Changes to the Financial Reporting Council’s (FRC) corporate governance code have been welcomed by industry professionals, with particular praise reserved for “the greater emphasis on the need for companies to embed a positive ‘ethical’ culture”.
Following the FRC’s largest stakeholder consultation on the Code in 2023, revisions have been kept to a minimum, with those related to the role of audit committees on ESG issues; expanding diversity and inclusion expectations; over-boarding provisions, and expectations on committee chairs’ engagement with shareholders all dropped.
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Instead, the FRC has prioritised revisions in one key area – internal controls. While existing rules mean boards should monitor the company’s risk management and internal control framework, the main change the FRC is now making is asking boards to explain, through a declaration in their annual reports, how they have done this alongside their conclusions.
The new Code expectation for the board declaration will come into effect from 1 January 2026, one year after the rest of the updated Code comes into effect from 1 January 2025, to give companies time to develop their internal controls approaches.
“A global reputation for high standards of corporate governance is a competitive advantage for UK plc and our revised Code helps this by enhancing transparency on internal controls, but in a way that is proportionate and minimises reporting burdens on businesses,” commented the FRC’s CEO, Richard Moriarty.
“The small, but important, change to the expectations on internal controls will better support boards asking the right questions at the right time to help them gain the level of assurance they require, and to be able to demonstrate good governance to investors and other stakeholders.”
The FRC also decided to uphold the principle of board’s having the flexibility to ‘comply or explain’, with investors and their advisors encouraged to actively support the flexibility approach to ensure governance expectations are better tailored to the specific circumstances of each company.
Reaction
Embedding a positive ethical culture within companies means that boards “should go further than just assessing and monitoring culture”, according to Ian Peters, director of the Institute of Business Ethics. They should also take steps to ensure the desired culture is implemented effectively and that people across the organisation embrace ethical values and live by them, which the revisions to the code should help facilitate.
“The move is part of a global regulatory trend towards the explanation and evidence of ethical practice, with incoming laws such as the European Corporate Due Diligence Directive also now mandating evidence of compliance,” continued Peters.
“It is, however, disappointing that the UK government remains unwilling to legislate to put the FRC on a statutory footing, a move that have been due since the government announced plans in 2019.”
For Richard Stone, chief executive of the Association of Investment Companies (AIC), a flexible, pragmatic approach to achieving proper governance standards is “essential” if UK markets are to maintain their attractions in an increasingly competitive global market for listings.
“This is a more balanced approach from the FRC than had originally been proposed. The FRC has taken on board concerns from the AIC and others that the original proposals were poorly targeted and disproportionate,” commented Stone.
“The decision to uphold the well-established principle of ‘comply or explain’ is welcome and emphasises the importance of investors and agencies carefully evaluating companies’ explanations where they diverge from the Code. Many of our members are smaller companies, and this principle is particularly important for them.”