Corporate Law Update 25 Feb 2022

In this week’s update: guidance on the new regime for climate-related financial disclosures, new recommendations for promoting gender balance in large companies, corporate governance reporting by large private companies, the PLSA’s 2022 voting guidelines and a consultation on changes to vertical block exemptions.

Government publishes new guidance on mandatory climate reporting

The Government has published new non-binding guidance for organisations to assist them with complying with the new statutory regime for making climate-related financial disclosures.

Under the new regime, certain companies and LLPs with more than 500 employees must make climate-related financial disclosures based on the specific recommendations in the Final Report of the Financial Stability Board’s Taskforce on Climate-related Financial Disclosures (the TCFD Recommendations). This includes, among other things, scenario analysis.

The regime applies to financial years beginning on or after 6 April 2022, meaning we will see the first disclosures sometime in 2023.

For more information on the regime, you can read our separate summary piece.

The guidance includes the following interesting points.

• Group reporting. Reporting should be at the “group level” where an entity is within a group. The guidance confirms this and notes that subsidiaries whose activities are included in a consolidated group report need not report individually. This includes where the parent is established overseas, provided its consolidated report contains the required information.
• Applying the thresholds to a group. If a parent undertaking will be preparing individual accounts (rather than consolidated accounts), it should aggregate employee numbers and (if relevant) turnover from its subsidiary undertakings when deciding whether it is required to report under the new regime. However, the parent undertaking’s disclosures should relate to its own activities, and individual subsidiary undertakings should report separately.
• Scope of disclosures. Disclosures should cover global activities and not just activity within the UK. If a parent decides to prepare a consolidated report, it should report on the global operations of the group (whether conducted through a UK or overseas subsidiary).
• Governance arrangements. When explaining its governance arrangements, an entity should describe which person or committee has responsibility for identifying and considering climate-related risks and opportunities and the extent to which the board considers those matters.
• Identifying and assessing risks and opportunities. An entity should describe its systems and processes for assessing and managing climate-related risks and opportunities. This should include how frequently risk identification is carried out and how risks and opportunities identified by subsidiaries are reported up through the group.
• Time horizons. Entities should consider all relevant time horizons when describing risks and not merely timelines normally considered for budgetary or planning purposes. Risks should be categorised (where possible) into short, medium and long term and an entity should explain the likely period over which a risk is expected to crystallise.
• Types of risk. Entities may consider distinguishing between “physical risks” (i.e. weather-related events, changes to longer-term weather patterns, and temperature and sea-level rises) and “transition risks” (i.e. risks associated with transitioning to a net-zero economy). Transition risks can be broken down further into technological, policy, market and legal/reputational risks. The guidance gives useful examples to illustrate these different types of risk.
• Scenario analysis. Entities should consider scenarios most relevant to their business. These could include both gradual and sudden required reductions in emissions. Scenarios should be sufficiently varied to cover a range of future outcomes. Entities should disclose any assumptions and estimates used when carrying out scenario analysis, as well as any year-on-year change to assumptions. Analysis should be qualitative before quantitative. Yearly analysis may not be necessary, but new analysis should be undertaken on a significant change in assumptions.
• Listed companies. The guidance recognises that listed companies are subject to separate obligations in the Listing Rules to disclose directly against the TCFD Recommendations. It notes that companies that are subject to both the Listing Rules and the statutory regime are likely to be able to comply with both regimes through a single set of disclosures.

New targets proposed for female representation on UK company boards

The Government has announced that the new FTSE Women Leaders Review has published its first report on women’s representation on publicly traded company boards.

The Review was created in October 2021 to continue the work of its forerunner, the Hampton-Alexander Review, which had previously set a voluntary target of 33{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} female representation on FTSE 350 boards by the end of 2020.

The report, available from the Review’s website, reviews progress on gender balance in FTSE leadership and proposes four new recommendations for further progress.

What progress has been made?

The report notes that 39.1{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} of UK FTSE 100 and 36.8{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} of FTSE 250 board positions are now occupied by women (up from 36.2{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} and 33.2{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} at the beginning of 2021), roughly in line with the position when the Hampton-Alexander Review ended. The figure for the FTSE 350 overall is 37.6{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a}.

85 FTSE 100 and almost 200 FTSE 250 companies have now met or exceeded the Hampton-Alexander Review target of 33{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a}, with almost half of FTSE 100 companies and 92 FTSE 250 companies now demonstrating 40{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} or more female representation on their board.

The number of female FTSE 350 chairs has also risen from 38 (in 2020) to 48, and 115 women now occupy senior independent director (SID) roles. Almost half of FTSE 350 companies now have a female chair or SID.

And the number of “One & Done” boards (those that have only one woman on the board) has dropped from 74 in 2018 to just six.

According to the Review, the UK is now second in the international rankings for women’s representation on boards at FTSE 100 level (behind France), higher than countries (such as Norway) that impose mandatory gender quotas on businesses.

What is the Review recommending?

