Corporate Governance

Corporate Governance and Exec Compensation 2021

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Shearman & Sterling LLP Recent Corporate Governance Developments in the U.K. | 28 CORPORATE REPORTING The key reforms proposed in connection with U.K. corporate reporting concern three critical areas of new or enhanced disclosure by the board in its company's annual report — the company's internal controls, its resilience to coping with future risks and uncertainties and its approach to seeking internal and external assurance of its corporate reporting. Internal Control Statement The Paper acknowledges that some recent well-publicized corporate failures have shown that the U.K.'s current mix of legal, listing rule and U.K. Corporate Governance Code (the "Governance Code"), etc. requirements for companies' internal controls have not worked as well together as they need to. It therefore proposes addressing head-on the responsibility of directors for the adequacy of their company's internal controls by requiring the board to confirm expressly on an annual basis that it has reviewed the effectiveness of the company's internal controls and how any deficiencies that have been identified are being remedied. This will, at least as a matter of disclosure, involve much more than the current requirement of the Governance Code that the board simply confirms it has reviewed the effectiveness of the company's internal controls. It is also notable that consistent with the U.K.'s general approach of a board's collective responsibility (with no legal differentiation between executive and non- executive directors in terms of their duties as directors), the Government is proposing that the board, rather than just the CEO and CFO as under the U.S. Sarbanes-Oxley rules (SOX), should give this confirmation. The board will be required to acknowledge its responsibility for maintaining adequate internal controls for financial reporting and, after annual review, to confirm the effectiveness of those controls in a statement included in the annual report. Significantly, the Government is not proposing, as its initial preferred approach, requiring external auditor assurance or attestation of the statement, except in limited cases where, for example, there has been a serious and demonstrable internal controls failure. It has, however, also invited comments on the adoption of a more SOX- aligned approach with mandatory external attestation. Resilience Statement The second new reporting disclosure that is proposed will require directors to commit to a much clearer and more expansive public commentary on their company's financial and operational strength and viability over the short-to- medium and longer term than is currently the case. This proposed Resilience Statement would build on and consolidate the going concern and viability statements that are currently required in annual reports but would demand much more disclosure and analysis from the board than is commonly the case for the existing disclosures. The statement would set out the company's approach to exploring and mitigating risks and uncertainties over the short term (one to two years), the medium term (five years) and the longer term. Disclosure would be required of material uncertainties looked at by the board during its going concern assessment but subsequently judged not to be material, including because of mitigating action taken. In addition, boards would be required to include in their Resilience Statement at least two reverse stress-testing scenarios. Audit and Assurance Policy A further new reporting disclosure would require directors to be much more open about the level of external assurance the board seeks when reporting the company's results and financial position to the markets. This proposed Audit and Assurance Policy would be made in the annual report, either each year or every three years. Critically, it would also be subject to an advisory shareholder vote (for listed PIEs) when published. The Policy would have to describe the company's approach to seeking internal and external assurance of its corporate reporting over the next three years and would mark a major extension and clarification of the level of external scrutiny that companies currently invite on their corporate reporting. It would extend well beyond the existing required audit of statutory information (including non-financial information) found in the directors' report and strategic report and also various non-statutory information. This Policy might also disclose the extent to which the board has looked for any external assurance of its Resilience Statement. The response of proxy advisers to companies' Resilience Statements and the requirement for a shareholders' vote on the Audit and Assurance Policy (with the likely sanction of having a 20% or more vote against it being recorded on the Investment Association's public register), is likely to put boards under greater pressure to articulate more clearly and more robustly to their shareholders and other stakeholders how they see their companies are placed to weather future financial, pandemic and other economic or operational challenges. These new Internal Control, Resilience and Audit and Assurance Policy statement requirements would apply initially to premium-listed PIEs and then be rolled out to a broader range of other PIEs (as mentioned above) two years later.

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