EQ Shareholder Services Industry Monthly Update - August 2023

The influence of proxy advisors and ESG rating agencies on the actions and reporting of FTSE 350 companies and investor voting

The Financial Reporting Council (FRC) has published an analytical report - The influence of proxy advisors and ESG rating agencies on the actions and reporting of FTSE 350 companies and investor voting - viewable at the FRC Website.

The report notes in relation to proxy voting:

• an increasing number of investors ask for voting research to be based on their own in-house customised voting policies rather than the advisor’s benchmark standard policies.
• with the exception of remuneration, recommendations by the largest proxy advisors to vote against resolutions are relatively rare on most topics.
• companies felt that proxy advisor methodologies should be aligned to the UK Corporate Governance Code (the Code) to increase consistency.
• Companies and some investors raised concerns about the timeliness and timing of ESG rating agencies’ updates to their ratings and research reports.
• Proxy advisers noted that the Code is one of the main sources for their UK benchmark policy but that there are areas where benchmark policies are more specific than the Code and other UK regulatory requirements and standards.

As regards ESG rating agencies:

• investors stated that they primarily used ESG rating agencies as a source of data rather than relying on the rating itself to inform voting decisions; and some have developed their own proprietary rating systems.
• companies and investors would welcome greater transparency on the methodologies used by ESG rating agencies.
• companies identified a number of concerns about the data-gathering techniques used by some ESG rating agencies and data providers (data scraping and the use of controversial reports); and
• companies and some investors raised concerns about the timeliness and timing of ESG rating agencies’ updates to their ratings and research reports.

Audit Committee Chairs’ views on, and approach to Environmental, Social and Corporate Governance (ESG)

The Financial Reporting Council (FRC) has published a report relating to Audit Committee Chairs’ (ACC’s) views on and approach to Environmental, Social and Corporate Governance (ESG) activities and reporting. The full report can be viewed at FRC’s website.  Forty ACCs from a wide range of companies participated in interviews for the report.

Some of the main conclusions and findings of the report are:

• ACCs interviewed all showed an interest in ESG and a good understanding of the ESG activities undertaken in their organisations. However, many are not directly involved in the decision-making processes, especially in relation to environment and social elements. Their main role being related to risk and compliance.
• The Task Force on Climate Related Disclosures (TCFD) was well known amongst the ACCs in the study, larger companies were more familiar with TCFD targets and had the necessary resources to meet these requirements. There was some concern relating to the time and resources devoted by smaller companies in meeting the recommendations.
• The social component was reported by some ACCs to be increasing, especially regarding board and senior management diversity, staff wellbeing and equal pay.
• All ACCs felt they had a firm understanding of governance activities, issues, and risks, as these activities and measures are well established.
• Some participants considered that ESG was ‘too broad’ and that it continues to evolve and grow rapidly, which can make the measurement of ESG activities difficult and inconsistent across sectors and markets, particular emphasis was placed on challenges relating to indirect (Scope 3) emissions.
• Guidance on ESG related matters is complex to navigate and that practical, sector specific guidance from the FRC would be welcomed.

Insight Report: Disclosure of Dividends Revisited

The FRC Lab has published an updated Insight Report available from the FRC website.

It revisits some of the areas highlighted in a report published in 2015 which can be viewed here in light of the current economic environment.

The report notes that while the expectation of good disclosure remains, dividend policy should reflect current macroeconomic conditions even if this means that no changes is made to the dividend policy of a company. Three factors are highlighted with examples given of the areas where investors assess dividend policy:

1. Macro: How does the policy reflect Macro factors e.g., economic slowdown, inflation, and interest rate environment.
2. Market: How does the policy reflect market factors e.g., peer comparison, the need to respond to industry trends.
3. Entity: How does the policy reflect company factors e.g., the need to invest in green transition, financing and debt repayments, staff, and customer support.

Audit Quality Inspection Reports

The Financial Reporting Council (FRC) has published its annual inspection and supervision results for the seven largest audit firms (BDO, Deloitte, EY, Grant Thornton, KPMG, Mazars and PwC). The reports, accessible from the FRC website found that 77% of audits inspected were deemed good or required limited improvement; a 10% increase compared to the 67% recorded in 2020. Mazars and BDO both showed signs of improvement following initiatives and actions put in place to raise their audit quality.

The report also includes a section on how management and audit committees can play an integral role in the audit ecosystem and gives some recommendations for audit committees to ensure responsive and high-quality audits. These include the audit committee leading and governing a healthy and productive culture, instilling strong challenging mindsets and behaviours, the audit committee must hold management to account to ensure timely appropriate remedial action where the auditor highlights weaknesses in quality of information or insufficient control environment and active engagement with the auditor throughout the audit process.

Economic Crime and Transparency Bill

A proposal has been announced to reform the identification doctrine when dealing with economic crime offences by widening the scope of who is to be considered as “the directing mind and will” of a business to be included in the Economic Crime and Transparency Bill. No details of the proposed legislation are currently available but further information can be found at the GOV UK website.

A test will be applied to consider the decision-making power of a senior manager who has committed an economic crime. The definition of senior manager is the same as contained in the Corporate Manslaughter and Corporate Homicide Act 2007 (i.e. those who play significant roles in the making of decisions about how the whole or a substantial part of the organisation’s activities are to be managed or organised, or the actual managing or organising of the whole or a substantial part of those activities).

IFRS Sustainability Standards

Two IFRS Sustainability Standards have been issued by the International Sustainability Standards Board (ISSB): IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information and IFRS S2 Climate-related Disclosures. The Standards are effective for annual reporting periods beginning on or after 1 January 2024 although it is up to individual jurisdictions to decide whether companies need to adhere to the standards. In the UK, the government has indicated that there will be a consultation on a framework to adapt and endorse the Standards. Additionally, the Financial Conduct Authority has advised that it intends to update its reporting requirements for listed companies in line with the ISSB's standards once they are endorsed for use in the UK.

IFRS S1 provides a set of disclosure requirements designed to enable companies to communicate to investors about the sustainability-related risks and opportunities they face over the short, medium, and long term.

IFRS S2 applies to climate-related risks to which a company is exposed, which are climate-related physical risks and climate-related transition risks and climate-related opportunities available to the company.

The full Standards can be viewed by signing in or registering for an account at IFRS.

Board Performance Reviews

The Chartered Governance Institute (CGI) has published the following guidance notes:

• A revised Code of Practice for board reviewers
• Principles of Good Practice for listed companies using external board reviewers
• Guidance for listed companies on reporting on board performance reviews 

It should be emphasised that this Code of Practice is not mandatory. It is hoped that the Code can be useful in improving the market for independent reviews, but that attempting to impose minimum standards may not be the most effective way of doing so. The principles and guidance cover four broad topics: competence and capacity; independence and integrity; client engagements; and client disclosure. The principles are designed to mirror the CGI’s Principles of Good Practice for listed companies, while the guidance draws on the Financial Reporting Councils Guidance on Board Effectiveness.

In relation to the Principles of Good Practice the appointment of an independent board reviewer should be a decision of the nomination committee. Potential conflicts of interest should be fully disclosed in the annual report, with an explanation of why the company believes the reviewer to be independent. The Guidance for listed companies’ states that in the annual report the independent board member who was the reviewer’s escalation point should be identified and that where a reviewer provides additional services to a company the payment received for the board review should be shown as a percentage of the total paid to the reviewer.