Corporate Governance. f o r M a i n M a r k e t a n d a i M C o M p a n i e s

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1 Corporate Governance f o r M a i n M a r k e t a n d a i M C o M p a n i e s

2 The London Stock Exchange woud ike to thank the foowing organisations for their contributions to this guide:

3 Corporate Governance for Main Market and AIM Companies Pubished in association with London Stock Exchange pc Consuting editors: Padraig Cronin and Frances Murphy, Saughter and May Pubished by White Page Ltd

4 Corporate Governance for Main Market and AIM companies Consuting editors Padraig Cronin and Frances Murphy, Saughter and May Pubishing editor Nige Page Pubisher Tim Dempsey Production editor Matt Rowan Design London Stock Exchange pc Printing and binding Argent Litho Ltd Corporate Governance for Main Market and AIM Companies is pubished by: White Page Ltd, 17 Boton Street London W1J 8BH United Kingdom Phone: Fax: Emai: Web: First pubished: September 2012 ISBN: Corporate Governance for Main Market and AIM Companies September 2012 London Stock Exchange pc, 10 Paternoster Square, London EC4M 7LS Copyright in individua chapters rests with the authors. No photocopying: copyright icences do not appy. The information in this pubication is not offered as advice on any particuar matter and must not be treated as a substitute for specific advice. In particuar, information in this pubication does not constitute ega, professiona, financia or investment advice. Advice from a suitaby quaified professiona shoud aways be sought in reation to any particuar matter or circumstances. The chapters provided by the contributors are not the opinions of the London Stock Exchange pc or any of its group undertakings ( group undertakings sha be construed in accordance with Section 1161 of the United Kingdom Companies Act 2006). This pubication is provided for information and educationa purposes ony. Whie a information contained herein is obtained from sources beieved to be accurate and reiabe, neither the London Stock Exchange pc nor any of its group undertakings accepts responsibiity for any errors, omissions, or inaccurate information. A information in this document is provided as is without warranty of any kind. Neither the London Stock Exchange nor any of its group undertakings make any representations and discaims a express, impied and statutory warranties of any kind in reation to this pubication, incuding warranties as to accuracy, timeiness, competeness, performance or fitness for a particuar purpose. The London Stock Exchange crest and ogo, AIM, RNS and SETS are registered trade marks of London Stock Exchange pc. No part of these trade marks or any other trade mark owned by the London Stock Exchange or any of its group undertakings can be used, reproduced or transmitted in any form without express written consent by the owner of the trade mark.

5 Foreword Aastair Wamsey, Head of Primary Markets, London Stock Exchange Group The reationship between companies and their sharehoders has never been more important. With an ever-increasing range of goba investment options, companies need to focus on buiding ongterm reationships with investors, founded on trust and reguar communications. In doing so, companies wi maximise the fu benefits of being pubicy isted. Corporate governance is centra to this process. At the London Stock Exchange Group, we firmy beieve that high standards of corporate governance make an important contribution to companies ong-term performance. By reguary reviewing and deveoping appropriate corporate governance practices, both UK and internationa companies on our markets can ensure they are better paced to execute their strategy, manage their growth and drive vaue, whatever the prevaiing macro-economic conditions. The UK Corporate Governance Code (the Code) is maintained by the Financia Reporting Counci; it appies to a Main Market companies, both UK and internationa, with a Premium Listing of equity shares in London. Companies with a Standard Listing, which are required to meet EU minimum admission criteria, are subject to ess comprehensive standards of discosure and sharehoder rights. Athough companies on the London Stock Exchange s ong-estabished growth market, AIM, are not mandated under the AIM Rues to adhere to the provisions of the Code, they are encouraged to deveop strong governance procedures and are advised to aspire to achieve the key eements set out in the Code as they grow. As a minimum, a AIM companies are encouraged to adhere to the Quoted Companies Aiance (QCA) Guideines, which are based on the Code but specificay taiored to the needs of growth companies and their investors. The UK s principes-based approach to corporate governance, and the abiity for companies to compy or expain, continues to deiver strong and effective governance and ensures the UK governance regime is vaued and respected, importanty by both companies and investors. Corporate governance is the responsibiity of both companies and investors: companies are required to demonstrate they are acting in the interests of their sharehoders; and investors need to demonstrate they are acting in the interests of their cients. Under the framework of the Code for companies and the Stewardship Code for investors, the UK is a word eader. But governance is not simpy about codes or reguations; it is about reationships and trust. This is embodied in the non-prescriptive nature of the UK s fexibe and strong governance framework, ensuring that the corporate governance regime in the UK supports companies of a sizes. It is never too eary for companies, even those that remain privatey hed, to begin estabishing appropriate corporate governance poicies and procedures. For exampe, meeting investors expectations eary in an IPO process, engaging with the investment community on corporate governance reated decisions and maintaining open diaogue ony serves to enhance investors and other stakehoders confidence. Good governance standards are a centra premise of the London market s attractiveness to issuers and investors. The equity markets in the UK are underpinned by experienced and dedicated intermediaries, and we have produced this guide in conjunction with a number of these organisations. We are gratefu for their contributions. This guide is designed to assist companies in understanding a aspects of governance and the nuances of its appication whether they are aspiring to the highest standards of operation, preparing for an IPO or as part of best practice once isted as a pubic company. Good governance and strong management have never been more important to the continued heath of the UK s capita markets. This guide aims to encourage companies and executives to consider corporate governance in the widest sense, incuding board efficiency, transparency, reporting requirements, investor communications and sustainabiity. We hope you find it usefu and informative. Aastair Wamsey, September 2012

