Changes to the UK Corporate Governance Code

Updated December 2010

In May 2010 the Financial Reporting Council (FRC) issued the UK Corporate Governance Code (Code), which replaces the Combined Code, which applies to a UK company's financial year beginning on or after 29 June 2010 and for overseas companies for financial years beginning on or after 31 December 2009. As with previous editions of the Code, it seeks to "set out standards of good practice in relation to board leadership and effectiveness, remuneration, accountability and relations with shareholders".

The Code applies to all companies with a premium listing on the Main Market of the London Stock Exchange, regardless of which country they are based in. As with previous editions of the Code, companies are required to either confirm that they comply with the Code, or explain why they believe that the arrangements that they have in place are sufficient for them not to comply. This "comply or explain" requirement has been a feature of the Code since its inception and gives investors and shareholders a useful insight into the governance of the company.

While changes to the code are limited, the FRC has emphasised the importance of general principles which should guide the behaviour of a board. The updated Code introduces the following key changes:

Board evaluation – Every three years the board of a FTSE 350 company should arrange an independent evaluation of its performance and details of how this has been carried out should be included in the annual report.

Annual re-election – Each year all directors of FTSE 350 companies should be subject to re-election by shareholders. Directors of smaller companies should be subject to re-election at the first AGM after their appointment and at least once every three years thereafter. Where a non-executive director of a smaller company has served for nine years, they should be subject to annual re-election.

Board composition – Board appointments should be made on merit but with due regard to the benefits of diversity, including gender. The FRC believes that increased diversity in boards can improve the quality of the decision making. This is a general principle and does not go as far as other jurisdictions, for example France, in stipulating a fixed gender quota.

Effectiveness – The board should have the appropriate balance of skills, experience, independence and knowledge of the company to enable it to discharge its duties effectively. There is also a requirement for a formal, rigorous and transparent appointment procedure to achieve this. The chairman should regularly review and agree with each director their training and development requirements.

Leadership – The chairman is responsible for leadership of the board and for ensuring its effectiveness. Chairmen are encouraged to report personally in their annual statements on how the principles relating to the role and effectiveness of the board are being achieved. This includes promoting a culture of openness and debate and ensuring constructive relations between executive and non-executive directors.

Commitment – All directors, including non-executive directors, should be able to allocate sufficient time to the company to discharge their responsibilities effectively. Non-executive directors should undertake that they will have sufficient time to meet what is expected of them.

Accountability – The board should present a balanced and understandable assessment of the company's position and prospects, including an explanation in the annual report of the long term business model and its strategy for delivering the objectives of the company. It should also make a half-yearly statement that the company is a going concern.

Risk management – The board should maintain sound risk management and conduct an annual review of the effectiveness of its risk management and internal control systems.

Remuneration – Where an element of an executive director's remuneration is performance related, this should be designed to promote the long term success of the company. Grants under all incentive schemes should be subject to challenging performance criteria, reflecting the company's objectives (including non-financial performance, where appropriate). The board should also consider what compensation elements would be payable on the early termination of a director with a view to avoiding rewarding poor performance. Remuneration for non-executive directors should not include share options or other performance-related elements.

Dialogue with shareholders – The board as a whole has responsibility for ensuring that satisfactory dialogue with shareholders takes place and the chairman is responsible for ensuring that the views of shareholders are communicated to the board as a whole. Non-executive directors should be offered the opportunity to attend scheduled meetings with major shareholders.

The Code operates as a set of principles rather than rules and it is common for smaller companies outside of the FTSE 350 not to comply with certain elements where to do so would be disproportionate, or where the principles are stated not to apply to such companies. However the FRC encourages all fully listed companies to comply with the Code where possible.

Furthermore, it is likely that institutional investors will look for at least a reasonable attempt to comply from all publicly listed companies, including those with a standard listing or even those with shares traded on AIM.

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at December 2010. Specific advice should be sought for specific cases; we cannot be held responsible for any action (or decision not to take action) made in reliance upon the content of this publication.

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