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The FRC’s Corporate Governance Review: What You Need to Know
Following a 16-week consultation in 2023, the Financial Reporting Council (FRC) published its updated UK Corporate Governance Code on 22 January 2024.
The updated Code introduces a more limited range of amendments than originally set out in the 2023 consultation but still includes a number of legislative and governance reforms that will come into effect as the FRC transitions to the Audit, Reporting, and Governance Authority (ARGA).
The UK government initiated the Corporate Governance Code consultation in 2023 to further strengthen the country’s governance and audit frameworks – and consequently encourage investment and growth across the country. The reform effort is often described as ‘UK SOX’ thanks to its similarity to the US’ Sarbanes-Oxley (SOX) Act – which was implemented in 2002 to address a series of high-profile financial scandals and control failures. Unlike the US SOX Act, the UK Code is not prescriptive and does not mandate an external audit of internal controls.
The government’s push for corporate governance reform is likely to have a significant impact on the accounting industry. FloQast research in 2023 revealed that up to 60% of accounting professionals are unsure whether their company has sufficient resources to support control and compliance, while 70% reported that their control framework would benefit from full automation in order to meet the demands of the changing compliance landscape.
As UK businesses implement the Code updates in 2024 (and beyond), it’s vital that company directors and employees understand how the Code will change, and how that will affect their compliance responsibilities.
What is the UK’s Corporate Governance Code?
Published in its current form in 2018, the UK Corporate Governance Code is a set of principles that company directors must apply to their businesses in order to promote good governance, serve the interests of their employees and shareholders, ensure transparency and accountability, and ultimately reduce the risk of corporate scandal. Overseen by the FRC, the Code sets out expected standards of conduct for company leadership, including establishing and aligning the company’s purpose and values, and leading with integrity.
The Code allows for companies to either “comply or explain” their adherence. In practice, this means that companies may take alternative approaches to the relevant standards if they can demonstrate that doing so is more beneficial to good governance.
2024 Code Changes
The FRC consultation on the UK Corporate Governance Code included the following key changes:
- New disclosure requirements to address investor concerns about director overboarding.
- Increased transparency about the company’s succession process and the appointment of senior employees, including diversity and inclusion considerations.
- Increased board accountability for the company’s risk and internal control framework, including an explicit board declaration on the effectiveness of those systems.
- New malus and clawback arrangement disclosures.
- Consideration of environmental, social, and governance (ESG) factors, including requirements for sustainability disclosures and clarification of the role of the newly-formed audit committee.
Key Control Changes
The most significant updates to the Code emphasise the strengthening of corporate risk management and internal controls, including audit controls. The key control-related changes include:
Refocus on material controls: The scope of the new Corporate Governance Code will extend beyond financial controls, and refocus the term “material controls” to include “operational, reporting, and compliance” controls. The shift will allow for an emphasis on new control areas, such as those relating to sustainability. The Code makes clear that it is company boards that will decide what constitutes materiality, with consideration of the impact on the business, and on stakeholders and shareholders.
Board accountability: Central to the new Corporate Governance Code is the idea of board accountability for internal control frameworks. In practice, the Code will require boards to make the following statements and declarations:
- A statement about the effectiveness of risk management and internal controls.
- An evidence-based explanation for that statement.
- A statement describing control weaknesses or failures, and details of actions being taken to address those issues (within a given timeframe).
Audit committees: The new Code will require companies to introduce audit committees that will monitor the integrity of new reporting obligations, including a focus on sustainability. The committees will also review any significant reporting judgements.
The 2024 update to the Code did not include many of the prescriptive proposals originally introduced in 2023 which would have imposed more onerous ESG reporting responsibilities on audit committees. ESG requirements will still be in place for EU companies, so businesses still need to be aware of their obligations. The EU’s Corporate Sustainability Reporting Directive (CSRD) may apply to companies that have an EU subsidiary so it’s important to verify that point before ignoring ESG reporting requirements completely
How to Prepare for the New UK Corporate Governance Code
The FRC has stated that the new Corporate Governance Code will come into effect on 1 January 2025 – and apply to accounting periods that commence on or after that date, with the first reports due in 2026. Certain measures concerning the Board Declaration are expected to come into effect a year later, on 1 January 2026. Companies with year ends in December, therefore, only have months to review their existing Code compliance and make necessary adjustments or remediations in order to transform their control framework.
In January 2024, the FRC published accompanying guidance to help companies adjust to the new Corporate Governance Code regime. UK companies should consider taking the following steps and measures as they work through their transition process:
- Prepare a brief on the updated Code for the board and audit committee, including the company’s current compliance posture and any changes that need to be implemented.
- Survey the board to determine whether and how the company will need to respond to changes in the Code.
- Perform an assessment of the company’s current controls to gauge compatibility with the new Code.
- Depending on the results of the control assessment, draw up any requirements for control updates, including necessary resources.
- If possible, conduct a dry run of your Code compliance process prior to the first year of mandatory reporting. The dry run will ensure teams are not learning during their first mandatory reporting period, and help identify potential problems.
Companies that have not already begun their control transformation should move quickly to ensure they meet the 2025 deadline. Depending on existing control infrastructure, the transformation process may represent a significant administrative burden, and require the attention and focus of leadership executives.
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