Comply or Explain: What the FRC’s guidance means for governance reporting

The Financial Reporting Council (FRC) has published updated guidance on ‘comply or explain’ reporting. The recommendations aim to help investors, proxy advisers, and other readers of corporate reporting better interpret and appreciate the value of companies that elect not to strictly follow all provisions within the UK Corporate Governance Code.

The term “Comply or Explain” has become a hot topic amongst companies within the UK and Ireland. The subject makes frequent appearances on our CoSec Breakfast as companies and their Secretariat teams look at the best ways to demonstrate their approaches to good governance, whilst providing an accurate and clear-cut account for their investors to digest.

“Comply or Explain” is not about strict compliance

The FRC is explicit that there can be instances where an explanation for a departure from the Code represents better governance than strict compliance, particularly where a provision does not suit a company’s circumstances. They see the Code as being designed to allow companies to choose governance arrangements that best represent an organisation’s maturity, structure, and business model.

Over-reliance on the Code can distort how a company’s governance is presented and understood, increasing the risk of:

• Boilerplate reporting that could belong to any listed company, denying investors a clear picture and missing an opportunity to clearly explain the company’s position
• Low-value governance disclosures that say very little about what controls, material or otherwise, are in place
• Annual reports that miss the mark on how the company truly operates

This guidance reflects what Maureen Beresford noted on our “Comply or Explain” webinar: the FRC wants governance reporting to mature and move away from a perceived tick-box culture.

What should companies focus on in their governance disclosures?

The FRC notes that disclosures should focus on the activities and decisions made by the board, not operational management. They should demonstrate how governance contributes to the oversight, accountability, and risk management employed by the organisation in question, and explain the outcomes of governance actions rather than simply describing policies and procedures. For example, stakeholder engagement should explain how that initiative influenced board discussions and ultimately, the decisions derived from it.

Investors and proxy advisers should adjust their behaviour

The guidance is less about how companies should approach the matter, although this remains important, instead it is aimed at those making use of governance reporting.

The FRC encourages investors to evaluate the quality of explanations, not just the status of an organisation’s compliance. In doing so, they should allow flexibility in voting policies where companies offer transparent and thoughtful alternatives.

This is a significant point, the FRC is effectively asking investors and proxy advisers not to penalise companies by default where they stray from Code provisions.

What a meaningful “Comply or Explain” disclosure looks like

In the guidance, the FRC set out five elements of a good explanation. Per their guidance, strong governance explanations should include:

• A convincing rationale for why the board chose an alternative approach
• A clear consideration of governance risks that can arise from the departure
• Evidence of mitigating actions taken to address those risks
• A clear timescale on whether the departure is temporary or indefinite
• Clear context of the circumstances that led to the decision

The explanation for these should be clear, persuasive, and written in plain language.

Transparency is more important than perfect compliance

The FRC is realistic in its expectations and warns that some companies could claim full compliance with the Code but fail to disclose clear departures. This can create two problems.

Firstly, it can undermine confidence in governance reporting. This can have several knock-on effects, not least undermining investor confidence in the company. Secondly, it can bring into question not just the validity of these claims, but also the trustworthiness of the entire annual report.

Therefore, companies should clearly state where they fully comply or depart from specific provisions and explicitly name which provisions are involved in these exceptions.

Reporting on governance should demonstrate outcomes

A strong emphasis within the guidance is that reporting should show how the board discharged its responsibilities, what outcomes these governance decisions produced, and how governance has contributed to the success of the organisation.

The ultimate goal is that governance reporting should reflect the real work of the board and its advisers and avoid wherever possible disclosures that are vague and formulaic.

Conclusion

The UK governance model relies on the principle that companies should either comply with Code provisions or explain why an alternative approach is more appropriate. Investors and proxy advisers must remain open to the possibility that a well-reasoned explanation can represent stronger governance than mechanical compliance.

In the Financial Times, Richard Moriarty, CEO of the FRC, wrote: “A transparent and cogent explanation is not a confession or a failure. It shows that a board has thought carefully about the best way to govern the business it runs. It treats investors as informed partners rather than compliance auditors. It builds trust.”

The UK governance system ultimately depends on trust and transparency, not rigid adherence to rules. Boards and their Secretariat teams should feel confident exercising judgement and explaining their decisions openly, whilst investors should be prepared to assess those explanations thoughtfully.

If both sides engage with the framework as intended, the result should be more meaningful governance reporting, stronger board accountability, and a flexible governance framework that avoids becoming unnecessarily prescriptive.