6 Contents PART I: INTRODUCTION Chapter 1 The deveopment of the UK 8 corporate governance regime Financia Reporting Counci Chapter 2 Corporate governance and 11 smaer businesses The Quoted Companies Aiance Chapter 3 Why is corporate governance 14 so important? The Internationa Corporate Governance Network PART II: SETTING THE SCENE Chapter 4 The UK reguatory framework 17 Saughter and May Chapter 5 Corporate governance in 25 the EU context Freshfieds Bruckhaus Deringer LLP PART III: PRE-IPO CONSIDERATIONS Chapter 6 Preparations for an 33 initia pubic offering Bank of America Merri Lynch Chapter 7 Good governance and 41 sharehoder expectations an investor s perspective Gass, Lewis & Co LLC Chapter 8 Does corporate governance 47 matter for sharehoder vaue? F&C Investments Chapter 9 Corporate governance 53 requirements for a UK issuer: Premium Listing, Main Market Linkaters LLP Chapter 10 Requirements and 59 chaenges for non-uk companies isting in London Davis Pok & Wardwe London LLP Chapter 11 Structuring an effective 65 board The Zygos Partnership Chapter 12 The prospective 75 non-executive director Pinsent Masons LLP PART IV: POST-IPO CONSIDERATIONS Chapter 13 Corporate governance and 85 the Main Market Saughter and May Chapter 14 Corporate governance 93 and AIM Cobbetts LLP Chapter 15 The roe of the board in 103 effective risk management and oversight PricewaterhouseCoopers LLP Chapter 16 Inside information 117 Herbert Smith LLP Chapter 17 The UK Bribery Act and its impications for businesses Covington & Buring LLP Chapter 18 Managing directors conficts 137 Shepherd and Wedderburn LLP Chapter 19 The roe of the independent 145 adviser Rothschid

7 Chapter 20 Executive remuneration 151 Patterson Associates LLP Chapter 21 Sustainabiity governance: 161 taking corporate socia responsibiity on board ENVIRON Internationa Corporation Chapter 22 The reationship between 169 directors and sharehoders: financia communications and investor reations Hi + Knowton Strategies Chapter 23 Corporate governance 177 towards best-practice corporate reporting PricewaterhouseCoopers LLP Chapter 24 Protection for directors 189 and their companies Chartis Europe Limited Chapter 25 Board evauation 193 Boardroom Review Limited PART V: AN INTERNATIONAL PERSPECTIVE Chapter 26 Comparison of UK and US 203 corporate governance considerations Baker & McKenzie LLP Chapter 27 Comparison of UK and 213 Hong Kong corporate governance considerations Saughter and May AUTHOR BIOGRAPHIES 220 Gossary of terms and usefu sources 238

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9 Part I: Introduction Chapter 1 The deveopment of the UK corporate Page 8 governance regime Chapter 2 Corporate governance and smaer businesses Page 11 Chapter 3 Why is corporate governance so important? Page 14

10 1. The deveopment of the UK corporate governance regime Chris Hodge, the Financia Reporting Counci 2012 marks the 20th anniversary of the Cadbury Code, the first corporate governance code in the UK. That code named after Sir Adrian Cadbury who chaired the committee that wrote it was deveoped by the business community in response to a series of corporate scandas in the ate 1980s and eary 1990s. The London Stock Exchange payed an important roe in estabishing the immediate credibiity of the code by adding a requirement to its Listing Rues that a companies had either to compy with the code or expain to their sharehoders why they had not done so. There have been many changes to this framework since 1992; for exampe, responsibiity for the Listing Rues transferred to the UK Listing Authority (UKLA) in 2000, whie in 2003 the Financia Reporting Counci (FRC) took responsibiity for the content of what is now caed the UK Corporate Governance Code (the Code). As a resut of the new isting regime introduced by the UKLA in Apri 2010, the Code appies to a companies with a Premium Listing of equity shares, incuding those which are incorporated outside the UK. But the basic approach is unchanged. It is an approach that has stood the UK market in good stead over the ast 20 years. The foundation stone of that approach is the concept of compy or expain, a concept that was revoutionary at the time but has since been widey adopted esewhere. Compy or expain is based on two premises. The first is that, when it comes to effective governance, there is no one size fits a. Whie it may be possibe to identify processes and structures that wi be best practice for the majority of companies, there wi aways be cases where it is in the best interest of a company and its sharehoders to adopt different practices. The second premise is that if the purpose of corporate governance is to ensure the company is run in the ong-term interests of the sharehoders, it shoud be those sharehoders rather than reguators who decide whether that is actuay the case. For this reason, when companies choose not to foow the code, the expanation is given to the sharehoders. The inherent fexibiity of the compy or expain concept means that corporate governance codes can chaenge companies to improve their standards more quicky and, the FRC beieves, more effectivey than strict rues with which a companies must compy immediatey. Because they need to be capabe of being compied with by a companies regardess of their size and circumstances, rues usuay set out what is the minimum acceptabe standard. Whie this is important to estabish basic benchmarks of appropriate behaviour, it does not encourage companies to do more than the minimum. Compy or expain codes compement rues by setting out higher and more aspirationa standards, recognising that not a companies wi achieve them immediatey and that for some companies it may be more appropriate to take a different approach to protecting the ong-term interests of their owners. The effectiveness of this approach is sef-evident if you ook at the improvements in governance in the UK isted sector over the ast 20 years. Inevitaby Page 8 The deveopment of the UK corporate governance regime

