21 November 2023 Wilma Rix Capital Markets - Equity - Corporate Governance - ESG

FRC calls for more outcomes-based reporting

The Financial Reporting Council has published its latest annual review of corporate governance reporting. The review outlines areas where the FRC would like to see improvement as well as giving examples of good reporting and insights into corporate governance trends.

The report is a based on reviewing the annual reports of a sample group of 100 premium listed companies right across the size spectrum including FTSE 100, FTSE 250 and Small Cap companies. The sample group is different each year.

Areas where the FRC sees room for improvement include:

Outcomes rather than inputs

  • When companies report on how they have applied the UK Corporate Governance Code's Principles, the FRC encourages companies to avoid a formulaic “Principle by Principle" approach and to report on how the application of the Principles has made a difference to actions taken by their board.
  • This also applies in other reporting under the Code, where the FRC urges companies to report clearly on governance outcomes and the resulting actions, and on actual practices rather than policies and procedures. For example, while there is plenty of good reporting on workforce and stakeholder engagement activities, the FRC would like to see more on the outcomes from engagement, the feedback received and its impact on board decisions.
  • The FRC reminds companies that composition and diversity should be considered at the annual evaluation of the board – in many cases, it was not apparent from the reporting that this had taken place.

Comply or explain reporting

  • One of the FRC's perennial themes is the need for better quality explanations where companies are not complying with the Code. While the FRC has observed improvements, it criticises “unconvincing boilerplate reporting" and failure to say why alternative arrangements benefit the company and its shareholders. Companies should, where relevant, clearly state which provisions they do not comply with and whether/when they intend to bring their practices into line with the Code.
  • Sixty-three of the sample companies disclosed departure from at least one Code Provision. The provision with the highest rate of non-compliance is Provision 38 on pension alignment.

Audit, risk and internal controls

  • The FRC says that many companies do not report well in relation to their audit and internal controls, and fail to demonstrate robust systems and effective governance and oversight.
  • Only 20% of companies (both last year and this year) provided insightful information on how they reviewed the effectiveness of their risk management and internal control systems, with the rest, at best, only providing very basic or generic information. Good reporting on the process would include details of how the board (or its committees) have undertaken the review, who was consulted, what reports or evidence was received, and what areas were covered by the review. Reports should also provide an explanation of any material weaknesses identified and any actions that the board has undertaken to address these.
  • Although there was good reporting on risk, the FRC comments that there was often repetition in risk reporting within annual reports. Many companies were less good at describing their assessment of emerging risks and did not explain their procedures for identifying and managing these risks.
  • Other specific areas for improvement included auditor independence, tenure and tendering for external auditors.

Reporting on the environment and in line with TCFD

Although the Code does not require reports on environmental issues, it does cover risk governance, stakeholder engagement and Section 172 Companies Act 2006 reporting. As a result, the FRC's review considered TCFD-aligned reporting for a third year and was pleased to see that the 100 companies it surveyed had taken steps to improve their reporting and strengthen their governance of climate-related issues. The FRC expects this improvement to continue.

Specific findings in this area included the following:

  • Section 172 statement: almost a quarter of companies in the FRC's sample identified the environment as a key component of their section 172 statement.
  • Statement of consistency with the TCFD framework: the FRC has reminded companies that a good statement clearly explains a company's level of consistency with the TCFD recommendations and recommended disclosures, states any areas where they are not yet compliant, and avoids vague statements.
  • Governance of climate-related issues: as was mentioned last year, better reporting in this area included clear and specific disclosure of the governance structures and processes by which the board considers climate-related issues.
  • Committees: the FRC found that this year 46 companies had board-level committees such as sustainability, ESG and corporate social responsibility committees, which are responsible for assessing and considering environmental issues. Almost a quarter were created in the past year and they belonged to an even mix of FTSE 100, FTSE 250 and Small Cap companies.
  • Metrics and targets: as set out in the FRC's CRR Thematic Review, climate-related metrics and targets, including “net zero" plans, are seen as increasingly important by investors and other stakeholders. Most companies disclosed net zero or other climate-related targets but the metrics used to track progress were sometimes unclear and explanations of performance not always provided.
  • Scope 3 GHG emissions: many companies that reported partial compliance with the TCFD recommendations had not achieved full compliance due to the data integrity and availability of Scope 3 GHG emissions. Nonetheless, over 90% of companies reported at least some of the 15 Scope 3 emissions categories. The FRC would like to see disclosure of the methodology used to calculate data and information about the work that will support future reporting.
  • Board expertise: similar to last year, the FRC found that only around one quarter of companies disclosed senior management expertise or knowledge in the report.
  • Assurance: different forms of assurance are being sought by companies. This year 65% of companies surveyed obtained some form of external assurance over at least some aspect of their TCFD data disclosure, which is an increase on last year.
  • Climate change risk: this year the FRC found that 60 companies identified climate change as a principal risk and 17 as an emerging risk.

Governance trends

Some governance trends highlighted in the report include:

  • On culture, the FRC notes that 10% of companies had set up a specific board level task force or committee with a remit to focus on culture and people. On diversity, nearly all companies reported having a company-wide diversity policy. Companies in the telecoms and entertainment sectors had the most expansive list of diversity targets and objectives.
  • In relation to investor engagement, the FRC points out a growing use of perception studies where third parties engage with investors on behalf of a company to gather views on the board and to enable boards to better understand their investor base. The FRC notes that use of such third parties does not absolve board members of their responsibility to engage directly with shareholders.
  • Although the Code does not expressly require reporting on cyber risks, the FRC found that around 85% of the reports it reviewed noted cybersecurity or information technology as a principal risk. Many companies (49%) mentioned artificial intelligence last year, with a few citing the progression of AI as an emerging risk. The FRC notes the importance of boards having a clear view of the use and governance of AI within their company and considering the potential and risks of AI including the risks to wider society. This may require boards to increase their knowledge of AI whether through training or drawing on internal or external expertise.

See the FRC's report here.

For more information about aspects of the report which are particularly relevant to reporting on environmental, climate and social issues in 2023/24, see here. For information on the remuneration reporting aspects of the review, see here.