Disclosure Rules ‘Detriment’ to UK Investment, Financial Regulator Told

Warning comes as reporting requirement widens to include diversity and net-zero

Signage for the London Stock Exchange Group is seen outside of offices in Canary Wharf in London, on Aug. 3, 2023. Toby Melville/Reuters

Corporate disclosure requirements have become too rigid “to the detriment of the UK,” the financial regulator has been warned.

It comes a year after firms were given diversity quotas and ordered to report on their compliance status.

In a joint response to the Financial Conduct Authority (FCA) as part of its Primary Markets Effectiveness Review, two statutory advisory panels told the regulator that the “comply or explain” approach to the corporate governance and stewardship codes have in effect turned into “comply or else,” harming the UK’s competitiveness in corporate investment.

British and foreign companies listed on the London Stock Exchange are required to publish annual reports on their compliance to the UK Corporate Governance Code, while asset managers investing on behalf of UK savers and pensioners are asked to publish reports on their compliance to the UK Stewardship Code.

“Comply or explain” is a principle used in both codes to give flexibility in case companies need to depart from the rules because of their particular circumstances, or if they temporarily broke the rules because of unforeseen circumstances.

The Financial Reporting Council (FRC), which oversees the codes, has said it’s sometimes unavoidable to depart from the rules—for instance, if a non-executive director (NED) quits suddenly, leaving the board with fewer than half independent NEDs—and encouraged companies to report and explain their deviation from the rules.

However, in their joint letter (pdf) to the FCA, the Listing Authority Advisory Panel (LAAP) and Markets Practitioner Panel (MPP) said the “comply or explain” regime has “in reality become ‘comply or else.’”

“As such, we believe that it is acting as a constraint on the discretion and efficacy of boards as the delegated managers of issuers. This is ultimately to the detriment of the UK when compared to competitor jurisdictions,” the letter said.

The panels, which are made up of two dozen senior executives in the financial industry, said the codes need to be reviewed “urgently” and “reformed holistically” so they can be fit for purpose for the coming years.

However, some panel members believe the problems don’t lie with the codes, but with investors and proxy voting agencies, who use the codes to inform their policies.

Investors or shareholders often lean on proxy advisors and ESG rating agencies to inform them on how best to vote on company issues.

According to FRC research (pdf), all proxy advisers they interviewed said the Corporate Governance Code was one of the main sources they used to form their policies.

The research also said foreign investors were more likely to go along with the advisers’ recommendations than British advisers would.

The LAAP and the MPP suggested company directors may need to be more resilient when facing shareholder rebellions, which are often seen as the executives’ failure.

“An alternative view provided is that the approach of investors and the role of proxy voting agencies requires addressing, rather than the Codes themselves, and that Boards should perhaps be more willing to accept higher levels of dissent,” the letter reads.

Diversity Quota and Climate Policy

While the flexibility of the rules is not a new point of contention, companies are increasingly having to juggle considerations such as their diversity and environmental credentials, which are often reflected in their environmental, social, and governance (ESG) ratings.

The FCA last year added diversity quotas to its “comply or explain” reporting regime so companies would have to increase diversity rather than paying lip service to it.

Under the rules, companies would have to ensure at least 40 percent of the board are women; at least one woman is among the chair, the CEO, the senior independent director, and the chief financial officer; and at least one board member is from a non-white minority ethnic background. Companies that fail to reach the targets would have to explain why.

The government also announced plans earlier this month to set standards on sustainability disclosure.

Speaking to the Treasury Committee in May, Sir Jonathan Symonds, chair of GSK and member of the government’s Capital Markets Industry Taskforce, said the rules are no longer “very important ones around minimum expectations,” which directors and shareholders can decide not to adhere to.

“We have moved away from that to a very restrictive set of requirements that, effectively, comes down to, ‘You have to check all of these boxes, no more so than on remuneration,’” he said.

“ESG is coming in that way too. Every investor has its own perspective on what is important, and there nothing wrong with that. It is just that we cannot meet the expectations of 100 different investors.”

FRC: Companies Encouraged to ‘Explain’

In an email to The Epoch Times, the FRC said it’s “misleading” to say the codes themselves are “comply or else.”

“The UK’s principle-based codes are seen as the gold standard globally. Rather than mandating rigid rules, they provide the flexibility to tailor governance in the way most suitable for a company’s individual circumstances,” spokesperson said.

“The FRC actively encourages companies to use the ‘explain’ provision where full compliance is not appropriate and, through our regular monitoring of reporting, we are pleased to see the proportion of companies choosing to ‘explain’ has grown steadily over recent years. Anyone claiming the codes are ‘comply or else’ is misleading.

“High quality explanations offer real insight for investors and stakeholders to better understand a company’s governance and are far more useful than boilerplate compliance statements,” the statement reads.

An FCA spokesperson said it values input from industry leaders to help create a new system that provides greater opportunities for investors in UK markets and help create jobs and growth.

“Good corporate governance will remain important for companies to build trust and engage effectively with shareholders and other market participants. Transparency on corporate governance matters can therefore help inform investment decisions and support market integrity,” the spokesperson said.