Friday, 23 August 2013

Update to ASX Corporate Governance Principles and Recommendations – overhaul of approach or maintaining the status quo?

On 16 August 2013, as has been anticipated, the ASX Corporate Governance Council (CGC) released a consultation paper for a draft third edition of its Corporate Governance Principles and Recommendations (Principles and Recommendations).  This was released together with a separate consultation paper on Proposed Changes to ASX Listing Rules and Guidance Note 9, to supplement the proposed new Principles and Recommendations.

Although there have been some amendments to the second edition of the Principles and Recommendations (e.g. in relation to diversity initiatives), the draft third edition represents the first comprehensive review of the Principles and Recommendations since 2007 and, importantly, represents the first major redraft of key Australian corporate governance principles since the GFC.

The impact of the GFC is clearly seen in the new draft Principles and Recommendations, with an overarching focus by CGC on risk management and the importance of the board of directors having a greater degree of involvement and oversight in the adoption and implementation of corporate governance policies and procedures.  There is also a focus on encouraging the availability of corporate governance materials on a company’s website, rather than as a prescriptive requirement for the annual report.

The eight key principles enshrined in the Principles and Recommendations, together with the ‘if not, why not’ approach to reporting on corporate governance practices, have been retained in the draft third edition.  The overarching approach to corporate governance issues is therefore unlikely to alter.  However, the amendments to certain key principles and the approach to disclosure of corporate governance practices have received detailed attention, and it is worth reviewing the respective consultation papers to get a feel for these changes.

Some of the key proposed and/or interesting changes are:

To the Corporate Governance Principles and Recommendations:

  • A new recommendation 1.2(a) requiring a listed entity to undertake appropriate checks for an incoming director and to provide shareholders with all material information relevant to that person’s appointment.  This will act to supplement the relatively new admission requirement that a listed entity must show each director or proposed director is of ‘good fame and character’.
  • The diversity-related recommendations have been moved from principle 3 to principle 1 (relating to laying foundations for management and oversight), as CGC considers that the previous location of these recommendations resulted in confusion.  This is to be supplemented with a requirement that an entity report on the proportion of female employees in the whole organisation, in senior executive positions and on the board of directors.
  • More extensive guidance in relation to the ‘independence’ of directors has been included, to specifically include close family ties and service on the board for more than 9 years as indicators that a director may not be independent. 
  • Wording has been included in principle 3 on the importance of an entity promoting decision-making that creates ‘long-term value’ for security holders.  Combined with a new recommendation 7.3, relating to a listed entity disclosing how it has regard to environmental and social sustainability risks, there is a clear focus by the CGC on a move towards integrated financial reporting, as has recently been a focus of ASIC (see our comments in the blog dated 2 July 2013).
  • Principle 4 has been updated to provide for ‘formal and rigorous’ processes for financial reporting (which we expect is derived from recent cases such as the Centro decision). 
  • In relation to remuneration, CGC has provided a new recommendation for implementation of a ‘clawback policy’, which sets out when an entity may clawback performance-based remuneration for its senior executives (e.g. if there is a material misstatement of financial results).  This reflects relatively recent legislation proposed by the Australian Government.  The approach by CGC, that this is a matter best dealt with through an ‘if not, why not’ regime, rather than specifically through legislation, seems sensible – particularly in light of the complexities that have been faced by listed entities through the advent of the ‘two-strikes’ rule and other remuneration-related provisions of the Corporations Act.

To the ASX Listing Rules and Guidance Note 9:

  • Listing Rule 4.10.3 is to be amended to give greater flexibility for listed entities to make their corporate governance disclosures either in the annual report or on their website, and to make clear that an entity should disclose if it has not followed a recommendation for any part of the reporting period.  There is also an added requirement for an entity to state that the corporate governance statement has been approved by the board of directors, to ensure it receives appropriate focus at board level.
  • Perhaps the most significant change from an administrative viewpoint, is the proposed introduction of a new ASX form (Appendix 4G) to be completed and lodged with ASX each year (at the same time as the annual report).  This is intended to provide a key to assist investors and other stakeholders in locating an entity’s various corporate governance disclosures, recognising the flexibility being given by the amendments so that an entity’s corporate governance statements may not be in a single location on the company’s website or dealt with exclusively in the company’s annual report.  ASX has also indicated its hope that the Appendix 4G will act as a verification tool and reduce concerns in relation to standardised boilerplate documents.  We question whether the new Appendix 4G will achieve this outcome or simply become an additional administrative burden for entities during an already busy reporting period.
  • Although not directly governance-related, ASX is proposing to introduce a new Listing Rule 3.19B requiring specific disclosure of on-market purchases of securities (i.e. through a trustee structure) on behalf of employees, directors or their related parties within 5 business days.  ASX has indicated that, although it does not consider security holder approval is required, it is appropriate for disclosure to be made to the market, for such transactions.
  • Additional guidance has also been provided to highlight how the Principles and Recommendations apply differently to externally managed listed entities.

