What is comply or explain?

“Comply or explain” gives businesses a certain amount of flexibility in adhering to regulations – although the underlying need to play by the new rules remains the same. 

It also sets up a standardised way of communication regarding obeying new rules.

It’s a principle that gives companies two options to comply with corporate law. Either:

1. Just comply with it
2. Explain why they haven’t

The first is straightforward. Your company just needs to obey the rules that regulators have set. 

The second is essentially regulators acknowledging that no “one size fits all” model exists regarding corporate law. 

Instead, it reflects that some businesses may naturally need to deviate from standards. Comply or explain gives businesses the legal space to do this without worrying about penalties. All they need is reporting that demonstrates solid reasoning behind it.

It’s not supposed to be; you shouldn’t think of it as one. 

If you go with this option, regulators will assume that your business tried its best to fully adhere to the relevant law. You will have to report on your attempt, where you fell short, and why. 

All of this is done through reporting that will be analysed. If regulators don’t think your reports (and efforts) are genuine, you’re technically in trouble. 

That said, “comply or explain” attracts criticism for this very reason. In the past, businesses have gotten away with explanations that many would consider vague, misleading or just too basic – all to get out of full legal compliance.

• It lets companies make realistic decisions about their capabilities based on their current resources. They can comply with what’s feasible and use “explain” to highlight areas that need attention. 
• It encourages openness and honest reporting. If firms feel they have a way to communicate efforts that have fallen short effectively, they’re less likely to hide that information. 
• At the same time, it also encourages accountability. When firms choose the “explain” option, they’ll need to provide details and argue their case. 
• It fosters a constructive relationship between businesses and regulators.

Because it’s often central to new governance or ESG (environment, social and governance) laws. 

The UK corporate governance code is one of the oldest and best examples. It came into force in the 1990s to beef up governance standards and has been an underlying principle ever since. 

EU directives in governance and ESG also use “comply or explain” as an underlying principle. The EU is a vast market where the same standards simply can’t apply to all firms in the same way. Comply or explain gives businesses – even entire sectors – wiggle room if needed.