UK CG Code webcast with Mark Babington

The consultation on the UK Corporate Governance Code (the Code) was published on 24th May 2023, with a proposed effective date of 1 January 2025 once finalised. To get clarity over some of the proposals, EY hosted a webcast with Mark Babington, Executive Director of Regulatory Standards at the Financial Reporting Council (FRC) on 6 June. We summarised key areas of change; provided examples of practical challenges and asked Mark some of the audience’s pressing questions.

Risk management (RM) and internal controls (IC)

This area has generated most interest and debate including regarding the implications for foreign private issuers subject to US SOX (“FPIs”); the broadening to controls over non-financial reporting (NFR); the expectations in respect of operational and compliance controls; and whether boards plan to seek assurance before reporting on effectiveness.

Mark explained that the FRC’s proposals are designed with flexibility in mind to allow companies to tailor application to their own circumstances and the expectations of their stakeholders. This flexibility is also important for companies that may have to apply the Code in the future i.e., currently standard listed.

Mark was clear that this is not a form of US SOX, or indeed SOX-light. ?Rather, it is a change in reporting requirements for directors to include a more considered, and perhaps stronger declaration in respect of the effectiveness of those aspects of RM and IC they consider to be most material.

He noted that NFR, particularly on sustainability matters, is of increasing importance to stakeholders, which explains the FRC’s expansion from ‘financial’ to ‘reporting’ controls – an area that FPIs will need to consider carefully.

Interaction with secondary legislation on proposed reporting measures

The second area discussed was the interaction between the proposals and the four new reporting requirements to be introduced through impending secondary legislation.

Whilst these will apply only to UK incorporated companies with turnover of ￡750m and 750 employees, the FRC’s proposals mean all companies subject to the Code will be expected to prepare an Audit and Assurance Policy (AAP). Clearly companies below these thresholds could use the Code’s flexibility and explain. ?Interestingly, only 6% of those we polled had already drafted an AAP, with over half yet to commence work.

As regards commissioning assurance, Mark’s view was that existing permissible or “white-list” services would encompass assurance over ICFR and of other information within the annual report (ARA). However, unless required by law or regulation, any further assurance that companies may want from their auditor will be caught by the current 70% fee cap on non-audit services that auditors can provide. Mark clarified that changing this cap is a matter for government to address via law. Our poll shows that the majority were still undecided on the form of assurance over ICFR they were likely to seek, with 40% contemplating internal assurance.

The Resilience Statement (RS) has not been mandated for Code companies, as the Code already requires reporting on future prospects via the viability statement (VS). However producing a RS would address the VS requirements. Mark’s view – and something the consultation is seeking opinion on - is that given the VS has not been as effective as hoped, ?there may be benefit in all Code companies producing a RS. ?The FRC will be working with Government to develop guidance on the RS.

There are no proposals in the Code to introduce the other two legislative reporting measures i.e., statement on measures to prevent and detect material fraud or the statement on distributions.

Narrative reporting and non-financial metrics

Subsuming the AAP requirement into the Code dovetails with the expansion in the audit committee’s (AC) role to monitor the integrity of narrative reporting. Mark noted the increasing use of sustainability information in considering capital allocation decisions, making it imperative for such information to be high quality and reliable. He also emphasised the need to bridge the gap between narrative and financial reporting through better integration.

Mark referenced the FRC’s survey of AC chairs exploring their understanding and approach to ESG activities and reporting within their organisations. Since published, this report, shows that AC chairs have a strong interest and understanding of ESG activities, however their primary role is often limited to risk management, compliance and ensuring effective reporting. On the latter, many commented that the increased focus on ESG in reporting was making ARAs lengthier and unnavigable. On this note, Mark welcomed the Government’s call for evidence to refresh and rationalise the UK’s NFR framework.

A key question is on the boundaries of narrative reporting that ACs would need to oversee i.e., ?just in the ARA or outside too. This is not addressed in the consultation and Mark reiterated this was for companies to determine and the Code’s flexibility allowed companies to tailor their approach to what they consider material.

Just over 70% of those polled stated that their ACs already oversaw reporting on sustainability matters, only 15% did so for all sustainability reporting (i.e., even if outside the ARA).

Conclusion

It is vital that boards engage with the FRC, either by responding to relevant questions in the consultation by 13 September or via its ongoing stakeholder outreach. This will not only help shape the final measures in the Code and its supporting guidance but also the FRC’s understanding of the incremental time and effort required to be ready.

The FRC anticipates publishing the final Code and guidance by the end of 2024 giving companies c.12 months to prepare before the planned effective date. ?Mark emphasised that the FRC’s expectation is not that full compliance is achieved from day 1 but also that there isn’t one single approach for all companies. Fundamental to both these points is the comply or explain footing of the Code.

·??????Listen to the full webcast (one off registration may be needed)

·??????Download EY’s comprehensive summary of all proposed changes

·??????Look out for our points of view on key proposals which may be useful as you formulate your company’s response.?