12th October 2017 Exploring the government’s consultation on corporate governance reform

Anne-Marie Winton considers the key proposals affecting pensions outlined in the government’s response and suggests there is some bark, but not necessarily much bite from the pensions industry’s point of view.

Original news

The government has announced a package of corporate governance reforms which will, among other things, require all companies of significant size to explain how their directors comply with the requirements of section 172 of the Companies Act 2006 (CA 2006) to have regard to wider interests in pursuing the success of the company. The aim is to reassure the public that companies are being run with an eye to the interests of the employees, suppliers, customers and wider society as well as the board and shareholders.

What is the background to the green paper?

From a pensions perspective, the summer of 2016 had more plot twists than a season of Game of Thrones as the Work and Pensions Select Committee and (then) Business, Innovation and Skills Select Committee under the joint chairmanship of Frank Field MP sought better to understand the defined benefits pension regime through two inquiries into:

  • the Pension Protection Fund and Pensions Regulator
  • the sale of British Home Stores (BHS)

In their first report on BHS, published on 20 July 2016, covering also defined benefits schemes in general, the committees summarised the main duties of directors as set out in the Companies Act 2006 (CA 2006), applying to directors of private and public sector companies and equally to both executive and non-executive directors.

The report also explained that the non-statutory UK Corporate Governance Code (UKCG Code) produced by the Financial Reporting Council (FRC) provides further guidance for directors (and chairs) as to their duties, but that the UKCG Code only applies to listed companies and on a ‘comply or explain’ basis. So the question was raised as to whether similar guidance on good corporate governance ought to apply also to directors of private companies. The context was whether the interests of the members of a defined benefits pension scheme (either directly or via the trustees of the scheme, as unsecured creditors) were being adequately being taken into account in corporate decision making, whether on the sale of a subsidiary, in negotiating employer contribution requirements with the trustees or otherwise. In its summing up of its intended further ongoing inquiries, the report stated:

‘This inquiry has exposed how capitalism can be worked to the advantage of directors, financiers and advisers at the expense of employees and the wider public interest. This deeply concerning example of corporate governance brings into question the adequacy of existing company law and corporate governance regulation, particularly in relation to large private companies. That private companies are not subject to the same transparency requirements and codes of conduct as their public counterparts in no way absolves them of their wider responsibilities. Parliament is rightly cautious about imposing onerous new duties on our companies—but if large public or private companies do not behave in accordance with the ethical standards that society expects, further regulation may need to be considered. Ultimately business has a moral responsibility to operate within a framework which enjoys the confidence of the nation. These are issues to which the Business Select Committee will look to return.’

The green paper from the Department for Business, Energy and Industrial Strategy (DBEIS) published in November 2016 alluded to these themes in examining the requirements of CA 2006, s 172 under which directors have an ultimate duty to promote the success of their company for the benefit of its members (unless specified otherwise in the articles), and noting that companies have flexibility in how to meet these requirements, including determining which stakeholders’ voices are the most important to take into account. The interests of pension scheme members are explicitly not mentioned in CA 2006, s 172 (and many members may no longer be company employees).

Consultation questions included options for strengthening the voice of employees, customers and other interested parties at boardroom level and building confidence that CA 2006, s 172 is properly understood and applied.

It is worth noting that the DBEIS Select Committee published in March 2017 its separate report on whether the current corporate governance framework is still fit for purpose, and some of its conclusions pushed for more far reaching action than as set out in the green paper response. In that report the Committee expressed ‘some sympathy for the argument that there are insufficient incentives for directors to consider seriously the interests of other stakeholders, such as employees, supply chains and pension fund members’, but adding that the existing legislation was designed with a delicate balancing of interests in mind.

What are the key proposals affecting pensions outlined in the government’s response?

