A lot has happened in the corporate governance world since our last update in July. Among others, Professor John Kay published his final report on the review of UK equity markets and long-term decision making, and the Government published draft regulations implementing the proposed changes to narrative reporting.
Kay Review final report

Professor John Kay published his final report1 on the review of UK equity markets and long-term decision making (the Report) at the end of July 2012. As previously reported (see our April 2012 update), the department for Business, Innovation and Skills (BIS) had asked Professor Kay to “review activity in UK equity markets and its impact on the long-term performance and governance of UK quoted companies”.

Interestingly, the Report is premised on the assumption that the core purposes of equity markets are to “enhance the performance of UK companies and to enable savers to benefit from the activity of these businesses through returns to direct and indirect ownership of shares in UK companies” rather than to raise capital and provide liquidity.

Short-termism and its sources

Not surprisingly the Report concludes that short-termism is a problem in UK equity markets. According to Professor Kay, the principal causes of such short-termism are:

• the decline in trust and
• the misalignment of incentives
• throughout the equity investment chain caused in particular by:
• the fact that public equity markets currently encourage exit over voice as a means of shareholder engagement;
• that equity markets are no longer an important source of capital for new investment by UK businesses; instead, the IPO market is used only by smaller companies to achieve liquidity for early stage investors;
• the increase of shareholder fragmentation and foreign shareholding;
• the increase of intermediation in equity investment;
• the use of the efficient market hypothesis as a basis for regulation and investment;
• the dominant role of asset managers and the excessive level of trading activity;
• the short time scale at which asset managers’ performance is judged; and
• the focus of regulatory policy on detailed and prescriptive rules governing market conduct rather than on the establishment of market structures which provide appropriate incentives.


The Report strongly emphasises the principles of stewardship and states as its first recommendation that the Stewardship Code should be amended to incorporate a more expansive form of stewardship “focussing on strategic issues” as well as corporate governance. Directors, asset managers and asset holders should also adopt good practice statements promoting stewardship and long-term decision making.

Other recommendations of the Report include:

• establishing an investor’s forum to facilitate collective investor engagement;
• monitoring and reviewing merger activity by BIS and by companies themselves;
• consulting major long-term investors through the investors’ forum over chairman and important non-executive director appointments;
• applying mandatory fiduciary standards to all relationships in the investment chain which involve discretion over the investments of others or investment advice;
• disclosing all income from stock lending;
• removing quarterly reporting obligations and encouraging high quality narrative reporting; and
• structuring directors’ remuneration to align incentives with sustainable long-term business performance; incentives should only be in the form of company shares which should be held at least until after the director has retire from the business.

Some of the Report’s recommendations have already been taken on board: On 12 October 2012 the Institute of Chartered Secretaries and Administrators (ICSA) launched a consultation on “Improving engagement practices between companies and institutional investors”2  with the intention to issue guidance in March 2013.

The Government response to the Report is expected later this year.
Narrative reporting

On 18 October 2012 BIS published the draft regulations3 on the new structure for narrative reporting. As previously reported (see our January and April 2012 updates) in its March 2012 response BIS had introduced a new structure for narrative reporting. The details of this new structure can now be found in the draft regulations which are due to come into force in October 2013. Accordingly, annual reports for reporting years ending after 1 October 2013 will be expected to be prepared in accordance with the new regulations.
Strategic report

The regulations create a separate strategic report to replace the business review which currently forms part of the directors’ report. As was the case in relation to the business review, small companies will be exempt from the requirement to prepare a strategic report.

The strategic report increases the reporting obligations of quoted companies (i.e., companies listed on the LSE’s Official List (but not those admitted to trading on AIM) or admitted to dealing on the New York Stock Exchange or Nasdaq) compared to the enhanced business review as they will have to report on the following matters:

• The company’s strategy and business model. In practice this new requirement should not constitute a real additional burden for most quoted companies as they are already required to report on their strategy and business model under the UK Corporate Governance Code.
• Human rights issues. In addition to social and community issues quoted companies will be required to provide information about human rights issues.
• Gender diversity. In line with the recommendations in the Davies report on ‘Women on Boards’ (see our April update), the strategic report of quoted companies must include a breakdown showing the number of persons of each sex who are (1) directors, (2) managers (defined as persons who have responsibility for planning, directing or controlling the activities of the company and are employees of the company), and (3) employees.

The controversial requirement for quoted companies to include information about persons with whom the company has contractual or other arrangements which are essential to the company’s business will be removed.

New guidance on the strategic report will be prepared by BIS and the Financial Reporting Counsel (FRC) who are planning to consult on the style of the draft guidance early next year.
Annual director’s statement

BIS had previously proposed to replace the directors’ report with an annual director’s statement. However, this proposal has not been taken forward. Accordingly, with the exception of the business review (which will be replaced by the strategic report) and certain requirements which are proposed to be removed (such as, for instance, the requirements to state the company’s principal activities in the course of the year; to report their charitable donations above £2,000; and to note differences between the value of land in the balance sheet and directors’ view of the value of such land), the director’s report remains substantially in its current form.

Summary financial statements

It will no longer be possible for shareholders and others to receive summary financial statements (SFS) as SFS will be replaced with the strategic report. However, as is the case now in relation to SFS, shareholders retain the right to request a full report.

Greenhouse gas emissions reporting

Separately, the Department for Environment, Food and Rural Affairs (Defra) has been consulting about a new requirement for UK quoted companies to report their greenhouse gas emissions in the directors’ reports (see further Mandatory GHG emissions reporting is on its way). This new requirement is due to come into force for reporting years ending after 6 April 2013. However, the Defra consultation asked whether the regulations should come into effect at the same time as the BIS regulations on narrative reporting.

Marlies Braun

1 The Kay Review final report is available at http://lgl.kn/de7dfassets/biscore/business-law/docs/k/12-917-kay-review-of-equity-markets-final-report.pdf.�
2 The ICSA consultation is available at http://lgl.kn/d0492.
3 The draft regulations are available at http://lgl.kn/de7dfassets/biscore/business-law/docs/f/12-979-future-of-narrative-reporting-new-structure.pdf.