National Grid Transco - Annual Report and Accounts 2003/04 - Corporate Governance and Risk Factors

National Grid Transco is subject to the Combined Code on Corporate Governance that is appended to the Listing Rules of the UK Listing Authority. The Combined Code sets out principles and provisions relating to the good governance of companies.

The Combined Code has recently been subject to review (the Higgs Review of the role and effectiveness of non-executive directors) which resulted in the publication of a new Combined Code, applicable to financial years starting on or after 1 November 2003.

Throughout the year, National Grid Transco has complied with all of the relevant provisions set out in the Combined Code as applicable for financial years starting prior to 1 November 2003. Additionally, as at the date of this report, the Company complies with the relevant provisions of the new Combined Code as applicable for financial years starting on or after 1 November 2003. The following information is compiled in accordance with the new Combined Code.

The Board

The Board currently consists of 14 Directors comprising the Chairman, six Executive Directors (including the Group Chief Executive) and seven Non-executive Directors (including the Deputy Chairman and Senior Independent Director). Short biographical details of each of the Directors can be found in the Board of Directors section.

There were two changes to the Executive Directors on the Board during the year. Nick Winser was appointed on 28 April 2003 as Group Director responsible for UK and US Transmission. John Wybrew retired on 30 November 2003, having previously been Group Corporate Affairs Director. His role was divided between the remaining Executive Directors and certain senior managers.

There were also two changes to the Non-executive members of the Board. Bonnie Hill retired on 21 July 2003 and Maria Richter was appointed on 1 October 2003.

It has been announced that Rick Sergel will retire at this year’s Annual General Meeting (AGM) being replaced on the Board by Mike Jesanis.

All Directors are required to be re-elected by shareholders at the AGM following their appointment by the Board and then at least once every three years. To ensure that a representative number of Directors are re-elected each year, one-third of Directors (excluding new appointments) must stand for re-election at each AGM.

In the opinion of the Board each of the Non-executive Directors is currently independent under the guidelines set out in the new Combined Code. This opinion is based on current participation and performance on both the Board and Board Committees including consideration of the length of service at National Grid Transco together with that at either Lattice or National Grid.

The main duties of the Chairman outside of the Group are included in his biography in the Board of Directors section. During the year, the Chairman resigned as a Non-executive Director of Brambles Industries plc (October 2003). It has been announced that as from 1 June 2004 Sir John Parker will become the senior Non-executive Director designate of the Court of the Bank of England, taking over the chair in February 2005.

The Board is led by the Chairman whose role, along with that of the Group Chief Executive, has been set out and approved by the Board.

In order to ensure effective control of the Group the Board restricts certain decisions to itself. These matters reserved to the Board include:

The Board manages these matters at its regular Board meetings and strategy days. It also receives reports and presentations from each of the operating divisions, key central functions and minutes and/or oral reports of Board Committee meetings. This ensures that all Directors are aware of, and are in a position to monitor effectively, Group operations and current issues.

The Chairman meets the Non-executive Directors at least twice per year in formal session (once with the Group Chief Executive present). These meetings and other regular informal discussions create the opportunity for valuable input from the Non-executive Directors.

The Board is also ultimately responsible for the Group’s system of internal control and for reviewing its effectiveness. National Grid Transco’s system of internal control helps to safeguard the Group’s assets and is designed to manage, rather than eliminate, material risks to the achievement of the Group’s business objectives. The review of internal control recognises that any such system can provide only reasonable, and not absolute, assurance against material misstatement or loss.

The Board, together with the Executive, Audit and Risk & Responsibility Committees, is central to the internal control process. Throughout the year the Board receives reports from each of these Committees and as part of the year-end process receives the Group Chief Executive’s Letter of Assurance. This process seeks to confirm compliance with all major internal and external requirements along with the existence of appropriate controls and processes to manage risks and to provide details of material risks and control weaknesses. The Board additionally conducts a formal review of the effectiveness of internal controls based on the information and assurances provided to it directly and via the Committees mentioned.

In response to Section 406 of the US Sarbanes-Oxley Act 2002, the Board has adopted a Code of Ethics for senior financial professionals. This code is available on the Group website at www.ngtgroup.com/about/mn_corp_govern.html (where any amendments or waivers will also be posted).

