UK changes elevate disclosure on stakeholder considerations

Friday, 21 February 2020


    New reporting requirements formalise listed-company board focus on stakeholders.

    Australian directors interested in the future of governance should examine recent reforms in the United Kingdom that could take disclosure of Environmental, Social and Governance data – and the board focus on ESG – to new heights.

    New reporting requirements on how UK companies consider stakeholder needs, and a review of the UK audit profession headline key developments – and follow reporting reforms for large privately-owned UK companies and a raft of other disclosure changes.

    “2020 is the year when the focus of UK boards on stakeholders ratchets up,” says Dr Roger Barker, Head of Corporate Governance at the Institute of Directors (IOD), the UK equivalent of the Australian Institute of Company Directors (AICD), and a leading global governance expert.

    “There’s been a lot of talk in UK governance about the need for boards to broaden their focus beyond shareholders, to other stakeholders. Now, boards are being required to disclose how they govern for stakeholders and their organisations are having to disclose more ESG data.”

    Governance developments in the UK are important for Australia, for the two markets have much in common. The UK has implemented significant governance change in the past decade.

    Like the UK, Australia has had a long-running debate on shareholder versus stakeholder capitalism. The Banking Royal Commission in Australia emphasised that boards should consider the needs of stakeholders such as customers, employees and the community – and not only shareholders.

    High-performing boards know that the distinction between stakeholder and shareholder capitalism is, in many ways, redundant. Consistently doing the right thing by stakeholders and considering them in governance decisions is smart business – and ultimately good for shareholders.

    However, there is a difference between Australian boards recognising they need to consider stakeholders in governance decision-making, and having clear legal requirements for them to do so – and being required to report on how those requirements are being met. Professor Ian Ramsay, a prominent law academic at Melbourne Law School, in an article in the Governance Leadership Centre in September 2019, called for a new debate on whether Australia should follow the United Kingdom’s lead and clarify directors’ duties to consider the interest of stakeholders, beyond shareholders.

    Ramsay believes it is time for Australian lawmakers to reconsider section 181 of the Corporations Act 2001 (good faith) and whether it should include corporate social responsibilities or explicit obligations to take account of the interests of certain classes of stakeholders.

    The UK made important changes in 2006 to clarify directors’ duties to stakeholders. Section 172(1) of the Companies Act 2006 (UK) provides that directors of a company must act in a way they consider, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (among other matters) to:

    • The likely consequences of any decision in the long term;
    • The interests of the company’s employees;
    • The need to foster the company’s business relationships with suppliers, customers and others; 
    • The impact of the company’s operations on the community and environment; 
    • The desirability of the company maintaining a reputation for high standards of business conduct; and
    • The need to act fairly as between members of the company.

    In Australia, section 181 of the Corporations Act says directors or officers of a corporation must exercise their powers and discharge their duties:

    • In good faith in the best interests of the corporation;
    • For a proper purpose.

    The UK now requires certain UK companies (for financial years starting on or after January 1, 2019) to include a statement in their strategic report describing how directors have had regard to matters set out in section 172(1)(a) to (f) when performing their duties under section 172.

    In addition to this statutory requirement, boards of premium UK-listed companies should understand the views of the company’s other key stakeholders and describe in the annual report how their interests and the matters set out in section 172 have been considered in board discussions and decision-making, under Provision 5 of UK Corporate Governance Code 2018.

    Put simply, certain UK companies in 2020 will disclose how their board considered the needs of customers, employees, suppliers, the community and the environment in their governance processes – a change that takes the focus on stakeholder capitalism to new levels.

    Separately, the Brydon Review into the quality and effectiveness of audit in the UK also has implications for how boards consider stakeholder needs and disclosure of a section 172 statement.

    The Brydon Review recommended that directors present an annual Public Interest Statement that explains the company’s view of its obligations to the public interest, whether arising from statutory, self-determined or other obligations, and how the company has acted to meet this public interest over the previous year.