11 Introduction there are sti governance faiings at individua companies no system can provide a guarantee against poor decision-making or inappropriate behaviour but genera standards in the UK are consistenty ranked as being among the highest in the word, and compiance with the Code is very high. Many of the features of good governance that are now taken as read have been deveoped through the code-based approach, starting with the origina Cadbury Code in 1992 which recommended the separation of the roes of chairman and chief executive and the estabishment of independent audit committees. In 2003 the Code first recommended reguar evauation of the board s effectiveness, something that ruffed many feathers at the time but is now universay seen as good practice, in the UK at east. As recenty as 2010, the Code recommended annua eection for a directors of FTSE 350 companies. Again this was controversia when first proposed, but within 12 months over 80 per cent of those companies had introduced annua eections. Codes are sometimes incorrecty characterised as sef-reguation. As wi aready be cear, they do not operate in isoation, but are ony part of a broader reguatory framework. Some minimum standards of behaviour are set out in company aw and the Listing Rues, as are discosure requirements intended to ensure that investors have the information they need to assess the performance and prospects of the company. One exampe is the Listing Rue requirement for companies to report on how they have appied the UK Corporate Governance Code. Importanty, both the aw and the Listing Rues give sharehoders rights that enabe them to hod the board to account. Whie the specific governance arrangements of individua companies are a matter for the board and sharehoders, reguators or market authorities do pay a roe in monitoring the overa impact of codes and taking action to improve their effectiveness where necessary. In the UK this function is performed by the FRC. As we as updating the content of the Code when necessary, foowing consutation with the market, the FRC pubishes an annua report on its impact and takes steps to improve its effectiveness. For exampe, in 2012 the FRC pubished a paper describing the sort of information that shoud be provided when companies choose to expain rather than foow the Code. This heps companies to know what is expected of them, and provides a benchmark for sharehoders when assessing expanations. The effectiveness of the compy or expain approach, and the appropriate baance between codes, reguations and supervision, wi be significanty infuenced by the structure of the market in which it is appied. Looking back at the UK market in 1992, there were three specific features of the market that persuaded those invoved in producing the Cadbury Code that the then nove concept of compy or expain coud be made to work. Without them, it is arguabe whether that approach coud have been contempated. The first feature, as has aready been mentioned, was the reativey strong rights that sharehoders had in comparison to other markets at that time. A system that makes boards nominay accountabe to their sharehoders but gives the sharehoders no abiity actuay to hod boards to account has itte credibiity. The second feature was the dispersed nature of the sharehoder base in most UK isted companies. Whie compy or expain has been made to work in markets where ownership is more concentrated, The deveopment of the UK corporate governance regime Page 9

12 it can be difficut for minority sharehoders to provide a meaningfu check and baance to the interests of a bock hoder. In such cases the baance between codes and hard rues, and the roes of sharehoders and reguators, may need to be different. The FRC has recognised that the existence of companies with concentrated ownership structures on the London market raises chaenges to a compy or expain approach designed for a market where dispersed ownership is standard. The fina feature of the UK market 20 years ago that gave the Cadbury Committee confidence in compy or expain was the significant presence of institutiona investors seeking a ong-term return on their assets most specificay UK insurance companies and pension funds, which at that time owned 50 per cent of the market. Whie individuay they owned ony a sma percentage of shares in any company, coectivey they had both the motivation and abiity to demand high standards of governance of the companies in which they invested, and the wiingness to engage with the boards of those companies about their specific circumstances. That is the reason why the FRC issued the UK Stewardship Code in This set out for the first time what is expected of institutiona investors in terms of monitoring and engagement and reporting back to their cients or beneficiaries. The initia response has been very positive, with over 250 institutions to date having committed to appying the code, but it is too eary to say whether the code wi achieve its objective of increasing the quantity and quaity of engagement. If it does not, then there is a risk that the compy or expain approach wi be perceived by sceptics to have faied. This woud be whoy unfair given its track record in the UK over the ast 20 years, but in the continuing aftermath of the financia crisis nothing can be taken for granted. So there is a need to demonstrate that compy or expain continues to deiver strong and effective governance, and is taken seriousy by companies and investors. Faiure to do so coud resut in an approach that is more prescriptive about the way companies organise themseves, and coud give more power to reguators at the expense of sharehoders. It is this feature that has changed most dramaticay since UK insurance companies and pension funds now own ess than 15 per cent of the market. There has been a significant increase in investment from overseas. Those investors naturay find it more difficut to engage directy with UK boards even when they have a desire to do so. In order to ensure that compy or expain can continue to operate effectivey in the future, there is a need to rebuid the critica mass of investors with a ong-term perspective who are wiing and abe to monitor and engage with the boards of UK isted companies. Page 10 The deveopment of the UK corporate governance regime

