UK Corporate Governance Policy The expert’s perspective

In this article, Karl West provides his perspective on some of the discussion’s key themes.

A wide range of governance subjects were debated and dissected at the roundtable, including the post-Carillion corporate governance and audit reforms, the governance consequences of UK listing rules reform and the Financial Reporting Council’s review of the Stewardship Code for institutional investors.

Each of these subjects can be interpreted as a narrow, individual issue. But during the 90-minute discussion a few overarching themes developed to form a broader, complex debate about regulation, the markets and the role of corporate governance.

Making sense of these big, often conflicting pressures may provide the key to unlock Britain’s economic potential over the next decade.

Market Turbulence 

In December 2023, the Financial Conduct Authority (FCA) set out plans to press ahead with an overhaul of the UK listings rule book. It is moving forward with these reforms despite openly acknowledging they could increase the risk of more company failures. The upside is that they may also encourage more businesses to float their shares in London.

“The proposals could entail an increased possibility of failures, but the changes set out would better reflect the risk appetite the economy needs to achieve growth,” the financial regulator has stated.

The plans, which include abolishing the distinction between London’s premium and standard listing segments and removing a requirement for shareholders to approve some large transactions or those with “related parties”, are aimed at boosting the UK market’s attractiveness to international companies.

Current requirements for advance shareholder approval for large transactions leave the UK’s premium listed companies at a disadvantage when bidding for assets in competitive sales processes, the FCA argues.

It adds: “This means UK premium listed companies believe they have to pay a premium, agree to high break fees or lose out on competitive opportunities.”

Fund managers and investor groups have previously expressed concern that reducing their ability to approve or veto transactions would leave them exposed to more risk.  But the FCA says that its proposed “disclosure-based regime” would give investors enough information and enable them to “influence company behaviour and decide how they want to invest”. Companies would still need shareholder approval before a reverse takeover or delisting their shares.

The proposals have been launched against a backdrop of companies dropping their London listings and a dearth of new companies joining the stock exchange.

According to Lord Hill’s UK Listings Review, published in 2020, the number of listed companies in the UK has fallen by about 40% from a recent peak in 2008. Between 2015 and 2020, the UK accounted for only 5% of Initial Public Offerings (IPOs) globally.

Some of the main justifications for them jumping ship include the huge pools of liquidity in the US that mean company valuations are higher, a more extensive market for talent, vastly higher rates of executive pay, fewer rules and lower regulatory scrutiny … which feed into the perception that the US has a more business friendly environment.

One roundtable delegate hit back at this, noting: “The US has many more mandatory rules [Sarbanes Oxley, quarterly reporting, etc] so to make the point that the UK has more rules is wrong. Operating in the US is highly complex in terms of litigation risk and the compliance burden.”

Nonetheless, huge companies like CRH, Smurfit Kappa, ARM, Ferguson, BHP and Flutter have all recently either dropped their UK listings and moved elsewhere – mainly to the US – or turned their backs on London as a listing destination.

The question of how to balance the ‘animal spirits’ of executive teams with the requirement for good governance and regulatory guard rails provided fertile ground for debate at the roundtable.

One delegate said: “To throw the baby out with the bath water is a retrograde step for the UK. There is no evidence, in my view, that if you reduce governance standards, you can expect more companies to come in. There are a lot of other things going on [including Brexit].

“A lot of us here are disappointed with the way the UK is going in terms of diluting corporate governance checks and balance .”

Another noted that many pre-IPO companies are under pressure to list in the US due to their ownership and funding structure.

“At every stage your funding is likely to come from the US [either seed capital or venture capital money]. So, at every stage, companies are under pressure to list in the US,” she said.

A third acknowledged the obvious pull factor of the deeper pools of liquidity on offer in the US compared to the UK. London can never compete with that and must offer something different.

“We are moving towards a smaller version of the US, where London is a Mini-Me of New York. But we are never going to have the same depth of liquidity. If we throw out everything that differentiates us as a market, then we will fail,” he said.

The delegate noted the failure of We Soda – the world’s largest producer of natural soda ash, an ingredient used in glass production – to get its planned London IPO off the ground. In June 2023, it scrapped plans to raise £600m through a flotation, valuing the firm at more than £6bn.

