Corporate weekly highlights—25 October 2018

This week’s edition of Corporate highlights includes an examination of the Takeover Panel’s consultation on asset valuations under Rule 29 of the Takeover Code (including market commentary from Selina Sagayam, Head of UK Transactional Practice Development at Gibson Dunn), new GC100 guidance on directors’ statutory duty under section 172 of the Companies Act 2006 and the Financial Reporting Council’s findings regarding its annual review of corporate governance and reporting in the 2017–2018 period.

In this issue:

Public company takeovers

Takeover Panel seeks to provide clarity on treatment of asset valuations

Corporate analysis: On 17 October 2018, the Code Committee of the Takeover Panel (Code Committee) published a consultation paper on proposed amendments to Rule 29 of the Takeover Code (Code), which relates to asset valuations (PCP 2018/1). The analysis examines the Code Committee’s proposals and includes market commentary from Selina Sagayam, Head of UK Transactional Practice Development at Gibson Dunn.

Rule 29 of the Code requires that when a valuation of assets is given in connection with an offer, it should be supported by the opinion of a named independent valuer. The rationale for this rule is that if a valuation of assets is given in connection with an offer, it is likely to be of such fundamental importance to shareholders’ decisions on the offer that they should have the benefit of an opinion on the valuation from an expert valuer of appropriate independence and competence.

The Code Committee has undertaken a review into the purpose and operation of Rule 29. It generally agrees with the way that Rule 29 is currently applied by the Executive, but feels that certain aspects of the Takeover Panel Executive’s practice are not reflected in Rule 29 itself. PCP 2018/1 includes proposals to amend Rule 29 to more accurately reflect current practice and provide a more logical framework for the asset valuation regime.

The deadline for sending comments on the consultation is 7 December 2018.

Selina Sagayam, Head of UK Transactional Practice Development at Gibson Dunn, notes that the proposed changes both broaden and narrow the scope of the existing regime:

‘The Panel is proposing a more purposive approach which is to be welcomed by looking to capture valuations which gives the Panel the discretion not to require a Rule 29 valuation if it considers this not material for target shareholders in reaching an informed decision. This codifies the general purposive approach the Executive takes in granting dispensations with the interests of target shareholders being a fundamental consideration.

‘Although the Panel states that it is not its intention to expand the scope of assets to which Rule 29 applies, the “future-proofing” wording of the new rule does in fact give the Panel the ability to expand the scope of Rule 29 to assets to which it may not apply (or even exist) today. The consultation paper refers to the ability to capture “more unusual classes of assets where appropriate”…or perhaps “unusual” (or uncommon) looked at through the lenses of today.’

For further information, see News Analyses: Takeover Panel seeks to provide clarity on treatment of asset valuations and LNB News 17/10/2018 81.

Directors; Corporate governance

GC100 publishes guidance on statutory duty under Companies Act 2006

The GC100 has published guidance on the statutory duty for directors under section 172 of the Companies Act 2006 (CA 2006). As they carry out this duty (the section 172 duty), directors must have regard to how the company’s activities and their decisions or input will impact, among others, employees, customers, suppliers, the community and the environment.

The guidance follows on from the package of corporate governance reforms published by the Department for Business, Energy and Industrial Strategy (BEIS) in August 2017 which, among other things, set out proposals to strengthening the voice of employees, customers and other stakeholders. Among other things, the government invited the GC100 to complete and publish new advice and guidance on the practical interpretation of the directors’ duties in CA 2006, s 172.

Directors should consider five specific things to help embed CA 2006, s 172 in the decision making of the company:

  1. strategy—reflect the section 172 duty when setting and updating company strategy
  2. training—establish and attend training courses on induction to the board, with ongoing updates on the section 172 duty in the context of wider duties and responsibilities
  3. information—consider, and arrange to receive, the information needed on appointment and going forward to help carry out the role and satisfy the duty
  4. policies and process—put in place policies and processes appropriate to support the company’s operating strategy and to support its goals in the light of the section 172 duty
  5. engagement—consider what should be the company’s approach to engagement with employees and other stakeholders for the company, whether through board engagement or wider corporate engagement

For further information, see: LNB News 24/10/2018 78. For further details on corporate governance reforms, see Practice Note: 2017/2018 Corporate governance reforms.

ISS proposes new policy on auditor ratification

Institutional Shareholder Services (ISS) has launched a consultation on adopting a policy in the UK whereby it would inform investors where any lead audit partner is engaged at a public company having previously been linked with prior significant audit controversies. It may make a negative recommendation for auditor ratification where the lead audit partner had been linked with a corporate failure or other material destruction of shareholder value arising from fraud or other accounting issues.

