In its response to its Green Paper on Corporate Governance (see this blog post for more), the government invited the FRC and several other bodies to create a group that would work on a set of corporate governance principles for private companies. On the 30th January 2018, the FRC announced that this group, known as the Coalition Group would be chaired by James Wates CBE, Chairman of the Wates Group. On the 13th June 2018, the Coalition Group published a consultation document on the Wates Corporate Governance Principles for Large Private Companies.
Reporting requirements and scope of the Principles
In its response to the Green Paper, the government stated that it would pass subordinate legislation requiring all companies of a significant size that do not currently provide a corporate governance statement to disclose their corporate governance arrangements. A few days before the Coalition Group published its consultation paper, the Companies (Miscellaneous Reporting) Regulations 2018 were laid before Parliament. These regulations which, if approved, will apply to financial years starting on of after the 1 January 2019, insert new provisions into the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 that will apply to any company that:
- has more than 2,000 employees, and/or;
- has a turnover of more than £200 million and a balance sheet total of more than £2 billion.
Such companies must include in their directors’ report a ‘statement of corporate governance arrangements’ that states:
- which corporate governance code, if any, the company applied in that financial year;
- how the company applied this code, and
- if the company departed from that code, its reasons for doing so.
Companies will be able to adopt the Wates Principles and report on them as required under these new provisions.
Apply and explain
The UK Corporate Governance Code operates on a ‘comply or explain’ basis, meaning that companies to whom the Code applies can either comply with the Code’s recommendations or explain their reasons for any non-compliance. The Wates Principles differ and instead operate on a ‘apply and explain basis,’ as follows:
A company that adopts the Principles is expected to apply them fully. Using an apply and explain approach, large private companies are expected to provide a supporting statement for each principle that gives an understanding of how their corporate governance processes operate and achieve the desired outcomes. The principles are supported by non-exhaustive guidance that helps companies apply the principles in practice.
This is an interesting approach. The UK Corporate Governance Code operates on a comply or explain basis because a one-size-fits-all approach would not work, and so companies are allowed to depart from the Code’s recommendations. The consultation to the Wates Principles also recognises that, in large private companies, ‘[d]iffering management and ownership structures means that a one-size-fits-all approach to corporate governance in large private companies is not appropriate.’ However, the Wates Principles provide companies with the requisite flexibility through the Principles themselves, which as discussed in the next section, are very broad and provide companies with significant flexibility in terms of their application.
The core of the Wates Principles consists of six Principles, namely:
- Principle One – Purpose: An effective board promotes the purpose of a company, and ensures that its values, strategy and culture align with that purpose.
- Principle Two – Composition: Effective board composition requires an effective chair and a balance of skills, backgrounds, experience and knowledge, with individual directors having sufficient capacity to make a valuable contribution. The size of a board should be guided by the scale and complexity of the company.
- Principle Three – Responsibilities: A board should have a clear understanding of its accountability and terms of reference. Its policies and procedures should support effective decision-making and independent challenge.
- Principle Four – Opportunity and risk: A board should promote the long-term success of the company by identifying opportunities to create and preserve value, and establishing oversight for the identification and mitigation of risks.
- Principle Five – Remuneration: A board should promote executive remuneration structures aligned to the sustainable long-term success of a company, taking into account pay and conditions elsewhere in the company.
- Principle Six – Stakeholders: A board has a responsibility to oversee meaningful engagement with material stakeholders, including the workforce, and have regard to that discussion when taking decisions. The board has a responsibility to foster good stakeholder relationships based on the company’s purpose.
Each Principle is accompanied by brief guidance on how the Principle should be applied. It is clear to see that the Principles are written in a ‘high-level’ manner and provide companies with considerable flexibility in terms of their application. The consultation document itself provides an example of this, noting that draft Principle 3 could be applied in several different ways including:
- A large family owned company might seek to appoint an independent director to its board to introduce independent challenge. It could explain how the appointment of this director has delivered improved outcomes to its board’s decision-making processes by identifying an example where the provision of independent challenge from the independent director has improved board decision-making.
- A private equity-owned company with a small shareholder board might appoint an external consultant to provide independent advice on its corporate strategy. It could describe the value that independent insight has had on refining the company’s purpose.
A large subsidiary of a UK-listed company may establish an advisory committee to seek independent, objective advice as to the effectiveness of the board’s decision- making. It could explain how this appointment demonstrates the directors’ commitment to accountability and acknowledgement of their duties under the Companies Act 2006.
It should be remembered that the Wates Principles, as currently drafted, are draft Principles only and so could undergo change prior to them being finalised in December 2018. They will then apply to financial years starting on or after the 1 January 2019.