What constitutes compliance?

The Financial Reporting Council in the UK thinks it has the answer. And who should know better? It is, after all, the custodian of the UK Corporate Governance Code and has orchestrated the revisions of its predecessors for the past decade. Under its "comply-or-explain" regime, the UK code leaves room for listed companies to vary their practice. Indeed, "Through the concept of 'comply or explain' the UK has successfully promoted high standards of corporate governance over many years. This has led to widespread improvements in practice," the FRC stated. But what it means to comply has always been open to interpretation. And what constitutes a good explanation in absence of compliance it even murkier. So the FRC has issued a document to add some definition to what code states.

Although compliance is in general rather good, "a very few egregious or notorious deviations can undermine support for the whole concept of 'comply or explain'," the FRC said. "For that reason and, particularly given the debate in Europe about the future of 'comply or explain', the FRC felt it was timely to bring together those who make explanations and those to whom they are addressed in order to compare notes about what each side understands by the word explanation."

It wants companies that choose to explain to do so in a way that is "as full as is necessary to meet the expectations of shareholders". Even aiming for such a standard should help companies, since stronger explanations will discourage shareholders from adopting a box-ticking approach. The FRC's document is, in effect, a bit of preventative medicine. It wants to reinforce the argument it makes in Brussels that the "right way to address current corporate governance challenges is to make the existing system work better rather than to introduce new prescriptive regulation. As indicated in its recent report on the impact of its two codes, the FRC is considering whether to reflect the outcomes of these discussions in the revised UK Corporate Governance Code on which it will consult later in the year."

Source document: The FRC document "What constitutes compliance under 'Comply or Explain'" is a 10-page pdf file.