The Profession

Combined code is flawed, says ACCA

The UK Financial Reporting Council has issued its revised Combined Code to include the proposals made in Derek Higgs� review of corporate governance and the work of Sir Robert Smith on audit committees. But ACCA has responded by arguing that the Code fails to take sufficient regard of the interests of smaller shareholders and other stakeholders.

The FRC�s new Code is a radical shake-up of corporate governance in the UK. It provides new definitions for the role of the board, its chairman and non-executive directors. It seeks to appoint directors from a wider pool of talent, using more open and rigorous appointment procedures, with formal evaluation of the performance of boards, committees and directors, backed by more professional training and skills development support. At least half the board of larger listed companies will be expected to be independent non-executives.

There is a strengthening of the expectation that the roles of chairman and chief executive should be split, with the chief executive not going on to become chairman of the same company. Rather, the chairman and the senior independent director should develop closer relationships with major shareholders and non-executive directors. There is to be a strengthened role of audit committees, monitoring the integrity of companies� financial reporting and reinforcing the independence of auditors.

The FRC is to monitor and review the effectiveness of the Combined Code on a permanent basis through the creation of a standing group. The published Code differs in some respects from the Higgs and Smith proposals. The Code will not only include principles, but also supporting principles to allow companies greater flexibility in how they implement the provisions. Other changes will allow listed companies outside the FTSE350 to have less than half their board comprising non-executives, providing there are at least two non-executives.

Sir Bryan Nicholson, chairman of the FRC, said: �The Code... represents a positive and sensible advance in corporate governance in the UK and gives us a leading position internationally. It will foster far reaching changes in British boardroom practice and help to develop further the professionalism of non-executive directors.� He added: �I expect to see non-executive directors better able to make their full contributions within the unitary board.�

Sir Bryan also said that the new Code should help to promote a more open dialogue between boards and institutional shareholders, which will be �productive� if all are committed to it. He asked companies to report soon on what steps they were taking to implement the Code.

But Paul Moxey, head of corporate governance at ACCA, expressed disappointment at the rules, which he argued were too focused on internal board dynamics and the relationship between the board and large institutional shareholders. The result, he suggested, was that small shareholders in particular were being overlooked.

�The revised code contains many references to major shareholders - but these are institutions which only hold shares on behalf of others and therefore do not have a direct beneficial interest in companies� success,� argued Moxey. �It would seem not to be too interested in small investors. It is a pity that the needs of real shareholders have largely been ignored.

�There are no provisions or principles here which focus on the broad framework of corporate responsibility. The FRC appears to have ignored those who feel let down by business leaders and the investment community as the extent of corporate greed and negative environmental and social impact becomes clearer. Other codes, such as the recent King report in South Africa, have recognised the need for boards to be alert to issues of corporate social responsibility and accountability.

�Despite the improvements brought about by the Higgs and Smith reports, the new Code looks like an opportunity missed. The UK had the chance to produce a really significant contribution to improving corporate governance, but, while there are useful points, much more could have been achieved had the will been there. We fear that, like many others, including elements of the UK Government, the FRC may see the forthcoming mandatory Operating and Financial Review statement as a panacea for wider stakeholder concerns. But the fact that companies will need to address non-financial issues in the OFR does not mean that a stronger lead on corporate governance could not have usefully been given here.�

KPMG also expressed concerns about the revised Combined Code. By changing many of the proposed �provisions� into corporate governance principles, the FRC has massively increased the disclosure burden on companies, argues the firm. The problem, says KPMG, arises from the resulting requirement on businesses to explain to shareholders in narrative form how key principles have been applied - such as how �a formal and transparent procedure for developing policy on executive remuneration� works in practice.

�Transparency should always be welcomed, but we have to ask whether so much governance disclosure will provide real and commensurate benefits to investors,� said Timothy Copnell, director of corporate governance at KPMG. �Increasing the number of principles companies will have to report on will produce reams of extra pages in the annual report. This will add to the regulatory burden faced by listed companies, but one has to question whether it will provide a meaningful insight into how each organisation is governed, if investors will read it, and whether it will influence company behaviour.

�By seeking to reduce the number of provisions, and hence potential Code non-compliance, the FRC may have unwittingly changed the goal posts from a �comply or explain� regime to an �explain and explain� regime for many of the new Code elements. And, ironically, most of the provisions that have switched to principles are the very things that most companies will comply with anyway.�

Illustrating once again the increasing variance in approach taken by the Big Four, Deloitte and Touche instead praised the approach taken by the FRC. Martin Scicluna, Deloitte�s UK chairman, said: �The Government has rightly avoided Sarbanes Oxley style solutions and the Financial Reporting Council has acted wisely in responding to the corporate sector�s concerns. What is needed now is to allow the corporate sector to get on with the task of implementing the revised Code and supporting guidance, justify, where appropriate, non-compliances and take the steps necessary to restore growth to the economy.

�While the implementation of the code has been deferred slightly to reporting years beginning on or after 1 November 2003, the timetable is still demanding and institutional investors should expect progressive implementation of the revised Code rather than instant compliance. The regulatory agenda for the next few years is already demanding and, if sustained economic growth is to be achieved, then further burdens on business must be avoided.