The FRC published guidance material on 26 February 2021, Improving the quality of ‘comply or explain’ reporting. This is aimed at companies that report on their compliance with the UK Corporate Governance Code and provides details about the FRC’s expectations regarding the quality and transparency of reporting of the degree of compliance with the Provisions of the Code.
The FRC strongly encourages companies to aim for high quality reporting of good governance practice, rather than an attempt to declare full compliance with the Code when that may not in fact be the case.
In summary, the FRC explains that when a company departs from a Provision of the Code, the annual report should clearly demonstrate both:
- The action taken by the company: What Provision it has departed from and what alternative approach it has chosen; and
- The outcome: How is that alternative approach more efficient and appropriate than that prescribed by the Code, and how is it helping the company to achieve good governance?
The publication includes examples of good practice and descriptions of ineffective practice. It is split into three main sections.
Section 1: Companies should offer clarity about the Provisions of the Code that they have departed from by making it easy for a reader to find this in their annual reports
- Companies should state in the Compliance Statement required by the Listing Rules whether the company has:
- fully complied with all elements of the Provisions of the Code; or
- has departed from any of the Provisions of the Code citing any Provisions that they have not complied with and state where in the report the explanation can be found.
- Companies should provide the explanation for non-compliance in one of the following ways:
- as part of the compliance statement (particularly when the company has only departed from one or two Provisions); or
- signpost to another page/section of the annual report, where the reader can easily find the explanation.
Section 2: Companies should report any departure from any Provision of the Code
The FRC’s research indicates that some companies have not acknowledged departure from one or more Provisions of the Code. The FRC calls out certain Provisions where companies are not reporting non-compliances, including:
- Provision 19 – a non-compliance should be disclosed where the Chair has been in place for more than 9 years.
- Provision 38 – a non-compliance should be disclosed unless all executive director pension contributions are in line with those of the workforce.
In line with the Listing Rules and the Code’s requirements, the FRC explains that it expects companies to clearly acknowledge any departures from the Code and provide full and comprehensive explanations.
Section 3: Clear and meaningful explanations for departures from the Code
The FRC explains that a full and meaningful explanation for non-compliance should show that an alternative arrangement is more appropriate and beneficial in upholding high standards of governance.
It proposes the following structure for providing clear and meaningful explanations that demonstrate that departures from Provisions of the Code are justified:
- Set the context and background
- Give a convincing rationale for the approach being taken
- Consider any risks and describe any mitigating actions
- Set out when the company intends to comply (timescales)
- Explanations should be understandable and persuasive
The FRC also notes that it is a good addition to an explanation to state that shareholders are supportive of the departure, having consulted appropriately. However, this statement should not replace any of the elements of a good explanation set out above.
The FRC’s publication can be found here.