Ashurst Governance and Compliance Update - Issue 28

1. FRC publishes Annual Review of Corporate Reporting 2021/2022

The Financial Reporting Council has published its annual review of corporate reporting for 2021/2022 and its year-end update of key corporate reporting matters.

The FRC notes that the quality of corporate reporting within the FTSE 350 has been maintained, requiring fewer substantive questions in relation to the top ten areas of challenge compared with the prior year. In particular, it notes improvements in companies’ reporting of judgements and estimation uncertainty, impairment of non-financial assets, alternative performance measures and revenue. However, it also notes scope for improvement, particularly in relation to financial instruments and deferred tax. Indeed, the number of restatements prompted by regulatory reviews nearly doubled in 2021/22 compared with last year and the FRC believes that many of these errors could have been picked up by robust pre-issuance reviews.

Cash flow statements remain an area of considerable concern for the FRC, with almost twice the number of errors found in this review cycle compared with last year. The FRC also asked more questions about financial instruments this year when, in many instances, it believes that queries could have been avoided by clearer accounting policies and disclosures. An increased number of queries in respect of accounting for income tax were also raised. The FRC also reflects on the first year of mandatory climate-related disclosure noting a 'range of maturities' in relation to these disclosures and reiterating the Financial Conduct Authority's findings of deficiencies, including by companies claiming full compliance.

The Review contains a reminder of the FRC's priority sectors for assessing companies in 2022/23 which are:

• Travel, hospitality and leisure.
• Retail.
• Construction materials.
• Gas, water and multi-utilities.

In its monitoring work, the FRC states that it will review disclosures that address risks and uncertainty in the current challenging economic environment, including those relating to climate change. Companies should assess and clearly articulate the impact of these risks on their strategy, business model, viability and going concern assessments, ensuring consistency across the annual report.

2. FRC publishes Review of Corporate Governance Reporting

The FRC has published its Review of Corporate Governance Reporting for 2022. This is based on a review of 100 FTSE 350 and Small Cap companies.

Headline findings

The FRC's findings include:

• A continued improvement in governance reporting, particularly in relation to the disclosure of risk management procedures and ESG disclosures and, more generally, in explanations where companies have departed from the provisions of the UK Corporate Governance Code (although this is an area where continued focus is needed). However, few companies meet the highest standards throughout their report.
• Workforce engagement issues continue to be high on company agendas, although disclosures on outcomes of engagement are almost exclusively in relation to flexible working matters. Where companies engaged their workers in reviewing corporate culture, purpose, values or desired behaviours, most reported on the positive impact of such an approach.
• Reporting on wider stakeholder engagement is generally of a good standard. However, there is often insufficient narrative on the outcomes from the engagement, including commentary on whether the board acted on any of the issues raised and how decisions align with company strategy, culture, purpose or values.
• The FRC found minimal disclosure of specific board members’ engagement with major shareholders. Votes against remuneration matters remain high, and there is renewed interest in environmental, and social matters; therefore, the FRC expected to see reporting on engagement by the chair and committee chairs increase in both quantity and quality. This has not been the case and, where engagement is reported, it offers little insight.
• The majority of companies have met or are on track to meet external diversity targets although this progress has yet to translate into senior roles, for example, CEO and CFO roles where progress appears slow (on which, see the report from Cranfield School of Management). Due to the lack of transparency in relation to diversity policies and targets, it is unclear how many companies strive to exceed external targets.
• Over half of the companies provided a statement confirming that their risk management and internal control systems are effective or are without weaknesses or inefficiencies . However, many of those companies do not explain how they assessed the effectiveness of these systems to justify the results of their assessment.

Listing Rules and Code compliance

Reporting on the application of the Code's Principles improved in the year but the FRC expects companies to provide more 'meaningful' discussion, particularly in relation to those Principles requiring action by the Board, such as Principle D in relation to shareholder engagement.

