[co-author: Heidi Fitchett, Trainee Solicitor]

In addition to the revised corporate governance code published by the Financial Reporting Council in July 2018 (the “Code”) (which applies to accounting periods beginning on or after 1 January 2019), new legislative reporting requirements have been introduced pursuant to The Companies (Miscellaneous Reporting) Regulations 2018 (the “Regulations”). The Regulations apply to company reporting in respect of financial years commencing on or after 1 January 2019¹ and are intended to build confidence in the way that large private and quoted companies are run.

The Regulations amend the Companies Act 2006 (the “Companies Act”) and the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008² (although it is not intended that the relevant legislation will be consolidated). 

We look at the most significant changes brought about by the Regulations below.

Regulation 4: Strategic Report – Section 172 Reporting.

Regulation 4 requires companies to include a statement in their strategic report³ (and, if not a quoted company, on a website) describing how the directors have had regard to the matters set out in Section 172(1)(a) – (f) of the Companies Act when performing their duty under that section (the “s.172 Statement”).

Whilst the information that each company will include in its s.172 Statement will depend largely on its individual circumstances, Department for Business, Energy & Industrial Strategy guidance suggests that companies should likely include information relating to: (i) the issues, factors and stakeholders that the directors consider relevant in complying with section 172(1)(a) – (f) and how they have formed that opinion; (ii) the main methods that the directors have used to engage with stakeholders and to understand the issues to which they must have regard; and (iii) the effect of such regard on the company’s decisions and strategies. The Financial Reporting Council’s Guidance on the Strategic Report makes clear that the s.172 Statement should focus on strategically important matters and that the level of information should correspond to the size and complexity of the company.

Regulation 13: Directors’ Report – Engagement with Employees, Suppliers and Customers

The draft Explanatory Memorandum in respect of the Regulations confirms that Regulation 13 underpins the new Code so as to “establish the importance of strengthening the stakeholder voice.” Specifically, Regulation 13A applies to companies which employ more than 250 employees (on average) during the financial year and provides that the directors’ report must contain a statement:

(a) describing the action taken to introduce, maintain or develop arrangements aimed at taking account of employees' interests (such as information sharing, consulting on employee views and encouraging involvement of employees' through, for example, an employee share scheme); and

(b) summarising how the directors have engaged with employees and had regard to employees’ interests.

Regulation 13B provides that the directors’ report must also contain a statement summarising how the directors have had regard to the need to foster the company’s business relationships with suppliers, customers and others. This obligation applies to companies which, broadly, satisfy two of the following three thresholds: (i) turnover of more than £36 million; (ii) balance sheet total of more than £18 million; and (iii) employ more than 250 employees.

Regulation 14: Directors’ Report – Corporate Governance Arrangements

A further important amendment to the directors’ report is the introduction of a statement of corporate governance arrangements under Regulation 14. A company is brought within the scope of Regulation 14 if they satisfy either or both of the following criteria: (i) it has more than 2000 employees; and/or (ii) it has a turnover of more than £200 million and a balance sheet total of more than £2 billion. However, there is a specific exemption from this requirement for companies which are otherwise required to provide a corporate governance statement pursuant to rule 7.2 of the Financial Conduct Authority’s Disclosure Guidance and Transparency Rules sourcebook (such as Main Market-listed companies).

The corporate governance statement requirement requires in-scope companies to state:

(a) which corporate governance code, if any, the company applied in the financial year;

(b) how the company applied such corporate governance code; and

(c) if the company departed from such corporate governance code, the respects in which it departed therefrom and the reasons therefor.

To the extent that the company did not apply any corporate governance code for the financial year, the statement must explain the company’s reasons for that decision and explain the arrangements for corporate governance which were applied.

Given that AIM-listed companies are subject to similar requirements by virtue of the recent revisions to AIM Rule 26⁴, Regulation 14 will generally concern only the largest privately-held companies. In connection with the supposed need to encourage high standards of corporate governance in such companies, a coalition group established by the Financial Reporting Council published The Wates Corporate Governance Principles for Large Private Companies, which is expected to be the default corporate governance code that in-scope companies choose to apply.