Board Committees

To ensure that the broad range of responsibilities that fall to the Board are managed effectively and in an appropriate manner, it has established a number of Committees. These are the Audit, Executive, Finance, Nominations, Remuneration, and Risk & Responsibility Committees.

Each Committee has established terms of reference, agreed by both the Committee and by the Board. The terms of reference for each of these Committees are published on the Group website at www.ngtgroup.com/about/mn_corp_govern.html.

Audit Committee
The members of the Audit Committee are John Grant, Ken Harvey and Paul Joskow. The Committee is chaired by George Rose. Each of these Non-executive Directors is independent. The Board has determined that George Rose is an ‘audit committee financial expert’ as required by the Audit Committee terms of reference and pursuant to Section 407 of the Sarbanes-Oxley Act (for his biographical details see the Board of Directors, Non-executive Directors).

The Chairman, Deputy Chairman, Group Chief Executive, Group Finance Director, external auditors, Group Head of Audit, and Group Company Secretary and General Counsel are invited to attend most meetings.

During the year, the Audit Committee met separately with the external auditors without management being present.

Expanding on the Audit Committee’s role with respect to the external auditors the Committee is responsible for managing the relationship which includes (but is not limited to):

Details of both the audit and non-audit fees paid to the auditors during the year are set out in note 3 to the accounts.

Executive Committee
The Board has essentially delegated the day-to-day running of the Group to the Executive Committee which is made up of each of the Executive Directors, the Group Company Secretary and General Counsel and Mike Jesanis as Chief Operating Officer of National Grid USA. The Executive Committee is chaired by the Group Chief Executive.

The Executive Committee is responsible for managing and safeguarding the interests of the Group. In managing the Group the Committee is responsible for furthering Group strategy, business objectives and other targets established by the Board.

The Executive Committee’s key tasks include keeping under review the adequacy of reporting arrangements and the effectiveness of internal control and risk management. At its regular meetings it considers safety and environmental performance reports and operational business performance reports. The Executive Committee also considers the Group’s annual business plan, the capital allocation programme and the annual operating budget.

On behalf of the Board the Executive Committee receives and considers half yearly due diligence and certifications by the operating businesses and corporate centre functions in connection with the completeness and accuracy of financial statements and associated disclosures. The Committee also receives regular reports on the results of internal audits and, on an exception basis, on safety and environmental audits and occupational health reviews.

Finance Committee
The Finance Committee is chaired by Paul Joskow, the other members being Roger Urwin, Steve Lucas, Stephen Pettit and Maria Richter (who joined the Committee following her appointment to the Board in October 2003).

The Finance Committee is responsible for setting investment and financing policy decisions including items such as bank accounts, guarantees and treasury management. The Finance Committee also provides recommendations to the Board in respect of tax, pensions and insurance strategy.

Nominations Committee
The members of the Nominations Committee are James Ross, John Grant, Ken Harvey and George Rose, each of whom is independent. Sir John Parker chairs the Committee.

The main responsibility of the Nominations Committee is to keep under review the size, structure and composition of the Board. When necessary it is the responsibility of the Committee to identify and nominate for appointment Board Directors and direct reports to the Group Chief Executive. The Nominations Committee must also consider the annual reappointment of Directors, proposing which Directors should retire and seek reappointment by shareholders, having first considered the effectiveness and independence of any Non-executive Directors.

The Nominations Committee is also responsible for reviewing the leadership needs of the Group and for co-ordinating the review of the Board and Committees as well as Director independence each year.

Remuneration Committee
The Remuneration Committee members are Ken Harvey, Stephen Pettit (who was appointed to the Committee in November 2003) and George Rose. The Committee chairman is John Grant. Bonnie Hill was a member of the Committee until her retirement from the Board in July 2003. Each of these Non-executive Directors is independent.

The Chairman, Deputy Chairman, Group Chief Executive and the Group Human Resources Director are invited to attend meetings as appropriate.

The Committee is also responsible for ensuring that the employee pay and benefit structures are aligned throughout the Group and for compiling and recommending to the Board for approval the Directors’ Remuneration Report.

The Remuneration Committee has authority to obtain the advice of outside independent remuneration consultants and, where appointed, is solely responsible for their retention, termination, approval of fees and other terms.

