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Corporate governance developments in the UK are summarised as follows:
Initial corporate governance developments in the UK began in the late 1980s and early 1990s in the wake of corporate scandals such as Polly Peck and Maxwell. Financial reporting irregularities led to the establishment of the 'Financial Aspects of Corporate Governance Committee' led by Sir Adrian Cadbury. The resulting Cadbury Report published in 1992 outlined a number of recommendations around the separation of the role of an organisation's chief executive and chairman, balanced composition of the board, selection processes for non-executive directors, transparency of financial reporting and the need for good internal controls. The Cadbury Report included a Code of Best Practice and its recommendations were incorporated into the Listing Rules of the London Stock Exchange.
Following Cadbury, a 'Working Group on Internal Control' was established to provide guidance to companies on how to comply with Principle 4.5 of the Cadbury Code 'reporting on the effectiveness of the company's system of internal control'. This led to the publication of the Rutteman Report in 1994 on 'Internal Control and Financial Reporting'.
In 1995, following concerns about directors' pay and share options, the Greenbury Report recommended extensive disclosure in annual reports on remuneration and recommended the establishment of a remuneration committee comprised of non-executive directors. Again, the majority of the recommendations were endorsed by the Listing Rules.
In January 1996, the Hampel Committee was established to review the extent to which the Cadbury and Greenbury Reports had been implemented and whether the objectives had been met. The Hampel Report led to the publication of the Combined Code of Corporate Governance (1998) covering areas relating to structure and operations of the board, directors' remuneration, accountability and audit, relations with institutional shareholders, and the responsibilities of institutional shareholders.
The 1998 Combined Code applied to all listed companies from 31 December 1998 until reporting years commencing on or after 1 November 2003 until it was superseded by the revised Code in 2003. It was appended to Listing Rule 12.43A requiring companies to provide in their annual reports a narrative statement of how they have applied the Code principles and state that they have complied with the Code provisions or, if not, why not and for what period.
Part of the 1998 and 2003 Combined Codes required companies to provide a statement in their annual report on how they have applied the Code Principle and Code Provisions relating to internal control. Guidance for companies on how this should be approached was needed. This led to the establishment of the Turnbull Committee in 1998 by the Institute of Chartered Accountants in England & Wales (ICAEW) which then resulted in the Turnbull Guidance, "Internal Control: Guidance for Directors on the Combined Code" published in September 1999. The Guidance is a Securities & Exchange Commission (SEC) approved framework for management to show that they have adequate internal control structures and financial reporting procedures in place in order to comply with section 404 of the Sarbanes-Oxley Act.
In 2001, the relationship between institutional investors and companies was addressed with the Government commissioned Myners Review, 'Institutional Investment in the UK'. The objective of the review was 'to consider whether there were factors distorting the investment decision-making of institutions'. It included suggestions for the improvement of communication between investors and companies and encouraged institutional investors to consider their responsibilities as owners and how they should exercise their rights on behalf of beneficiaries.
In 2002, the Directors' Remuneration Report Regulations were introduced to further strengthen the powers of shareholders in relation to directors' pay. The regulations increased the amount of information shareholders are given on directors' remuneration, certain disclosures, as well as performance graphs. Shareholder may vote in an advisory capacity to approve the directors' remuneration report.
In July 2002, the Department of Trade and Industry (DTI) and HM Treasury instigated a review of the Combined Code following a review of company law. It initiated the Higgs Report on "The Role and Effectiveness of Non-Executive Directors" which was published in January 2003. Recommendations from Higgs included a definition of 'independence' and the proportion of independent non-executive directors on the board and its committees; an expansion on the role of the senior independent director to provide an alternative channel to shareholders and lead evaluations on the chairman's performance; added emphasis on the process of nominations to the board through a transparent and rigorous process and evaluation of the performance of the board, its committees and individual directors.
Around the same time, the Financial Reporting Council published the Smith Report, "Guidance on Audit Committees". Both the Higgs and Smith Reports were published in January 2003 followed by the Tyson Report on the recruitment and development of non-executive directors commissioned by the DTI. The recommendations from the Higgs and Smith Reports led to changes in the Combined Code of Corporate Governance published in July 2003. It applied to all companies listed on the primary market of the London Stock Exchange for reporting years commencing on or after 1 November 2003.
In 2004, the Financial Reporting Council established the Turnbull Review Group to consider the impact of 'Internal control: Guidance for Directors on the Combined Code' and to determine whether the guidance needed to be updated. Accordingly, "Internal Control: Revised Guidance for Directors on the Combined Code" was published by the Financial Reporting Council in October 2005.
In 1998, the UK Government instigated a Company Law Review and produced a White Paper in 2002. A number of proposals in the White Paper related to company reporting and a significant development was the requirement for companies to provide a mandatory Operating and Financial Review to provide information on the company's current and prospective performance and strategy. This came into effect from financial years beginning on or after 1 April 2005.
The European Union also significantly influences corporate governance in the UK. The European Commission's "Corporate Governance and Company Law Action Plan" (May 2003) proposed a mix of legislative and regulatory measures which would affect all member States relating to:
exercise of voting rights;
cross- border voting;
disclosure by institutional investors; and
responsibilities of board members.
