The future of corporate governance for private companies – Winds of change

09 December 2016

By Georgina Milis, Entity Governance & Compliance solicitor at PwC Legal and Gilly Lord, Head of Regulatory Affairs at PwC

With approximately 41% of the UK’s economy made up of private businesses, some might be surprised that such a significant portion of the economy remains unregulated. With a greater focus on trust and transparency by businesses there is now, more than ever, calls for the reform of private company corporate governance. Listed companies on the other hand have had for some time clear parameters and measures to help them achieve appropriate standards, for example, the UK Corporate Governance Code (the “Code”), the Listing Rules etc. and listed company shareholders have become more active in engaging with companies when these codes and standards aren’t embraced.  Similarly, private PRA/FCA regulated companies are also subject to stricter governance requirements by virtue of the PRA/FCA regulations that apply to them (CRDIV, MIFID etc), for example requiring board committees and additional reporting requirements about capital, liquidity and longer term viability.

Teresa May’s recent promise to “reform capitalism” and crack down on “irresponsible behaviour” in the corporate world and the subsequent establishment of a MP Select Committee to conduct a Corporate Governance Enquiry, together with the plans by the IOD to republish its corporate governance guide and principles for unlisted companies in the UK (the “Guidance”) by November this year might result in a tightening of the regime for private companies.

Currently, the Guidance follows the key principles of the Code but has been adapted to address the requirements of smaller companies. It is a practical set of principles that can be applied relatively easily by directors of private companies in a way which suits their needs to improve how they are run and managed. However, unlike the Code (all listed companies in the UK must either comply with the principles of the Code or explain in their annual report why they do not comply) it is entirely voluntary. This is because private businesses range from start-ups to single owner manager companies to private equity owned companies so making this diverse range of companies consider the same set of principles doesn’t seem necessary or practical.

What will the future look like?

The IOD has asked the Government to endorse the Guidance once it is updated. The question is whether endorsing it will be enough or the Guidance needs more formal status. Enshrining changes in the law seems a step too far and could be unworkable for a number of smaller private businesses. Maintaining the Guidance as voluntary, with changes like those suggested below, might be the step we need for greater transparency and accountability, particularly for the large/complex private businesses. 

We expect that the IOD may incorporate more elements of the listed company approach into the Guidance, as set out below. PRA/FCA regulated companies, should recognise some of the elements below given the regulations that they are subject to and, where they don’t, should consider implementing them as a matter of best practice:  

  • Comply-or-explain for the larger/more complex companies

For larger (based on a financial threshold) and/or more complex unlisted companies we may see the IOD introduce a comply-or-explain approach.  This would mean that those companies in scope would be obliged to consider the principles of the Guidance, and either adopt them, or explain why not as part of their annual reporting.  We could even see the IOD suggest that parts of the main Code should apply directly to these large private companies.  Either way, these businesses will need to be prepared for an increase in disclosure and transparency.  As listed companies have already experienced, a consequence of the “comply-or-explain” regime is that stakeholders have the opportunity to challenge companies on their governance decisions.  We regard this engagement as highly positive – but private companies will need to ready themselves to respond!

  • Increase in checks and balances

The review of recent scandals suggest that there will be renewed scrutiny on directors’ responsibilities and an increase in ‘checks and balances’ that subject the actions of individuals to scrutiny. Again, an alignment with listed company requirements might follow:

  • reinstating the requirement to have a company secretary (which was removed for private companies but is still maintained for public companies);
  • the minimum number of directors could be increased (as is the case for public companies), as the current need for only one director contributes to blurring the lines when sole shareholders are also the director and the manager in a company;
  • a recommendation to appoint independent non-executive directors to the board, to assist with increasing scrutiny and accountability regarding decision making.
  • larger private companies could be recommended to establish appropriate board committees in order to allow a more effective discharge of the board’s duties; and

It is clear that business owners will have to be prepared to be more open and accountable.

  • The role and duties of the director

All directors already have an obligation to abide by their legal duties which are set out in the Companies Act 2006. Amongst other things, they have a statutory duty to promote the success of a company for the benefit of its members as a whole. They must also have regard to the long-term consequences of their decisions, and the impact on the interests of other stakeholders such as, employees, suppliers, customers and communities. As has been highlighted by the ICSA recently, in their experience, many directors are not as familiar with these duties and their many other legal obligations as they should be, and that this is particularly the case in private companies. So we see arguments for better oversight of these legal obligations, perhaps via an appropriately qualified governance professional to advise directors on their duties, including conflicts of interest and help them navigate their way through their legal obligations.

What do you need to do now?

Whilst the changes are yet unknown, we already see large private groups embracing more transparency by publishing annual reports and accounts and embracing the set-up of a diverse and large board of directors (for example, the Grosvenor Group and Pentland Group plc). Business leaders should be thinking about how they can embrace more transparency, and structure their business to make it robust. After all, good corporate governance is recognised as contributing to the long term success, survival and value of non-listed companies.

The challenges will be how the guidance will be applied to the different types of private companies, how will any changes be enforced and how to introduce such changes without significantly increasing the administrative burden and continuing to make the UK an attractive place to do business.

For more information please contact or Joan Medland on Tel: 020 72135815 or email Joan.Medland@uk.pwc.com.

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