13 Introduction 2. Corporate governance and smaer businesses Tim Ward, the Quoted Companies Aiance One size does not fit a quoted companies and this is particuary true in the area of corporate governance. Premium Listed companies have a prescribed corporate governance code, whie Standard Listed and AIM-quoted companies have more fexibiity about the corporate governance regime that they can choose to adopt. The Quoted Companies Aiance sees corporate governance as a code of behaviour expressing how management teams in companies shoud act and be organised (governed) both to create and protect vaue on behaf of sharehoders. We beieve that the purpose of corporate governance is to create and maintain a fexibe, efficient and effective framework for entrepreneuria management that deivers growth in sharehoder vaue over the onger term. Any aspect of a company s behaviour, structure and organisation shoud be capabe of being tested against the question: How is this designed to deiver growth in sharehoder vaue over the onger term? The London Stock Exchange has said that the UK Corporate Governance Code (the Code) serves as a standard to which pubic companies shoud aspire, but fu adherence shoud not necessariy be the expectation for a AIM companies. The Quoted Companies Aiance s Corporate Governance Guideines for Smaer Quoted Companies (the QCA Guideines) appy key eements from the Code and other reevant guidance to the needs of sma and mid-size quoted companies for which the Code may not be entirey or directy reevant due to their size or reative ack of compexity. The QCA Guideines These 12 guideines endorse the compy or expain' approach and represent minimum best practice for smaer quoted companies. Boards shoud therefore consider each one carefuy, and provide a reasoned expanation for any deviations. Fexibe, efficient and effective management (1) Structure and process. A company shoud put in pace the most appropriate governance methods, based on its corporate cuture, size and business compexity. There shoud be carity on how it intends to fufi its objectives, and, as the company evoves, so shoud its governance (2) Responsibiity and accountabiity. It shoud be cear where responsibiity ies for the management of the company and for the achievement of key tasks. The board has a coective responsibiity for the ong-term success of the company, and the roes of the chairman and the chief executive shoud not be exercised by the same individua (3) Board baance and size. The board must not be so arge as to prevent efficient operation. A company shoud have at east two independent non-executive directors (one of whom may be the chairman, provided he or she was deemed independent at the time of appointment) and the board shoud not be dominated by one person or a group of peope (4) Board skis and capabiities. The board must have an appropriate baance of functiona and sector skis and experience in order to make the key decisions expected of it and to pan for the future. The board shoud be supported by committees (audit, remuneration and nomination) that have the necessary character, skis and knowedge to discharge their duties and responsibiities effectivey Corporate governance and smaer businesses Page 11

14 (5) Performance and deveopment. The board shoud periodicay review its performance, its committees performance and that of individua board members. This review shoud ead to updates of induction evauation and succession pans. Ineffective directors (both executive and non-executive) must be identified and either heped to become effective, or repaced. The board shoud ensure that it has the skis and experience it needs for its present and future business needs. Membership of the board shoud be periodicay refreshed (6) Information and support. The whoe board, and its committees, shoud be provided with the best possibe information (accurate, sufficient, timey and cear) so that they can constructivey chaenge recommendations to them before making their decisions. Non-executive directors shoud be provided with access to externa advice when necessary (7) Cost-effective and vaue-added. There wi be a cost in achieving efficient and effective governance, but this shoud be offset by increases in vaue. There shoud be a cear understanding between boards and sharehoders of how this vaue has been added. This wi normay invove the pubication of key performance indicators, which aign with strategy, and feedback through reguar meetings between sharehoders and directors. Entrepreneuria management (8) Vision and strategy. There shoud be a shared vision of what the company is trying to achieve and over what period, as we as an understanding of what is required to achieve it. This vision and direction must be we communicated, both internay and externay (9) Risk management and interna contro. The board is responsibe for maintaining a sound system of risk management and interna contro. It shoud define and communicate the company s risk appetite, and how it manages the key risks, whie maintaining an appropriate baance between risk management and entrepreneurship. Remuneration poicy shoud hep the company to meet its objectives whie encouraging behaviour that is consistent with the agreed risk profie of the company. Deivering growth in sharehoder vaue over the onger term (10) Sharehoders needs and objectives. A diaogue shoud exist between sharehoders and the board so that the board understands sharehoders needs and objectives and their views on the company s performance. Vested interests shoud not be abe to act in a manner contrary to the common good of a sharehoders (11) Investor reations and communication. A communication and reporting framework shoud exist between the board and a sharehoders such that the sharehoders views are communicated to the board, and sharehoders in turn understand the unique circumstances of, and any constraints on, the company (12) Stakehoder and socia responsibiities. Good governance incudes a response to the demands of corporate socia responsibiity (CSR). This wi require the management of socia and environmenta opportunities and risks. A proactive CSR poicy, as an integra part of the company s strategy, can hep create ong-term vaue and reduce risk for sharehoders and other stakehoders. As we as setting out these guideines, the QCA Guideines incude exampes of governance structures as we as minimum discosures. Page 12 Corporate governance and smaer businesses

