Last week, some of the UK’s biggest businesses received a rap on the knuckles, as the Financial Reporting Council (FRC) published its annual review of how well companies lived up to the Corporate Governance Code.
Some FTSE firms, the accounting and governance regulator argued, were simply “paying lip service to the spirit of the Code”, which sets out the principles and best practice for the boards of directors of listed companies. FRC chief Sir Jon Thompson bemoaned the fact that a “box-ticking compliance” approach could end up harming both shareholders and the public.
The regulator’s chief has put his finger on a real problem. Good governance is not about following a pre-determined set of procedures and thinking that this constitutes success in its own right. Checklists can be reassuring, but they can also end up replacing rather than complementing critical thinking and careful strategy.
So why does the UK appear to be moving towards a much more rigid system that could promote exactly the box-ticking approach we want to avoid?
At present, corporate governance is regulated under a “soft law” approach. Under this method, the FRC works with firms to set out best practice for their board of directors through the Corporate Governance Code.
At the heart of this model is the “comply or explain” principle. This gives boards the freedom to diverge from specific requirements, but they must outline to the world at large why they have done so, while keeping true to the broad principles of the Code.
In practice, boards tend to follow the Code’s recommendations, but the set-up encourages directors to consider the spirit of the rules while avoiding “creative compliance”, and means the regulator isn’t expected to anticipate every potential problem — which would clearly be an impossible task.
As a result, our corporate governance regime is respected throughout the world. Combining high standards with flexibility, the system helps to mark the UK out as an attractive destination for global businesses and investors alike. But this is being put at risk by proposed changes to the way companies are overseen.
Under current plans, the FRC is to be beefed up substantially, evolving into a new regulator — the Auditing, Reporting, and Governance Authority (Arga). This body will be underpinned by stronger statutory powers, with a bigger arsenal of penalties at its disposal and a fresh new management team — led by Sir Jon himself, formerly of HMRC — to wield them.
The change has been prompted by the numerous perceived failings in the audit sector. Critics have argued that the current regulatory set-up has produced a lacklustre response to a list of corporate scandals, most notably the collapse of Carillion.
Few would dispute that auditing needs a regulator with teeth. But whereas audit oversight — which IoD members agree needs beefing up — might benefit from a set of steadfast rules, this simply isn’t the case with corporate governance.
With new powers and a mandate to use them, Arga is expected to take few prisoners when it comes to auditing and accounting failures. It’s difficult not to see corporate governance being caught in the crossfire. With the Corporate Governance Code also falling under Arga’s remit, can we realistically expect that firms will not focus more on complying with the letter of the law, rather than its spirit? .
To maintain our global reputation on governance, Britain must avoid the temptation of a heavy-handed legalistic approach. Instead, the government’s long-term aim should be establishing a separate body to oversee governance, designed to aid corporate decision-making rather than constrict it.
Otherwise, the box-ticking that Sir Jon Thompson so rightly deplores will become the norm.
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