Morningstar isn't the only organisation focused on governance this week. The Financial Reporting Council has just published its latest revisions to the corporate governance code.
This is the eighth revision to its "comply or explain" guidelines outlining the regulator's recommended practice for implementing oversight and control of the UK's listed companies. Yet this round of changes is unlike anything in the Code's 35-year history.
In 2023, the FRC put out to consultation 18 proposals to revise and extend the Code. However, in November, the regulator took many by surprise in deciding not to take forward most of those ideas. The proposed revisions were intended to be the vehicle for delivering the bulk of earlier government proposals to reform the corporate governance and audit framework in the UK – proposals that were also themselves pared back.
The main proposed change in the latest set of revisions is boards of UK companies would declare via the annual report how they have monitored and reviewed the effectiveness of "material" financial, operational, reporting and compliance controls – a much-reduced scope from the originally-proposed US-style management attestations over such controls (known as "SOX").
Why The Change in Direction?
To answer this, it's important to understand what's happened over the last half-decade.
Concerns over sudden failures of UK businesses – such as Carillion, Patisserie Valerie, and others – have prompted a host of proposals to strengthen the corporate governance framework, such as those described above.
Alongside that, new listings on the London market have all but dried up, and the less-than-stellar performance of companies that have listed in recent years – Deliveroo (ROO), Aston Martin (AML) and CAB Payments (CABP) among them – hasn't helped.
And then there was Arm (ARM).
The decision by former London-listed chipmaker Arm to list in New York was a particularly tough pill to swallow for cheerleaders of the UK market, who have seen a slew of young UK businesses list in the US over recent years, attracted by that market's higher valuations and its reputation as a home for growth companies.
The Magnificent Seven (Apple (AAPL), Microsoft (MSFT), Alphabet (GOOGL), Amazon (AMZN), Nvidia (NVIDIA), Meta Platforms (META), and Tesla (TSLA)) is just one example of an astonishing market success a long time in the making.
Meanwhile, several large companies – including names like Tui (TUI), Flutter Entertainment (FLTR) and CRH (CRH) – plan to de-list. Many more companies are being lost to takeovers, particularly in the small cap sector of the market, as a recent analysis by broker Peel Hunt points out.
In the face of all this, corporate governance changes – seen as burdensome by a government keen to prioritise deregulation – have been reduced to a minimum. Instead, policymakers are prioritising the removal of restrictions seen as unattractive to new businesses seeking to list. As City minister Bim Afolami puts it, "if you’re regulating a market, in any area, there's no point having the safest graveyard."
The changes include new listing rules permitting a greater role in public markets for companies with "dual class" share structures that permit company executives greater voting power than other shareholders; as well as changes in the "free float" requirement, meaning the percentage of a company's shares that must be available for public sale will fall from 25% to 10%.
The Capital Markets Industry Taskforce – a body chaired by London Stock Exchange chief executive Julia Hoggett – is seeking to reverse the London market decline, and welcomes the rollback of corporate governance stipulations. It's even pushing for more.
A Huge Gamble
However, concerns remain that the existing corporate governance requirements are in fact an important pull factor for investors. For example, dual-class share structures are a particular source of consternation for many institutional shareholders, who believe they entrench management and reduce its accountability.
Looking overseas has not always proven to be a panacea either. UK companies seeking success in the US have not always found it to be an easy ride.
Several businesses that listed in New York via special purpose acquisition companies (SPACs) over the last few years have largely not lived up to expectations. A 2023 study by Bloomberg and the London Stock Exchange indicated an investor in 13 British SPAC companies would have lost 90% of their investment.
Furthermore, with the US being the home of SOX, reporting burdens are often higher in that market compared with the UK. Investor perception is that the cost of compliance in the US is more than offset by the lower cost of capital.
Overall, the UK's deregulation push is a big bet. Even now, companies seeking a London listing cite the market's strong corporate governance as a key factor. Maintaining that reputation while attracting the growth companies of the future will be crucially important.
Lindsey Stewart, CFA, is director of investment stewardship research at Morningstar, and the former head of stakeholder engagement at the FRC.
