Ashurst Governance and Compliance Update - Issue 2

1.  QCA publishes research report on SME board performance reviews

In conjunction with Downing LLP, the Quoted Companies Alliance (QCA) has published research commissioned to look into board performance reviews. The research identifies how most smaller companies’ boards can be characterised as either "inactive", "reactive" or "proactive" with regards to such reviews and provides a snapshot as to how growth companies differ from larger companies in this area. The idea underpinning the research is to allow companies to benefit from understanding where they sit on this spectrum and to assess if there are improved practices they can learn from other companies at a similar stage of development to them.

To accompany this report, the QCA has also published a practical guide to board performance reviews which takes the findings of the research and distils them into six good practice recommendations for companies to follow.

The research is free for QCA members and can be purchased for a fee by non-members.

2.  Duty to avoid conflicts of interest continued to apply to former director

The case of Burnell v Trans-Tag Ltd & Anor [2021] EWHC 1457 (Ch), serves as a reminder that Section 170(2)(a) of the Companies Act 2006 provides that any person who ceases to be a director potentially continues to be subject to the duty in section 175 (duty to avoid conflicts of interest) as regards exploitation of any property, information or opportunity of which such person became aware at a time when he was a director (the extended section 175 duty).

The case is complex and involved the collapse of a business with claims and counter claims by the parties to it. Of relevance here, a former director was accused of having breached his extended section 175 duty when he exploited information of which he became aware whilst he was a director. He subsequently used this information after he had resigned to secure for himself the rights to exploit intellectual property in products which were licenced to the company of which he had been a director to the alleged detriment of that company.

One issue before the court was whether the extended section 175 duty could be breached by a former director when all relevant acts took place after the individual had resigned.

The court decided that the extended section 175 duty is a continuing duty and that it must therefore be possible for a breach of that continuing duty to be founded on acts which take place after a director has resigned his or her directorship. Once it was established that a breach of duty could be founded solely on post-resignation events, in order to determine whether a breach of duty had actually occurred, the court may take into account the nature of any pre-resignation and post-resignation conduct by the relevant party as part of a merits-based and highly fact-specific assessment.

Ashurst comment: The case highlights the fact that once a director resigns it could be a breach of duty for that director to exploit an opportunity which competes or information which allows competition with the interests of the individual's former company. However, the court will base its determination on a subjective assessment of the surrounding facts. In short, in seeking to exploit an opportunity which competes with the interests of a company of which an individual has been a director, he or she must tread very carefully indeed.

3.  Modern slavery enforcement watchdog announced

The Department for Business, Energy & Industrial Strategy (BEIS) has confirmed that it will be creating a workers' rights watchdog – a single enforcement body responsible for combatting modern slavery, enforcing employment rights and protecting agency workers. The new enforcement body will have the power to impose:

• financial penalties for non-compliance with the Modern Slavery Act 2015 (MSA) reporting regime; and
• civil penalties for any breaches under the gangmasters licensing and employment agency standards regimes resulting in wage arrears.

The creation of the new body was announced as part of the government's delayed response to a consultation published in July 2019 ("Good Work Plan: establishing a new single enforcement body for employment rights"). This is important news for companies operating in the UK. Many have noticed an increase in outbound communications from the Home Office about modern slavery enforcement, and therefore have been waiting to hear when modern slavery compliance requirements will be stepped up. As regards other changes to the MSA regime, you can find a reminder of the government's proposals here. There is currently no fixed timetable for these reforms to be taken forward.

Independent of government, the Modern Slavery (Amendment) Bill has been introduced to the House of Lords, sponsored by crossbench peer Lord Alton of Liverpool. The Bill seeks to amend the MSA to prohibit the falsification of modern slavery and human trafficking statements, to establish minimum standards of transparency in supply chains on the issue of modern slavery, and to prevent companies using supply chains which fail to demonstrate minimum standards of transparency. The Bill proposes a fine of up to 4% of global turnover or £20m, whichever is the lower and/or imprisonment for up to two years for any relevant individual. The legislation also proposes the same level of fine if a company receives a warning from the anti-slavery watchdog but continues to source from suppliers failing to meet minimum standards of transparency.