15 Introduction Concusion One size does not fit a. Whie best practice shoud be a guide to company governance and organisation, it is not aways the case that such practice shoud be rigidy adhered to. Directors need to do what is right for the company in its own unique circumstances and maintain an open and fu diaogue with the company s sharehoders. The fu version of Corporate Governance Guideines for Smaer Quoted Companies (September 2010) is avaiabe onine at Corporate governance and smaer businesses Page 13

16 3. Why is corporate governance so important? Michee Edkins, Internationa Corporate Governance Network Whether you consider corporate governance to be important or not wi in part depend on how you think about it. If you consider it a compiance issue for the company secretary to hande and the board to sign off on, then you probaby do not give it much weight. If, on the other hand, you consider it a framework within which to set operationa and behavioura standards for the board, the executive management and the wider staff, then it wi be an essentia part of your business panning and execution. If corporate governance practices are focused on quaity eadership and management, companies are better positioned to be abe to protect and enhance economic vaue for their ong-term sharehoders. The Internationa Corporate Governance Network (ICGN) beieves that there are goba principes that shoud appy to most situations where companies seek capita from the markets. Accountabiity of management and boards for their actions, and transparency through timey and good-quaity reporting, are widey accepted as good practice. There are more nuanced, but equay widey expected, practices articuated in many goba governance principes covering the board of directors, corporate cuture, risk management, remuneration, audit, and sharehoders rights and responsibiities. The importance of good governance practices is evidenced in strong eadership, a positive cuture and robust risk management. These a encourage and reinforce behaviours that ensure company representatives act to protect the ong-term interests of the company and its sharehoders. The coroary is the oss of sharehoder vaue attributabe to poor governance and poor decision-making that we see reported in the media. Good governance can hep companies pre-empt and prevent adverse situations. As the trend to gobay diversified investing continues, it seems ikey that the attention paid to corporate governance standards at a market eve wi increase. Internationa investors who are ess famiiar with the nuances of a particuar market wi ook to the reevant stock exchange to provide a quaity mark for the companies isted by it. Simiary, internationa companies seeking to raise capita wi be drawn to those markets where high standards attract investors and premiums. Sound corporate governance practices underpin investor confidence in a market and trust in individua company management. In practice, goba corporate governance principes provide a framework within which oca codes can address the unique characteristics of each market. Fexibiity or compy or expain is important because there is no proven idea mode for corporate governance. The framework that achieves the desired behaviour at a company wi be shaped by company-specific circumstances as we as wider ega and societa factors. It is important that companies and their sharehoders are thoughtfu about what constitutes good corporate governance in that context. Page 14 Why is corporate governance so important?

17 Part II: Setting the scene Chapter 4 The UK reguatory framework Page 17 Chapter 5 Corporate governance in the EU context Page 25

18 The firm is praised for its depth of expertise: Quaity is a given whie the extra commercia and strategic thinking adds another dimension CHAMBERS UK,

19 4. The UK reguatory framework Frances Murphy and Padraig Cronin, Saughter and May The UK reguatory framework for corporate governance comprises a number of sources: egisation, particuary the Companies Act 2006; the Listing Rues (the LR), the Discosure and Transparency Rues (the DTR) and the Prospectus Rues (the PR), which are made and enforced by the Financia Services Authority as the UK Listing Authority (UKLA); the UK Corporate Governance Code (the Code) and the UK Stewardship Code for institutiona sharehoders, which are the responsibiity of the Financia Reporting Counci (FRC); and the Takeover Code, which is issued and administered by the Takeover Pane. The egisation and reguations estabish basic standards of conduct and transparency, whie the non-statutory codes of practice use sef-reguation as a means of maintaining good corporate governance. As described in the FRC s Effective Corporate Governance guideines, the overa effect of this reguatory framework is to create a principesbased system of corporate governance, based on proportionaity, fexibiity and targeting, that cannot be achieved through a one size fits a approach. The compy or expain approach to corporate governance Under the LR and DTR, a isted company must report to its sharehoders on how it has appied corporate governance guidance and, where it has not appied the guidance as envisaged, provide an expanation as to why it has not done so. Sharehoders can then decide whether they are satisfied with the company s corporate governance practices. The compy or expain approach is the FRC s aternative to a strict rues-based system of corporate governance. The FRC recognises that a company may prefer not to adopt a provision of the Code, or other guidance, if good governance can be achieved by means more suited to the cuture and organisation of the individua company. The advantage of this approach is that when making decisions on governance practices, the board can make judgements on a case-by-case basis, taking into account the size and compexity of the company and the nature of the risks and chaenges it faces. Compy or expain reies on sharehoders and boards to scrutinise their companies. Accountabiity to sharehoders in particuar underpins the UK corporate governance system. The reguatory framework described above is designed to ensure that sharehoders have the requisite information to judge the governance practices of the company, and the rights necessary to hod the board to account if such practices are found wanting. In order to satisfy the information requirement, companies must expain their reasons for not foowing guidance ceary and carefuy to sharehoders. The FRC states in the Preface to the Code that, in providing an expanation, companies shoud aim to iustrate how their actua practices are both consistent with the principe to which the particuar provision reates and contribute to good governance. Sharehoders can then discuss the position with the company and may take action to infuence the board using their voting powers. Section 168 of the Companies Act gives sharehoders the abiity to appoint and dismiss individua directors, whie Sections 303 to 305 give them the right to ca a genera meeting of the company. The Code states that companies incuded in the FTSE 350 index must put a their directors forward for re-eection each year, or expain why they have not done so. Sharehoders of companies with securities isted Setting the scene The UK reguatory framework Page 17

