Corporate Governance in the Context of Brexit and Political Uncertainty in the United Kingdom and Europe

The United Kingdom faces significant uncertainty in 2018 as negotiations for its exit from the European Union in 2019 continue to develop.  

Domestically, the political situation is unstable following a general election in 2017 in which Prime Minister Theresa May’s Conservative Party lost its majority in the UK parliament. In this political context, the UK government has proposed wide-ranging reforms to the corporate governance regime with implications for listed companies’ practices in relation to executive remuneration and stakeholder engagement, among other things.

Brexit

The United Kingdom delivered its “Article 50” notice on March 29, 2017, starting the two-year clock on its negotiated exit from the European Union, which will be automatic unless the remaining 27 member states (the
EU 27) unanimously agree to extend negotiations. The United Kingdom has confirmed that it does not seek future membership of the European single market, but will aim to negotiate a comprehensive free trade agreement with a transition period of around two years following Brexit.

After slow progress in exit negotiations over the course of 2017, UK and EU negotiating teams reached a breakthrough in early December, and the European Council has now issued a decision confirming the EU 27’s willingness to proceed to the second phase of negotiations, which will include discussions around the United Kingdom’s future trading relationship with the European Union.  However, the process is expected to continue to be fraught.  

Companies’ exposure in relation to Brexit will vary widely, and we expect that boards have taken steps during 2017 to identify vulnerabilities.

As Brexit negotiations evolve during 2018, boards should focus on the following:

Be alert to early indications of the direction of trade negotiations.  Key indicators of the EU 27’s position will be the European Commission’s negotiating directives in relation to the discussion of the future UK-EU relationship (expected in early 2018) and the outcome of the European Council meeting scheduled for late March 2018.

Continue to review and develop contingency plans with an eye on implementation timelines.  Despite interest in the United Kingdom and the European Union in maintaining a strong relationship, companies with undertakings in the United Kingdom should nevertheless prepare for the possibility of a “no-deal” Brexit.  Boards should confer with advisers to clarify the process and timing of potential contingency plans and may wish to begin to implement such measures early in the coming year.

Identify opportunities.  Following Brexit, we expect the UK government to make efforts to preserve and enhance the competitiveness of the United Kingdom as a home for international business. Boards should consider how to engage strategically with the government or industry bodies to make the most of these opportunities.

Corporate Governance Reform in the United Kingdom

In a surprise UK general election held on June 8, 2017, Prime Minister May’s government lost its majority, significantly weakening her leadership and forcing her to form a minority government propped up by the support of a small socially conservative party.  Against the backdrop of Brexit and this political uncertainty, the UK government has announced a program to significantly reform the UK corporate governance framework.  Changes will be introduced at a legislative level (expected by mid-2018), supported by a revised (and significantly condensed) edition of the UK Corporate Governance Code (the Code, applicable to premium-listed companies on a “comply or explain” basis).  A consultation on the Code was launched in December 2017.

Boards should prepare for these reforms but should be aware that they are closely associated with Prime Minister May’s leadership.  Should there be a change in the Conservative Party leadership, or even a change of government, they are unlikely to be implemented in the form in which they have been proposed.

Executive Compensation

U.S. public companies, most of which will make a similar disclosure for the first time for fiscal years starting on or after January 1, 2017 with the result that many of these companies will begin making disclosures in early 2018, may take comfort from the fact that their UK counterparts will soon be required to disclose the ratio between CEO and average (not, as in the United States, median) pay. We expect further details to be released in early 2018 and will be looking at the challenges faced and lessons learned already.

Unlike in the United States, UK companies listed in the United Kingdom or the European Economic Area, or admitted to trading on the New York Stock Exchange or NASDAQ (Quoted Companies), are required to prepare (i) a directors’ remuneration policy; and (ii) an annual remuneration report on remuneration paid or awarded to directors during the previous reporting period, which must also include a statement describing how the company intends to implement the current directors’ remuneration policy in the year of the report, as well as information on targets that will trigger future bonus payments and benefits for directors under long-term incentive plans (LTIPs).

The remuneration report must be put to an advisory shareholder vote at each annual general meeting and the remuneration policy is subject to a binding shareholder vote at least every three years (or earlier to approve changes or because the advisory vote was not passed).

The UK government now intends to legislate increased public disclosure by Quoted Companies of potential outcomes for directors under LTIPs and has asked the Investment Association, which is the trade body that represents UK investment managers, to maintain a public register of Quoted Companies that experience shareholder opposition of 20 percent or more to the advisory vote.  Boards of Quoted Companies should take stock of the scale of any such historical shareholder opposition to identify reputational vulnerabilities that may arise from such disclosures and should also consider increasing their engagement with significant shareholders on proposed pay arrangements.

To complement these reforms, the Financial Reporting Council’s consultation on amendments to the Code covers the steps premium-listed companies should take when encountering significant voting opposition from shareholders, increased engagement by remuneration committees with the workforce as a whole and the introduction of a minimum combined vesting and holding period of five years for director share awards.

Stakeholder Engagement

The UK government has made several proposals intended to strengthen the voice of company stakeholders. These include introducing a requirement for public and large private companies to report on how directors have complied with their existing statutory duty regarding stakeholder interests.  Additionally, the draft revised Code requires premium-listed companies to adopt a method for engaging with its workforce, suggesting a number of options (including having a director nominated from among the workforce, establishing formal staff advisory panels and designating a non-executive director to represent workers’ interests).  

The new provisions, while potentially far-reaching, significantly fall short of initial proposals to mandate the appointment of employee representatives to company boards.  To assist boards in complying with the new requirements, the government has asked the Investment Association and the Institute of Chartered Secretaries and Administrators (the professional body for corporate governance professionals) and, separately, the GC100 (the professional body for professionals working as general counsel and/or company secretaries in FTSE100 companies), to publish practical guidance.

Most boards will already have mechanisms in place to engage with key stakeholders, but they should consider the following:

• Identify and prioritize key stakeholder groups.  Employees, customers and suppliers are likely to be key stakeholders for most large companies, but boards should cast the net wider to consider, for example, local communities that may be impacted by their operations.  In relation to their workforce, boards should be aware of moves underway in the United Kingdom to improve the position of those in atypical working arrangements who are not strictly classified as employees, which may include, for example, agency workers or workers on “zero hours” contracts.  Companies that take the opportunity to engage with these groups now may find themselves ahead of the curve as UK employment law evolves.
• Review existing stakeholder engagement mechanisms.  Boards of companies subject to the Code should closely follow the Code consultation and developing guidance, including the Investment Association/ICSA’s guidance on The Stakeholder Voice in Board Decision Making (published in September 2017).

Large Private Companies and Smaller Premium-Listed Companies

Recognizing that large businesses are increasingly choosing to operate as private companies in the United Kingdom, as is the case elsewhere, the UK government intends to increase the transparency of large private companies.  

The proposed new legislation would require all companies over a certain size that are not already subject to a separate reporting requirement to disclose details of their corporate governance arrangements in their directors’ report, which forms part of their annual report and accounts.  This obligation would be complemented by a new set of voluntary corporate governance principles for large private companies.