While it is important to provide information on processes and procedures, a good statement of how Principles have been applied should also show:

• Actions – the work and decisions taken by the Board during the year.
• Outcomes – the impact their work and decisions have had on the company’s strategy and governance and how it affects shareholders and other stakeholders of the company.

Overall there was no significant change in the rate of non-compliance with the Code's Provisions, albeit there was a noticeable change in non-compliance with Provision 38 (pension alignment) and Provisions 24 and 32 (composition of the audit and remuneration committees). Conversely, there was also a significant drop in the rate of non-compliance with Provision 9 (the chair not being independent on appointment, or the roles of Chair and CEO not being combined).

Nevertheless, full transparency on non-compliance issues remains an issue. The FRC discovered that four companies with a chair who had been on the board for more than nine years did not explain their non-compliance with Provision 19. Explanations for departures from the Code in other areas remain poor with instances of companies:

• Failing to provide an explanation other than disclosing non-compliance.
• Merely stating that they had either complied or will comply but without giving a reason for non-compliance.
• Offering brief and vague explanations lacking clarity.
• Providing uninformative boilerplate explanations which failed to explain any possible benefits of non-compliance.
• Failing to provide information about risks associated with non-compliance and mitigating actions taken by the board even where they had given slightly more detailed and meaningful explanations.

Reporting expectations

The Review contains a reminder of the principal characteristics of good reporting highlighted by the FRC last year including clear and consistent explanations, supported by real-life examples of application and cross-referencing between related initiatives and sections. The FRC notes that only better companies have taken this on board and also disclosed the outcomes and impacts of the governance policies that have been put in place.

The FRC further reminds companies that reports should avoid:

• duplication and repetition, along with declaratory or boilerplate statements that offer little insight into company governance; and
• repeating extracts of the Code and including paragraphs from previous years’ reporting with minimal updating.

As to this year's reporting, the FRC's expects companies to:

• Provide more specific disclosures and move away from giving declaratory statements.
• Give clear and meaningful explanations when departing from the Code.
• Demonstrate how the company’s culture is aligned to its purpose, values and strategy.
• Report on engagement with shareholders and stakeholders, and how their views have been considered.
• Make clear links in the report to policies or disclosures that relate to stakeholder matters.
• Report on diversity, including at a senior leadership level beyond the recommended external targets including objectives and targets.
• Explain how the board or a committee has reviewed the effectiveness of the risk management and internal control systems.
• Report on how the executive remuneration arrangements align with the company’s purpose, values and strategy.

Looking forward, the FRC confirms that the proposed consultation on the Code, which it announced in July 2022, will not be a 'wholesale revision' of the Code but will focus on those issues identified in the FRC's Position Paper, as well as areas where the FRC believes reporting is currently weaker.

On the issue of diversity, Cranfield School of Management has published its annual publication which looks at trends in female representation on FTSE 100 and FTSE 250 boards. It reveals that while women account for almost 40 per cent of directors on FTSE 100 boards and 39 per cent on FTSE 250 boards, there is a significant and noticeable lack of progress when it comes to the appointment of women into executive roles. By way of illustration, 91 per cent of women on FTSE 100 boards are in non-executive director roles, while just nine are chief executives. Recommendations in the report include increased guidance for nomination committees, and for chief executives whom the report suggests have the ability to increase the pace of change. 'Action beyond compliance' is urged.

3. FCA publishes detailed UK proposals for financial products

Following on from DP21/4 which was published in November 2021, the Financial Conduct Authority has published a significant consultation (CP22/20) on the Sustainability Disclosure Requirements and investment labels for the UK market.

The proposals aim to provide greater clarity and harmonisation on the rules for financial products which are marketed as being 'sustainable' in the UK. In short, there will be sustainable investment labels and extensive disclosure requirements, as well as naming and marketing rules, requirements for distributors and a general anti-greenwashing rule.