20 on a reguated market, such as the Main Market of the London Stock Exchange, aso have an advisory vote on directors remuneration and wi, from ate 2013, have a binding vote on pay poicy and exit payments. The UK Corporate Governance Code The Code consists of five sections: Leadership, Effectiveness, Accountabiity, Remuneration and Reations with Sharehoders. Each section contains Main Principes, Supporting Principes and Code provisions. The Main Principes set out broad tenets of good corporate governance practice; the Supporting Principes and more detaied Code provisions expand on the Main Principes. The current edition of the Code was pubished in May A revised version of the Code is schedued to appy from October 1, Summary of the Main Principes Leadership Every company shoud be headed by an effective board that is coectivey responsibe for the ong-term success of the company. The chairman is responsibe for eadership of the board and the chief executive for the running of the company s business. The board shoud incude nonexecutive directors whose roe it is to constructivey chaenge and hep deveop proposas on strategy. Effectiveness The board and its committees shoud have the appropriate baance of skis, experience, independence and knowedge of the company to enabe them to discharge their respective duties and responsibiities effectivey. The updated Code wi incorporate a requirement that the board consider board diversity, incuding gender, when making new appointments. Accountabiity The board is responsibe for maintaining sound risk management and interna contro systems. The board shoud estabish forma and transparent arrangements for considering how they shoud appy the corporate reporting and risk management and interna contro principes, and for maintaining an appropriate reationship with the company s auditor. Remuneration Leves of remuneration shoud be sufficient to attract, retain and motivate directors of the quaity required to run the company successfuy. A company shoud avoid paying more than is necessary and a significant proportion of executive directors remuneration shoud be inked to performance. There shoud be a forma and transparent procedure for deveoping poicy on executive remuneration. Reations with Sharehoders There shoud be a diaogue with sharehoders based on the mutua understanding of objectives. The board shoud use the annua genera meeting to communicate with investors and encourage their participation. In the compy or expain section of the Preface to the Code, the FRC states that the Main Principes are the core of the Code and that the way they are appied shoud be the centra question for a board as it determines how it is to operate according to the Code. The Code is not a rigid set of rues, and the FRC has drafted the Supporting Principes broady to give companies the fexibiity of deciding their own method of impementation. In addition, the Code refects the fact that some provisions are more appicabe to companies of a certain size than others. For exampe, B.7.1 on the annua reeection of directors appies ony to companies in the FTSE 350, and B.1.2 on the composition of the Page 18 The UK reguatory framework

21 board and C.3.1 on the audit committee distinguish between companies that are in the FTSE 350 and those that are not. Meaningfu expanations The FRC is proposing to set out in the Preface to the Code those features that it regards as characteristics of an informative expanation. Athough the Preface serves ony as guidance to the Code, the FRC intends that identifying these features wi hep companies understand what is expected of them when they choose to deviate from the Code, and wi provide sharehoders with a benchmark against which to judge expanations. An FRC February 2012 consutation paper What constitutes an expanation under compy or expain? identified that an expanation shoud: set out the context and historica background give a convincing rationae for the action the company is taking describe mitigating action to address any additiona risk and maintain conformity with the reevant Principe indicate whether the deviation from the Code is imited in time and when the company intends to return to conformity with the Code. In addition, participants in the consutation fet that expanations shoud be specific to a company s position, and not generic or off the shef. Expanation shoud appy to deviations from the provisions of the Code, and not just to deviations from its Main Principes. Reporting obigations for Premium, Standard and AIM companies The extent of a company s obigation to compy or expain depends on the nature of the isting of that company s securities. Companies appying to admit securities to trading on the Main Market of the London Stock Exchange must have their securities admitted to the UKLA Officia List. Since Apri 6, 2010, there have been eight isting categories on the UKLA Officia List. The isting categories set out distinct isting obigations for specific security types and issuer types. Each category fas into one of two high-eve segments, Premium or Standard. A Premium Listing is ony avaiabe to equity shares issued by trading companies and by cosed and open-ended investment entities. Standard Listings cover shares, goba depositary receipts (GDRs), debt and securitised derivatives. In order to be eigibe for the FTSE UK Index Series, which incudes the FTSE 100 index, a company must have a Premium Listing. Companies with a Standard Listing must compy with EU minimum requirements on corporate governance discosure, namey the Statutory Audit Directive and the Company Reporting Directive. These directives were impemented in the UK through the DTR. Companies with Premium Listed equity shares are subject to more stringent UK discosure standards in addition to the EU minimum requirements. There is no compy or expain obigation on companies admitted to AIM. However, the London Stock Exchange s A Guide to AIM states that companies seeking admission to the market must pubish an admission document that incudes a statement on whether or not the company compies with its home country s corporate governance regime, and if not, an expanation as to why. The guide goes on to state that compiance with the Code by AIM companies is widey regarded as good practice and has become expected of arger AIM companies. Many investing institutions expect their investee AIM companies to compy with the Code or set out the reasons for non-compiance in much the same way as Main Market companies. DTR 7.2: Compy or expain for Premium and Standard Listings DTR 7.2 sets out the compy or expain obigation for companies whose securities are admitted to Setting the scene The UK reguatory framework Page 19