Regulation 17: Executive Pay Ratios

The Regulations also place additional obligations on UK companies with more than 250 employees to publish the ratio between the total remuneration of their CEO and that of average full-time equivalent employees. The additional information is required to be included in all directors’ remuneration reports published from 2020. Under the Companies Act, only quoted companies are currently required to prepare directors’ remuneration reports and consequently, only quoted companies meeting the 250 employee threshold will fall within the scope of this provision. 

For the purpose of calculating average employee pay, the Regulations define “employees” as persons employed “under a contract of service by the company other than a person employed to work wholly or mainly outside the UK.” It is therefore not envisaged that agency workers and independent contractors will be included within the calculation. Where companies operate as a group, they should determine whether the number of UK employees exceeds 250 across the group as a whole. 

Under Regulation 17, in-scope companies must report the ratio as between the CEO’s remuneration and each of the 25th, 50th and 75th percentile full-time equivalent UK employee remuneration (the “Pay Ratio”). The CEO remuneration figure provided must be the existing “Single Figure of Total Remuneration” (“SFTR”) in the director’s remuneration report, comprising salary, fees and benefits, together with performance-related bonuses and share schemes. Provided that a company remains in-scope for the purposes of the Regulations, this disclosure will build year-on-year to eventually cover a 10-year period.

The Regulations stipulate three alternative methods to determine the relevant employees to use as the basis of the comparison:

• Option A: companies determine the total full-time equivalent remuneration for all UK employees for the relevant financial year, and subsequently identify employees whose pay ranks them at the 25th, 50th and 75th percentile.

• Option B: companies identify the employees at the 25th, 50th and 75th percentiles using their most recent gender pay gap information.

• Option C: companies identify the employees at the 25th, 50th and 75th percentiles using other pay data gathered no later than the previous financial year. 

In addition to the Pay Ratio figures, companies must publish: (i) a supporting explanation for the methodology chosen to calculate the ratios; (ii) justifications for any changes to the Pay Ratios as compared with the previous year; and (iii) in the case of the median Pay Ratio, a statement as to whether the Pay Ratio is consistent with the company’s wider policies on employee pay, reward and progression. 

Regulation 18: Share Price Impact Reporting

UK quoted companies (regardless of their number of employees) will also be required under Regulation 18 to include additional provisions in both their annual directors’ remuneration report and remuneration policy covering the impact of share price on executive remuneration. 

The remuneration report will require additional disclosure covering:

(a) an estimate of the amount of the SFTR which may be attributed to share price appreciation; and

(b) whether, and if so, how, discretion has been exercised (i) as a result of share price appreciation or depreciation; and (ii) on executive remuneration outcomes generally. 

Within the remuneration policy, companies must also indicate the impact of a 50 percent. growth in the company’s share price on executive directors’ remuneration, with respect to performance targets relating to more than one financial year. 

Our View

A concerted effort has been made to update and improve the UK corporate governance regime in the wake of various high-profile corporate failures, such as BHS and Monarch Airlines, in recent years. Consultation in this area has focused on the key areas of directors’ duties and executive pay, particularly in relation to large private companies that have traditionally been subject to few mandatory corporate governance rules. It is expected that large private companies will be most affected by the Regulations and consideration will have to be given to board composition (in particular for companies where directors may have shorter appointment periods, such as those held by private equity owners) so as to allow such companies to effectively comply with their new obligations.

Coming shortly after the introduction of gender pay gap reporting, the new disclosure requirements place a further administrative burden on human resources and payroll teams. Although the government has sought to ease this concern by allowing multiple calculation options for executive pay ratios, the inconsistency of methodology between companies may also mean there is little possibility of drawing useful comparisons. Further, factors such as the fluctuating, performance-related nature of CEO pay and labour outsourcing of certain business functions may result in pay ratios which are a poor reflection of a company’s overall remuneration structure. 

The new Regulations seek to bring greater transparency to executive pay, and allow shareholders, employees, suppliers and customers to hold large companies to account over business strategy and stakeholder engagement. In this respect, companies are likely to become reliant on internal and external communications teams to present a clear narrative on the correlation between company performance and executive pay, as well as clear and considered engagement with wider stakeholder interests.