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Nearly two-thirds of major UK firms passing the corporate governance test

UK companies have adapted well to a recent overhaul of corporate reporting requirements, even amid the disruption posed by COVID-19, according to an EY review of 2019-20 FTSE350 annual reports - ‘Annual Reporting in 2019-20: From Intent to Action’. 

The review looked at 100 FTSE350 companies’ annual reports and found that 61% had complied with all Provisions of the new 2018 UK Corporate Governance Code, while 80% had complied with all but one Provision. The 2019-20 annual reports were the first to be affected by these changes.

“The new Code and related regulations place significant new requirements on companies, that have implications not just for reporting but the underlying governance processes too," said Mala Shah-Coulon, head of Corporate Governance at EY. "COVID-19 has been a litmus test, forcing companies into action and bringing purpose, culture and stakeholder engagement - key aspects of the 2018 Code - to the fore. Our review found that FTSE350 companies have made a good start at implementing the changes, but more work is needed to turn intent into action.”

The new Section 172 (1) statement requires companies to describe how directors have had regard for stakeholders when making principal decisions. However, EY’s review found that 45% of the companies sampled did not provide these examples or case studies to illustrate how stakeholder considerations had affected the decisions taken.

EY’s analysis also found that many of the FTSE350 companies reviewed had weak links between their stated purpose and the strategic objectives outlined in their annual report. While 86% of companies have a purpose statement, very few articulate the link to their business strategy.

“Purpose statements in an annual report can sometimes read like they are interchangeable between companies and industries," commented Shah-Coulon. "Although much time can be spent on crafting purpose statements, arguably their wording is less important than the ability to demonstrate how the purpose has been implemented. Companies need to report the actions they have taken to put their commitments and stated philosophy into action.”

Action required on improving ethnic minority diversity and its reporting

EY’s research also reveals FTSE350 companies have room for improvement when it comes to reporting on ethnic minority diversity: just 12% of the companies sampled report on the ethnic minority diversity of their board in their annual report. By contrast, 56% of companies report on the make-up of their board beyond its gender diversity, but these additional metrics tend to be limited to factors like nationality, tenure and age.

FTSE100 companies have just one year left to meet the Parker Review’s recommendation of having at least one person of colour on their board by 2021 while FTSE250 companies have until 2024. The Parker Review’s February 2020 update report found that 41% of the FTSE350 companies who took part in the study had an ethnic minority director on their board. There is therefore a disconnect between practice and reporting and it is important that companies disclose their progress and the concrete actions that are needed to meet these goals by the deadlines. 

"We know that measuring progress is a driver for achieving change - as has been demonstrated by the substantial strides made in improving gender diversity on boards - and transparent reporting is key to that,” said Shah-Coulon.

Key areas of non-compliance

The Code Provisions with the highest rate of non-compliance by FTSE350 companies in 2019-20 related to independence and employee engagement. EY’s review found that 9% of companies were not compliant with requirements to ensure that executive pension contribution rates were aligned to employee contribution rates, 8% were non-compliant with chair tenure requirements, while 6% were non-compliant with board, chair or remuneration committee independence requirements.

"Especially given it is the first year that companies have applied a new Code, non-compliance on specific provisions is generally low," concluded Shah-Coulon. "In any case, strict ‘tick box’ compliance against the Code is not the ultimate aim - companies have to apply its spirit and explain comprehensively and insightfully how they operate. Some companies will have a leadership structure centred around an executive chair, for example. This doesn’t meet the Code’s requirements on chair independence, but as the Code operates on a ‘comply or explain’ basis investors would not necessarily compel a company to make a change unless the explanation for non-compliance was lacking.”

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