The report sets out four new recommendations to build on the progress of the last decade. It terms the recommendations “expectations and aspirational goals”, continuing the UK’s voluntary approach.

• Increase the voluntary target for FTSE 350 boards and leadership teams from 33{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} to 40{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} by the end of 2025.The target would apply to both women and men. The 40{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} threshold mirrors that proposed by the Financial Conduct Authority (FCA) in its recent consultation on mandatory board diversity reporting (see our previous Corporate Law Update), which would apply to listed companies.The recommendation also illustrates a sharpened focus on executive committees and direct reports, recognising that vacancies in key board positions do not come round frequently.

• FTSE 350 companies should have at least one woman as chair or SID, and/or one woman as chief executive officer (CEO) or finance director, by the end of 2025.On the face of it, this recommendation sets a relatively modest target of ensuring that at least one of the four main board positions is occupied by a woman. Many companies have already met this target.However, the thrust of the recommendation is clearly to ensure female representation at the top of both the executive and non-executive arms of the board. This may provide more stretching for many companies and boards will need to begin pipeline planning now.

• Key stakeholders should continue to set guidance and put in place mechanisms to encourage FTSE 350 boards to achieve the 33{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} target for 2020.Organisations such as Glass Lewis, Institutional Shareholder Services (ISS) and the Pensions and Lifetime Savings Authority (PLSA) already include the Hampton-Alexander Review’s 33{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} target in their voting policies.IVIS, the research and monitoring arm of the Investment Association (IA), already “red-tops” FTSE 350 companies with female representation below 30{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} on the board or 25{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} on executive committees and among direct reports.It would not be surprising to see these bodies incorporating the new 40{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} target in the next iteration of their guidance.

• Targets should extend beyond FTSE 350 companies to include the largest 50 private companies in the UK by sales.This is the most striking of the Review’s recommendations. The report specifically highlights private equity-backed companies and companies owned by founders, families, management or staff as candidates for the new targets.These kinds of company are not currently subject to specific board diversity targets, although very large private companies are required to report on their corporate governance arrangements (which could extend to promoting diversity in the pipeline of talent).Basing the application of targets on “sales” could prove tricky, as companies might well drift into and out of the top 50 on a regular basis.Using revenue alone as a reference point is not unheard of. (This is, for example, how reporting under the UK’s modern slavery regime operates.) However, more recent reporting initiatives for large private companies have focussed on a combination of revenue, balance sheet total and employee numbers, providing predictability and stability.There is also a question of who will encourage compliance as contemplated by the Review’s third recommendation. Gender targets do not currently feature in the Walker Guidelines for private equity portfolio companies or the Wates Principles for very large private companies.In the absence of investment associations, the task may need to fall to the Financial Reporting Council and its successor, the Audit, Reporting and Governance Authority, or (indeed) the FTSE Women Leaders Review itself.

What next? The new recommendations remain voluntary and companies will need balance the intrinsic value and benefits of pursuing gender balance with the specific circumstances of their business.

Companies that have already achieved the Hampton-Alexander Review’s 33{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} target should consider steps they can take towards the new 40{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} target. This is particularly relevant to listed companies, which may well soon find themselves subject to the FCA’s new target.

Publicly traded companies should anticipate updates to investor guidance and proxy advisor voting policies to reflect the new targets. In particular, we wait to see whether the IA will amend its eagerly awaited shareholder priorities for 2022 to reflect the new targets.

The largest private companies should now consider the extent to which gender targets should form part of their corporate governance arrangements and factor into any corporate governance reporting.

There is, of course, nothing to stop private companies below the “top 50” threshold from applying the recommendations. Smaller PE-backed companies, in particular, should consider the extent to which working towards the Review’s targets might improve their ESG credentials. For more information on how PE houses can improve their ESG profile, you can read this article by our colleagues Alex Edmondson and Matilda Calvert-Barr.

FRC publishes first report on large company corporate governance reporting

The Financial Reporting Council (FRC) has published the first in-depth assessment by the Coalition Group on the quality of corporate governance reporting by very large private companies.

What are the Wates Principles?

For financial years beginning on or after 1 January 2019, very large private UK companies have been required to report on their corporate governance arrangements. (This includes very large subsidiaries of publicly traded companies.)

The requirement applies to a company that has either more than 2,000 employees (worldwide) or both worldwide turnover above £20m and a global balance sheet total above £2bn.

(Reporting technically extends to very large AIM companies, although AIM companies of all sizes are required separately by Rule 26 of the AIM Rules for Companies to report against a recognised corporate governance code.)

To assist private companies with complying with their reporting obligations, the Coalition Group (chaired by Sir James Wates, CBE) published a set of corporate governance principles for large private companies, known as the Wates Principles.

There are six separate principles covering purpose and leadership; board composition; director responsibilities; opportunity and risk; remuneration; and stakeholder relationships and engagement.

The Principles are to be used on an “apply and explain” basis. Rather than merely stating that they have complied and explaining any areas of divergence, companies are encouraged to provide descriptive narrative as to how they integrate the principles into their governance arrangements.

