Speech by Sir Winfried Bischoff at Grant Thornton's Governance Dinner
News types: Speeches
Published: 1 May 2015
On 30 April, Sir Winfried Bischoff spoke at Grant Thornton's Governance Dinner.
Sir Winfried Bischoff
Chairman, Financial Reporting Council
Grant Thornton Governance Dinner
30 April 2015
RAC, Pall Mall
Culture within organisations
In 2006 the atmosphere in big financial centres like London and New York was one in which entrepreneurialism was admired and encouraged. However, this drive for new opportunities and better, bigger companies was, in some cases, what led to the collapse of several financial institutions. Those institutions could not support the level of growth they were going through, and some Boards had failed to sufficiently evaluate risks.
Of course it’s easy to look back and correct things in hindsight, but it’s important for us to use this opportunity to make positive changes in a period of relative stability, so that we can be ready for the future.
The FRC approached these challenges from two directions. The first by encouraging Boards to think about their long-term business model and the company culture they set, the second by encouraging shareholders in turn to engage with companies on these issues.
Going concern and viability statement
The UK Corporate Governance Code for listed companies sets out good practice covering issues such as Board composition and effectiveness, the role of Board committees, risk management, remuneration and relations with shareholders.
For investors, as providers of risk capital, knowing how the Board is managing and mitigating risks is an important indicator when judging whether the company will be able to deliver the value that providers of capital seek.
The Code update also introduced a new type of viability assessment separate from this narrow accounting evaluation, in which Boards will need to state whether they believe the company will be able to continue in operation and meet their liabilities, taking account of their current position and principal risks. Boards will now specify the period covered by this statement – which we expect will be significantly longer than 12 months – and why they consider it appropriate. Directors can make the new statement in the Strategic Report, which means that they will benefit from safe harbour.
Some have questioned whether we are asking companies to stare into a crystal ball but we believe we are asking them to do what they should already be doing: evaluating risk effectively and making their shareholders’ needs a priority in their reporting.
Remuneration
The other significant change to the Code is on executive remuneration – an ever-topical subject.
2014’s AGM season saw the effect of enhanced voting rights for shareholders on remuneration introduced by the Government in October 2013. While few votes were lost, there were high levels of dissent in others. Hopefully companies will heed these signals and take care to ensure that they demonstrate a clear link between the performance of their directors and the pay they receive.
The Code wording is:
“Executive directors’ remuneration should be designed to promote the long-term success of the company. Performance-related elements should be stretching and rigorously applied.”
It is a small but nuanced change and one that hopefully sends an unambiguous message that the interests of the company rather than the interests of the employee should have priority.
Culture and tone from the top
I read with interest an article in Forbes this week that said:
“Most of the time creating a distinct culture comes from a series of deliberate steps. It’s almost like the genes of the leaders are passed down through the generations of employees.”
Boards should define the purposes of the company and what type of behaviours it wishes to promote by asking questions and making choices: how to achieve the correct balance between constructive innovation and disproportionate risk-taking; integrating new leaders into the company culture, particularly at times of merger or acquisition; maintaining culture under pressure; deciding whether different part of the business should operate different cultures, and communicating culture to shareholders in order to encourage constructive discussion.
Unfortunately we still see examples of governance failings but during 2015 we will continue our market-led work to assess how effective companies are at establishing company culture and practices. We have held breakfast meetings with a group of FTSE 100 Chairs to discuss the culture from the Board’s perspective. The output of this meeting is now being used to scope the project detail ahead of holding a series of in-depth roundtables with a broader selection of stakeholders over the summer to discuss and promote good Board practice in determining and ensuring appropriate culture.
Diversity
A further aspect of good culture is diversity and that is something that continues to be on our radar in 2015. Diverse Boards, and by that I don’t just mean a balance of gender, but of background and experience, geography and ethnicity, not only encourage better leadership but also contribute to better all-round Board performance, engagement and innovation, and ultimately increased corporate performance for both the company and its shareholders.
The FRC has been carrying out a project to identify good practice on how the nomination committee can play its role effectively. A discussion paper will be published next month in which we have sought to identify important issues in order to provoke further debate, and feedback to the issues raised will be requested.
Stewardship Code
Engaged shareholders are a key ingredient of a healthy capital market. Effective investor stewardship supports the long term success of companies delivering sustained benefits to their shareholders. The UK Stewardship Code, introduced in 2010, encourages fund managers and owners to engage with companies on all matters of concern. We are seeking an improvement in the quantity and quality of engagement; for asset managers to be more accountable to their clients, who should in turn generate the demand for stewardship; and for proxy advisers to be more accountable for the quality of their advice.
Response from investors has been encouraging. Many of them have signed up to the Code, and many large companies report greater engagement with their major shareholders on a wider range of issues. We are seeing more demand from clients of asset managers for stewardship when awarding mandates.
But there are still barriers to overcome. Resource constraints mean that investors are not engaging with smaller companies in which they do not have a significant investment, and some of the managers that have signed up to the Code do not appear to be backing up their words with actions. So we need to continue to encourage and incentivise them to play their part.
This year we will be working to influence the development of the new EU Shareholder Rights Directive to ensure UK interests are met and, closer to home, we plan to work closely with the newly formed Investor Forum to facilitate and stimulate engagement.
Comply or Explain
The UK’s strong governance culture is a beacon to the world, encouraging companies to list in London (and some to leave when they don’t meet our standards). One of the principle reasons why the two Codes have been such a success is that they operate on a principles basis rather than relying on strict regulation to bring about change.
The 'comply or explain' method of adherence has given companies flexibility and has made it possible to set more demanding standards than can be done through hard rules. Experience has shown that the vast majority of companies attain these standards – in 2014 we found that 94 per cent of companies complied with all, or all but one or two, of provisions in the UK Corporate Governance Code. And by requiring companies to report to shareholders rather than regulators means that the decision on whether a company's governance is adequate is taken by those in whose interest the Board is meant to act. I would like to remind both companies and investors that simply complying without giving due consideration to what is appropriate and relevant reduces the flexibility that this approach aims to achieve. To this end, further work will be conducted during the rest of this year to monitor reporting by companies on explanations given when they are not compliant with the Code.
Conclusion
Enhanced risk reporting, remuneration reporting, as well as better, more robust culture should give investors even greater confidence in listed companies, attracting more capital to UK markets. This virtuous circle of long-term, sustainable returns attracting capital that creates demonstrable value for the real economy through increased employment and innovation is probably the most powerful way in which markets can win back the support of the public.
I look forward to discussing this with you in more detail, and thank you to Grant Thornton for giving me the opportunity to speak to you today as well as the part they play in monitoring developments in corporate governance in their FTSE 350 governance report, which the FRC always finds to be very useful.