‘Comply or explain’ reporting
The Financial Reporting Council (“FRC”) recently released updated guidance to enhance the quality of corporate governance reporting under the UK Corporate Governance Code (“the Code”). The core message is a reminder that the Code is intended to be a flexible framework and not a rigid compliance exercise from which companies feel they cannot depart.
Why has this guidance been released
The FRC observed that the Code has increasingly been treated as a ‘tick-box’ compliance exercise. In a desire to demonstrate full compliance many companies produce boilerplate disclosures that lack insight into how they operate. This guidance serves as a reminder that the Code is a flexible framework, not a rigid set of rules. A well-reasoned explanation for a departure from the Code can be evidence of better governance than rigid compliance.
The link between reporting and board effectiveness
High quality ‘comply or explain’ reporting is not merely a drafting task – it is the output of a board that is functioning effectively. To provide a convincing rationale for its governance choices, a board first needs a clear understanding of its own position on matters such as composition, dynamics and risk appetite. With this information the disclosure can move beyond boilerplate language and demonstrate why a chosen approach is the most effective for a company’s success.
‘Best practice’ disclosure for a departure from the Code
To gain investor and stakeholder support, companies must clearly explain why an alternative action is warranted. Meaningful explanations demonstrate that the alternative approach is more appropriate and beneficial in upholding high governance standards.
Therefore, the explanation for any departure should provide sufficient information to enable investors and other stakeholders to assess the situation, such as:
Be clear and transparent about the provision being departed from and where the supporting explanation can be found in the Annual Report;
Provide context and background, describing the specific circumstances and reasons for the departure;
Give a convincing rationale for the approach taken;
Demonstrate that the risks of the approach have been considered and describe the mitigations in place; and
State whether the company intends to comply in the future and provide an estimated timeframe.
Ellason commentary
We welcome this guidance, as it reinforces the principle that governance should not be viewed as a compliance exercise. A board that carefully considers how the principles of good governance are appropriately applied to its specific circumstances demonstrates the attributes of a thoughtful and accountable board. It is vital that this is evidenced through clear and transparent reporting, providing investors with a window to how the board operates and how seriously it takes its role as steward.
Please do not hesitate to contact any of the Ellason team should you wish to discuss this issue further.
Please do not hesitate to contact any of the Ellason team should you wish to discuss this issue further.