UK's Financial Reporting Council: The Higgs And Smith Reports: Next Steps Towards A Revised Combined Code Following Consultation

At its meeting yesterday, the FRC decided to set up a working group of FRC members to produce a revised draft of the Combined Code in the light of points made in response to the FRC's recent consultation. The group will be chaired by Sir Bryan Nicholson, Chairman of the FRC, and will comprise:

• Sir John Egan, President CBI and Deputy Chairman FRC
• Peter Wyman, President ICAEW and Deputy Chairman FRC
• Charles Allen-Jones, Formerly Senior Partner, Linklaters and Alliance
• David Clementi, Chairman, Prudential plc
• Derek Higgs, Chairman, Partnerships UK plc and Senior Adviser in the UK to UBS Warburg
• Paul Myners, Chairman, Guardian Media Group plc and former Chairman, Gartmore Investment Management plc
• Colin Perry, Chairman, LTE Scientific Ltd and former chairman of the CBI SME Council|
• Sir Robert Smith, Chairman, The Weir Group PLC

Sir Bryan Nicholson said: "The consultation exercise reinforced the wide welcome for the general thrust of the Higgs report and its recommendations to strengthen the role of non-executive directors and the transparency and accountability of boards to shareholders. Responses included a great deal of thoughtful comment and many good suggestions, but also identified some strong criticism about certain aspects of the proposed Code changes. The FRC will now work to produce a draft taking account of the consultation, with the intention of reaching a final draft of the Code that will build on Higgs' approach and command general support. I believe the new Code will make a substantial contribution to strengthening corporate governance in the UK."

In today's discussion, the FRC strongly supported the incorporation of the substance of the Higgs and Smith reports into the Combined Code.

It was recognised that the 'comply or explain' principle was key to the successful working of the Code and that the dialogue between companies and institutional shareholders was not as well developed as it should be. Both needed to put more effort into making the system work; there would be occasions when a company would choose to use the 'explain' option, and institutional investors should consider such explanations carefully, giving reasons if they did not accept the explanation.

On the basis of the consultation responses, the FRC concluded that:

• the chairman should be allowed to chair the nomination committee (though the chairman should stand down when the committee was discussing recruitment of a new chairman);
• the chairman should chair regular meetings of the non-executive directors; but the senior independent director should chair at least annual meetings of the non-executive directors without the chairman present to appraise the chairman's performance;
• the chairman should ensure that shareholders' views are communicated to the board as a whole; the senior independent director should attend as an observer sufficient meetings of management with a range of major shareholders to help develop a balanced understanding of their concerns;
• re-election of non-executive directors beyond six years should not require special explanation but should be subject to rigorous review, with no automatic re-appointment;
• the provision that at least half the board, excluding the chairman, should comprise independent non-executive directors could be difficult for many smaller listed companies (below FTSE 350); for them, the Code should provide for boards of such companies to include at least two independent non-executive directors but should encourage them to move towards meeting the full provision;
• some of the 'provisions' in the draft (with which companies must 'comply or explain') were more akin to 'principles' (where companies must report how they are applying those principles); a new draft should take this into account.

The working group will aim to produce a revised text by July, with a view to bringing the new Code into effect as soon as possible consistent with a high quality output.

Background

Derek Higgs' report "Review of the Role and Effectiveness of Non-Executive Directors" and Sir Robert Smith's report "Audit Committees - Combined Code Guidance" were both published on 20 January 2003. The Higgs report included a proposed new Combined Code to supersede the 1998 Hampel Combined Code. It incorporated proposals from both the Higgs and Smith reports.

On the same day, the FRC invited comments on the proposed new Code, with a closing date of 14 April.

181 responses to the consultation were received. A summary is available on the FRC website. The responses of those who have given their consent will be available on the FRC website shortly.

The new draft will build on the text proposed by Derek Higgs and Sir Robert Smith, and will also cover the draft guidance on audit committees proposed by Sir Robert.