Ashurst comment: As a Private Members' Bill, the draft legislation is unlikely to make it onto the statute book. Clearly, if it did, it would mark a significant shift in the law and strengthening of the MSA regime. Nevertheless, the Bill does underscore the direction of travel on the subject. It's one to watch. We'll keep you updated.

Item contributed by Ruby Hamid, Partner in our Dispute Resolution team.

4.  Persons with Significant Control regime - Level of compliance and convictions for default

In responding to a question raised in Parliament, the government revealed that the number of registered companies in the UK which had not complied with the requirements to declare beneficial ownership under the Companies Act 2006, Persons with Significant Control (PSC) regime stood at 11,107, comprising 0.25 per cent of companies registered at Companies House. In addition, between 1 April 2019 and 31 March 2021, the Insolvency Service achieved a total of 210 convictions, of which 91 companies and 119 directors were convicted for offences relating to the beneficial ownership of companies. Two of the convicted directors also received disqualification orders for a period of three years. The government statement serves as a reminder that the PSC regime is policed and that failure to comply with it comes with serious consequences.

5.  Law Commission publishes discussion paper on corporate criminal liability

The Law Commission has published a discussion paper on the corporate criminal liability of legal persons such as companies and LLPs. In particular, it focuses on the fact that, at present, such entities usually may only be convicted of an offence it if is one which does not require any element of fault – i.e. is a "strict liability" offence – or if an individual or group of individuals who are very senior within an organisation – i.e. can be considered as the "directing will and mind" of the organisation - have the necessary fault element.

The Law Commission is seeking views on whether, and how, the law in this area can be improved so that it can appropriately capture and punish criminal offences committed by companies, their directors or senior management, including in relation to economic crime.

The discussion paper sets out the current legal framework, including the general law on corporate criminal liability and specific related legislation, procedural rules attendant to it, and recent developments. It presents various alternative options for improvement and ends with 13 questions for discussion, in doing so drawing comparisons with approaches taken in other jurisdictions.

The consultation closes on 31 August 2021.

6.  GC100 publishes members' poll on reporting in line with TCFD recommendations

The GC100 has published a members' poll which focuses on how companies are responding to the new Listing Rules requirements which oblige premium-listed companies to state in their annual financial report whether they have reported in line with the recommendations and recommended disclosures of the Financial Stability Board's Task Force on Climate-related Financial Disclosures (TCFD). The Listing Rules, which operate on a "limited" comply or explain basis, apply to financial periods beginning on or after 1 January 2021. Findings from the survey include:

• Two-thirds of respondents indicated that they had already included detailed reporting in line with all or part of the TCFD recommendations in previous financial reports.
• 73 per cent intend to include a statement of full compliance with the TCFD recommendations for their financial year beginning on or after 1 January 2021.
• 88 per cent stated that they would locate their climate-related disclosures in their annual report.
• 73 per cent agreed that one of the biggest challenges in implementing the TCFD recommendations is navigating the proliferation of overlapping guidance and frameworks.
• 66 per cent stated that incorporating processes for identifying climate risks into existing management processes was a particular challenge.

• Anticipated costs of implementing the regime ranged from £100,000 to £500,000, with many respondents indicating that the main costs derive from hiring external consultants for advisory support.
• Two-thirds would be seeking independent assurance of their TCFD disclosures to be carried out by either environmental consultants, sustainability ratings providers, quality assurance providers or members of the accounting profession.
• Just over half of respondents had identified strategic opportunities for their company as a result of the work done to date.

Key takeaways from the survey include to:

• Take a structured long-term approach in adopting the TCFD recommendations. While superficial compliance can be achieved in a short time period, implementing climate-risk assessment processes and data gathering to inform strategy is a long-term initiative and challenging.
• Embracing the process enables the business to identify risk and opportunities, as well as enabling engagement at all levels of the company.
• Climate change affects the business as a whole, so it is important to get buy-in across the entirety of an organisation.

