Strengthening governance whilst maintaining an enterprise-led economy

The UK needs a strong corporate governance system to deliver trust and resilience in its capital markets. Equally, it must encourage enterprise and avoid bureaucracy in order to support post-pandemic recovery and to attract international listings to the London market. Exactly how these two-potentially competing-forces should be held in balance is one of the big questions the Government has to address in its forthcoming White Paper on audit and wider corporate governance reform.

In our view, the answer lies in not throwing the baby out with the bath water. The UK already has a modern high quality Corporate Governance Code that, subject to strengthening in a few places, is ‘fit for purpose’, the emphasis has to be on its implementation if our governance is to be world-class in practice as well as on paper. There are four main areas to be addressed:

Asking directors to confirm the effectiveness of controls, at least on reporting
More generally, ensuring board and audit committee effectiveness and determining appropriate regulatory sanctions for directors
Introducing a duty of alert for auditors to report going-concern or other audit-related concerns
Increasing regulatory review to cover the whole of the annual report

Reforms in these areas should be underpinned by some key principles including a balanced focus on enterprise and accountability, being proportionate, encouraging improvement, addressing issues promptly rather dealing with the aftermath of crises, and committing to an integrated governance ecosystem in which boards, auditors, investors and regulators work together for the common good.

There has been much talk of the introduction of a UK version of the Sarbanes-Oxley (SOX) framework but this rather misses the point. Reporting, and other, controls are important but we already have expectations in place on reporting on controls and any enhancements should build on our existing model rather than importing a new approach from elsewhere. We do not need to introduce an expensive system with very detailed rules which stifle business, especially when we already have the framework for success. Such a system may generate significant fees for professional services firms, especially if external assurance is required or encouraged, but it would be likely to do the UK’s economy a disservice, particularly at the moment.

Provision 29 of the UK Corporate Governance Code already says: “The board should monitor the company’s risk management and internal control systems and, at least annually, carry out a review of their effectiveness and report on that review in the annual report. The monitoring and review should cover all material controls, including financial, operational and compliance controls”. In our view, we only need to add some wording to the effect of: “The board should confirm whether in its view the controls were effective during the period under review and have continued to be so”.

What we do not need is ‘attestation’ in the annual report on whether controls are effective by individual directors. This contradicts the UK’s approach of the board accepting collective responsibility for the leadership and direction of the business. In order to be proportionate, confirmation of effectiveness could initially be limited to FTSE 350 companies and also possibly to financial reporting controls. It should, however, cover at least all reporting controls in the near future as there is a real need to improve the effectiveness of reporting on sustainability-related issues. For this reason, we also support the Kingman Review recommendation that the regulator should review the whole of the annual report of listed and other leading companies and not just the financial statements.

A duty of alert for the auditor to report going concern or other audit-related concerns to the regulator would be helpful. The regulator should also have the power, as proposed by Kingman, to commission an independent board evaluation or examination of the audit committee where it has major governance concerns on leading companies. In addition, for independent board evaluations under the UK Corporate Governance Code, we believe there may be merit in board reviewers being appointed by shareholders as happens in the case of the auditors.

When considering the system of fines and bans on directors care is required to be robust when needed, as with auditors, but also to be fair, balanced and proportionate so as not to dissuade the most able directors and potential directors from serving on boards as this will not help governance in practice.

With difficult economic times ahead, we must support the UK’s companies and reward responsible enterprise. Good corporate governance, building on with our well-respected UK approach, will be a powerful asset as we do so.