22 trading on a reguated market. This incudes a companies with a Premium or Standard Listing of securities on the Main Market of the London Stock Exchange. (Overseas companies issuing GDRs and companies issuing convertibe bonds are subject to the same corporate governance reporting requirements as a company with a Standard Listing of equity shares. Debt issuers are not required to adhere to the Code or make the corporate governance statements specified under DTR 7.2.) Under DTR 7.2, such companies must make a corporate governance statement in the directors report, in a separate report pubished with the annua report, or on the company website. If the governance statement is pubished on the website, the directors report must incude a crossreference to the statement. Where the corporate governance statement is set out separatey from the directors report, the statement must, under Sections 419A and 447 of the Companies Act, be approved by the board and signed on its behaf and fied with the Registrar of Companies. The company s corporate governance statement must identify the governance code to which the company is subject. LR 9.8.6R (5) and (6) provide that Premium Listed companies are subject to the Code. Standard Listed companies are not subject to the Code but must refer to any corporate governance code with which they have vountariy decided to compy. Premium Listed companies and those Standard Listed companies vountariy appying a corporate governance code must state the extent to which they depart from the reevant corporate governance guidance and their reasons for doing so. If a company decides not to appy any provision of a code, it must expain its reasons for that decision. LR 9.8.6R (5) and (6): Premium Listed companies Under LR 9.8.6R (5), a UK incorporated company with a Premium Listing of equity shares must incude a compy or expain statement in its annua financia report setting out how the company has appied the Main Principes of the Code. LR 9.8.7R and LR 9.8.7AR make the same provision for Premium Listed companies incorporated outside the UK. There is no prescribed form for this statement; as is cear from the exampes in the panes on the right and over the page, companies tend to report on their governance poicies by exception, specifying any specia circumstances that have ed them to divert from the Code approach. The Preface to the Code encourages chairmen to report personay in their annua statements on how the principes reating to the eadership and effectiveness of the board have been appied. The FRC beieves that this may make investors more wiing to accept expanations when a company chooses to expain rather than to compy, and may reduce the fungus of boier-pate that the FRC regards as dead communication. LR 9.8.6R (6) provides that the statement must set out whether the company has compied during the accounting period with a the reevant provisions of the Code, and if it has not, describe: those provisions that the company has not compied with for provisions of a continuing nature, the period within which the company did not compy with those provisions the company s reasons for non-compiance. This must be done in a manner that enabes sharehoders to evauate how the Main Principes have been appied. DTR 7.2.4G provides that a Premium Listed Page 20 The UK reguatory framework

23 company compying with LR 9.8.6R (6) wi satisfy the requirements of DTR 7.2.2R and DTR 7.2.3R. LR 9.8.6R (6) does not require Premium Listed companies to compy with the Code. In accordance with the UK s principes-based system of reguation, it requires companies to state whether they have compied with the Code, and expain and justify any non-compiance. Smaer isted companies may judge that certain provisions of the Code, such as those on re-eection of directors, are disproportionate or ess reevant in their case. However, such companies may adopt provisions of the Code if they consider it appropriate. AIM companies The obigations to compy or expain under DTR 7.2, LR 9.8.6R (5) and (6) and LR appy to companies whose shares are isted on a reguated market. AIM is not a reguated market for this purpose. The AIM Rues for Companies do not require adherence to a particuar set of corporate governance rues. The London Stock Exchange beieves that a banket requirement to compy or expain by reference to a particuar code woud not be appropriate for the predominanty smaer, growth-stage companies that make up AIM s constituent members. The London Stock Exchange s Inside AIM newsetter (issue 2, Juy 2010) stated: Such a step may simpy be seen as more reguation rather than as a beneficia set of practices to improve the running of a company and the interaction between board and sharehoders. For many AIM companies, according to a A Guide to AIM, the costs of fu compiance with the Code woud outweigh the benefits to the average sharehoder. Instead, the AIM reguatory framework reies on the Nomad system to assist companies with the appication of corporate governance guidance. A company seeking to join AIM must appoint a Company exampes Premium Listed companies frequenty report by exception on their compiance with the Code. For exampe, on one company website, under Governance code compiance, it is stated that [the company] compied throughout 2011 with the provisions of the UK Corporate Governance Code, except in the foowing aspects... One major UK food retaier stated in its annua report for that it did not compy with Provision B.6.2 of the Code, which requires that every three years there shoud be an externay ed evauation of the board s performance. Athough an externay faciitated evauation was due in 2010, the chairman s statement expained that, given the extensive board and senior management changes that had taken pace in 2010, it was decided to defer the externa evauation for a year. An internationa oi and gas company states on its website that it did not compy in 2011 with Provision D.2.2 of the Code, since the remuneration of the chairman is not set by the remuneration committee. Instead, the chairman s remuneration is reviewed by the remuneration committee, which makes a recommendation to the board as a whoe for fina approva, within the imits set by sharehoders. The company expains the reasoning behind this wider process, namey that it permits a board members to discuss and approve the chairman s remuneration, rather than soey the members of the remuneration committee. nominated adviser (Nomad), who wi hep the company come to market. Under the current AIM Rues for Nominated Advisers, a Nomad shoud consider, with the Setting the scene The UK reguatory framework Page 21

