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Companies Failing To “Comply Or Explain” Properly – FRC Report


Companies Failing To “Comply Or Explain” Properly – FRC ReportThe UK Corporate Governance Code sets out a best standard of practice for the quality of corporate governance within an organisation. 

In the UK, Companies are required to comply with the Code or explain why they have not done so, i.e. ‘Comply or Explain’. However, a report published by the Financial Reporting Council (FRC) in the UK has advised that Companies are not explaining their nonconformance of the Code properly.

The report, What Constitutes an Explanation under ‘Comply or Explain’?,  indicates that despite FTSE 350 Companies complying with 96% of the provisions set out in the UK Corporate Governance Code, the 4% of provisions not being adhered to may undermine the support for 'Comply or Explain'. Therefore, the FRC argue that many companies do not provide satisfactory explanations towards their actions.

What Is The ‘Comply Or Explain’ Approach?

As already indicated, the Code sets out a best standard of practice for the quality of corporate governance within an organisation. The Code does not have legal powers however it requires Companies to comply with the Code or explain why it has not done so, i.e. ‘Comply or Explain’.

This approach acknowledges that successful corporate governance cannot be constricted by statutory regulations which may not be appropriate for all organisations. Therefore, alternatives to provisions in code may be justified in certain conditions on the basis that the Company provides an explanation in its annual report as to why they did not comply with the Code.

By promoting the ‘Comply or Explain’ model, the UK has successfully gained high standards of corporate governance resulting in improvements in practice across the FTSE 100 and beyond.

Despite this claim, the European Commission in 2009 raised questions over the ‘Comply or Explain’ model such as the level of monitoring of statements made by companies on their compliance with the Code and the quality of their explanations for not adhering to the Code.

Grant Thornton Survey On Corporate Governance

An examination of 60 UK Annual Reports by the FRC show that some Companies chose to adhere to basic functional obligation over the need to explain.

However, Grant Thornton argues in its latest survey that 50% of FTSE 350 companies report full compliance with the UK Corporate Governance Code, with two thirds of those who do not comply explaining in a great level of detail, whilst the remaining third explain with a less detailed response.

Grant Thornton also state that no Companies on the FTSE 350 failed to provide any explanation in cases whereby no compliance occurred.

Overall, Grant Thornton found that the FTSE 350 complied with 96% of provisions of the Code that applied to them.

This may indicate a strong result however, the FRC argue that only a small number of deviations away from the Code with no explanation can undermine the support for the ‘Comply or Explain’ model.

As a result of the survey from Grant Thornton on Corporate Governance in the FTSE 350 and the debate in Europe regarding the future of ‘Comply or Explain’, the FRC brought together those who may explain to those to whom they are explaining to, in order to establish what each party understands from the term ‘Comply or Explain’.

FRC Favours ‘Comply Or Explain’ Over New Regulations

Overall, the FRC believes they can assist with the UK market to increase the effectiveness of the ‘Comply or Explain’ model. The FRC believe that ‘Comply or Explain’ should also reinforce the UK’s argument in Europe that it is the most effective way of addressing corporate governance issues with a greater focus on improving on the existing framework, as opposed to introducing new regulations.

The FRC will consider reflecting on the results of these considerations in the revised UK Corporate Governance Code, which will be consulted later this year.

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