On 18 October 2018, ISS announced the launch of its 2019 benchmark voting policy consultation period, soliciting views from governance stakeholders globally on certain proposed voting policies for 2019. Of the nine voting policy areas covered in the consultation period, the proposal that relates to the UK (as well as Ireland and Europe) is ’Auditor ratification’.

Against the backdrop of a number of recent, high-profile corporate failures and accounting scandals that have occurred at large, widely-held public companies which have, in the words of ISS, ‘raised questions about the efficacy of the financial statements and the need for improved audit quality and stronger boardroom oversight’, ISS is proposing to inform investors where any lead audit partner (and/or partnership firm) who has been linked with prior significant audit controversies is engaged in the audit of other public companies (even if no audit concerns have been identified at the subject company). Where the lead audit partner has previously been linked with ‘a corporate failure scenario or other material destruction of shareholder value arising from fraud or other accounting issues’, ISS may make a negative recommendation on auditor ratification. ISS say that such a recommendation would be limited to ‘egregious circumstances’.

ISS is specifically seeking feedback on these questions:

  1. would your organisation consider the lead audit partner’s involvement in a significant accounting controversy—even if this occurred at another company—to be a potential area of concern?
  2. would your organisation support ISS adopting in future a similar approach in other markets (outside the UK and Europe) where disclosure of the lead engagement partner is available?

Comments are due by 1 November 2018. ISS expects to announce its final 2019 benchmark policy changes during the middle of November 2018.

For further information, see: LNB News 19/10/2018 74.

Accounts and reports; Corporate governance

FRC calls for improved reporting—annual review of corporate governance and reporting 2017/18

On 24 October 2018, the Financial Reporting Council (FRC) has published its Annual Review of Corporate Governance and Reporting 2017/18 (the review), together with an open letter to finance directors and audit committee chairs (the letter).

Based on the findings of its review of 220 annual and interim reports and three thematic reviews, the letter calls for companies and their auditors to focus on the basics and make improvements in a number of areas of corporate reporting and corporate governance to ensure that investors are receiving clear and accurate information.

Key areas for improvement set out in the review include getting the basics right and ensuring the company has an adequate control environment. The FRC identified an increase in the number of basic errors in reports and accounts. Management are encouraged to have effective procedures in place to ensure compliance with the basic reporting requirements of the International Financial Reporting Standards (IFRS), which investors take as a given in audited report. Basic errors can easily detract from the integrity of the company’s report and accounts, and trust in management.

While overall compliance with the UK Corporate Governance Code (the UKCG Code) has risen, the FRC warns that high levels of compliance are not necessarily an indication of high standards of governance and could, in fact, be an indicator of excessive focus on formulaic compliance rather than reporting on how they have applied the UKCG Code in a manner that shareholders can evaluate.

In several sections of the review, the FRC emphasises the present period of change and uncertainty in the UK, and the rapidly evolving corporate reporting and governance landscape in the UK due to changing stakeholder and societal expectations for better reporting on subjects such as gender pay gaps, payment practices and climate change.

Brexit is a main contributing factor to the period of uncertainty. Disclosures on the impact of leaving the EU were analysed, but due to a continuing lack of clarity on exit arrangements, the development of focussed disclosures has been patchy. The most informative disclosures made were by those companies most significantly impacted. These explained the reasons for any changes in risk assessments and identified mitigating options. The best disclosures identified those responsible for developing their strategic response to the challenge. Some companies reporting the outcomes of stress testing in their viability reporting.

The review signposted a number of upcoming developments which will address existing shortcomings in identified areas and/or contribute to the changing corporate reporting environment, including:

  1. the introduction of a definition of senior management based on the Hampton-Alexander recommendations in the 2018 UKCG Code—the top level of management below board level (often referred to as the executive committee) and their direct reports—this will address inconsistencies with the interpretation of ‘senior managers’ for the purposes of reporting on gender diversity
  2. the requirement in the 2018 UKCG Code to give an update on engagement with shareholders following a significant ‘no’ vote against a resolution six months after the vote, which should address concerns about the lack of adequate disclosures on follow-up action and engagement
  3. the development of a voluntary set of corporate governance principles for large private companies, the Wates Corporate Governance Principles for Large Private Companies, which will be finalised in December 2018 and apply to companies reporting for financial years starting on or after 1 January 2019

For further information, see: LNB News 24/10/2018 114.

Brexit

Implications of no Brexit deal for UK-EU cross border businesses and European entities

Corporate analysis: On 12 October 2018, the government issued its fourth tranche of technical notices on a no-deal Brexit scenario. One notice in the tranche gives an explanation of implications for businesses operating across the UK-EU border and European specific entities in the event that the UK leaves the EU in March 2019 with no agreement in place.

