Last month, the Financial Reporting Council (FRC) announced a public consultation into the UK corporate governance code with a specific focus on how company boards are addressing ESG responsibilities.
Here, Andromeda Wood, vice president of regulatory strategy at risk and reporting platform Workiva, answers ESG Clarity’s questions what the revised code may look like and how investment managers will need to prepare.
Why is it necessary for the UK Corporate Governance Code to be strengthened? What have been the key developments in the corporate world that have led to this decision from the government?
The drive behind the strengthening of the UK Corporate Governance Code is clear – there is a need to bring new rigor to auditing, encourage shareholder investment, mitigate risk of corporate failure and drive growth across the UK. Ultimately, the code has been designed to simplify assurance over reporting processes. This is reflected in the decision to make changes to the existing Code in lieu of introducing additional legislation.
The consultation is a result of a number of reviews which looked at audit and corporate governance quality in the UK in general. That history includes The Brydon report, the Kingman Review and the government white paper Restoring trust in audit and corporate governance. These reviews were prompted by a series of high-profile corporate failures with resulting questions about how the regulatory, audit and governance regimes could improve.
Alongside those pressures we have also seen the increasing focus on sustainability in the corporate and consumer world – a topic that is not explicitly addressed in existing governance guidelines and therefore, something which needed to be added to keep up with the world-view.
In terms of sustainability information what do you think the FRC will be taking a closer look at?
Sustainability isn’t just an important topic globally, it’s important on a policy level. It has long been a consideration of investors and one of the factors they take into account when looking at the value of an organisation. After looking at upcoming regulations, it’s clear that sustainability and financial reporting are converging and driving investor demand for greater assurance and more control.
Therefore, the Finance Reporting Council (FRC) has already conducted multiple reviews of TCFD reporting, which is now a requirement. Other topics reviewed by the council include net-zero commitments, modern slavery disclosures, stewardship reporting and Streamlined Energy and Carbon reporting.
The updated FRC ESG statement of intent in January also indicated that they intend to look in more detail at the strategic report, as well as materiality, ESG data and how sustainability issues might affect financial reporting and results. It’s important to remember that more general reviews on good governance are of course also a part of the broader sustainability picture and something the FRC are likely to also take a closer look at.
Companies already have a lot to consider in terms of sustainability disclosure coming up – ISSB, TCFD – will this be aligned or is there a risk it could confuse matters?
Interoperability and alignment are areas of concern for many international companies, mandates related to ESG topics are either in place (CSRD, TCFD in the UK & Switzerland) or being considered (Climate in the US & Australia for example).
The ISSB itself has been formed via a coming together of a number of existing standards and frameworks. It has also been aligned with other frameworks such as TCFD – this has been one of the considerations during the standards development.
Additionally the European Sustainability Report Standards (ESRS) developers have aligned their climate work to the ISSB climate standard where possible, and additional work has taken place in the latest draft to align further with the ISSB general disclosure requirements.
Obviously there will be some differences but companies with strong existing disclosures will find that they have a significant advantage. We have also started to see companies look to the more comprehensive European Standards as a guide while the international standards are still in development.
See also: –ISSB standards to be rolled out January 2024
How can the code “encourage shareholder investment, mitigate risk of corporate failure and drive growth across the UK”?
The governance code is not a new requirement – the proposed changes look to specifically boost areas related to control and audit. Both of these areas are routinely looked to by shareholders and other stakeholders for indications that they can have confidence in corporate governance.
Bolstering both of these areas aims to bring back the trust that the BEIS white paper refers to. Improved control should raise the quality of internal governance and provide earlier awareness of any issues that might need to be addressed. Stronger audit committees and external audit processes adds an extra layer of external review, meaning the trust is likely to be higher, resulting in greater confidence from investors and less risk of corporate failure.
How can organisations prepare for the changes?
The proposed changes shouldn’t be a major shock to anyone who’s been keeping track of what was once referred to as UK SOX, or a SOX-like (or even SOX-lite) regime in the UK. The roadblocks to compliance remain the same – a lack of ability to link control frameworks to financial reporting, scattered control data, manual attestation control processes, and manual control testing. The amount of work, and time, that’s required for companies in scope to prepare for compliance depends on the maturity of the risk and controls programme – technology will be a key component to overcoming many of these roadblocks.
In addition to taking time to improve materiality practices within your organisation, another critical first step will be to accelerate the development of unified, integrated reporting practices. It’s only by firming connections between risk, finance and sustainability teams and processes that audit professionals will be able to gain the oversight they need to respond to these new requirements with confidence. Embracing this reporting transformation will enable businesses to thrive in an increasingly competitive and evolving marketplace, where transparency and responsible practices are not only expected but also rewarded.
How will the changes bring assurance to investors?
With the changes proposed and outlined, the improved control and quality of internal governance should bring additional assurance to investors. With both stronger audit committees and further external audit processes, investors can – and should – feel more comfortable investing with less risk.
Additionally, investors have been asking for sustainability information to be included in these standards for some time. By this now being slowly introduced, they can be assured that companies are complying with their demands, therefore giving assurance for those looking to invest in multinational corporations.
Assurance ready processes are another vital component to eliminate investor risk. Embracing technology and gaining insight through digital transformation will enable businesses to thrive in an increasingly competitive and evolving marketplace, where transparency and responsible practices are not only expected but also rewarded.
