Earlier this month, the Financial Reporting Council (FRC) published new guidance that asks directors to sign off annually on the effectiveness of their companies’ internal controls and governance.
The updated Code was borne from a push to improve corporate governance following the demise of a number of high-profile UK companies but the final document has been scaled back after extensive consultations with stakeholders. A concern from the City was that overly prescriptive or heavy-handed requirements would impede the competitiveness of UK companies in comparison to those in other markets.
‘Comply or explain’ is the key message for UK businesses. The FRC were keen to stress that the update is guidance, not new regulation, and their job is not to prescribe what material factors organisations should report on — this is something Boards need to decide for themselves. They hope, however, that the updated Code will lead to transparency in reporting over generic and generalised statements.
Having scaled back the remit of the Code, with changes to ESG and DEI being sidelined for now to focus purely on reporting, internal controls took a front-seat:
“What really mattered to enhance governance was the area of internal controls. If you go back over [company] failures and you look at case studies, internal controls are nearly always something that comes to the fore.”
Richard Moriarty, CEO, FRC in the Financial Times
With the revisions in place, it is provision 29 that covers these changes and now reads:
The board should monitor the company’s risk management and internal control framework and, at least annually, carry out a review of its effectiveness. The monitoring and review should cover all material controls, including financial, operational, reporting and compliance controls.
The board should provide in the annual report:
- A description of how the board has monitored and reviewed the effectiveness of the framework;
- A declaration of effectiveness of the material controls as at the balance sheet date; and
- A description of any material controls which have not operated effectively as at the balance sheet date, the action taken, or proposed, to improve them and any action taken to address previously reported issues.
The above can be interpreted as a push from the FRC for companies to explain how they came to their conclusions on reporting internal controls whereby if they’re not meeting all requirements set out yet, the FRC will be satisfied if the narrative explains the ‘why’ and the ‘where’ regarding their progress in addressing the matter. It allows companies to show continual progress in how they measure their controls whilst granting their stakeholders increased visibility into what plans are in place for the future.
The FRC hope that the new regulations balance the demand of investors who see the UK’s strong governance as a ‘pull’ factor to attract capital, against companies who might be concerned about the regulatory burden they now face. They have also stated that the guidance will be a living document to be updated as and when needed.
What the new UK Corporate Governance Code means for businesses
The updated guidance gives companies time to decide whether they need to report differently and, if so how, with the Code coming into effect for financial years beginning on or after 1st January 2025. The internal controls provision will be given leniency for the first year but will come into effect from 1st January 2026.
The declaration seeks to make sure the board is aware of all controls and risks within the business, but they also appreciate that no system can account to cover for all issues. This gives companies the facility to provide their reasoning and explanation behind such matters.
The FRC also took time to explain that while controls should be addressed at the balance sheet date there would be instances where issues may need to be resolved afterwards.
It’s also worth noting that whilst the FRC currently only has powers over directors who are qualified accountants — with limited ability to act against others — they wish to extend their reach to cover all directors but so far the legislation required has been repeatedly delayed.
How the market has reacted
Overall, the market has seemed welcoming to the changes with Dr Roger Barker, Director of Policy and Corporate Governance at the Institute of Directors saying “Overall, the FRC has sought to find a balance between upholding high standards of governance and ensuring the competitiveness of UK listed companies.” The FRC have managed to straddle the line between governance and competitiveness, which is key to the growth of the UK economy as well as remaining attractive to overseas businesses looking to trade here.
“The revisions to the Code clearly reflect a more focused direction of travel based on the varying agendas incorporated as part of last year’s consultation, and perhaps indicative of an acceptance across Government of the need to reduce unnecessary burden on companies. By taking a more proportionate approach and not applying prescriptive rules to how companies report internal controls, the FRC asks for companies to be transparent to their investors without burdening them with more procedures.”
Shervin Binesh, Cytec Solutions
Key Dates and Information
When does the new Code come into force?
The new Code will be applied to financial years beginning or after 1 January 2025.
When does Provision 29, regarding internal controls, become active?
This will be enacted a year after the rest of the Code, beginning 1 January 2026.
Is there any guidance for companies available?
The FRC guidance document provides advice, further detail and examples.