The Financial Times recently published an article by Brian Cheffins, professor of corporate law at the University of Cambridge, advocating for the abolition of the UK Corporate Governance Code (the “Code”). While Professor Cheffins raised a number of interesting points, I respectfully disagree with his view that the Code should be abolished.
Professor Cheffins’ article coincided with the publication by the Financial Reporting Council (FRC) of its Position Paper. The Paper outlined the FRC’s plans to support the Government’s audit and corporate governance reforms as the FRC transitions into the Audit, Reporting and Governance Authority (ARGA). Part of that work includes changes to the Code addressing internal controls, expanded sustainability and ESG reporting, enhanced resilience statements and fraud reporting by directors.
These changes are part of a long list of enhancements that have been made since the publication of the first set of corporate governance principles in the Cadbury Code in 1992. The Code has certainly come a long way in the 30 years since Cadbury. The Combined Code replaced the Cadbury Code in 1998 and would continue until 2010 when, in response to the 2008-09 financial crisis, the first edition of the Code was published. The current version of the Code, published in 2018, contains further revisions and enhancements.
Despite the Code representing 30 years of corporate governance evolution, Professor Cheffins identified various problematic features of the Code that “collectively justify [its] abolition.”
Duplication Of Mandated Rules
According to Professor Cheffins, much of the Code “duplicates what is mandated elsewhere”..
One of the benefits of the Code is that it brings together best practice in one document. That some of the requirements exist elsewhere is to be expected; corporate governance does not operate in a vacuum and is closely linked to every aspect of an organisation’s operations. By duplicating what is mandated elsewhere, the Code is bringing those areas specifically into the realm of corporate governance, creating greater focus on such areas than would have previously existed.
If the Code were abolished because, in part, it is comprised of some mandated rules elsewhere, corporate governance would be poorer as a result.
Comply Or Explain Is Ineffective
The “comply or explain” nature of the Code is considered by Professor Cheffins to be ineffective, allowing companies to “opt not to adhere to a code provision so long as they disclose the rationale.”
Under Listing Rule 9.8.6, premium listed companies are required to apply the principles of the Code and provide a report to shareholders on how those principles have been applied. In addition, such companies must state whether they have complied with all relevant provisions of the Code and, if not, explain their reasons for non-compliance.
While the Listing Rules allow for non-compliance to be explained, the Code expects more. The FRC stated in its paper “Improving the quality of ‘comply or explain’ reporting”, that it “…encourages companies to embrace the flexibility offered by the Code … and choose what is best for them… Companies and shareholders should not favour strict compliance over effective governance and transparency.”
The framework is therefore in place for companies to adopt a bespoke governance structure; the fact that companies choose not to avail themselves of the flexibility offered by the Code is not the fault of the Code.
Inherently Flawed Stakeholder Protection Mechanism
Professor Cheffins sees the Code as an “inherently flawed stakeholder protection mechanism” because “enforcement depends upon shareholders lobbying for change.”
Lack of engagement by shareholders has been an issue for many decades. It was deemed necessary to introduce the UK Stewardship Code in 2010 to incentivise institutional investors to engage with directors on corporate governance. That the Code offers protection for stakeholders but relies on a historically inactive group to enforce such protections is, on its face, problematic. However, the inclusion of stakeholder protection in the Code should be seen as a positive as it has raised awareness of other key stakeholders.
In addition, the third iteration of the UK Stewardship Code was published in 2020 as best practice in this area evolves. It is possible that shareholder engagement will increase to a level where there is an active protection mechanism in place. If not, Government is free to legislate in this area to provide the protections needed. Even then, retaining stakeholder protections in the Code – despite any overlap – would help keep those protections at the forefront of corporate governance best practice.
Time should be given to see how well stakeholders are protected before the Code is deemed ineffective in this respect.
Mandatory Disclosure In The Listing Rules
Professor Cheffins’ proposed solution is to amend the Listing Rules to “mandate disclosure of high-priority corporate governance arrangements and allow tailored solutions.”
The Listing Rules already require public companies to disclose how they comply with the main principles of the Code. There are five sections of the Code divided into 18 main principles with which public companies are expected to comply and report against. Which of those are considered to not be “high-priority” by Professor Cheffins we are not told. In addition, as highlighted above the Code already allows for tailored solutions through its “comply or explain” approach and it is not the fault of the Code that companies choose not to develop more bespoke corporate governance practices.
If the Listing Rules were amended as Professor Cheffins suggests, it would run the risk of taking us back to the Cadbury Code. Paragraph 1.3 of the Cadbury Code set out its purpose: “At the heart of the Committee’s recommendations is a Code of Best Practice designed to achieve the necessary high standards of corporate behaviour.” Best practice has evolved considerably since then, with new areas being added when appropriate. Amending the Listing Rules to specify a list of “high priority” corporate governance practices would take us back to where we began and would inevitably result in future additions to the “high priority” list in the same way the Code has evolved.
There is no need to look back. The Code has already evolved to reflect the needs of today, and it will continue to evolve to reflect the needs of tomorrow. Continued evolution, not abolition, will best serve shareholders and stakeholders alike.
Article written by our USA Ambassador, Daniel Murray.