What does the FRC’s assessment reveal?

From a total population of 1,815 companies subject to the regime, the Coalition Group sampled annual reports from 1,206 companies. This certainly provides a substantial starting point for assessment, although the report notes that this is not a definitive figure of the number subject to the regime.

The headline points from the report are as follows.

• 410 companies (34{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a}) did not provide any information on their corporate governance arrangements. Of the 796 companies that did provide a corporate governance statement, 57{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} applied one or more corporate governance codes, 35{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} stated that they relied on alternative corporate governance arrangements, and 8{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} did not discuss their governance arrangements.
• Of the 454 companies that adopted one or more corporate governance codes, 348 (77{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a}) reported against the Wates Principles, followed by the UK Corporate Governance Code (19{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a}). Ten companies applied two corporate governance codes, and one company applied three.
• Companies that reported against the Wates Principles tended to disclose more information over how their practices and policies have matured over the years. The report suggests this might indicate that many companies are still in a “learning phase” as their arrangements evolve.
• There was good disclosure of general information about formal policies, but lower levels of disclosure when it came to how policies are applied in practice. The report suggests there is “room for improvement” in this respect and hopes its report will help companies in this area.
• The average length of a corporate governance statement was 1,985 words. (The longest was 11,427 words and the shortest 74 words.) The report notes that length of statement is not an indicator of quality, but that a very short statement is unlikely to offer meaningful transparency.
• Not all companies reported against all six principles. Explanations were given more frequently for director responsibilities (96{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} of companies) and stakeholder engagement (95{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a}) than for remuneration (90{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a}) and board composition (91{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a}).
• The report also rates the quality of disclosure against each principle. The best quality explanations related to opportunity and risk (average score of 41{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a}), followed by stakeholder engagement (37{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a}) and director responsibilities (34{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a}). The report provides further breakdowns of disclosure quality for specific topics within each of the six principles.
• The “worst” area of disclosure was purpose and leadership. Only 88{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a} of companies provided explanations for this principle, with an average disclosure score of 18{e421c4d081ed1e1efd2d9b9e397159b409f6f1af1639f2363bfecd2822ec732a}. More detailed analysis in the report suggests that this was mainly driven by poor explanations of a company’s purpose. This will no doubt be an area on which the Coalition Group will be focussing in future years.

What next?

The report is a useful early indicator of take-up of the Wates Principles versus other corporate governance codes and initial levels of disclosure and compliance.

However, it is important to see the figures in context. These are still early days, with many companies still getting to grips with a new approach to narrative reporting. Over time, it is reasonable to expect disclosures to evolve and become more fulsome.

The Coalition Group will continue to monitor corporate governance reporting and consider the need for future work on the Principles. We will look with anticipation to next year’s report.

PLSA publishes 2022 Stewardship and Voting Guidelines

The Pensions and Lifetime Savings Association (PLSA) has published its stewardship and voting guidelines for 2022.

The key changes to the guidelines since the previous version include the following.

• Climate reporting. All listed companies are expected to reference the Taskforce on Climate-related Financial Disclosures (TCFD) in their reporting. (As noted above, this is now mandatory for companies with a premium or standard listing of equity securities.) Investors expect companies to treat climate risks as a priority, particularly as large pension funds are themselves now subject to TCFD reporting and will require climate information for their own disclosures.
• Executive remuneration. Against the backdrop of a rise in the cost of living, companies are expected to show restraint on executive remuneration, especially those that have benefitted from Government support during the Covid-19 pandemic. The PLSA is also calling for more remuneration packages linked to achieving climate-related goals.
• Workforce disclosure. The PLSA wishes to see improved disclosure in this area. It warns that companies that fail to meet the Parker Review targets should expect to see investors use their vote in response. (The principal Parker Review target is a minimum of one director from an ethnic minority background by 2021 for FTSE 100 companies and 2024 for FTSE 250 companies.)
• Virtual AGMs. The PLSA continues to support virtual-only AGMs as a way of ensuring continued participation during what it calls “unprecedented times”. (This marks a slight shift away from the 2021 guidelines, in which the PLSA opposed making virtual AGMs permanent.) However, it urges companies that hold virtual AGMs to look at ways to increase investor engagement opportunities.
• Diversity and inclusion. The guidelines now contain more explicit detail on expected disclosures of a company’s D&I policies. This should cover not only gender, ethnicity and neurodiversity, but also disability, sexuality, gender reassignment, marital status, religion and belief system, socio-economic background, veteran status and return to the workplace. Investors may vote against the re-election of the board and nominations committee chairs if a company has no D&I strategy.

Other items

• Government consults on exemptions from competition law restrictions. The Government is consulting on changes to the vertical block exemptions under UK competition law. These exemptions permit certain arrangements between players at different levels of the supply chain that might otherwise be considered anti-competitive and, therefore, unlawful. The current exemptions (which come from EU law) are due to expire on 31 May 2022. The consultation closes at 11:45 p.m. on 16 March 2022.