, supervising the management of the business and reporting to shareholders on their stewardship."
Corporate governance: who does it apply to?
Most private unlisted companies are not technically required to adopt formal corporate governance principles or report on any they may have. However, the Companies (Miscellaneous Reporting) Regulations 2018 (SI 2018/860) introduced a number of new reporting requirements for financial years beginning on or after 1 January 2019 including a requirement for all companies of a significant size to disclose their corporate governance arrangements in the annual report and on their website.
These companies are also required to state which formal governance code they follow (or provide an explanation as to why they do not follow one).
UK-incorporated companies with either:
- more than 2,000 employees; or
- turnover of more than £200 million and a balance sheet total of more than £2 billion
are required to disclose their corporate governance arrangements with effect from financial years beginning on or after 1 January 2019.
There are various reasons why private unlisted English companies might want to voluntarily introduce more formal corporate governance principles. These include demonstrating good corporate governance practice to stakeholders and road mapping how they intend achieve the long-term sustainable success of the company. There are a number of options on which to base such principles, including the UK Corporate Governance Code (the Code), the Corporate Governance Code for Small and Mid-Size Quoted Companies produced by the Quoted Companies Alliance, and the Institute of Directors corporate governance principles. The Wates Principles are a further option.
The Wates Principles
As a reminder, the Wates Principles are intended to be flexible and high level and are not prescriptive. This acknowledges the wide variety of ownership structures among large private companies. Each of the six principles is accompanied by guidance to help a company understand how to apply the principle in a way appropriate tor it. Rather than a “comply or explain” approach adopted in the Code under the UK Listed Rules, an “apply and explain” approach has been taken. This means that companies who adopt the Wates Principles will be expected to report on their governance processes against each principle.
The Six Wates Principles
- Purpose and leadership. An effective board develops and promotes the purpose of a company and ensures that its values, strategy and culture align with that purpose.
- Board composition. Effective board composition requires an effective chair and a balance of backgrounds, experience and knowledge, with individual directors having sufficient capacity to make a valuable contribution. The size of a board should be guided by the scale and complexity of the company.
- Director responsibilities. The board and individual directors should have a clear understanding of their accountability and responsibilities. The board’s policies and procedures should support effective decision making and independent challenge.
- Opportunity and risk. A board should promote the long-term sustainable success of the company by identifying opportunities to create and preserve value, and establishing oversight to identify and mitigate risks.
- Remuneration. A board should promote executive remuneration structures aligned to the long-term sustainable success of a company, taking into account pay and conditions elsewhere in the company.
- Stakeholder relationships and engagement. Directors should foster effective stakeholder relationships aligned to the company’s purpose. The board is responsible for overseeing meaningful engagement with stakeholders, including the workforce, and having regard to their views when taking decisions.
One of the key themes of the recent governance reforms is the introduction of an annual reporting requirement in relation to section 172 of the Companies Act 2006, commonly known as the s172 Director's Duty. This is the well-known duty to "promote the success of the company for the benefit of its members as a whole", whilst having regard to various other stakeholder interests.
The purpose of the s172 Director's Duty is to encourage boards of companies to create a culture whereby decisions are made with greater consideration for the wider impact upon the organisation beyond the traditional emphasis on just financial performance and strategic objectives.
The GC100 group has commented that the s172 Director's Duty has one overarching theme: culture. With their focus on the importance of culture and broader stakeholder engagement, adherence to the Wates Principles is therefore also likely to assist those companies in meeting their section 172 reporting obligation.
Are private limited companies implementing the changes necessary to comply with the new legislation, and has anybody publically adopted the Wates Principles?
Baker McKenzie recently conducted a survey of 200 general counsels, in-house lawyers and company secretaries (the survey) and found that many companies are still struggling to implement the changes that are necessary to comply with these new corporate governance reforms.
Some of the key findings of the survey were as follows:
- 56% of companies surveyed lack a clear corporate governance framework in their organisation.
- 72% of companies surveyed say that they will have difficulty compiling and verifying the information required to comply, while 32% do not have the resources available to compile the relevant information.
- 50% of companies surveyed admit that they have limited or no budget available to address the new reporting requirements.
The overall response from the survey was that better corporate governance can help prevent the collapse of large private companies, and a large percentage says that good corporate governance is a priority for their board.
There have been a number of larger private limited companies that have already chosen to include in the Annual Report and Accounts an "apply or explain" section in relation to compliance with the Wates Principles including The Wates Group (unsurprisingly as Sir James Wates is their chairman!), and Marshall of Cambridge (Holdings) Limited.
What steps should be taken in practice by larger private listed companies who want to promote a more structured set of corporate governance principles?
- Consider your current corporate governance principles. Are they still fit for purpose?
- Does any company within your group fall within the ambits of the new reporting requirements introduced by the Companies (Miscellaneous Reporting) Regulations 2018 (SI 2018/860) (CMR Regulations)? If so, are its current corporate governance principles suitable to explain how the directors have had regard to the matters set out in section 172(1)(a) to (f) of the Companies Act 2006, how the directors have engaged with employees and had regard to employee interests, and how the directors have had regard to the need to foster relationships with the company’s suppliers, customers and others as required by the CMR Regulations?
If not then adopting new principles based on the Wates Principals may be beneficial as they were developed alongside the CMR Regulations to be used as a user-friendly framework and benchmark for those large privately owned companies that are required to produce a statement of their corporate governance arrangements.
- Review your current board practices on matters such as agendas, board papers, board minutes, board and committee composition and reporting lines, stakeholder interaction/sharing and policies and processes in connection with it to check they are still fit for purpose.
- Consider the group's data protection, environmental, social and financial governance policies and procedures and update as required including in relation to areas such as modern slavery, anti-money laundering and anti-bribery provisions, compliance with the Data Protection Act 2018 (and GDPR) and reporting lines and frequency of updating the board.
- Compile and seek board approval for a plan of action (and budget) to ensure compliance, involving relevant departments in the process, and setting regular monitoring and update meetings and addressing procedures to react to shortcomings – corporate governance is an on-going and evolving process and must therefore be constantly monitored and updated.
- Consider the need for training for directors and relevant employees to facilitate a proper governance system and obtain necessary budgets and the need to allocate clear responsibility and reporting lines for implementing the plan of action to relevant board and employees across the group.
- If the group has overseas members, consider and take local legal advice on codes of governance that impact them and how they will be integrated into the wider governance policies and procedures for the group. In particular be aware of health and safety and environmental, social and financial governance policies where a parent company could potentially be vicariously liable for its subsidiary's actions.
This article is for general information only and does not, and is not intended to, amount to legal advice and should not be relied upon as such. If you have any questions relating to your particular circumstances, you should seek independent legal advice.