In our view, these are well thought through and significant rules in relation to which financial products will be permitted to use sustainable investment labels in the UK and the relevant disclosure obligations that will accompany such labels. Note that there is no obligation or requirement to use the labels but, if not used, there will be naming and marketing restrictions that will apply which will limit how products can be described as to their sustainability.

Our briefing summarises the position on scope, labelling and the required disclosures, and. can be accessed here.

Importantly these proposals do not apply to overseas funds marketed into the EU but the FCA goes to great lengths to highlight that it will consult shortly on extending the regime to this population of products.

For further thoughts on the greenwashing-related proposals and the enforcement of them, click here.

[Item contributed by Lorraine Johnston, Partner in our Financial Regulation team.]

4. Pre-Emption Group updates Statement of Principles and template resolutions

The Financial Reporting Council, on behalf of the Pre-Emption Group (PEG), has issued a revised Statement of Principles on the disapplication of pre-emption rights, together with template resolutions. The 2022 Statement of Principles, which implements the revised pre-emption regime set out in the UK Secondary Capital Raising Review (SCRR), is effective immediately. See AGC update, Issue 23 for an overview of the SCRR.

By way of reminder, the Statement of Principles provides guidance on the factors to be taken into account by companies and investors when considering the disapplication of pre-emption rights. The Statement of Principles was last updated in 2015 and was relaxed on a temporary basis during the Covid-19 pandemic.

Whilst the SCRR highlighted the importance of the principle of pre-emption, recommending that it be maintained and enhanced, the SCRR recognised the need for this principle to be calibrated appropriately against an efficient capital raising process. In line with this objective, the SCRR recommended, amongst other things, that the ability for companies to carry out smaller fundraisings quickly and cheaply be increased and that 'capital hungry companies' be provided with greater flexibility.

The SCRR's recommendations were accepted in full by the government and endorsed by PEG.

Revised Statement of Principles

The revised Statement of Principles includes the following:

(1) An increased disapplication threshold

A company may now seek shareholder approval at its AGM by special resolution for a non-pre-emptive issue of up to:

• 10 per cent of issued ordinary share capital to be issued on an unrestricted basis (i.e. whether or not in connection with an acquisition or specified capital investment); and
• an additional 10 per cent of issued ordinary share capital to be used only in connection with an acquisition or a specified capital investment (announced contemporaneously with the issue, or which has taken place in the preceding 12 month period and which is disclosed in the announcement of the issue).

This is an increase from the previous approach which allowed for a non-pre-emptive issue of up to 10 per cent of issued ordinary share capital, on a five per cent plus five per cent basis.

Follow-on offers

In each case, companies may now also seek further authority to disapply pre-emption rights for up to an additional two per cent of issued share capital, to be used only after a placing for the purpose of a 'follow-on offer' to retail investors and existing shareholders. The expected features of such follow-on offers are set out in the Statement of Principles and include that qualifying shareholders should be entitled to subscribe for shares up to a monetary cap of no more than £30,000 and that the number of shares issued should not exceed 20 per cent of those issued in the placing.

Duration

As before, the revised disapplication authorities should last no more than 15 months or until the next AGM, whichever is the shorter period.

Conditions for use of 20 per cent disapplication authority

A company issuing equity securities non-pre-emptively for cash pursuant to a general disapplication of pre-emption rights should:

• Prior to announcement of the issue, consult with its major shareholders to the extent reasonably practicable and permitted by law.
• Give due consideration to the involvement, in the placing and/or in a follow-on issue, of retail investors and existing investors not allocated shares as part of the soft pre-emptive process (referred to below).
• Provide an explanation of the background to and reasons for the offer and the proposed use of proceeds, including details of any acquisition or specified capital investment.
• As far as practicable, make the issue on a soft pre-emptive basis.
• Involve company management in the process of allocating the shares issued.
• Within one week of completion of the issue, make a post-transaction report (a template for which is included in the Statement of Principles). The report should be publicly announced through a RIS and submitted to PEG for inclusion in its Pre-Emption Database.