The notice, entitled Structuring your business if there’s no Brexit deal, covers businesses operating across the UK-EU border, or who have taken on the form of a European specific entity, including European public limited liability companies (or Societas Europaea) (SEs) or European economic interest groupings (EEIGs). It also covers European groupings of territorial co-operation (EGTCs).

It confirms that in the event of no deal, the government will ensure that the UK continues to have a functioning regulatory framework for companies and businesses on exit day and beyond and that, as far as possible, the same or equivalent laws and rules that are currently in place will continue to apply via the European Union (Withdrawal) Act 2018. However, there are limits to the extent to which the government can provide continuity for UK-registered European specific entities or for UK entities operating in EU Member States that will find themselves subject to another country’s national law.

This notice is one within a government collection: How to prepare if the UK leaves the EU with no deal. An overarching guidance document accompanying the collection seeks to put the notices into context, see UK government’s preparations for a no deal scenario.

For a summary of the fourth tranche of notices published on 12 October 2018, see: LNB News 12/10/2018 107.

The notice summarises ways in which a no deal situation would affect cross border business operations. Two of the most notable implications of a no deal scenario are that:

  1. UK companies and limited liability partnerships with their central administration or principal place of business in certain EU Member States could find that their limited liability status is no longer recognised unless their corporate structure satisfies the Member State’s national requirements for company incorporation (which is due to certain jurisdictions, eg Germany, operating a ‘real seat’ principle of incorporation), and
  2. cross border mergers involving UK companies will no longer be able to take place under EU Directive 2005/56/EC

Other implications for cross border business operations include:

  1. EU companies that operate branches in the UK will become subject to different information and filing requirements (although changes are minimal)
  2. UK citizens and investors may face restrictions on their ability to own, manage or direct a company in the EU, depending on the business sector and EU Member State, possibly by having to satisfy nationality or residency requirements and/or limits on the amount of equity that they can hold, and
  3. EU companies with a branch in the UK that are required by their parent law to prepare, have audited and disclose accounts will have to file those accounting documents in the UK; EU companies with a branch in the UK and not so required to prepare, have audited and disclose accounts will have to comply with the provisions of CA 2006, Pt 15 that apply to overseas companies by the Overseas Companies Regulations 2009, SI 2009/1801

Following exit day, the UK will no longer be a Member State, meaning that EEIGs and SEs will no longer be capable of registration in the UK.

The notice confirms that for SEs and EEIGs that are registered in the UK and have not made alternative arrangements before exit, the government will put in place a way of automatically converting them into a new UK corporate structure so that they will have a clear legal status post exit. For SEs this will include maintaining the employee involvement provisions. This will be good news for the 40 or so remaining UK-registered SEs which are running out of time to make proposals to transfer their seats to other Member States (a process which takes well over two months) or convert to UK PLCs. For further information, see Practice Notes: European companies—alteration of registered particulars, ongoing administration and transfer of registered office and European companies—winding up, liquidation, insolvency and conversion to PLC.

For further information, see News Analysis: Implications of no Brexit deal for UK-EU cross border businesses and European entities.

Accounting and audit if there is a no deal Brexit

Corporate analysis: On 12 October 2018, the government published its fourth tranche of technical notes on a ‘no deal’ Brexit scenario. One of these notices sets out the implications for accounting, corporate reporting and audit after 29 March 2019 if the UK leaves the EU without an agreement in place.

Technical notice ‘Accounting and audit if there’s no deal’ (the Guidance) outlines the implications and high level guidance for accounting, corporate reporting and audit—including plans for ensuring a functioning regulatory framework for companies that mirrors, as far as possible, the same laws and rules that are currently in place.

The Guidance highlights that the UK currently follows the EU rules and regulations in relation to accounting, corporate reporting and audit which sets out how companies and other legal entities report on their financial activity, corporate governance arrangements and how those reports are audited. This is reflected in the UK in the CA 2006 and secondary legislation made under it. Specific legislation may apply to legal entities other than companies, but such legislation generally mirrors the legislation for companies (albeit with modifications). The Guidance clarifies that it applies to companies and other legal entities as appropriate.

The Guidance states that although the corporate reporting regime will remain unchanged in many respects, certain changes will be required to reflect that the UK is no longer a Member State.

UK incorporated companies (including subsidiaries and parents of EU companies) will continue to be subject to the UK’s corporate reporting regime, but certain exemptions in CA 2006 relating to the preparation of individual accounts will no longer be extended to companies with parents or subsidiaries incorporated in the EU.

