Comments from ACCA to the Financial Reporting Council (FRC), July 2012.
The proposed revisions in draft revised Code focus on four main areas:
We agree these are all important issues on which to consult. We are concerned, though, that the Code is becoming longer and more prescriptive with each update. The danger, of course, is that the longer the Code becomes the more likely it is that a tick box approach will be taken to it. We query whether all the present detail is still required.
Many respondents, including ACCA, have expressed the view, when submitting responses to previous consultations about amendments to the Code, that a more appropriate name for the principle underpinning adherence to and enforcement of the Code would be ‘apply or explain’. The Code contains principles companies must apply and boards are required to report to shareholders on how they have done so. The key verb is therefore ‘apply’. The Code also contains provisions with which companies are expected to comply or boards must give an explanation as to why if they do not comply. The essence of the Code can therefore be expressed as ‘apply and comply or explain’.
As ACCA has long argued, the continuing focus on ‘comply or explain’ emphasises the importance of provisions and compliance over the application of higher level principles. The FRC says in the Preface to the Code that more attention should be paid to the spirit of the Code and we agree. The spirit of the Code is to be found in the principles, including supporting principles, and in the pages preceding the principles. The spirit is not to be found in the provisions. Therefore, the way to ensure more attention to the spirit of the Code is for the FRC to signal in the Code that boards and shareholders pay as much, and preferably more, attention to the Code principles than they do to the provisions.
The proposed additional text in paragraph 3 of the ‘Comply or Explain’ section of the Code seems likely to deter companies from explaining and coerce them into compliance. The additional text could be inferred to mean that there is a presumption that the provision must be complied with and that other ways of applying the spirit of a principle cannot exist. Unfortunately, this would serve to reinforce a tick box approach to compliance by companies.
We agree with the third paragraph in the first section of the Code that corporate governance is about what the board of a company does and how it sets the values of the company. As we have pointed out in the past, it seems to be a significant omission that the Code contains no requirement for boards to report on how they set the values of the company or take steps to satisfy themselves that such values are being lived. The only reference to values, or anything like it such as culture or ethics, is in the supporting principle to Principle A.1. There is no requirement though for boards to report anything in relation to values, ethics or culture and few boards do so voluntarily. The lack of any requirement to report on values or culture contrasts sharply with the degree of prescription elsewhere in the code on matters which are probably of less importance to good governance.
The LIBOR fixing scandal has once again highlighted the importance of values and culture. Financial institutions implicated in rate fixing and mis-selling interest rate derivative contracts have been fully compliant with relevant governance provisions yet obviously something was not right with their governance – at least in some of the institutions. We suggest that having the right culture is what was missing and encourage the FRC address this fundamental omission. We have suggested how this could be done in our responses to previous consultations on the Code and would be pleased to elaborate if requested.
We suspect that the main beneficiaries of a requirement to name search consultancies and external facilitators would be the larger search and board evaluation consultancies. It would be valuable free publicity for them. Board evaluation is a rapidly evolving area where innovation is still needed, boards are likely to be deterred from employing other consultants if they do not already have an established brand to support them.
ACCA is of the view that boards are better where there is diversity of thinking. Diversity of membership, including in gender, is likely to promote diversity of thinking but does not guarantee it. It is a means to an end and should not be regarded as an end in itself. The proposed provision and supporting principle makes diversity of membership the end. We suggest that a provision referring to how the chairman encourages diversity of thinking would be more useful for improving board decision making.
The FSA report into the collapse of RBS made the following recommendation:
In order to demonstrate that boards have subjected proposals from the executive to appropriate discussion and challenge, the secretary should ensure that minutes of the board should set out the substance of the views expressed and record key elements of the debate and challenge provided, as well as the conclusions reached in respect of each agenda item.
This recommendation if implemented would provide evidence of diversity of thinking when important decisions are being made. The FRC should consider incorporating words to this effect into the Code.
Boards have always had a responsibility to ensure that their annual report as a whole is fair, balanced and understandable and The Companies Act requires information on performance, business model and strategy. The proposed Provision C.1.3 ought not to be required.
The fact that it is being proposed should be of serious concern and highlights the problem with culture alluded to above. Deciding on whether or not a report is fair, balanced and understandable is a subjective matter: who determines what is fair and who should find it understandable? However, inquiries into the Enron scandal and the financial crisis have suggested that not all directors fully understood their annual reports. We think it is important that the whole of the board, not just the audit committee, should be able to understand their annual report.
How should boards, or audit committees, determine whether all the required information ‘necessary for users’ has been provided? Which users should they ask and should ‘necessary’ be defined? The Guidance on Audit Committees implies primary responsibility for determining this is to be conferred on to audit committees. We are not convinced that expecting the audit committee to fulfil this function is right. Audit committees already have many onerous responsibilities, we suggest this is a matter better reserved to boards.
We note some inconsistency between the draft revised Stewardship Code and the draft revised UK Corporate Governance Code in how they articulate the role of shareholders. The latter, in (2) of ‘Governance and the Code’ on page 1 says:
'The shareholders’ role in governance is to appoint the directors and the auditors and to satisfy themselves that an appropriate governance structure is in place’.
The draft revised Stewardship Code refers to investors rather than shareholders and does not make explicit reference to the appointment of directors or auditors but sets out a far broader role for investors.