As set out in the SCRR, the revised model (20 per cent authority on a 10 per cent plus 10 per cent basis) has the benefit of having been 'tried and tested' during the Covid-19 pandemic.

(2) Additional flexibility for capital hungry companies

Companies that need to raise larger amounts of capital more frequently ('capital hungry companies'), such as those operating in the technology or life sciences sectors, may seek additional disapplication authority, whether or not in connection with an acquisition or specified capital investment, if the reason for exceeding the usual threshold is specifically highlighted at the time the request for a general disapplication is made.

Capital hungry companies may also seek disapplication authority for a longer period if the reason for the longer period is also specifically highlighted at the time the request for a general disapplication is made (or, where relevant, disclosed in the company's IPO prospectus).

Companies seeking admission to the Official List that wish to be considered a 'capital hungry company' for these purposes should make the relevant disclosures in their IPO prospectus.

Timing for obtaining shareholder approval and transitional measures

Companies should obtain shareholder approval for capital raisings under the revised Statement of Principles at their next AGM. However, in urgent or exceptional cases in the interim, companies wishing to make a non-pre-emptive offer under the new regime should follow the transitional arrangements (as set out in the SCRR). Under these arrangements, PEG recommends that investors, on a case-by-case basis, consider supporting issuances by companies of up to 20 per cent of existing share capital provided they otherwise comply with the prescribed conditions.

PEG monitoring, governance and membership

PEG will monitor practice annually in relation to disapplying pre-emption rights and issuing equity securities under such disapplications. PEG also plans to establish the governance and membership recommended by the SCRR and will make a further announcement when this is complete.

5. ISS publishes 2023 voting policy consultation

Institutional Shareholder Services has published its annual benchmark policy consultation seeking views on its approach to the 2023 AGM season.

ISS seeks views on policy changes in relation to the following:

• Climate Board Accountability (to apply to all markets): In relation to the 'universe' of high emitting companies – which it is proposed will continue to be defined as those in the Climate Action 100+ Focus Group – ISS proposes to extend globally the policy on climate board accountability first announced last year and introduced in selected markets, including the UK & Ireland, for 2022.
  
  ISS also proposes to update the factors considered under the policy. In cases where a company in the universe is not considered to be adequately disclosing climate risk disclosure information, such as those required by the Task Force on Climate-related Financial Disclosures, and does not have either medium-term GHG emission reductions targets or Net Zero-by-2050 GHG reduction targets for at least its own operations (Scope 1) and electricity use (Scope 2), ISS will generally recommend voting against what it considers to be the appropriate director(s) and/or other voting items available. Emission reduction targets should also cover the vast majority (95 per cent) of the company’s operational (Scope 1 & 2) emissions.
  
  For 2023, ISS plans to use the same analysis framework for all Climate Action 100+ Focus Group companies globally but with differentiated implementation of any negative vote recommendations depending on relevant market and company factors (for example, voting item availability). Additional data and information will be included in the company information section of the ISS research reports for all Climate Action 100+ Focus Group companies in order to support this extended policy application.
• Remuneration (to apply to UK & Ireland): There is a concern that part of the current UK and Ireland policy on remuneration may be as misinterpreted as encouraging companies to increase directors' base salaries proportionally in line with increases made to the wider company workforce. On the basis that adopting such an interpretation would lead to a widening of the compensation gap between executives compared to that of the average employee, the proposed change modifies the policy to clarify that keeping directors' annual salary increases low and ideally lower proportionately than general increases across the broader workforce is considered to be good market practice.

Comments should be submitted to ISS by 16 November 2022. ISS expects to announce its final 2023 benchmark policy changes in or around the first week of December 2022. The new policy will be applied to shareholder meetings to be held on or after 1 February 2023.