Risk & Responsibility Committee
James Ross chairs the Risk & Responsibility Committee, its other members being Stephen Pettit and Maria Richter (who joined the Committee following her appointment to the Board in October 2003). Bonnie Hill had been a member of the Committee until her retirement from the Board in July 2003.

The Group Chief Executive, two external specialists (advisors on safety and environmental affairs), the Group Corporate Responsibility Director and the Group Company Secretary and General Counsel are expected to attend meetings.

The responsibility of the Committee is to review the strategies, policies, management, initiatives, targets and performance of the Group, and where appropriate its suppliers and contractors, in the following areas:

The Risk & Responsibility Committee is involved in the internal control process as it considers and provides reports to the Audit Committee on reputational risks and other risks of a non-financial nature including safety, health and environmental risks.

Board and Board Committee attendance

The following table indicates the number of meetings of the Board and each of its Committees held during the year and the number of those meetings that each of the Directors attended as a member:

(i) Mike Jesanis was not attending the Executive Committee as a member of the Board but as Chief Operating Officer of National Grid USA.
(ii) Nick Winser was appointed to the Board on 1 May 2003.
(iii) John Wybrew resigned from the Board on 30 November 2003.
(iv) Bonnie Hill resigned from the Board on 21 July 2003.
(v) Stephen Pettit was appointed to the Remuneration Committee on 18 November 2003.
(vi) Maria Richter was appointed to the Board on 1 October 2003.

Disclosure Committees

In response to the requirements of the Sarbanes-Oxley Act, National Grid Transco constituted several disclosure committees across the Group. The Group Finance Director chairs the Group disclosure committee. The main purpose of this committee is to ensure that when disclosing information the Company represents itself completely, fairly and accurately to its security holders and that it complies with applicable laws and stock exchange requirements. The committee is also responsible for reviewing the evaluation of disclosure controls.

Board effectiveness

The effectiveness of the Board, its Committees and each of the Directors is important to the operation of the Group. A formal evaluation process has been established to address this issue. This process is in the form of a questionnaire used to assess the effectiveness of the Board, the Chairman and each of the Committees. The questionnaire is supplemented by one-to-one meetings between the Chairman and each of the Directors where individual performance is openly discussed. The Non-executive Directors also meet separately to discuss the performance of the Chairman. Based on the output of the questionnaire and the one-to- one meetings, an action plan is drawn up to ensure continuous improvement in Board processes and procedures. This evaluation process highlighted several areas where improvements have been made to processes and Board Committee terms of reference, particularly in terms of interaction between the Committees.

Communication with shareholders

During the year the Group Chief Executive and Group Finance Director have regular meetings with institutional investors, fund managers and analysts to discuss information made public by the Group. In addition the Chairman reminds major shareholders, in writing, of his availability (along with that of the Senior Independent Director or Non-executive Directors where required) should there be issues which shareholders may wish to raise.

To ensure that the Board is effectively informed of shareholder views it receives regular presentations, in particular twice a year following the publication of results. Feedback on major shareholders’ views is provided by the Company’s brokers and supplemented by the Group Head of Investor Relations. This ensures that all Board members, including the Non-executive Directors, are aware of the views of major shareholders and of any outstanding issues that they may have.

The principal method of communicating with the majority of shareholders is via the Annual Review. All shareholders also have the opportunity to attend the Company’s AGM and to question Directors on any issues relating to the management of the Company. The Group also has in place a Shareholder Networking Programme, which allows a small number of shareholders to visit operational sites and meet with senior managers and Directors. More details of the Shareholder Networking Programme can be found in the Shareholder Information section.

Corporate governance practices: differences to New York Stock Exchange (NYSE) listing standards

The corporate governance practices of the Group substantially conform to those required of US companies listed on the NYSE. The principal area of difference is that governance issues are not considered by a separate committee of independent Non-executive Directors, but by the Board as a whole, as is usual practice in the UK.

Risk management overview

In the course of 2003/04 and in close collaboration with our operating businesses and Corporate Centre functions, we have developed a best practice Group-wide risk management process to replace the respective processes that both National Grid and Lattice had in place at the time of Merger. The new enhanced process requires us to define our Group objectives and then consider the key risks that may prevent us from achieving those objectives. For the purposes of this exercise five Group objectives, considered fundamental to the success of National Grid Transco, have been set. These are as follows:

Corporate governance

Combined Code statement of compliance