The consultation response published in August 2017 makes little explicit reference to pensions (possibly due to the inactivity of the joint pensions Select Committee over the consultation period), but the response on strengthening the employee and wider stakeholder voice can be applied to the pensions industry. A total of 86% of respondents thought that the stakeholder voice ought to be strengthened, but there was no agreement on how best to do this—the options proposed being:

  • designating existing non-executive directors to represent key interested groups, such as employees
  • creating stakeholder advisory panels
  • appointing individual stakeholder representatives to company

Anyone familiar with the member-nominated trustee regime will have some familiarity with the pros and cons of some of these options in terms of seeking fairly to represent interests of a scheme’s beneficiaries (which can include the sponsoring employer as well as the members), without derogating from the principle that all directors/trustees are equal and have equal duties

The outcomes proposed to be taken forward following the consultation are:

  • introducing regulations to require all private and public companies of significant size to explain how their directors comply with the requirements of CA 2006, s 172 to have regard to employee and other interests
  • asking the FRC to consult on a new code principle establishing the importance of strengthening the voice of employees and other non-shareholder interests at board level, including requiring premium listed companies to adopt on a ‘comply or explain’ basis one of three employee engagement mechanisms:
    • a designated non-executive director
    • a formal employee advisory council
    • a director from the workforce
  • encouraging industry-led solutions by asking the Institute of Chartered secretaries and administrators and the investment association to complete their joint guidance on practical ways in which companies can engage with their employees and other stakeholders, and asking the GC100 group of the largest listed companies to publish new advice and guidance on the practical interpretation of the directors’ duties in CA 2006, s 172
  • seeking to put in place a voluntary set of corporate governance principles for large private companies (with contributors including the FRC, the Confederation of British Industry, British venture capital association and Institute of directors)
  • introducing regulations to require companies of a significant size (and possibly also limited liability partnerships) to disclose their corporate governance arrangements in their directors’ report online

So some bark, but not necessarily much bite from the pensions industry’s point of view. And nothing explicitly driven by the pension scheme potentially being a company’s largest unsecured creditor—although I would expect many of the industry bodies being invited to participate in shaping the new regime to have the expertise and motivation to shape this debate further.

How has the pensions industry responded to the government’s proposals?

Response from the pensions industry has been fairly muted to date. However, the most high profile comments have probably come from national association, the pensions and lifetime savings association (PLSA), who responded both to the green paper and also provided written evidence to the DBEIS Select Committee. Broadly, the PLSA supported better corporate governance on the basis this leads to more successful companies (in whom, pension funds are invested) and was in favour of the strategic report section in a company’s annual report highlighting the key risks and opportunities from working practices, stakeholder relationships and corporate culture. On the latter, the PLSA would like to see a change of corporate culture in the UK by a move away from a focus on short term profitability to, instead, delivering the best possible outcome to all stakeholders (including, directly or indirectly pensions savers) over the long term. In terms of executive pay, the PLSA favoured more transparency in disclosing executive pay and pay ratios, building on its own 2016 stewardship toolkit, which set out recommended standards for corporate reporting of employment practices and workforce characteristics. In terms of strengthening the stakeholder voice on corporate boards, the PLSA saw the merits in both options of stakeholder advisory panels and appointing stakeholder representatives to the board, provided that these were combined with reporting obligations to inform shareholders on stakeholder relations.

What is the timetable for implementation of the changes? What are the government’s next steps?

What had been announced are some new statutory instruments, but also voluntary industry action and further consultation—with a stated aim to bring reforms into place by June 2018 to apply to company reporting years on or after that date. This is an ambitious timeframe. But the FRC is planning on consulting on amendments to the UK Corporate Governance Code in late autumn, and the new regulations are expected to go before Parliament by March 2018.

In the meantime, we can expect the joint Director of Work and Pensions/DBEIS pensions committee to continue its inquiries and, as usual, make its views widely known.

Interviewed by Kate Beaumont

This article was first published on Lexis®PSL Pensions on 5 October 2017. Click for a free trial of Lexis®PSL.

The views in this article are intended for general information purposes only and should not be used as a substitute for professional advice. ARC Pensions Law and the author(s) are not responsible for any direct or indirect result arising from any reliance placed on content, including any loss, and exclude liability to the full extent. Always seek appropriate legal advice from a suitably qualified lawyer before taking, or avoiding taking, any action. If you have any questions on the points raised in the above, please do not hesitate to get in touch.