FRC waters down ESG and audit requirementsby
Following a revision of the UK’s corporate governance code, accounting experts have warned that diluting boardroom standards to kickstart business may come back to haunt regulators.
Britain’s accounting watchdog has loosened the UK’s corporate governance code, dropping a series of proposals that would have toughened environmental, social and governance (ESG), audit committee and compliance requirements.
Billing the update “a significant move aimed at promoting smarter regulation”, the Financial Reporting Council (FRC) on Monday announced a revision of the voluntary code that applies to firms with a premium listing on the London Stock Exchange.
Previous promises to tackle ESG, diversity and inclusion, and expectations on audit committee chairs’ engagement with shareholders have been shelved in favour of a focus on improving internal controls.
The most significant update is a new requirement for boards to explain through a declaration in their annual reports how their risk management and internal control reviews were carried out.
Boards must also present their conclusions from their own analysis of the company’s material controls, covering financial, operational, reporting and compliance.
FRC CEO Richard Moriarty said that the agency had “listened to stakeholders” in designing the new code.
The regulator will publish the updated guidance on 29 January, and said a “root and branch” review of the stewardship code will follow later in 2024.
The updated code is to come into effect on 1 January 2025, with the internal controls guidance to enter into force on 1 January 2026. The extra year is intended to give boards adequate time to adjust to the new requirements.
Other updates phased in through 2025 include firms need to outline malus and clawback provisions in directors’ contracts covering remuneration.
Moriarty appeared on an FRC webinar to expand on the update, and defended the decision to ditch many of the 18 proposals that had been laid out in its consultation last May.
The decision was taken, he said, to balance “supporting UK economic growth and competitiveness”.
Moriarty said that the ESG provisions had been removed because the regulatory landscape for sustainability and environmental matters was moving too quickly to pin down in the code.
Updates to the role of audit committees were removed, as were alterations to existing provisions concerning “overboarding”, intended to restrict individuals from holding too many board seats.
Governmental own goal
Campaigners pushing for tougher corporate standards in the wake of major collapses such as Carillion, BHS and Patisserie Valerie, were dismayed by the FRC’s decision.
Several commentators said making the UK more attractive for global corporations should not mean watering down regulations and standards.
“What regulators need to realise is that markets work best when they are well regulated,” said Richard Murphy, professor of accounting practice at Sheffield University Management School.
He told AccountingWEB a level playing field that competitive markets require to be efficient “is not created by a free-for-all but by ensuring that everyone plays by the same rules”.
“These new regulations are the exact opposite of that – letting companies decide on their own standards,” he said. “They are like every team in the football league having their own offside rule. That wouldn’t work in football. These governance rules will do nothing for UK markets either. Expect more confusion and market failure to follow.”
Checking the power of corporations
With the Post Office scandal and more evidence of senior management and government failures fresh in minds, the FRC risks failing “to check the power of corporations and their directors to abuse stakeholders”, said Labour peer Lord Prem Sikka.
“The codes have neither curbed executive pay nor secured equitable distribution of income,” he said. “The codes do not require companies to pay decent wages or shun profit shifting and tax avoidance schemes. They do not give stakeholders any enforceable rights.”
Last year, business secretary Kemi Badenoch paused legislation that would have introduced new governance reporting rules for large companies, with ministers citing the need to cut red tape for businesses.
Step in the right direction
Accounting associations noted more could be done, but also that the update presented a “welcome step forward”.
Increasing the focus of boards on internal controls and managing risk “should strengthen corporate governance overall, and in turn boost investor confidence”, said Peter van Veen, the Institute of Chartered Accountants in England and Wales (ICAEW) director of corporate governance and stewardship.
“However, without adequate powers handed to the FRC, we worry that these revisions could lack the desired impact,” he added. “Even with the upcoming guidance it may not be possible to avoid a Sarbanes-Oxley-style regime by the back door and more work may be needed by the profession and the regulator to avoid this.”
UK regulators have previously floated the idea of a “SOX-Lite” regime, based on the US Sarbanes-Oxley Act of 2002, with the aim of creating greater accountability in corporate financial systems and reporting.
The FRC’s decision not to run a public consultation or consult key stakeholders on the contents of the associated guidance due out later this month “feels like a missed opportunity”, van Veen added. He also pointed to the “gap in alignment” with revised G20 and Organisation for Economic Co-operation and Development principles for corporate governance on sustainability.
The ICAEW and the Institute of Chartered Accountants of Scotland (ICAS) both welcomed the inclusion of an additional year for implementation.
Bruce Cartwright, chief executive at ICAS, said that providing a declaration on all material controls “could be challenging for some companies”.
He added that the revised code is “a step in the right direction” and “better balances governance needs and proportionate regulation”.
“We’ve been disappointed in the pace of audit and corporate governance reform by the UK government, but we believe this is a step in the right direction,” Cartwright said.