6. Barclays: FCA publishes decision notices for disclosure failures

The Financial Conduct Authority has issued decision notices against Barclays plc and Barclays Bank plc (together, Barclays) and announced that it has decided to fine Barclays a total of £50 million in relation to its failure to disclose certain arrangements agreed with key investors as part of Barclays' high-profile capital raisings at the height of the 2008 financial crisis.

The decision notices follow FCA warning notices issued to Barclays in 2013, in which the FCA notified the bank of its intention to take enforcement action. The case was paused pending the resolution of criminal proceedings brought by the Serious Fraud Office against Barclays and senior executives, which concluded in 2020 with the acquittal of the Barclays executives; the charges brought against Barclays were dismissed in 2018.

Barclays has referred the decision notices to the Upper Tribunal. The action set out in the decision notices will therefore have no effect pending the determination of the cases by the Tribunal.

Facts

In June and October 2008, Barclays undertook two capital raisings pursuant to which it intended to raise up to £4.5 billion and £7.3 billion respectively. A small number of 'anchor investors', including certain Qatari entities, agreed to participate in each of the capital raisings. The Qatari entities agreed to participate for up to £2.3 billion in each capital raising, representing over 50 per cent of the total capital raised in June 2008 and over 31 per cent of the total capital raised in October 2008. The anchor investors were paid certain fees and commissions in connection with their participation in the capital raisings.

At the same time as the capital raisings, Barclays entered into two advisory agreements with one of the Qatari entities which involved payments to it that were calculated specifically by reference to the Qatari entities' maximum commitment in the capital raisings, rather than the value of the advisory services that Barclays expected to receive under the agreements. Whilst the agreements formed part of the basis on which the Qatari entities agreed to participate in the capital raisings, in the announcements, prospectuses and circular produced in connection with the capital raisings, Barclays did not disclose the October advisory agreement nor the payments under the capital raisings or their connection to the Qatari entities' participation in the capital raisings.

FCA findings

According to the FCA, the disclosure of the fees to be paid under the agreements and their connection to the Qatari entities' participation in the capital raisings would have had a material impact on the terms of the capital raisings as disclosed. Indeed, disclosure of the fees would have more than doubled the disclosed level of payments due to the Qatari entities in connection with their participation in the June capital raising and more than tripled the disclosed level of payments due to the Qatari entities in connection with their participation in the October capital raising. In the FCA's view, this would have been highly relevant to shareholders, investors and the wider market, particularly in October 2008 where there were already concerns about the high cost of the June capital raising (including fees).

According to the FCA, Barclays breached:

• Listing Rule 13.3.1R – the failure to disclose the fees payable under the October advisory agreement, and their connection to the October 2008 capital raising, in the circular relating to that capital raising meant that the circular did not contain all information necessary to allow Barclays plc's shareholders to make a properly informed decision as to the voting action required of them.
• Listing Rule 1.3.3R – the failure to disclose certain arrangements agreed with the Qatari entities as part of the capital raisings in June and October 2008 in the announcements and prospectuses relating to those capital raisings rendered the information in them misleading, false and/or deceptive and meant that they omitted matters likely to affect the import of the information disclosed.
• Listing Principle 3 (as it was) – by failing to act with integrity towards Barclays' actual and potential shareholders, which was highlighted in the context of the FCA's decision to impose a financial penalty as a deterrent.

Mark Steward, the FCA's Executive Director of Enforcement and Market Oversight commented on the decision notices as follows:

'At the height of the financial crisis in October 2008, Barclays paid hundreds of millions of pounds in fees to certain Qatari investors so that they would contribute new capital. Barclays did not inform the market and shareholders about these matters as required. Barclays’ failure to disclose these matters was reckless and lacked integrity and followed an earlier failure to disclose fees paid to Qatari investors in June 2008…… Due transparency is always critical to financial markets, especially in times of market or financial stress…….'

