Ashurst Governance Compliance Update Issue 10

1. FRC publishes research report on corporate culture

The Financial Reporting Council has published a report on corporate culture, 'Creating Positive Culture: Opportunities and Challenges'. This builds on its 2016 research report: 'Corporate Culture and the Role of Boards', significant aspects of which were distilled into various recommendations of the UK Corporate Governance Code 2018 (augmented by the FRC's Guidance on Board Effectiveness) where directors are urged to ensure that the culture of their companies promotes integrity and openness, values diversity and is responsive to the views of shareholders and other stakeholders.

The report aims to promote good practice and positive working cultures. In producing it, the FRC engaged with numerous organisations including The Chartered Governance Institute, The Institute of Business Ethics and The Chartered Institute of Internal Auditors, as well as board directors, senior individuals from across different functions and workforce representatives.

The report explores how companies frame culture, how they assess, monitor, embed and assure it, and what enablers and barriers they encounter in doing so. The key findings recognise that positive culture should be attained through honest conversations and by building trust, which will support companies in achieving success over time.

The report finds that the pandemic has challenged the resilience and agility of companies, with many having to swiftly adapt their strategy, business model and ways of working. There have been changes in stakeholder and investor priorities. There is now a strong emphasis on the importance of environmental, social and governance (ESG) matters, particularly for the workforce and investors, but also other stakeholders. Areas such as wellbeing, flexible working and working constructively with stakeholders are now seen as more important than ever.

The FRC's conclusions include:

• Fostering a healthy culture is beneficial to all companies, regardless of their ownership structure. The benefits of good corporate culture go beyond premium listed companies, and the findings of the report will, therefore, also be of relevance and application to unlisted companies.
• Leadership should come from the top, through actions and attitudes, but the workforce must feel engaged and able to contribute. The board should ensure that an organisation’s culture is aligned with purpose, values and strategy. The CEO plays an essential role in driving and embedding culture throughout a company. When managers are empowered and supported, they are critical to achieving cultural change.
• While companies are now collecting a vast amount of culture-related data and information, in many cases the benefits that can be gained from joining up across different functions are not being effectively utilised. For example, by encouraging greater cooperation and communication between HR, internal audit, ethics & compliance and risk functions, companies may be able to better assess, monitor and embed their culture.
• Timely implementation of any follow-up action points and regular assurance are equally important. Without clear and timely follow-up actions and feeding back to workers and other stakeholders, companies can be accused of ‘culture washing’, leading to the loss of trust – the biggest barrier to driving positive culture.
• Creating a positive culture should improve performance. Trust, empathy and psychological safety are crucial to fostering positive culture. Everyone should be encouraged to speak up, share concerns and have candid conversations. The key challenge for companies and their boards is to acknowledge that culture requires patience, openness and commitment to continuous development through any future changes to senior personnel.
• Reporting on culture is a lens through which culture change can be assessed. As evidenced by the FRC’s Review of Corporate Governance Reporting, there is room for improvement in both the way that companies promote culture and how it is assessed. It is an area on which the FRC will continue to focus.
• Based on its findings, the FRC has stated that it will consider what further action to take, including any amendments to the Guidance on Board Effectiveness.

2. Spencer Stuart Annual Board Index published

Recruitment consultant Spencer Stuart has published its latest UK Board Index, which contains a review of board composition, governance practice and key trends in the FTSE 150. Key findings as at the Index's cutoff date of 30 April 2021 include:

• Ethnic diversity – 61 percent of FTSE 100 companies had met the Parker Review target of at least one director from a minority ethnic background; 18 percent reported that they had not done so; 19 percent were silent on the issue. Note that directors are described as 'minority ethnic' in relation to the dominant ethnicity of the country in which the company is headquartered.
  
  42 percent of the FTSE 100 reported the number or percentage of minority ethnic directors on the board; 29 per cent merely reported whether they were either 'compliant' or 'non-compliant'; nine percent adopted a 'granular' approach and reported how each director self-identified.
  
  The Index also demonstrates that a largely equal number of male and female ethnic minority background directors were appointed in the FTSE 150 in the review period.
• Gender diversity – 67 percent of FTSE 150 boards had reached the Hampton-Alexander target of 33 percent women, a five percent increase on last year. Only 15 boards have achieved gender parity, five more than in 2020.
  
  Within the sample set, UK boards comprised an average of 3.6 women members against an average board size of 9.9.
  
  For the first time, female non-executives outnumbered their male counterparts.

• Board leadership – While gender diversity among non-executives has improved , the picture is less rosy at executive level with just 14 percent of women holding such roles, the same proportion as in the 2020 Index. Only 18 percent of new appointments were women, with seven of the nine being CFOs. There were 12 female CEOs, only five more than a decade ago.
  
