Comply or Explain – what the FRC Guidance Means in Practice

Financial Reporting Council (“FRC”) recently released updated guidance on comply-or-explain reporting, aimed at strengthening how companies articulate and justify departures from the UK Corporate Governance Code (the “UK Code”).

The FRC’s CEO, Richard Moriarty, states that:

“The UK Corporate Governance Code is a global standard precisely because it offers companies the flexibility to govern in a way that suits their circumstances. A well-reasoned explanation for departing from a provision is not a red flag — it is evidence of a board thinking seriously about what good governance means for their company. We want to support companies and investors alike to embrace that spirit with confidence.”

The FRC is encouraging investors, proxy advisors and other stakeholders to recognise that a well-reasoned, transparent explanation for non-compliance should be regarded as meeting "the spirit of the Code". Rather than signalling a governance weakness, an informed explanation, grounded in the company's specific circumstances, can demonstrate proportionate, thoughtful governance and a departure from a purely box-ticking approach. In recent months, comments made by Mr Moriarty have implicitly endorsed companies such as Marks & Spencer which extended the tenure of its chairman during a period of transformation.

Where companies choose not to follow a particular provision, it remains entirely acceptable to identify the provision and provide a clear explanation in the annual report. For example, the board may determine that reducing the size of the Board is appropriate for cost-efficiency for companies undergoing a wind down. In such a situation, the Board may temporarily fall short of the gender or ethnic diversity provisions, and replacing directors solely to achieve compliance would not serve shareholders' interests where the existing directors are suitably placed to oversee the wind-down.

According to the FRC, good explanations include the following:

1.  context and background to the departure;
2.  a clear and credible rationale for the approach taken;
3.  consideration of any associated risks, including mitigating actions;
4.  an indication of whether the company intends to comply; and
5.  clear, accessible and persuasive reasoning that allows users to understand the decision.

The position of proxy advisors on comply-or-explain is critical and will vary depending on the voting guidelines of each. They tend to set a high-bar when it comes to accepting an explanation so explanations should be robust, cogent and concise.

This update has been provided by Ricky Law from MUFG Corporate Markets’ Corporate Governance team. If you wish to find out more about this topic, you are very welcome to reach out to Ricky directly.

You can also find out more about our Corporate Governance and Company Secretarial team by clicking here.

Whether you require assistance navigating the practical requirements of comply or explain, or any other regulatory or legislative challenges, we have a team of dedicated corporate governance professionals with diverse backgrounds, skills, knowledge, and experience ready to help you progress with confidence.