UK adopts new corporate governance code

Long term shareholders need to have a responsible approach to the governance of companies in which they invest, writes Robin Johnson


On the 28 May 2010 the Financial Reporting Council published a new Corporate Governance Code (the “Code”) which replaces the old Combined Code.  On Friday 2 July the Financial Reporting Council (“FRC”) also published “the first of its kind in the whole world” Stewardship Code aimed at institutional investors which is designed to complement and support the Code.

The FRC review had been accelerated as a result of the financial crisis and in particular the commentary made in the Walker report which primarily focused on the governance and risk of financial institutions.  

The Code applies to accounting periods beginning on or after 29 June 2010.  It is in effect an updating of the Combined Code as the FRC found there were no serious failings associated with the current “comply or explain” system.  In effect the Code remained “fit for purpose”.

However there is a real danger of a two tier system being created in that rather than addressing governance issues associated with regulated companies in the financial sector through the Code the approach that is being taken to governance in the financial services sector is to utilise the financial services regulatory and supervisory regime under the auspices of the FSA.  Therefore there is going to be a divergence which in a long term could result in a two tier UK governance regime whereby the “comply or explain” regime of Code applies to non financially regulated companies where as governance in the financial sector will be based on a more prescriptive and regulatory based approach through the FSA or its successor body.  

This article concentrates on the Code and does not go into detail about the FSA approach for example the “approved persons” regime or the approach being taken by the FSA to risk through its “high level systems control source book”.  

The Code, which is very easy to read, fundamentally re-focuses corporate governance back on the key principles that were set out back in the original Cadbury Report. In fact the Code specifically defines corporate governance utilising the original Cadbury definition.  The Code emphasises the need to move away from box ticking which has become the norm with a number of investor related support organisations more towards behavioural activity.  Whether this will actually happen remains to be seen though again the UK Stewardship Code (see below) also focuses on the necessity for engagement rather than box ticking. 

The Code emphasises that compliance with the Code itself is not good governance.  The Code is only a guide to the principles structures processes and values that should be adopted and it is up to individual boards to determine its own effective corporate governance.  There is a strong emphasis around the key leadership role of an effective chairman supported by an effective company secretary.  

The Code is principle based rather than rule based.  This approach allows a board to explain why it does not consider it appropriate to comply with all elements of the Code.  It allows a board to adapt its circumstances to fit to “the glove or the shoe” reflecting the complexity of the company or the nature of risk and challenges a company faces.  Inevitably there will be different governance issues for an oil company compared to a health care sector company, a construction company compared to the more sector regulated company.  However the fundamental principles should apply to all of them.  Companies should “comply or explain”.
The Code is split into five areas leadership, effectiveness, accountability, remuneration and relations with shareholders though in the last case this is now replaced already by the Stewardship Code.