7.  Further consultations propose to extend mandatory climate change reporting

In response to investor sentiment, the Financial Conduct Authority (FCA) has published a consultation (CP 21/18) which proposes to extend the current obligations as regards climate-related disclosures for premium-listed commercial companies to certain issuers of standard-listed equity securities. To this end, the FCA proposes to add a new rule in Chapter 14 of the Listing Rules which directly replicates the equivalent rule currently in Chapter 9. This would require relevant standard-listed issuers to include a statement in their annual financial report setting out certain information about their climate-related disclosures, including whether they comply with the TCFD recommendations and to explain any non-compliance. The same guidance as that applicable to premium-listed companies will also be included in Chapter 14. It is proposed that the new requirements would take effect for financial periods beginning on or after 1 January 2022.

The new rules are proposed to apply to standard-listed issuers of equity shares under Chapter 14 but not standard-listed investment companies or shell companies. The FCA is also seeking views on:

• whether standard-listed issuers of shares other than equity securities and issuers of Global Depository Receipts under Chapter 18 should be covered by the requirements; and
• whether, and how, issuers of standard-listed debt and debt-like securities listed under Chapter 17 should also be scope.

The FCA has also added a "discussion component" to the consultation which seeks views on ESG topics in capital markets, specifically trying to generate discussion and engagement on issues such as green, social or sustainable debt instruments and ESG data and ratings providers.

Separately, the FCA is also consulting (CP 21/17) on proposals to introduce climate-related disclosure requirements for asset managers, life insurers, and FCA-regulated pension providers. These obligations would also align with the TCFD recommendations.

Both consultations close on 10 September 2021.

8.  New climate reporting requirements for occupational pension schemes

The government has published a response to the consultations it carried out to improve reporting standards and governance by occupational pension schemes in relation to climate-related risks and opportunities. The government's response was accompanied by new draft regulations - the Occupational Pension Schemes (Climate Change Governance and Reporting) Regulations 2021 - which have now been laid before Parliament.

The purpose of the regulations is to implement new reporting standards aligned with the TCFD recommendations. The draft regulations, which are accompanied by statutory guidance, will come into force on 1 October 2021 for very large schemes (with assets over £5bn), and then in staged intervals for smaller pension schemes. When the new framework is in place, trustees of occupational pension schemes will need to comply with additional reporting and disclosure requirements, and ensure that they have the requisite knowledge and understanding of climate-related issues, while also taking care that, when setting their scheme's investment strategy, they consider climate-related issues in the context of their general fiduciary duties to invest in members' best financial interests.

Item contributed by John Gordon, Head of our London Pensions team.

9.  BEIS publishes research on executive pay and investment in the UK

The Department of Business, Energy and Industrial Strategy (BEIS) has published the findings of research it has commissioned from PwC, which looked into CEO remuneration performance targets and whether they affected companies' investment levels. This follows criticism over the years that LTIP and annual bonus targets being linked to profit-based figures has led to investment being reduced to keep company short-term profits high and so trigger pay-outs. While the PwC report found limited evidence that this was the case – i.e. that executive pay caused underinvestment - it did find general support for performance targets influencing behaviour and strategic decisions by executives which will be viewed positively.

Ashurst comment: This report follows another report commissioned by BEIS (where the research was also conducted by PwC) which looked at whether companies' share buy-back programmes were being used to increase executive pay by improving EPS performance (and where it also concluded that there was no misalignment). While research is therefore not supportive of allegations that executive pay design is inherently at odds with the interests of investors, for most companies and investors it is specific issues on quantum and performance conditions which are more pressing than the progress of any academic debate in this area, though the difficulties with setting the right or indeed any performance conditions are one of the factors behind companies moving to using restricted share plans rather than LTIPs.

Item contributed by Nicholas Stretch, Head of our London Incentives team.

10.  GTAG constituted to deliver UK's Green Taxonomy

The government has announced the establishment of a new group, the Green Technical Advisory Group (GTAG), which will oversee the delivery of the UK's “Green Taxonomy” – a framework which – like its European equivalent - will determine whether investments can be defined as environmentally sustainable. The UK has previously committed to establishing its own UK Taxonomy by the end of 2022. The launch of GTAG is a critical step towards achieving this.

