UK changes reporting rules for private company directors

Privately owned companies are being asked to provide greater transparency — and regulatory changes in the UK could indicate the way forward for Australia, writes Professor Pamela Hanrahan.

Large private companies have always been an important feature of the Australian business landscape. Data compiled by IBISWorld indicates that almost one in eight (48 of 390) Australian companies with revenue over $1b are in this category. The top 500 privately owned companies generated more than $219b in revenue in 2017–18 and accounted for an estimated 4.6 per cent of total employment. They include Visy Industries, Hancock Prospecting and 7-Eleven. The scale of their operations means decision-making in these companies can impact significantly on the communities and markets in which they operate.

In Australia, privately owned companies have traditionally operated outside the formal governance and transparency frameworks applied to listed entities such as the ASX Corporate Governance Council’s Corporate Governance Principles and Recommendations. While standard financial reporting obligations apply to unlisted public companies and large proprietary companies, those reports may not be widely available and do not typically include governance disclosures. In the absence of external shareholders, corporate law has given privately owned businesses and their boards considerable latitude to structure governance arrangements to suit the specific needs and preferences of the owners, without having to disclose those arrangements — or the rationale for them — publicly. Of course, those needs and preferences may be quite different between family businesses, companies controlled by private equity, subsidiaries of foreign corporations and quasi-partnerships.

This traditional approach is being rethought in the UK, where changes to corporate reporting requirements that take effect in January 2019 recognise more explicitly the interests of stakeholders other than shareholders in the manner in which large privately owned companies are governed.

In its report on corporate governance released in April 2017, the House of Commons’ Business, Energy and Industrial Strategy Committee concluded there was a need for greater transparency and accountability for large private companies in the UK. The committee was persuaded by arguments that companies with “a significant presence in the community should be required to report on non-financial matters for the benefit of employees and other stakeholders”. It recommended changes to corporate reporting requirements for large private companies, along with the development of an appropriate corporate governance code.

The UK government adopted the recommendations in 2018. The first new reporting obligation applies to all large UK private companies — a category that includes businesses with more than 250 employees, or turnover of more than £36m and net assets exceeding £18m.

From 2019, the annual reports of these companies must include a statement describing how the directors have had regard to the matters set out in section 172(1) (a) to (f) of the Companies Act 2006 (UK). Section 172 requires a director of a UK company to act “in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so [to] have regard to” specified matters.

These matters are: the likely consequences of any decision in the long term; the interests of the employees; the need to foster the company’s business relationships with suppliers, customers and others; the impact of the company’s operations on the community and the environment; the desirability of the company maintaining a reputation for high standards of business conduct; and the need to act fairly between members of the company.

The new reporting obligation requires directors of large private companies in the UK to explain publicly how they have taken these considerations into account in corporate decision-making. The companies are also required to disclose how the directors have engaged with its employees and how they have had regard to employee interests.

The second change affects very large private and unlisted public companies — generally those with more than 2000 employees globally, or global turnover exceeding £200m and a balance sheet of over £2b. It imposes on directors an obligation to report against a corporate governance code or, if the directors decide not to apply an existing code, to explain their reasons for not doing so and the corporate governance arrangements they have in place for that financial year.

This change was accompanied by the release in December 2018 of the Wates Corporate Governance Principles for Large Private Companies in 2018. Developed for the UK Financial Reporting Council (FRC) by a consultative group convened by James Wates CBE, chair of a large family-owned construction and property business, the Wates Principles address matters of board composition and responsibilities, and the role of the board in the areas of corporate purpose, opportunity and risk, remuneration and stakeholder engagement.

For Australian directors of privately owned companies, the Wates Principles may provide a useful starting point for discussions by boards — and between boards and owners — about the way in which corporate decision-making should be structured to take account of the interests of stakeholders. More broadly, many directors will be watching with interest to see how enhanced disclosure of governance matters in UK private companies affects their behaviour and the behaviour of their various stakeholders.