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FRC issues ‘comply or explain’ reporting guidance

Author: ICAEW Insights

Published: 02 Mar 2021

3 March 2021: The Financial Reporting Council has published new guidance to help companies overcome compliance issues with corporate governance code provisions.

The FRC’s latest annual review of corporate governance reporting included familiar criticisms of companies’ over-reliance on boilerplate language. However, the FRC has addressed the particular problem of companies providing inadequate explanations for their non-compliance with code provisions in new guidance. It is a thorough exploration of the problem and potential solutions and includes real-life examples of good and bad reporting practice.

The guidance reiterates that departures from the code are allowed in the short and long term as long as they are clearly communicated. Companies must specify the provisions which they have not complied with, outline any risks which arise from non-compliance and state whether risk mitigations are in place. Companies also need to disclose when they will start to comply, or if non-compliance is indefinite then companies need to give an indication as to what might lead them to review their decision not to comply.

If a company wishes to claim it is compliant with a provision, then it must fulfil every aspect of it. For example, in order to claim compliance with provision 5 the company must report on (i) and on (ii) or (iii). 

(i) A description of how stakeholders’ interests and matters set out in s.172 of the Companies Act (2006) have been considered in board discussions and decision-making, ie, the outcome; and, 

(ii) identification of which of the three methods for workforce engagement, or a combination, have been used, ie, director appointed from the workforce, workforce advisory panel or designated non-executive director; or,

(iii) what alternative arrangements for workforce engagement are in place and why they are considered effective.

Of course, engagement is a two-way process: surveying the workforce isn’t engagement because it’s only one-way. 

The FRC suggests that companies divide stakeholders into those who impact the company and those who are impacted by the company. Taking the brave decision to report on difficulties encountered with stakeholder engagement adds depth and credibility to reports. 

One of the areas of the code which is most commonly not complied with are pension contributions for directors not being aligned with the workforce. Although the FRC accepts there may be contractual barriers standing in the way of immediate alignment, they do expect companies’ explanations for non-compliance with provision 38 to include a time estimate for reaching alignment. 

Companies that have decided to retain directors for longer than the usual nine years in order to preserve continuity during COVID-19 will need to provide detailed explanations for this decision in due course. Just referring to directors’ skills and experience is insufficient. Where possible, companies should explain when they expect to replace long-serving directors in their reports.

However, it’s not all bad news. The FRC has some positive things to say about companies’ culture reports. Although a minority of companies still mistake a marketing slogan for purpose, over half the companies reviewed reported on culture in a meaningful way and an even greater proportion commented on how their values are linked to their culture. Culture dashboards have become fashionable, and they include matters such as turnover, absenteeism, whistleblowing and exit interviews. 

Some of the things which the FRC has to say about remuneration also offer glimmers of hope. There is a healthy trend towards non-financial KPIs and the ability of remuneration committees to exercise discretion is now widely accepted. 

Further resources:

FRC guide: Improving the quality of ‘comply or explain’ reporting

FRC: Review of Corporate Governance Reporting November 2020