In February 2012, the Financial Reporting Council ("FRC") published a report of discussions between companies and investors on what constitutes an explanation under the comply or explain approach in the UK Corporate Governance Code. In light of the debate in Europe about the future of comply or explain and whether there should be more prescriptive regulation, the FRC concluded that it would be appropriate to address the question of what constitutes a meaningful explanation under comply or explain in order to promote explanations that are full enough to meet the needs of shareholders.
The FRC has pulled together a number of conclusions from the discussions, including that:
- The starting point should be an improvement in the general quality of disclosure in relation to corporate governance and a clear explanation by each company as to how its corporate governance arrangements support its business model;
- The chairman could play an important part in this and the chairman's statements could be fuller than they are currently in relation to corporate governance. More specifically, insights into how key features of leadership and board effectiveness are achieved in practice could be included in the chairman's statement; and
- Companies that provide a clear explanation of their approach to corporate governance could find that shareholders are more prepared to accept their explanation if they choose to deviate from a particular provision of the Code.
The report looks at the context of explanations, what elements are needed for a meaningful explanation and obstacles to greater disclosure. The key elements for a meaningful explanation are that it should:
- Set the context and historical background;
- Provide a convincing rationale for the deviation that is specific to the company, ensuring the explanations are understandable as well as persuasive;
- State what mitigating action the company is taking to maintain conformity with the relevant principle of the Code and to address any additional risk; and
- Indicate whether the deviation from the Code's provisions was limited in time and when the company intends to return to conformity with the Code's provisions.
The FRC is considering whether to reflect the conclusions of these discussions in the revised UK Corporate Governance Code on which it is intending to consult later in 2012.
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