The majority of the changes are intended to become effective on 1 July 2014, with some of the amendments to the ASX Listing Rules to come in earlier (on 1 January 2014).  ASX and the CGC have asked for comments by 15 November 2013.  We will be collating any responses received from our clients on the consultation papers and considering appropriate submissions to make to ASX and CGC.  We will also continue to monitor and comment on the developments in this area, which will result in a revised Chapter 4 of The Chairman’s Red Book in due course. 

Wednesday, 7 August 2013

UK Corporate Governance Reform Proposals and the Implications for Australia

Recently, the UK Business Secretary, Dr Vince Cable, launched a policy paper entitled Making companies more accountable to shareholders and the public containing some radical law reform proposals with major implications for corporate governance.  As corporate law developments in the UK often influence Australian law reform, it is worth considering some of the more dramatic proposals.

The role of British banks in the GFC and the consequential impacts upon public finances and the economy in the UK provided the setting and motivation for the release of the paper.  In particular, it drew on the considerations and recommendations set out in the final and major report of the Parliamentary Commission on Banking Standards (PCB) entitled Changing banking for good.

That report criticised the lack of regulatory body action against those who had presided over substantial failures within banks and found the existing regime provided an imbalance of incentives (i.e. permission to undertake aggressive risks but without sufficient accountability mechanisms to act as a counterbalance).  Further, it identified a combination of collective decision-making, complex decision-making structures and extensive delegation which made it difficult to hold particular senior banking officials responsible for even the most widespread and flagrant failures. Two measures in particular recommended that:
  • all key responsibilities within a bank be assigned to a specific, senior individual who, regardless of any delegation or sharing of tasks, would remain legally responsible (Senior Persons Regime), and
  • the Commission proposed the creation of a new criminal offence of reckless misconduct in the management of a bank which was subsequently supported by the Industry Secretary .  This offence would apply to those covered by the proposed Senior Persons Regime.  Regardless of the degree of difficulty in obtaining a conviction, such a specific regime would galvanise the attention of those who lead a bank which is over-leveraging its assets; creating high risk, complex products; or departing from reasonable standards of asset allocation.  The criminal offence proposal is accompanied by a recommendation that civil recovery action can be taken against those convicted of reckless management of a bank.  To increase the prospect of directors being personally liable for the consequences of fraudulent or wrongful trading (a term of potentially wide import) liquidators will have the right to sell or assign fraudulent or wrongful trading actions.
Other proposals put forward by Secretary Cable include:
  • a regime to identify beneficial ownership of company shares to effectively identify the ultimate controllers of shares and companies
  • limits on the use of bearer shares, and
  • new directors’ duties and wider powers for the Court to assess directors’ duties.
The paper proposes some specific reforms for the banking and finance sectors and others of general applicability to directors.

Secretary Cable supported the PCB's recommendations that directors of a bank be subject to a duty to prioritise the safety and stability of the bank over the interests of shareholders.  Further, it is proposed to widen the powers of the Court to disqualify directors by allowing a much more extensive range of matters to be considered including the scale of the loss and the impact on wider society.  This would require directors to balance a wider range of stakeholder interests when making decisions and keeping matters under review.  When combined with the Senior Persons' Regime, these proposals, if adopted, have significant implications for corporate governance, including the recruitment process and criteria for appointing senior executives of banks and members of boards.

As history shows, radical regulatory reform proposals often follow dramatic crashes.  This is entirely understandable, as is the desire of a government to respond to failures of market forces which result in, as has recently been the case, the public assumption of private debts and losses.  The Senior Persons Regime appears to be capable of eliminating some of the enforcement complexities and failures of the existing regime, but the wider director duty proposals may, upon closer scrutiny, be more problematic than practical.

For example, if the board in effect has to have regard to the national interest, how in practical terms, can it distill a decision from a wide range of possibly competing factors.  Equally, if there is a duty to advance safety and stability over other considerations, would it imply that all directors have to have extremely high, possibly actuarial, levels of financial literacy?  Without these, how would one be able to assess the potential impacts of complex instruments and algorithmically generated portfolios.

The proposals, which are open for public consideration, will be watched carefully for any signals they may send to Australian law reformers.

Peter is a Professor of Business Law, Executive Dean of the QUT Business School and a Consultant to McCullough Robertson on Corporate Advisory issues.