ASX-listed entities (along with the rest of corporate Australia) will need to review their corporate governance policies and procedures, following the release this morning of the finalised version of the fourth edition of the ASX Corporate Governance Principles, which takes effect from a listed entity's first full financial year commencing on or after 1 January 2020. This means that entities with a financial year ending 31 December will need to adopt and report against the new Principles in respect of the financial year ending 31 December 2020, and entities with a financial year ending 30 June will need to adopt and report against the new Principles in respect of the financial year ending 30 June 2021.
Onerous and controversial recommendations in the Consultation Draft of the Principles have been removed, including those recommendations which potentially conflicted with the traditional understanding of the duties and responsibilities of directors in Australia. Further, sections which gave rise to uncertainty have been clarified. For example, the concept of a "social licence to operate" has been removed.
The Principles emphasise the matters to be addressed in an entity's Board charter and the composition and roles of Board committees including audit, risk, nominations and remuneration. As a consequence, entities will need to review their existing committees and the applicable charters.
We will be sending a fuller analysis of the new Principles in the next few days; in this Alert we will highlight the main changes from the Consultation Draft, and the key areas for future action.
What was proposed: The Board is responsible for defining the entity's "purpose", with the implication that entities are explicitly expected to have a positive impact on its stakeholders and society at large.
Status: Boards are now generally expected to clearly define the entity's purpose and to set its strategic objectives (Recommendation 1.1). The Principles have also introduced some further commentary reinforcing Commissioner Hayne's comments in the Final Report of the Financial Services Royal Commission with respect to the responsibility of the Board and its interaction with management. Boards must consider both financial and non-financial risks, implement frameworks for relevant information to be reported by management to the Board, and ensure that they challenge management where appropriate. Boards must also satisfy themselves that remuneration policies are aligned with the entity's purpose, values, strategic objective and risk appetite.
Instil the desired culture
What was proposed: The Board and Management are expected to instil a culture across the entity of acting lawfully, ethically and in a socially responsible manner ie. be "good corporate citizens". A listed entity's "social licence to operate" is one of its most valued assets and is designed to compel entities to ensure a broad range of stakeholders are borne in mind. Securityholders expect Boards and management to engage with these stakeholders and to be, and be seen to be "good corporate citizens".
Status: The much debated introduction of the "social licence to operate" concept has been scrapped, although the idea that companies should consider a broader range of stakeholders to maintain their reputation and standing in the community is still prevalent in the new edition. The commentary in the Principles provides that entities should act lawfully, ethically and responsibly and this should be reflected in the statement of values (Recommendation 3.1). The Principles are less prescriptive in how an entity may instil this desired culture, but the concepts of culture, values and trust remain intact.
However, the removal of the "social licence to operate" will not end the ongoing discussions within the broader community as to the role of corporate Australia, and its reputation and meeting community standards. Nor will it end the continuing debate with respect to shareholder primacy and the need for Boards to have regard to the interests of other stakeholders.
What was proposed: The Board is expected to define the entity's "core values", which must include providing positive outcomes for a variety of stakeholders, including employees, customers, local communities and shareholders, and not just shareholders. "Core values" create a link between the entity's purpose and its strategic goals.
Status: The Principles emphasise that the Board must now define the entity's "values" as opposed to its "core values". Those values must include providing positive outcomes for a variety of stakeholders, not just an entity's shareholders. This change is a clear response to the issues emerging form the Hayne Royal Commission and goes directly to the desire to create a more ethical corporate culture amongst entities.
Environmental and social risks
What was proposed: The Board must ensure that it reviews the listed entity's risk management framework so that it is taking into account long-term risks (such as climate change, environmental and social risks) that correlate with broader stakeholder interests. This recognises that a listed entity's "social licence to operate" can be lost or seriously damaged if the entity conducts its business in a way that is not environmentally or socially responsible. ASX-listed entities should also carefully consider their benchmarks for disclosure with respect to environmental or social risks (eg. climate change).
Status: These changes have been adopted, although they have been somewhat watered down with the removal of the concept of an entity losing its social licence to operate where an entity does not act environmentally or socially responsibly. The benchmarking concept was retained, so that entities who do not think they have any material exposure to environmental or social risks should benchmark their disclosures against those made by their peers. The Principles also adopt the recommendation listed entities with material exposure to climate change risk to consider implementing the recommendations of the Financial Stability Board’s Task Force on Climate-related Financial Disclosures.
