Listed entities will face more onerous reporting under proposed changes to the ASX's Corporate Governance Guidelines.
The changes will affect annual reports for financial years beginning on or after 1 July 2014.
The Corporate Governance Council is seeking comments on the proposals.
Background to the proposed changes to the ASX's Corporate Governance Guidelines
The last major rewrite of the Guidelines was in 2007, just as the GFC was biting. The Corporate Governance Council ("CGC") notes that overseas legislators are now facing demands for mandatory requirements to address the governance failings that allegedly led to the GFC. The CGC makes no bones about the fact that the new rewrite is aimed at heading off similar demands in Australia.
This is particularly apparent in a new requirement that entities disclose whether (and how) they have regard to "economic, environmental and sustainability risks". While this requirement may seem far-reaching, the CGC makes the point that it is considerably less onerous than some overseas requirements, such as UK's "enlightened shareholder duty". This important new development is explained in greater detail by Claire Smith in this edition.
Finally, there will be a number of important structural changes to reporting on the Guidelines, including:
the current split between governance recommendations and the guides to reporting on those recommendations has been dropped, thus providing a one-stop shop for companies to determine what their reporting requirements are; and
a new Listing Rule Appendix 4G (which entities will have to lodge with their annual report) will give entities a checklist of the Corporate Governance Guidelines disclosure requirements and will require them to indicate where they have made those disclosures.
The new Appendix 4G will be useful for both reporting entities and anyone who has ever had to hunt through a company's annual report and website to find particular governance disclosures. It will also direct investors to information relevant to a company's compliance with a recommendation (which may not otherwise be apparent).
Key features of the new Corporate Governance Guidelines
A number of features of the new Guidelines are particularly worth noting.
There is a new recommendation for the establishment of a risk committee (either standalone or part of the audit committee) or an explanation of the Board's approach to risk management.
There is also a modification of director independence criteria and approach, including:
a recommendation that background checks on proposed directors be conducted;
a statement that directors holding that office for more than nine years are no longer prima facie considered to be "independent"; and
a recommendation that listed entities have a program for inducting new directors and providing appropriate professional development opportunities be provided to continuing directors, and a summary of the main features of such a program be reported.
Greater emphasis on risk management
The Corporate Governance Council says that risk management deficiencies were significant contributors to the causes and severity of the GFC. As a result, risk management assumes greater significance in the new edition of the Guidelines.
The key change is a considerably expanded requirement to report on the entity's risk management. The new Guidelines recommend that entities:
- have a standalone risk committee; or
- include risk management in the responsibilities of the audit committee; or
- if they do not have a risk committee (standalone or as part of the audit committee) disclose the processes that they use for identifying, measuring, monitoring and managing the material business risks that they face (Recommendation 7.1).
The Committee also ramps up the requirements for risk management systems.
At present, entities only have to disclose whether management has designed and implemented a risk management system and whether management has given the board a report about the system's effectiveness.
The new Guidelines impose a greater responsibility on the board itself. The board or a board committee should annually review the risk management framework with management, with three objectives:
to satisfy itself that the risk management framework is sound;
to determine whether there have been any changes in the material business risks faced by the entity; and
to ensure that the entity is operating within the risk appetite set by the board.
The commentary to this new recommendation suggests that entities should disclose any insights they gain from the review and any consequential changes they make to their risk management framework.
As noted above, the new Guidelines include three significant changes relating to directors.
Vetting potential directors
Perhaps the most unexpected is a recommendation that entities should undertake "appropriate checks" before appointing a director, or putting a person up for election to the board (Recommendation 1.2(a)).
What are "appropriate checks"? According to the commentary accompanying Recommendation 1.2(a), they include checks such as:
While the potential benefits of undertaking such checks are obvious (and indeed many listed companies will do this as a matter of course, either directly or through recruitment agents), there is no explanation of the reasoning behind this requirement. The references to criminal records, bankruptcy and character references appear to be aimed at ensuring that directors are not "bad eggs". However, the requirement to check a potential director's education appears to go to the person's qualifications for the job – in which case, it may be expected that their relevant practical experience should also be vetted.
What is an independent director?
This has been one of the most contentious issues in corporate governance since ASX first promulgated its corporate governance guidelines in 2003.
In the first edition of the guidelines, it was said that an independent director was a person who, among other things, had not served on the board "for a period which could, or could reasonably be perceived to, materially interfere with the director's ability to act in the best interests of the company". This reference to the length of a director's tenure was dropped from the 2007 edition, but has made a return in the proposed new guidelines, where matters "that might cause doubts about the independence if a director include if the director… has been a director of the entity for more than 9 years".
The CGC observes that nine years has been adopted as the appropriate yardstick by the UK, Singapore, South Africa and Hong Kong.
Of course, having served on the board for more than nine years (which equates to approximately three standard terms) does not necessarily mean that a director is not independent. However, if an entity decides that a director with more than nine years' service is still independent, it will be required to explain to members why it has reached that conclusion.
Professional development for directors
The commentary to the current guidelines suggests that entities should provide induction training for new directors and that existing directors "should have access to continuing education to update and enhance their skills and knowledge". However, this is not a recommendation against which entities have to report.
The proposed new guidelines go further, requiring entities not only to report on whether they have an induction and professional development program for directors, but also to provide a summary of the main features of that program.
As with the nine-year test for independent directors, the CGC bases this change on developments overseas.
Where to from here?
As noted above, the new guidelines are proposed to apply to annual reports for financial years beginning on or after 1 July 2014. Companies with a balance date of 30 June will be expected to comply with the new recommendations commencing with the financial year ended 30 June 2015 and companies with a balance date of 31 December will be expected to comply commencing with the financial year ended 31 December 2015.
The deadline for comments on the new guidelines is 15 November 2013, noting that ASX will be conducting a national road show later this month to discuss the proposed changes.
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