The company said at the time that UK investors “remain extremely cautious” and We Soda was unable to reach a fair valuation.

The delegate noted: “We Soda came to the UK market looking for too much money. Most of the stuff that has come to the market has performed appallingly [e.g. THG, Dr Martens, Deliveroo and Moonpig]. The UK market has therefore worked in the interests of savers [by being cautious about listings].”

Bonfire of the Regulations? 

Six years after the devastating collapse of Carillion – a huge construction company that had contracts across both the private and public sector, including hospitals – not much has come of the long-promised reforms to the responsibilities of company directors or the audit profession. Radical proposals to shake up the entire audit industry and the audit regulator, the Financial Reporting Council (FRC), seem to have fizzled out.

There has been a tweak to the UK Corporate Governance Code [in January 2024], so the boards of quoted companies with a premium listing on the London Stock Exchange will have to declare that their firms’ internal controls are up to scratch.

One delegate at the roundtable noted: “A wholesale rewriting of [governance] standards misses the point. Most of the time they [disasters] are down to a failure of boards. Are shareholders holding boards to account? Are boards holding management to account?”

“Basically, our structure is quite good. We have to make it work better from within rather than fiddle with the rules.”

Another delegate said: “The dramatic changes in corporate governance since the Cadbury Report thirty years ago [appointment of senior independent directors, chairs serving a 9-year maximum term, etc.] took place without stringent regulatory enforcement.”

He noted these changes were made proactively through engagement between investors and directors, who recognised issues at individual issuers and dealt with them.

“I strongly believe this can still work. The suggestion that you should now create an ever bigger, more powerful regulator is strange,” he added.

A policy consultation that has just started is the FRC’s review of the UK Stewardship Code for institutional investors – to ensure that it supports growth and the UK’s competitiveness. This review is taking place at a time when some UK boards have expressed concern about the poor state of their relationships with investors.

As part of the first phase of the review process, the FRC is seeking views from stakeholders including pension schemes and asset managers on whether the Code is being used in a way that drives better stewardship outcomes. The revised Code is likely to be published in early 2025.

There are currently 273 signatories to the Code, representing £43.3 trillion in assets under management. Membership of the Code is voluntary, but UK asset owners are increasingly expecting their managers to sign up.

The FRC’s plans to shake up the Stewardship Code come amid investor concerns around increasing ESG (environment, social and governance) reporting requirements, particularly for smaller asset owners.

The tensions between those who are sceptical of increased reporting requirements and those who find it a useful exercise were on show at the roundtable.

One delegate said: “There’s a difference between a good stewardship report and good stewardship per se. There is a whole industry that has grown up, which advises investors on writing a good stewardship report. We have to be careful we don’t fall into a situation of style over substance.”

Another delegate, who runs a large pension fund, said: “[We are] both a user and a preparer of stewardship reports – ours comes in at 94 pages, so I’m pleased to hear we’re only average and not excessively long.

In terms of our own stewardship, we find these reports tremendously useful for providing a formal opportunity for us to reflect on the previous year – though of course we reflect regularly. It can never be read in isolation and good disclosure doesn’t necessarily equal good practice.

“As an asset owner, stewardship reports from our managers give us additional information around where we might probe and ask pertinent questions.”

Conclusion 

In many of the debates around governance – whether relating to the listing rules, the Stewardship Code or audit reform – there is sometimes an implicit (or indeed explicit) assumption that good governance is somehow at odds with competitiveness or strong business performance.

However, a key message from many of the delegates at the roundtable was that it is perfectly possible to run a competitive, successful business within the current UK policy framework, both as a listed and an unlisted company. On the whole, the current UK policy framework supports rather than hinders the capacity of companies to do that.

As one of the delegates observed: “The lower interest in listing in London is mostly related to other factors, such as Brexit, more investment for start-ups in the US, lower regulation around remuneration so you can pay more, and the increased media and political scrutiny of listed companies – but not specifically corporate governance.”

The roundtable took place on the basis of the Chatham House Rule, whereby all comments are unattributable.