The Enron scandal in 2001 eventually led to the bankruptcy of the Enron Corporation, and the dissolution of Arthur Andersen, one of the five largest audit and accountancy firms in the world. In addition to being the largest bankruptcy reorganisation in American history at that time, Enron undoubtedly was the biggest audit failure. As a consequence of the Enron scandal in 2001, new regulations and legislation were enacted to expand the reliability of financial reporting for public companies. The Sarbanes-Oxley Act was introduced in 2002 to increase the accountability of auditing firms to remain objective and independent of their clients. Sarbanes Oxley Act.pdf
Seven years since Enron placed corporate governance under the spotlight, the recent global financial crisis has renewed that focus. Deficiencies and failures in corporate governance in the new Millennium have led to the new financial crisis starting with the collapse of Lehman Brothers in September 2008 followed by several UK and European Banking Groups. These events have confirmed that the soaring pay packages for top bank executives were driven by extraordinary risk-taking rather than real sustainable profits.
The economic crisis has prompted governments across the world to re-evaluate their financial regulatory framework, to try to tackle the causes of, and fallout from, the global downturn. The UK Government has taken unprecedented action to prevent and contain future crises in the financial markets and support the broader economy focusing on stabilising the banking system to protect people's savings and the economy.
The global financial crisis has revealed widespread and massive failures in risk management practices. Many economists, organisations and governments have suggested a link between weaknesses in corporate governance arrangements which did not serve their purpose to safeguard against excessive risk taking in a number of financial service companies.
The UK Government commissioned Lord Turner in October 2008 to review the causes of the global financial crisis. The Turner Review, issued in March 2009, was a UK regulatory response to the global banking crisis. The Turner Review outlines recommendations on the redesign of regulation and supervisory approach needed to create a more robust banking system for the future. The Review also focuses on the improvements in the effectiveness of internal risk management and corporate governance. Turner Review.pdf
In February 2009 Sir David Walker, ex-City regulator had been asked by the Prime Minister to review corporate governance in UK banks in the light of the experience of critical loss and failure throughout the banking system. The Walker Review published in November 2009 recommends more transparent pay and bonus structures for all high earners following a serious and ongoing corporate governance failings in the financial sector. Walker Review.pdf
The review examines corporate governance in the UK banking industry and makes recommendations on:
the effectiveness of risk management at board level, including the incentives in remuneration policy to manage risk effectively;
the balance of skills, experience and independence required on the boards of UK banking institutions;
the effectiveness of board practices and the performance of audit, risk, remuneration and nomination committees;
the role of institutional shareholders in engaging effectively with companies and monitoring boards; and
whether the UK approach is consistent with international practice and how national and international best practice can be promoted.
As a result of Walker's recommendations, the role of the Chief Risk Officer may fundamentally change. Walker suggests that the CRO mandate should encompass all material risks and become, at least in part, the 'eyes and ears' of the Board Risk Committee.
The Combined Code and associated guidance
The Combined Code on Corporate Governance sets out standards of good practice in relation to issues such as board composition and development, remuneration, accountability and audit and relations with shareholders.
All companies incorporated in the UK and listed on the Main Market of the London Stock Exchange are required under the Listing Rules to report on how they have applied the Combined Code in their annual report and accounts. The Combined Code contains broad principles and more specific provisions. Listed companies are required to report on how they have applied the main principles of the Code, and either to confirm that they have complied with the Code's provisions or - where they have not - to provide an explanation.
In March 2009 the FRC announced a review of the Combined Code, as a result of which it proposes to make a number of revisions to the Code. Consultation on these proposals ends on 5 March 2010.
Subject to the outcome of consultation it is intended that the revised Code - which will be known as the UK Corporate Governance Code - will apply to financial years beginning on or after 29 June 2010.
Corporate Governance Codes, Best Practice Guidelines & Reports UK
Institute of Directors, (2001) Standards for the Board - Improving the effectiveness of your board, London: Kogan Page
Committee on Corporate Governance, Hampel Committee, Final Report (January 1998)
Department for Trade and Industry Report on the Committee on the Financial Aspects of Corporate Governance, Cadbury, (December 1992)
Department for Trade and Industry, Higgs Review on the Role and Effectiveness of Non-Executive Directors (January 2003)
Department for Trade and Industry, Myners Committee. Developing a Winning Partnership: How Companies and Institutional Investors are Working Together (1995)
Financial Reporting Council, The Smith Guidance on Audit Committees, (January 2003);
Department for Trade and Industry, The Tyson Report on the Recruitment and Development of Non-Executive Directors, (June 2003)
Hermes Investment Management Ltd, International Corporate Governance Principles, (December 1999)
Institute of Chartered Accountants in England and Wales, Internal Control Guidance for Directors on the Combined Code, Turnbull (Sept 1999)
London Stock Exchange, Combined Code: Principles of Good Governance and Code of Best Practice, (July 2003)
Study Group on Directors' Remuneration, Final Report (Greenbury Report) (July 1995)
The Institute of Chartered Accountants in England and Wales, Closing the Communications Gap: Disclosure and Institutional Shareholders (April 1997) and Audit Committees: A Framework for Assessment (May 1997)
Cadbury A (2002) The Chairman and Corporate Governance, London
ICSA A Guide to Best Practice for Annual General Meetings, London, ICSA
ICSA A guide to the Statement of Compliance, London, ICSA
ICSA Duties of a Company Secretary, London, ICSA
ICSA The Appointment and Induction of Directors, London, ICSA
ICAEW, Internal Control and Financial Reporting, Rutteman Report, 1994
CIPFA, The good governance standard for public services, 2005
USA federal law, the Sarbanes-Oxley Act (July 2002)
Financial Services Authority, The Turner Review: A regulatory response to the global banking crisis (March 2009)
HM Treasury, The Walker Review of corporate governance in UK banks and other financial industry entities (November 2009)
Financial Reporting Council, 2009 Review of the Combined Code: Final Report (December 2009)