The Principles introduce some additional and emerging risks that Boards must review as part of their organisation's risk management framework, including conduct risk, digital disruption, cyber-security, privacy and data breaches (as well as the already mentioned sustainability and climate change risks).
These changes reflect the fact that entities must provide greater disclosure on these issues, and particularly non-financial risks and the impact those risks may have on an entity.
Directors' knowledge of the entity
What was proposed: Increased emphasis on directors having "knowledge of the entity and the industry in which [the entity] operates" in order for the Board to be effective (Recommendation 2.1).
Status: The Principles now reflect that the Board should collectively have the skills, commitment and knowledge of the entity and the industry in which it operates, to enable it to discharge its duties effectively and to add value.
Directors' skills matrix
What was proposed: Reformed Board "skills matrix" process so that Boards are transparent in disclosing the skills and knowledge the Board requires, and comparing that to the existing skills and knowledge of the current directors.
Status: The addition of detailed commentary around Board skills matrixes has been removed, reflecting feedback that it is inefficient and unnecessary to recruit Board members to address an apparent skill gap. The requirement to disclose the skills of individual directors has been removed and disclosure need only be made collectively across the Board as a whole (Recommendation 2.2).
Directors' professional development
What was proposed: New emphasis on professional development for directors in a number of key areas such as the entity's structure, business operations, history and culture, as well as legal duties and responsibilities as a director, and a basic level of understanding of accounting matters.
Status: Directors must now be offered training on the "entity's structure, business operations, history, culture and key risks" and may involve conducting site visits of key operations (Recommendation 2.6). Where necessary, training should also be offered on the "legal duties and responsibilities as a director" and a basic accounting skills. As such, any gaps identified amongst the skills of the directors should not be "addressed in the short term by new appointments", but rather by professional development.
Directors should be aware that they must engage in continual professional development to stay up of date with current technological, legal and financial challenges and practices to ensure they maintain that industry knowledge. This is particularly relevant for Directors who have served on a Board for an extended period of time.
Measurable objectives for diversity
What was proposed: New emphasis on "numerical, measureable objectives" for diversity at all levels of a listed entity, include the composition of its Board, senior executives and workforce generally. The explicit target has been set for ASX300 listed entities to have not less than 30% of its directors of each gender on the Board within a specified period, representing a shift away from "aspirational objectives" to hard, numerical targets. The Consultation Draft also proposed that entities should disclose, in relation to each reporting period, the measurable objectives set for achieving gender diversity as well as progress towards achieving those objectives.
Status: While much of the prescriptive commentary with respect to measurable objectives for diversity has been deleted from the Principles, the numerical target of 30% for ASX300 listed entities remain. The proposal that entities should report on measurable objectives (and the progress of those objectives) for achieving gender diversity has been retained.
Broadening the types of diversity to be considered
What was proposed: Board composition should now factor in other aspects of diversity in addition to gender, such as geographic and cultural.
Status: Again, while some of the prescription has been removed, the concept of considering all aspects of diversity such as age, ethnicities and backgrounds remain as part of the suggestions of a diversity policy for an ASX-listed entity.
Again, echoing the concerns raised by Hayne, the Principles provide some additional parameters for listed entities to consider when developing their remuneration model and structure, recognising now that remuneration is a key driver of culture and a key focus for investors. Implications of a remuneration model on an entities reputation and standing in the community must be considered by a listed entity as part of the matters it balances when developing a remuneration structure. Furthermore, the Principles suggest that performance-based remuneration should not reward conduct that is contrary to the entity's values or risk appetite. Listed entities must take into account the implications of their remuneration model in terms of how it drives behaviour from within an organisation, and how it impacts its perception outside of the organisation (Recommendation 8.1 and 8.2).
These entities will need to review their Board and Board committee charters, roles, responsibilities and day to day activities to ensure that they are consistent with the Principles and if not, to be able to disclose the reason for the non-compliance. Specifically, the Principles further emphasise the messages emerging from earlier reports including the Hayne Royal Commission Report of the importance of an entity's purpose, culture and values.