FRC imposes extra duties on UK company directors

Companies should not face a “one-way ratchet” of ever-increasing regulation, the head of the UK’s accounting watchdog said, as he unveiled a reduced slate of new rules for directors that falls well short of originally proposed changes.

The comments from Richard Moriarty, chief executive of the Financial Reporting Council, came as the regulator published new rules on Monday requiring directors of the UK’s biggest listed groups to sign off annually on the effectiveness of their companies’ internal controls.

These will come into force in 2026, a year later than previously signalled. 

“We have got to keep an eye on the stock and the overall level of the burdens that we’re requiring on businesses,” Moriarty told the Financial Times.

“And that does require us to have a bit of a self-denying ordinance sometimes,” he added, suggesting regulators should exercise restraint in introducing new rules.

The tightening of the regulations on internal controls was one of the few proposed changes to survive from the 18 outlined by the FRC in a May 2023 consultation aimed at overhauling the UK corporate governance code.

Moriarty, who joined the watchdog in October, said late last year he planned to drop many of them.

The scaling back of the new rules illustrates the clash between a years-long push to improve governance following high-profile corporate failures such as Carillion and BHS, and warnings from the City of London that excessive requirements would damage UK companies’ competitiveness. 

City minister Bim Afolami said in November that there was “no point having the safest graveyard”, and urged regulators to allow more risk-taking.

Moriarty said the FRC had tried to balance the demands of some investors, who argued that the UK’s strong governance regime helped to attract capital, and companies that were “worried” about the regulatory burden they face.

The FRC has pressed ahead with a new requirement for large listed companies to include remuneration clawback provisions in directors’ contracts from 2025. Companies will be expected to publish details of these clauses annually and explain how they have been used in the past year.

Plans to impose extra diversity reporting requirements and give audit committees new responsibilities for environmental, social and governance issues have been dropped, along with proposals on how boards should engage with shareholders.

A proposal for companies to give an annual statement on their financial resilience has also been scrapped, as have planned rules on reporting on distributable profits.

The decision to drop some of the changes followed the government’s move to abandon related legislation after lobbying by companies.

The watchdog had avoided introducing requirements that were merely “nice to have”, said Moriarty. “What really mattered to enhance governance was the area of internal controls. If you go back over [company] failures and you look at case studies, internal controls are nearly always something that comes to the fore.”

Boards are already supposed to review the effectiveness of their financial, operational, reporting and compliance controls at least once a year.

The new rules will require them to make an annual declaration the controls they deem materially important are effective. They must also describe how they have monitored these systems and how they have addressed any shortcomings. But companies will not need an external auditor to review their controls, as required under the US’s Sarbanes-Oxley Act. 

The overhaul of boardroom rules has been pared back since earlier versions of the proposed changes, including a 2021 government white paper that set out plans for legislation to require directors of large companies to declare their internal controls were up to scratch.

Instead, the obligation will be included in an update to the corporate governance code. The code applies only to companies with a premium listing on the London Stock Exchange and allows them to ignore its requirements so long as they explain why they have done so. 

Moriarty, a former aviation regulator, said he had also been pressing to have the FRC’s reach broadened. Currently it only has powers over directors who are qualified accountants, giving it limited ability to take action against others who flout the code. But such a move would require legislation, which has been delayed repeatedly.

Moriarty also defended the code’s “comply or explain” principle, which is intended to give companies the freedom to deviate from its requirements so long as they explain their reasons.

Some businesses have criticised big institutional investors and proxy advisers for restricting this flexibility by putting pressure on boards to stick rigidly to the code’s requirements. Julia Hoggett, chief executive of the London Stock Exchange, said last year that companies felt it had become a “comply or else” regime. 

Moriarty said: “I think this view . . . that it is ‘comply, or else’ is very misplaced . . . You can either apply the requirements of the code, or you can set out a cogent, well-justified explanation for why you’re not doing it. Both are really, really in line with our views on compliance.”

But he acknowledged that some companies feel pressured to comply with the code rather than explain deviations. He signalled that this would be considered as part of a “fundamental review” of the FRC’s stewardship code, which regulates how investors oversee the companies in which they invest.  

The regulator also attempted to strike a conciliatory tone with City leaders, some of whom have been critical of what they claim are excessive corporate reporting requirements.

“If it’s about making the UK really attractive for capital and growing businesses, [I’m] absolutely all for that . . . We are on the same team here,” he said.