  Men hold all four senior roles - Chair, SID, CEO, and CFO - in 64 of the FTSE 150, with only 14 women in Chair roles. The number of women in SID roles has dropped to 26 percent (2020: 34 percent).

• Senior management – Despite the purview of the Hampton-Alexander targets extending to executive committees, these remain predominantly male with women making up only 24 percent of their membership and only 25 percent of such committees meeting the target. Nine percent of ExCos were all male.
• Board committees – The Index contains analysis of the scope and make-up of board committees. Six boards created dedicated ESG-related committees in 2020, each being chaired by women.
• External commitments and board tenure – The Index suggests that concerns about 'overboarding' have been exacerbated during the Covid-19 pandemic as boards have met more frequently (on average 11.6 times, a 50 percent increase on pre-pandemic levels) often in 'crisis mode'.
  
  The average tenure on UK boards continues to be lower than in most of Europe and North America. Nevertheless, average CEO tenure has marginally increased to 5.8 years. Chair tenures are 5.7 years on average, with 17 percent having served for more than nine years.

• Remuneration – During 2020, many boards imposed temporary reductions on pay in response to the impact of the COVID-19 pandemic. On average, chair remuneration fell by six percent and senior independent director remuneration fell by five percent, marking the first reduction in the past six years. In contrast, non-executive director fees increased by two percent.
• Workforce engagement – By way of reminder, the UK Corporate Governance Code 2018 requires companies to formally create a mechanism for board engagement with the workforce. Among FTSE 150 companies, 47 percent have appointed a designated non-executive director, 65 percent of these being women; five percent have a workforce advisory panel.

3. ISS 2022 Proxy Voting Guidelines updated

Institutional Shareholder Services has published updates to its UK proxy voting guidelines for 2022.

The final changes relate principally to board gender and ethnic diversity representation, board recommended and shareholder-backed say on climate proposals, board accountability on climate issues, and the use of ESG performance conditions in variable remuneration schemes. All are substantively the same as those consulted on and on which more detail can be found in Ashurst Governance and Compliance update, Issue 8.

The updates will be effective for meetings held on or after 1 February 2022. ISS intends to publish full updated policy documents in due course

4. The biggest change to "retail" regulation yet? The Consumer Duty lands

Of relevance to all financial services firms with retail clients, the Financial Conduct Authority has published its highly anticipated further consultation paper (CP21/36) which includes proposals for the new 'Consumer Duty'.

Despite some industry pushback on the need for this new package of measures, the new Consumer Duty appears here to stay, with the FCA stating that they cannot meet their objective of setting a higher expectation for the standard of care that firms give consumers without new rules.

You can find more detail on the proposals here and further detail on the original May 2021 consultation here.

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

5. Latest Primary Market Bulletin deals with ESEF and market disclosure procedures

The Financial Conduct Authority has published its 37th Primary Market Bulletin. Issues covered of particular relevance to listed companies include:

• European Single Electronic Format reporting: As we have covered in previous Ashurst Governance and Compliance updates, the implementation of rules requiring the publication of annual financial reports in an ESEF-compliant structured format come into force on 1 January 2022. Here, the FCA provides a further reminder of the need for planning and testing ahead of the formal obligation to file in accordance with the new requirements, as well as its expectations as to quality; and
• Dissemination of regulated information: Issuers must use a Primary Information Provider, also known as a Regulatory Information Service or 'RIS', such as the RNS of the London Stock Exchange, to disseminate regulated information to the market. The Bulletin explains the importance of adequate business continuity procedures for PIPs themselves and, of more relevance, suggests that issuers may want to consider having more than one PIP account in order that they have a fall back option in case their principal provider is unable to disseminate information on their behalf in accordance with their obligations (for example, due to a systemic failure).

6. Companies House introduces online service for reporting PSC discrepancies

Companies House has announced that it has introduced a new online service to make the reporting by in-scope entities of discrepancies relating to those with significant control information easier and faster.

By way of background, in January 2020 the Fifth Anti-Money Laundering Directive (5MLD) was introduced in the UK. This requires obliged entities (OEs) to carry out customer due diligence and report discrepancies found in relation to PSC information to Companies House. OEs include banks, financial institutions and credit reference agencies, among others. Failure to do so can lead to sanctions under the Money Laundering Regulations. The new online service seeks to make this process easier and faster.

All OEs must tell Companies House if they discover a material difference between the information that they hold about a PSC (including those of limited liability partnerships and Scottish limited or qualifying partnerships) and the information on the PSC register. Companies House will then investigate the discrepancy and, if necessary, contact the company or other entity concerned.