FRC drops ESG plan in Corporate Governance update

The UK’s Financial Reporting Council (FRC) announced it has dropped its earlier proposals for revisions to the UK Corporate Governance Code “related to the role of audit committees on environmental, social and governance (ESG) issues.”

The UK’s financial auditing regulator announced its expected revisions to the Corporate Governance Code but said it “kept changes to the Code to the minimum that are necessary” and said it is “conscious that the expectations for effective governance must be targeted and proportionate.”

The FRC has faced opposition from the London Stock Exchange and others in UK financial and capital markets concerned that the existing code was already being applied too harshly — and allegedly putting companies off listing in London.

The FRC said: “The Financial Reporting Council has today announced important revisions to the UK Corporate Governance Code that enhance transparency and accountability of UK plc and help support the growth and competitiveness of the UK and its attractiveness as a place to invest.

“The changes published today deliver on the FRC’s intentions contained within its Policy Statement of November 7.

“In this, the FRC set out the future direction for its revisions to the Corporate Governance Code following the FRC’s largest ever stakeholder consultation on the Code in 2023.

“In a significant move aimed at promoting smarter regulation, the FRC has kept changes to the Code to the minimum that are necessary.

“The FRC is conscious that the expectations for effective governance must be targeted and proportionate. This approach ensures the FRC balances underpinning trust and confidence in UK plc for investors and others whilst keeping burdens on businesses to the minimum necessary.”

The FRC said it has prioritised revisions to the Code in one significant area — internal controls.

“As signalled on 7 November, the FRC has dropped its earlier proposals for revisions to the Code related to the role of audit committees on environmental, social and governance issues; expanding diversity and inclusion expectations; over-boarding provisions, and expectations on Committee Chairs’ engagement with shareholders.

“In relation to Internal Controls, the existing expectations in the Code will remain.

“Namely that the board should monitor the company’s risk management and internal control framework and, at least annually, carry out a review of its effectiveness.

“The existing Code also includes the provision that monitoring and review should cover all material controls, including financial, operational, reporting and compliance controls.

“The main substantive change the FRC is now making is asking boards to explain through a declaration in their Annual Reports how they have done this and their conclusions.

“It is for a board to determine what should comprise its material internal controls. The FRC is mindful that the needs for each business may vary and that the level of maturity of non-financial controls for some businesses may not be, or need to be, as mature as for their financial controls.

“It is for the board to determine what level of maturity is right for its business and their own levels of required assurance in relation to the effectiveness of these controls.”

The FRC said that in response to stakeholder feedback about the need for boards to have more time to develop their approaches to internal controls, the new Code expectation for the board declaration will come into effect from 1 January 2026, one year after the rest of the updated Code comes into effect from 1 January 2025.

“The FRC is clear that this approach is a targeted, proportionate and balanced response to meeting enhanced investor and stakeholder expectations for better governance reporting around risk management and internal controls whilst minimising reporting burdens on businesses,” adde the FRC.

“The FRC considers this approach to Internal Controls, which is principles based and relies on boards making their own judgments on what is material, is better suited for the UK commercial and governance framework than a more intrusive and prescriptive approach required in other jurisdictions.

“A small number of other more minor changes have been made to the Code that aim to better streamline the expectations or clarify the language. This relates to the Code provisions on malus and clawback and audit committee minimum standards.

“Importantly, the well-established principle of board’s having the flexibility to ‘comply or explain’ will remain.

“The FRC encourages boards, investors and their advisors to actively support the flexibility within the ‘Comply or Explain’ approach to ensure governance expectations are better tailored to the specific circumstances of each company.”

FRC CEO Richard Moriarty said: “A global reputation for high standards of corporate governance is a competitive advantage for UK plc and our revised Code helps this by enhancing transparency on internal controls, but in a way that is proportionate and minimises reporting burdens on businesses.

“The small, but important, change to the expectations on Internal Controls will better support boards asking the right questions at the right time to help them gain the level of the assurance they require and to be able to demonstrate good governance to investors to and other stakeholders …

“It is important that the flexibility of the ‘comply or explain’ principle is properly utilised.

“The FRC is clear that compliance can mean either complying with the Code provisions as set out or providing a cogent and justified explanation for why a provision is not suitable in the specific circumstances for the company whilst demonstrating the principles of good governance.

“Frankly, a good explanation illustrates better governance more than a situation where a board defaults to compliance with a specific Code provision that manifestly doesn’t suit its circumstances but where the Board lacks the confidence to make the explanation.”