24 Company exampes In its 2011 annua report, an AIM company reports by exception on compiance with the QCA Guideines. For exampe, it states that the board does not, contrary to the recommendation in QCA Guideine 5, undertake performance evauation of the board, its committees and its individua directors. The company does not expain why this is so. The website of another AIM company states that it is committed to a eve of compiance with the main provisions of the Code, in so far as they are considered to be appropriate for a smaer quoted AIM company. The 2011 annua report for a further AIM company states that it intends to adopt poicies and procedures that refect the Code so far as the Code is consistent with the QCA Guideines. The exampes of compiance with the Code by companies on the Main Market and AIM highight the appication of the Code in practice. Whether the approach a particuar company is taking is considered appropriate is, consistent with the phiosophy underpinning this aspect of UK reguation, eft to the investors in the company to decide. directors of an appicant, the adoption of appropriate corporate governance measures. Nomads are expected to work with their AIM company cients to estabish the corporate governance standards with which the company wi compy by reference to size, stage of deveopment, business sector, jurisdiction and so on. The London Stock Exchange encourages companies to use the Code or the Corporate Governance Guideines for AIM Companies from the Quoted Companies Aiance. The QCA Guideines are based on the provisions of the Code but are ess prescriptive. Page 22 The UK reguatory framework

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27 5. Corporate governance in the EU context Vanessa Knapp OBE, Freshfieds Bruckhaus Deringer LLP Historicay, the European Union has taken a rather piecemea approach to corporate governance. There have been some initiatives on individua issues but member states have argey been eft to put their own governance frameworks in pace. Good corporate governance needs to take account of a particuar country s company aws (which, for exampe, infuence board structures and sharehoder rights) and sharehoder profies (from widey dispersed ownership to controing sharehoders). This has ed to some differences in the corporate governance rues of the various member states, and, particuary in the wake of the financia crisis, there have been cas for a more harmonised approach across the EU. annua corporate governance statement, to discose the key eements of their governance structures and practices common minimum standards for nomination, remuneration and audit committees the creation of a European Corporate Governance Forum to encourage further coordination of the nationa codes and their enforcement. Recommendations on directors remuneration In 2004 the Commission adopted a recommendation on the remuneration of directors of isted companies. EU recommendations are not binding on member states, but may be a precursor to egisation. Setting the scene Deveopments at EU eve 2003 Action Pan The first steps towards such an approach came in 2003 when the European Commission reeased an Action Pan (the Pan) on company aw and corporate governance for consutation. The main objectives of the Pan incuded strengthening sharehoders rights and increasing the efficiency and competitiveness of businesses, party by adopting a common view within the EU on corporate governance rues. The Commission made it cear that it did not intend to introduce a European Corporate Governance Code but rather wanted to coordinate the nationa corporate governance codes through initiatives in a few key areas, incuding: directors remuneration, where the focus was on encouraging member states to put reguations in pace to increase transparency and give sharehoders more infuence over directors compensation packages requiring isted companies to pubish an This recommendation proposed discosure of detaied remuneration information for individua directors, that a poicy on directors remuneration for the foowing year shoud be submitted to a binding or advisory vote at the annua genera meeting, and that there shoud be prior sharehoder approva of share and share option schemes. The information that the Commission proposed shoud be discosed is simiar to the detais that quoted companies (in other words, UK companies whose equity shares are isted in the European Economic Area or admitted to deaing on the New York Stock Exchange or Nasdaq) must incude in their directors remuneration report, in accordance with the Large and Medium-sized Companies and Groups (Accounts and Reports) Reguations A Commission report in 2007 found that a arge majority of member states had introduced high discosure standards for the remuneration of individua directors. However, discosure of the remuneration poicy had not been widey adopted and few member states had recommended a sharehoder vote on remuneration criteria, Corporate governance in the EU context Page 25

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