    The Review also recommended that the auditor’s report should include a new section in which the auditor states whether the director section 172 statement is based on observed reality, on the basis of the auditor’s knowledge of the company and its processes.

    In 2018, the UK introduced the Wates Corporate Governance Principles for Large Private Companies, as part of reforms to the UK Corporate Governance regime. The change applies to companies in the UK that have either 2,000 employees or a turnover of more than £200 million and a balance sheet of more than £2 billion. Private companies that meet this criteria must publish a corporate governance statement in the annual report and website.

    The Governance Leadership Centre asked Roger Barker of IoD about the significance of these changes for UK boards:

    GLC: Roger, how significant is the new section 172 statement for UK boards?

    RB: It’s a very important change. There’s been a view that boards of some UK organisations pay lip-service to the legal obligation to take account of the needs of stakeholders when they make decisions. Now, organisations are being required to disclose how the board thinks about stakeholders in governance processes. Over time, this reporting requirement should help accelerate the transition from a hybrid governance model – where shareholders are the main focus and stakehodlers are secondary – to a full stakeholder governance model.

    Put simply, certain UK companies in 2020 will disclose how their board considered the needs of customers, employees, suppliers, the community and the environment in their governance processes – a change that takes the focus on stakeholder capitalism to new levels.

    GLC: What level of disclosure in the section 172 statement do you expect?

    RB: That’s the big question. It’s likely that some UK companies will see the section 172 statement as a ‘boilerplate’ exercise at the start and provide limited disclosure. Other boards that genuinely consider the needs of stakeholders might provide more information. Over time, I expect we’ll see more information in the section 172 statement as companies get comfortable with the process.

    GLC: What does the section 172 statement mean for directors at an individual level?

    RB: In general, it will add to the complexity and workload of directors. There is a statutory requirement now for boards to not only comply with a legal obligation to consider the needs of stakeholders, but to disclose how they do so. For the first time, boards will be subject to market scrutiny on how they considered stakeholders in their decisions. That will add new risk.

    GLC: Could activists use information in the section 172 statement to target companies?

    RB: It’s possible. Certainly, there is growing interest from hedge funds and other asset managers that specialise in shareholder activism around climate change and other ESG-related issues. When things go wrong, they look for evidence that a company did not meet disclosure or other legal requirements. The section 172 statement is potentially a way to assess if a board sufficiently thought about stakeholder needs, which cut across financial and non-financial issues.

    GLC: Moving to audit, should there be a requirement for ESG data to be audited, given the growing focus of financial markets on ESG in investment decisions?

    RB: It’s a good question. A lot of people who pick up an annual report may think all the information in it is audited, even though only the financial statements are. They rely on the company to ensure any ESG data presented is true and fair.

    In considering the future of audit, the Brydon Review said the audit profession would need to encompass a wider range of issues, including reporting of non-financial information. It’s seems inevitable that ESG information in time will be audited, again adding to governance pressure in this area.

    GLC: The IoD has expressed concerns about aspects of the new regulator for accounting firms in the UK, the Audit, Reporting and Governance Authority, which replaces the Financial Reporting Council. What are your main concerns?

    RB: The IoD sees the value of having a statutory regulator for the UK audit profession. Our main concern is that the nature of the UK Corporate Governance Code – specifically the ‘comply-or-explain’ model (for listed-company disclosure in the UK) would change under the new Audit, Reporting and Governance Authority.

    Auditors make independent, objective assessments on whether a company has met reporting requirements. The comply-or-explain model sensibly gives listed companies in the UK flexibility with disclosure. There is a risk that the new regulator could be less sympathetic to the comply-or-explain model and move to more of a ‘comply-only’ model where companies must disclose information in certain areas.

    With so much focus on climate change and other corporate-sustainability risks, future disclosure requirements might become a lot more prescriptive, diminishing the ability of listed companies to decide if disclosing certain information adds value to their stakeholders.

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