14 March 2019
The ASX Corporate Governance Council recently released the fourth edition of its Corporate Governance Principles and Recommendations (Corporate Governance Principles), which come into force from January next year. This timing was no accident – the release of the Corporate Governance Principles benefits from the charged environment surrounding the recently concluded Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry.
The community’s trust in corporate Australia is at a low point and the Council is looking to rebuild trust and return confidence. Some commentators have suggested that the Corporate Governance Principles would '…lack credibility and be regarded as useless if, in the wake of the Hayne Royal Commission, they did not include direct reference to the need for directors to focus on culture and values'.
This sits with Edelman's 2019 research that shows the 1150 participants from Australia recording an average trust level of 48 per cent. While distrustful overall, this is an improvement from the 40 per cent recorded in Edelman's 2018 research. But that improvement isn’t as universally accepted as we might think. There is a large gap between the 'informed' and 'uninformed' public.
More than 70 per cent of Australians believe corporates should take specific actions to increase profits and improve the economic and social conditions in the communities in which they operate. With this background in mind, Recommendation 3.1 requires listed entities to articulate and disclose their values. There are also other new recommendations – discussed below.
The Corporate Governance Principles call for an overt recognition of the role of values as the guiding principles and norms defining what an entity aspires to be and the expectations of directors, senior executives and senior employees. It looks for listed entities to provide guidance as to their and strategic goals and the expected standards of behaviour. This ties with the Royal Commission Final Report (Report) views on the community’s and investors’ expectation that entities will act lawfully, ethically and responsibly and that this should be reflected in an entity's values statement.
The 'social licence to operate' ideas contained in the earlier drafts have been replaced with references to 'reputation' and 'standing in the community'. This recognises that the Corporate Governance Principles themselves represent part of a 'contract' between business and society. In part it represents an attempt to come up with language which the Council believed was more likely to be understood and more consistently applied.
In this way the Corporate Governance Principles can be seen as an express attempt by the Council to address a perceived failure of some ASX-listed entities to appreciate and meet these obligations – or new ones created by a change in society's expectations, needs or priorities.
But the principle is clear – the Council sees an entity’s long term sustainable success as being dependent on maintaining the trust and goodwill of the various social groups with which it interacts. This seems to sit with comments made in the Report about the predominance of long term investors in the market. However, with ever greater focus on the year-to-year performance of superannuation funds it will be interesting to observe how this short term v long term focus manifests itself in assessments of company performance in coming years. It will also play out in their views on the application of non-financial remuneration thresholds to the remuneration of senior executives.
The Council’s position fits with the Report findings that companies do not owe it to shareholders to maximise returns at all costs. The Report says:
'It is not right to treat the interests of shareholders and customers as opposed. … Some shareholders may have interests that are opposed to the interests of other shareholders or the interests of customers. But that opposition will almost always be founded in differences between a short-term and a longer-term view of prospects and events.'
In the Commission’s – and, it would seem, the Council’s – view directors can 'stare down' the short term interests of shareholders in favour of non-shareholder interests:
'The longer the period of reference, the more likely it is that the interests of shareholders, customers, employees and all associated with any corporation will be seen as converging on the corporation's continued long-term financial advantage. And long-term financial advantage will more likely follow if the entity conducts its business according to proper standards, treats its employees well and seeks to provide financial results to shareholders that, in the long run, are better than other investments of broadly similar risk.'
We expect to see board charters and similar governance documents articulating more clearly how management and board responsibilities should be split, including the board’s responsibility for defining the entity’s purpose, approving the entity’s statement of values and code of conduct, and satisfying itself that remuneration policies are aligned with the entity’s purpose, values, strategic objectives and risk appetite.
We wonder whether Commissioner Hayne’s summary of the community’s expectations (obey the law; do not mislead or deceive; be fair; provide services that are fit for purpose; deliver services with reasonable care and skill; when acting for another, act in the best interests of that other) will find its way into many corporate statements.
This fits with the Report’s observations about what (at least the Commission) expects of directors, ie:
'… consideration of more than the financial returns that will be available to shareholders in any particular period. Financial returns to shareholders (or ‘value’ to shareholders) will always be an important consideration but it is not the only matter to be considered.'
It is again interesting that both the Corporate Governance Principles and the Report seek to explore the separation of responsibility between boards and management. The Report sees the duty of boards as including an obligation to continually engage and challenge management. The management must bring the right information to the board.
In the Corporate Governance Principles the Council makes it clear that they expect the senior executive team to be providing the board with accurate, timely and clear information. That information should concern not only financial performance, but also compliance with material legal and regulatory requirements and any conduct that is materially inconsistent with the entity’s values or code of conduct. This builds on observations in key court cases involving duties of directors and management, including James Hardie and Centro.
In the area of 'non-financial risk' a listed entity should disclose whether it has any material exposure to environmental or social risks and if does, how it manages or intends to manage those risks.
In the context of a material widening of the application of the Banking Executive Accountability Regime (BEAR), we also expect to see ASX entities reacting to these guidelines with a renewed focus on how remuneration packages are designed and measured. There will likely be a move away from pure return metrics towards better measurement of organisational culture. This will put a lot more pressure on remuneration committees. Could this mean for instance that the chair of the remuneration committee could become an 'accountable person' for overseeing the outcomes and alignment of remuneration practices?
The other key recommendations include:
The Corporate Governance Principles retain their fundamental design features, ie they have two distinct aspects:
This is why ASX Listing Rule 4.10.3 requires that listed entities report only against the Recommendations (but not the Principles and commentary) on an 'if not, why not' basis – or in other words, 'comply or explain'.
Before the start of the first full financial year commencing after January 2020, listed entities will need to focus on updating their policies and processes to have regard to the new Corporate Governance Principles and what they mean for their organisation. At the same time it will be important to consider whether the Report will impact on the way that you do business.
Australian Financial Service Licensees may need to extensively audit how their business operates. For many other firms it will mean a close look at the quality, independence and reliability of the internal processes adopted to manage their risks.
Organisations may need to review the framework they have in place to assess remuneration, to ensure it provides the right balance of financial metrics, customer outcomes and the management of non-financial risks over the long and short-term.
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