The Three Wise Kings of Corporate Governance in 2021

Based on a talk given to Women on Boards' Directors' Circle
by Tom Proverbs-Garbett, Senior Associate, Pinsent Masons LLP.

December 2021

Reflecting on corporate governance issues in 2021 into 2022, three areas of development come to mind. Here is a very high-level summary of those issues, along with suggestions on further reading. It is by no means exhaustive!

1. Climate change reporting

We’ve seen a significant ‘snowball effect’ on climate change reform, with various stakeholders bringing their influence to bear. Regulators have been looking at this for some time. Indeed, there are already duties in the Listing Rules requiring premium listed firms to report on climate in the next reporting cycle.

Customers, particularly in the public sector, are looking to their suppliers to evidence ‘green credentials’. Debt providers and investors similarly see the momentum in this direction, and it’s just good business to be part of that change. As Larry Fink said in his influential 2021 Black Rock letter to CEOs: “No issue ranks higher than climate change on our clients’ list of priorities.”

However, reporting on climate change is not simple. There are, as yet, no agreed reporting standards, either within or across different territories. Getting hold of your ESG data can be difficult, and companies need to do quite a bit of work to determine which metrics and data are most relevant for them. This makes it hard for investors to compare across companies, and there is little external assurance that internal data gives an accurate and full picture.

The recent FRS 102 Factsheet 8 Climate-related matters and the LSE’s Guide to Climate Reporting are useful recent resources, capturing the current state of affairs.

More broadly, expect to see increasing focus from the Financial Reporting Council (FRC) on ‘linkage’, not just in relation to climate change but in reference to the ESG agenda overall and, indeed, throughout the annual report and accounts. By ‘linkage’ the FRC means that statements made in an annual report should be internally consistent, connecting the financials, strategic priorities and risks the company has identified.

2. Section 172 statement

Section 172 of the Companies Act 2006 is the central duty for directors to make honestly held decisions for the success of the company for the benefit of its members. It’s at the heart of the boardroom.

In making decisions, section 172 requires directors to consider (where relevant) the long-term consequences, employees’ welfare, relationships with suppliers and others, impact on the community and environment, high standards of business conduct etc. The vast majority do this as a matter of course.

What is new is that larger companies now have to report against this duty. This can feel quite challenging, as decisions are often made on gut-feeling and engagement with stakeholders, historically, has been informal.

This new reporting requirement follows various high profile corporate governance failures, at BHS, Carillion and Patisserie Valerie for example. It’s important to remember that the purpose of reporting on section 172 is to give shareholders insight into whether and how directors make decisions in line with their statutory responsibilities, not to stop bad commercial decisions ever being made.

The aim of section 172 reporting is simple: to make directors and their companies think consciously about how these factors reach the boardroom.  The most powerful way of demonstrating compliance is by the inclusion of examples. This isn’t always straight-forward, as companies often want to keep their decision-making confidential. But it is the process that is important and difficult decisions are often the best opportunity to illustrate the section 172 duty at work. For example, you can show that a redundancy programme took into account the company’s financials, long-term business strategy, reputation, community impact and impact on staff with any mitigating initiatives.

The FRC’s Financial Reporting LAB ‘Reporting on Stakeholders, decisions and Section 172’, published July 2021 is a very useful resource on the point.

3. A UK Sarbanes-Oxley Regime (SOX) and more?

There has been a lot of discussion, and attention, paid this year to  the future direction of UK business, and its wider economy. However, there is clearly tension within government on the direction of travel. The UK is a world leader in corporate governance, and one ‘camp’ in government appears to feel we should be going further to maintain this position – strong governance being good for business overall. However, there is another view that post-Brexit, global Britain should be open for business with the rest of the world and that barriers to that investment should be kept to a minimum.  

One of the biggest proposals of 2021 – found in the government’s recent white paper consultation on reforms to audit and corporate governance – is to introduce a ‘light’ version of the US Sarbanes-Oxley regime (SOX) to the UK, focussing similarly on internal controls on financial reporting in listed companies. Amongst other things it would require an annual review on internal control effectiveness, a report on which would be included in the annual report. There has been some controversy around this and how it would link with the usual external audits. There are also a number of outstanding questions about who would conduct it and how.

Additionally, there are several other reporting requirements proposed. To name just three: a report on dividend payments, requiring a statement from directors that legal formalities have been complied with and that profits are available for distribution; a resilience statement, which would consolidate and build on the ‘going concern’ and ‘viability’ statements, considering risks to the company over the short, medium and long term; and an audit and assurance policy, describing the approach to external audit and checking the company’s reported information beyond the financials.

Reforming corporate governance, done well, need not and should not be a barrier but could help attract more global business with and within the UK. However, it is very much ‘watch this space’ to see where these proposals end up.  The white paper is available here.
This article is based on a longer talk given at our December 2021 'Directors Circle' event by Tom Proverbs-Garbett, Senior Associate at Pinsent Masons LLP.

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