The UK Stewardship Code and Corporate Governance changes on the horizon

Updated December 2010

Following the Walker Review of UK corporate governance rules, the Financial Reporting Council (FRC) published the new UK Stewardship Code (Code) on 2 July 2010. This update looks at the provisions of the new Code and also considers the other corporate governance issues which are currently under review.

Based on the Institutional Shareholders' Committee's Code, the new Code sets out a statement of good practice that institutional shareholders should follow when engaging with UK listed companies. The FRC now encourages all institutional investors to report on their websites the extent to which they comply with the new Code. This is similar to the "comply or explain" requirement under the UK Corporate Governance Code.

Who does the Code apply to?

The new Code took effect from 1 August 2010 and the FRC identifies the following groups who the Code applies to:

• Asset managers who manage portfolios for institutional investors.
• Institutional investors, such as pension funds, insurance companies and collective investment schemes; and
• Services providers, such as proxy voting services, who act on behalf of investors.

The FRC also asks that foreign investors comply with the Code. However, where their local legislation imposes a similar requirement then they should explain why they are unable to comply with the UK Code.

Website statement

The FRC encourages all institutional investors to put a statement on their website setting out how they comply with the Code. The deadline the FRC gave was the end of September 2010, after which they intend to publish a list of who has complied and who has not. However, to date a list has not been published on the FRC website.

Specifically, the statement should state how the institution has applied the Code, or explain why it has not been applied. It should also provide details of a person who can be contacted for further information by those interested in collective engagement. The FRC accepts that the Code will not be applicable in its entirety to all investors, however it encourages them to comply so far as possible.

Code principles

The Code has seven principles, which are largely similar to the Institutional Shareholders' Committee's Code. Guidance has also been published on each. Please contact us if you would like further information on the guidance. These principles require that institutional investors should:

• publicly disclose their policy on how they will discharge their stewardship responsibilities;
• have a robust policy on managing conflicts of interest in relation to stewardship. This policy should also be publicly disclosed;
• monitor investee companies: the FRC recommends that investors meet with the chair of the board and other board members, attend general meetings and consider a company's explanation for not complying with the UK Corporate Governance Code and challenge it if necessary;
• establish clear guidelines on when and how they will escalate their activities as a method of protecting and enhancing shareholder value;
• be willing to act collectively with other investors;
• have a clear policy on voting and disclosure of voting activity; and
• report periodically on stewardship and voting activities. These activities should be independently audited.

The FRC intends to begin monitoring take up and application of the Code in the second half of 2011. It is expected that this will be in cooperation with the Institutional Shareholders' Committee through its new body, the Institutional Investor Council, which is intended to give a single voice to the institutional investor community. It is also expected that the FRC will carry out a review of the Code in mid 2011.

Other Corporate Governance changes on the horizon

The following matters in respect of corporate governance are currently under review:

Audit Committees
The FRC recently consulted on changes to the Smith Guidance on Audit Committees. The consultation is in respect of non-audit services and closed on 23 October 2010. Proposed changes include:

• requiring an audit committee to establish a list of non-audit services for which audit committee approval is needed before contracting;
• specifying that audit committee pre-approval may be appropriate for non-audit services which provide an insignificant risk to auditor objectivity; and
• requiring companies to set out in their financial reports the level of fees paid to auditors for audit, audit related and non-audit services.

It is expected that the new guidance will be published later this month.

UK Listing Authority
The Treasury began consulting during the summer on where the UKLA should sit in the proposed new financial regulatory structure. It has recently published a summary on its website of the responses it received.

The intention is that the FSA (and UKLA) will cease to exist and will be replaced by three new regulatory bodies, the Financial Policy Committee (FPC), the Prudential Regulation Authority (PRA) and the Consumer Protection and Markets Authority (CPMA).

• The FPC will sit within the Bank of England and will consider macro issues affecting economic and financial stability.
• The PRA will be a subsidiary of the Bank of England and will be responsible for the regulation and authorisation of those firms which the government considers should be subject to significant prudential regulation e.g. banks, building societies, insurers, and firms with permission to deal as principal.
• The CPMA, like the FSA, will be a company limited by guarantee and will inherit the majority of the FSA's market conduct regulatory functions, including responsibility for the regulation of firms not regulated by the PRA. The CPMA will also be responsible for authorising firms seeking to carry out any regulated activity other than those regulated by the PRA.

The Treasury is also consulting separately on whether a new companies regulator is required to monitor company information, corporate governance and the new Stewardship Code.

Review of the Higgs Guidance

The purpose of the draft Higgs Guidance produced by the Institute of Chartered Secretaries and Administrators is to assist boards in the practical application of the UK Corporate Governance Code.

In December 2009 the Higgs Report made recommendations into improving board effectiveness. The Institute of Chartered Secretaries and Administrators published a consultation paper in March 2010 and a second consultation paper was published in July. Comments on the draft guidance were requested by 14 October 2010 and it is expected that the FRC will publish the final guidance later this month.

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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