7. Umuthi Healthcare Solutions: FCA publishes supervisory notice of decision to cancel shares

In July 2022, the FCA issued Umuthi Healthcare Solutions PLC with a first supervisory notice confirming the FCA's decision to discontinue unilaterally the listing of the Company's shares from the Official List with immediate effect. The Company's shares were admitted to listing on the standard segment of the Official List in March 2021.

Following the Upper Tribunal's recent interim judgment, on 28 October 2022, the FCA published the supervisory notice in full, explaining its decision in detail.

The FCA found that there were special circumstances which prevented ordinary, regular dealings and a fair and orderly market in the Company's shares, including the following:

• There was a fundamental uncertainty about the supply of the Company's shares which was unlikely to be resolved quickly. The Company was unable to provide the FCA with an adequate account of supply and ownership of shares and was also in an ongoing public dispute with individual investors as to the existence of certain shares.
• The Company’s financial position was fundamentally uncertain. It had been required to correct published financial information on two occasions and had failed to post yearly and half-yearly results in compliance with the FCA's Disclosure and Transparency Rules.
• The FCA saw no realistic prospect of the Company resolving the identified issues in the foreseeable future, having already provided the Company with a reasonable time period to address them. The FCA had given the Company numerous opportunities to explain the background to those issues and how they could be avoided in the future. However, the Company's responses had been consistently late, incomplete or inadequate. The FCA stated that adequate systems and controls and timely responses to the FCA are an important part of a company's continuing obligations for listing and, noting the Company's inadequate engagement with the FCA, highlighted Listing Principle 2 which requires a listed company to deal with the FCA in an open and cooperative manner.
• The FCA referenced Listing Rule 5.2.1 which provides that the FCA may cancel the listing of securities if it is satisfied that there are special circumstances that preclude normal, regular dealings in them. Listing Rule 5.2.2 also gives non-exhaustive examples by way of guidance including that ''the issuer no longer satisfies its continuing obligations for listing'' and ''the listing has been suspended for more than six months''. The most recent suspension of the Company's shares had been in force for more than 12 months and the shares had been suspended in total for all but two weeks since their listing.

In reaching its conclusion, the FCA highlighted that it had considered the impact of discontinuance of the listing on shareholders, but that this potential detriment was outweighed by reasons in favour of discontinuance, particularly the need to maintain market confidence and to ensure fair and orderly markets.

The Company has referred the decision to the Upper Tribunal.

8. FRC publishes 2023 taxonomy suite

The Financial Reporting Council has published its suite of taxonomies for use in 2023, which incorporates changes to all of the FRC's taxonomies including: UK IFRS, FRS 101, FRS 102 and the UK Single Electronic Format (UKSEF). Taxonomy documentation, supporting documents, key information sheets and release notes have also been published.

Key changes to the 2023 Taxonomy Suite include:

• To facilitate Companies House requirements, new or improved tags and guidance have been created for initial reporting, interim reporting, medium-sized companies, and filleted accounts.
• Alternative Performance Measures: Support has been added for reporting APMs, including a new 'hypercube' with new dimensions.
• Diversity & Inclusion: The FCA’s Diversity & Inclusion reporting proposals have been incorporated, including new 'hypercubes' for Gender/Sex and Ethnicity reporting.
• UKSEF: Following feedback on the efficacy of UKSEF 2022, the 2023 version of UKSEF makes use of XBRL's 'multiple target document' feature, enabling relevant issuers to file one report to multiple regulators and fulfils the technical requirements for both ESEF and FRS 102/UK IFRS tagging.

9. City of London Law Society issues update on electronic signatures

The City of London Law Society has published an updated practice note which sets out the legislative framework and provides guidance on the use of electronic signatures for executing commercial contracts. A version showing the changes made to the 2016 original has also been published.

The practice note has been updated to reflect developments since it was first published including the Law Commission's 2019 report on e-signatures and changes in practice adopted by HM Land Registry, and others. As the changes are largely mechanical or provide additional support for the views expressed in the original note, no wider consultation has been undertaken.