Currently, a company may benefit from an exemption from the requirement to prepare individual accounts for a financial year if it satisfies the conditions set out in CA 2006, s 394A (for further details, see Practice Note: Dormant companies—accounts and audit—Dormant company exemption from the requirement to prepare accounts). This means that, provided it satisfies all of the conditions in CA 2006, s 394A, a dormant UK subsidiary of an EU parent company which prepares group accounts will not be required to prepare individual company accounts.

Following exit day, however, this will no longer be the case (ie, a UK dormant company with an EU parent company that prepares group accounts will no longer be able to rely on the dormant company exemption from the requirement to prepare individual accounts). The exemption in CA 2006, s 394A will only apply if the parent company is a UK incorporated company.

UK companies with branches operating in the EU are not currently required to comply with specific accounting and reporting requirements of the Member States in which they operate—compliance with the accounting and reporting requirements in CA 2006 is treated by those Member States as sufficient. Following exit day, UK companies with a branch operating in the EU will become third country businesses and will be required to comply with specific accounting and reporting requirements of the Member State in which they operate.

Branches of EU companies established in the UK will become subject to additional requirements under the overseas companies regime, and after exit will be subject to the same accounting and reporting requirements as non-EU companies that have a branch in the UK.

The Guidance states that UK companies that are listed on an EU market may also be required to provide additional assurance to the relevant listing authority that their accounts comply with IFRS and that this would need to be done in accordance with EU third country requirements. The government believes:

  1. that in the short term, this could lead to changes to the compliance statements required in annual accounts submitted to listing authorities
  2. the changes to reporting requirements will have implications for how UK accounting and company secretariat service providers interact with their clients, which could lead to the need for amendments to systems to capture additional information for reporting purposes and to obtain additional agreements and assurances from the relevant listing authorities prior to the relevant reporting dates

UK companies operating solely within the UK will be unaffected in relation to audit requirements. However, there will be additional audit requirements for:

  1. UK companies operating cross border
  2. the provision of audit services cross border

The Guidance clarifies that the UK will unilaterally provide a transitional period in relation to audit until the end of December 2020.

In addition, the Guidance clarifies that following exit day:

  1. an individual’s UK audit qualification may no longer be recognised in a Member State
  2. a UK audit firm that wishes to own part of, or be part of the management body of, an EU firm will no longer be recognised among the required majority of EU qualified owners or managers
  3. audits of EU companies seeking to raise capital by issuing shares or debt securities on a regulated market in the UK will need to be undertaken by an auditor registered with the FRC—the audits will need to be included in a series of inspections by the FRC of the registered auditor in the Member State where the company is incorporated until country is recognised in the UK as having an equivalent regulatory framework
  4. audits of UK companies seeking to raise capital by issuing shares or debt securities on a regulated market in the EU will need to be undertaken by an auditor registered as a ‘third country auditor’ in the Member State in which the market operates—the audits will be included in a series of inspections by the relevant regulatory authority for that market

For further information, see News Analysis: Accounting and audit if there is a no deal Brexit.

Additional news—daily and weekly news alerts

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New and updated content

New Resource Notes

We have published the following Resource Notes in our Corporate Governance topic:

  1. 2018 UK Corporate Governance Code—Introduction
  2. 2018 UK Corporate Governance Code—Section 1—Leadership and purpose
  3. 2018 UK Corporate Governance Code—Section 2—Division of responsibilities
  4. 2018 UK Corporate Governance Code—Section 3—Composition, succession and evaluation
  5. 2018 UK Corporate Governance Code—Section 4—Audit, risk and internal control
  6. 2018 UK Corporate Governance Code—Section 5—Remuneration

Dates for your diary

Date Development
1 November 2018 Deadline for comments on ISS’ consultation on auditor ratification.

See: LNB News 19/10/2018 74.

Trackers

To track key legislative and regulatory developments, see our Trackers:

  1. Brexit legislation tracker
  2. Brexit timeline
  3. Market Abuse—timeline
  4. Prospectus Regulation tracker
  5. Transparency Directive tracker
  6. Listing Rules tracker
  7. Disclosure Guidance and Transparency Rules Sourcebook tracker
  8. Prospectus Rules tracker
  9. Small Business, Enterprise and Employment Act 2015 tracker

Latest Q&As

We have added one new Q&A this week: Can the shareholders seek to vote on a matter during the course of a general meeting if only the general nature of the matter has been described in the notice of the meeting?

Useful information

To view analysis of the latest deals in the market and the underlying transaction documents, use our Market Tracker deal analysis tool.

To read about the latest corporate announcements, see our Market Tracker weekly round-up—19 October 2018.

To read about the latest issues and developments which we are following in Market Tracker, see our latest blog post: Market Tracker weekly bulletin—25 October 2018.

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