We need better communication, not extra rules
BRITAIN’S comply-or-explain system of corporate governance has come in for some stick in Brussels since the banking crisis. Sometimes dubbed self-regulation, it is seen as unreliable, and a number of senior officials have indicated their preference for codes to be replaced by more prescriptive regulation.
Yet the facts tell a different story. Systematic research by Grant Thornton the accountancy firm shows that half of all FTSE 350 companies comply fully with the UK corporate governance code and two thirds of the rest provide a meaningful explanation for their deviation – which is what the code requires. Since companies that do not comply usually deviate from only one or two provisions of the code, companies in the FTSE 350 comply with around 96 per cent of all the provisions that affect them. That doesn’t suggest much need for a fresh dose of regulation.
True, this didn’t protect the banking system from coming unstuck, but the resilience of the non-banking sector in the face of severe economic pressure indicates that much was going right.
The real governance challenge facing the capital markets is somewhat different. This is the need to raise the level of trust between companies and the shareholders that provide their capital. Open, honest and clear explanations for deviations from the code are an important part of this, and that a substantial minority of companies still do not explain fully when they deviate from the code is worth addressing.
A new Financial Reporting Council paper, which is based on discussions between companies and investors, has thus sought to define what an explanation really involves. It should explain the background, provide a clear rationale which is not generic, indicate how long the deviation is likely to last and explain what other measures have been taken to deliver the code.
We hope this will be a useful benchmark for shareholders in pressing reluctant companies to step up to the plate and for companies, especially newly-listed ones.
In the process we should be able to show the European Commission that we are not complacent, but this is only part of the story. The real benefit should stem from the increased confidence that arises from better communication between companies and their shareholders.
Although the paper started out focusing on explanations, a strong view emerged that all companies, even those which comply with the code, could usefully include in their annual reports a brief description of their governance arrangements showing clearly that the board understands how they contribute to delivery of the company’s strategic objectives.
Such a clear articulation, accompanied if necessary by cogent explanations for deviations from the code, is a good indication that boards have thought carefully about their task. That should lead to behaviour of a quality which formulaic compliance with prescriptive regulation can never deliver. If we can manage that, we might even be in better stead next time the banking system starts to wobble.
Peter Montagnon is senior investment adviser at the Financial Reporting Council.