The focus of GTAG will be the establishment of the UK's technical screening criteria which determines whether an economic activity can or cannot be deemed to be environmentally sustainable. Like its European counterpart, the "Technical Expert Group" or "TEG", GTAG will provide non-binding advice to the government on market, regulatory and scientific considerations for the development and implementation of the UK's Taxonomy. The membership of GTAG will draw on representatives of users of the taxonomy, data experts, academia and subject matter experts. The UK's financial regulators will participate as observers only.

GTAG has been established for an initial period of two years with the aim of meeting quarterly. If the experience of the EU equivalent is a guide, it will need to move fast if the UK intends to launch its taxonomy by the end of 2022, not least because those in scope will need clarity on what will be included in the UK's technical screening criteria sooner rather than later. The UK Taxonomy will apply to both financial and non-financial firms.

Item contributed by Lorraine Johnston, Partner in our Financial Regulation team.

11.  Government outlines position on the development of the financial promotions regime

HM Treasury has issued a response to its July 2021 consultation on the regulatory framework for the approval of financial promotions. In its consultation, the government outlined plans to significantly narrow the circumstances in which an authorised firm, as set out in section 21 of the Financial Services and Markets Act 2001 (FSMA), could approve the financial promotions of an unauthorised firm. This was due to number of concerns that the existing financial promotions regime did not adequately protect consumers, and gave rise to a number of risks, including a lack of relevant approver firm expertise; a lack of approver firm due diligence; and challenges in exercising appropriate regulatory oversight.

The government consulted on the following proposals:

• a process (referred to as a "gateway") whereby FCA consent would be required before an authorised firm could approve an unauthorised firm's financial promotions; or
• specifying that the approval of financial promotions communicated by unauthorised persons is a Part 4A, FSMA "regulated activity" (which firms would need to have permission to perform).

In its response, the government confirms that, given the support expressed for the approach, it will be taking forward its regulatory gateway proposal. Under this regime, all new and existing authorised firms will be prohibited from approving the financial promotions of unauthorised persons (to be implemented via a requirement on their permission). In turn, new and existing authorised firms wishing to approve financial promotions will have to apply to the FCA to have the prohibition removed either entirely (allowing them to approve all types of financial promotions), or partially (allowing them to approve certain types of financial promotions).

Legislation will be brought forward to implement the regime when Parliamentary time allows. Implementation will also follow a transitional period, details of which are set out in the response. The FCA will also consult on its proposals for implementing the gateway aspects of the new regime in due course.

Item contributed by Lorraine Johnston, Partner in our Financial Regulation team.

12.  Notification of "uncertain tax treatments" to HMRC

The government is, in April 2022, introducing a new policy that will require large businesses to notify HMRC of "uncertain tax treatments". The aim of this policy is to highlight to HMRC possible areas of disagreement between taxpayers and HMRC in the interpretation or application of tax laws. HMRC expects this to reduce the "interpretation tax gap" by approximately £40m each year, albeit that this will not make much of an impact on the overall tax gap which HMRC estimates to be £4.9bn.

Corporates, partnerships and LLPs, with either a turnover exceeding £200m or a balance sheet total over £2bn, will need to assess tax positions taken in their returns to determine if these fall within a number of "triggers" designed to indicate potential differences of interpretation. These triggers include:

• adopting an interpretation of tax law that differs from HMRC's known position, or departs from established industry practice, or conflicts with the position taken in a previous tax return;
• using novel products, transactions or business structures such that the tax treatment cannot reasonably be regarded as certain;
• a provision being recognised in the accounts, in accordance with GAAP, to reflect the probability that a different tax treatment will be applied to the transaction;
• a difference between the tax outcome and the underlying economics; and/or
• a position adopted contrary to professional advice (which is not protected by legal professional privilege) indicating an alternative tax treatment, or basing a tax position upon advice which contradicts other available advice.

Businesses within the scope of these rules will need to put in place processes to identify when these triggers are met and a notification may be required. Any notifications will inevitably increase the risk of challenge by HMRC. As far as possible, consideration of these rules should take place as part of the approval process before the relevant transaction is implemented.

Boards should also consider these rules when instructing tax advisers, particularly in the context of second opinions and accountants' advice, given that the latter will not benefit from the exemption from these rules for tax advice which is protected by legal professional privilege.

Contributed by Nick Gardner, Partner, and Vicky Brown, Expertise Counsel, in our Tax team.