The controversial 'social licence to operate' terminology has been abandoned in the final version but the intent remains embedded?
The fourth edition of the ASX Corporate Governance Council's Corporate Governance Principles and Recommendations was released on 27 February 2019 following consultation. A high level overview of the key changes is below.
The fourth edition of the ASX Corporate Governance Council's (the Council's) Corporate Governance Principles and Recommendations was released on 27 February 2019 following consultation.
Commenting on the changes, Chair of the ASX Corporate Governance Council Elizabeth Johnstone said that the revised Principles and Recommendations address 'emerging issues around culture, values and trust, fuelled by recent examples of conduct by some listed entities falling short of community standards and expectations'.
The revised Principles and Recommendations come into force for financial years commencing on or after 1 January 2020.
The fourth edition maintains the same 'flexible, non-mandatory "if not, why not" approach' to disclosure as in the third edition. It also has the same structure: eight core principles, supporting recommendations, and commentary with guidance on implementing the recommendations.
The fourth edition contains 35 recommendations (compared to 29 in the third edition), including seven new recommendations. The new recommendations are as follows.
There are also two new recommendations that only apply to a small subset of listed entities.
In the final version, Principle 3 has been substantially redrafted to place a stronger emphasis on culture and values. It reads: 'a listed entity should instil and continually reinforce a culture across the organisation of acting lawfully, ethically and responsibly'. The revised principle is supported by three new recommendations: articulation and disclosure of organisational values (3.1), whistleblower policy (3.3) and an anti-bribery and corruption policy (3.4).
The Council notes that a number of submissions did not agree with the focus on culture in the fourth edition on the basis that 'the Principles and Recommendations should not attempt to prescribe culture' and that 'the focus of regulation should be on behaviour and not culture'. The Council explains that the changes were retained in the final version on the basis that they are considered 'fundamental' and necessary to addressing the governance and conduct issues raised in recent inquiries and to rebuilding trust.
The Council states that the fourth edition includes 'all of the key changes around culture and values proposed in the consultation draft' with some 'drafting changes'. Notable among these drafting changes is the decision against inclusion of the term 'social licence to operate' in the final version.
According to the Council, the proposed introduction of the term 'social licence to operate' into the fourth edition was 'unquestionably the most polarising issue addressed in the consultation feedback'.
The Council explains that the term was intended 'to convey the notion that a listed entity's long term sustainable success is dependent on maintaining the trust and goodwill of the various social groups with which it interacts'. However, submissions to the consultation raised concerns that that the term is 'vague and subjective', could be 'confused or conflated' with community support for particular social agendas, and that the notion of 'broader stakeholder accountability' inherent in it, might conflict with the duties of directors.
In response to this, the Council explains that the term has been 'replaced' in the fourth edition with references to 'reputation' and 'standing in the community'. Commentary under recommendation 3.1 (A listed entity should articulate and disclose its values) reads:
'In formulating its values, a listed entity should consider what behaviours are needed from its officers and employees to build long term sustainable value for its security holders. This includes the need for the entity to preserve and protect its reputation and standing in the community and with key stakeholders, such as customers, employees, suppliers, creditors, law makers and regulators.'
The Council states that it regards these concepts [standing in the community and reputation] as synonymous [with the term social licence to operate]' and adds that the 'modified terminology is more likely to be better understood and more consistently applied by listed entities'. The revised terminology is also consistent, in the Council's view, with the views put forward by Commissioner Kenneth Hayne.
Commenting on this, Governance Institute of Australia CEO Megan Motto is quoted in The AFR as stating that ' "[The guidance is] keeping step with the times but doing so in a language that is more meaningful and will not polarise but bring people together. That's the reason social licence to operate has been withdrawn as a piece of language even though the intent of that is still very much embedded'.
However, the deletion of the term 'social licence to operate' has been interpreted in some media reports as abandonment of the concept entirely.
In addition to a strong focus on culture and values, the fourth edition has stronger focus on management of non-financial risk. For example, commentary has been added under recommendation 7.2 to make clear that one of 'the key roles of the board of a listed entity' is to monitor the adequacy of the entity's financial and non-financial risk management framework. This includes satisfying itself that the risk management framework deals adequately with contemporary and emerging risks such as conduct risk, digital disruption, cyber-security, privacy and data breaches, sustainability and climate change.
A footnote to this commentary notes that this approach to risk is consistent with the approach taken in APRA's Prudential Inquiry into the Commonwealth Bank of Australia, which stated that: 'Conduct risk is 'the risk of inappropriate, unethical or unlawful behaviour on the part of an organisation's management or employees.' At its simplest, conduct risk management goes beyond what is strictly allowed under law and regulation ('can we do it?') to consider whether an action is appropriate or ethical ('should we do it?').'
The fourth edition includes a number of measures to encourage improvements to disclosure of environmental, social and governance (ESG) risks. These include the following.
Recommendation 1.1 includes a number of changes with respect to the role and responsibilities of the board, including with respect to the role of the board in 'instilling of the entity's values and performance generally'.
The fourth edition lists a number of new board responsibilities (aimed at supporting strong culture and governance). These include responsibility for:
New commentary has also been added to provide additional guidance on the role of the senior executive team and the role of the Chair. More particularly, the commentary to recommendation 1.1 has been amended to make it clear that the 'senior executive team is responsible for providing the board with accurate, timely and clear information on the entity's operations to enable the board to perform its responsibilities and that this is not just limited to information about the financial performance of the entity, but also its compliance with material legal and regulatory requirements and any conduct that is materially inconsistent with the values or code of conduct of the entity'.
The commentary in Box 2.3 (indicators of director independence) has been amended to: a) extend 'material business relationships' to include relationships as professional advisers and consultants; b) change 'close family ties' to 'close personal ties', along with the inclusion of commentary that these ties may be based on 'family, friendship or other social or business connections'; and c) to clarify that the reference to 'independence' having been compromised by long tenure refers to independence from management and substantial holders.
The commentary accompanying recommendation 2.3 states that where a director falls within one or more of the examples given, the board should rule the director not to be independent unless it's clear that it is not material and will not interfere with the directors' independent judgement and capacity to act in the best interests of the company.
With respect to board tenure, the revised Principles and Recommendations do not set a maximum tenure limit for board members. The commentary states that 'The mere fact that a director has served on a board for a substantial period does not mean that the director has become too close to management or a substantial holder to be considered independent. However, the board should regularly assess whether that might be the case for any director who has served in that position for more than 10 years'.
The commentary to recommendation 1.3 has been expanded to specify non-executive directors should be required to notify the organisation of 'or to seek the entity's approval before accepting any new role that could impact upon the time commitment expected of the director or give rise to a conflict of interest'.
In the consultation draft, it was proposed that new commentary be added to recommended 2.2 suggesting that boards give consideration to whether they have the necessary skills to deal with existing and emerging business and governance issues including: culture, conduct risk, digital disruption, cyber-security, sustainability and climate change. However, persuaded by arguments against the change (for example that inclusion of the list of skills implies boards need to be comprised of subject matter experts) the Council determined not to proceed. Instead, commentary has been added under recommendation 7.2 to make clear that one of 'the key roles of the board of a listed entity is to monitor the adequacy of the entity's risk management framework and satisfy itself that the entity is operating with due regard to the risk appetite set by the board.
Separately, some changes were made with respect to ensuring boards have and maintain the necessary skills to fulfil their roles, and to improve disclosure around board skills.
Recommendation 1.5 requires that boards (or a committee) have and disclose a diversity policy (in full) and to set measurable objectives for achieving gender diversity for senior executives and the workforce generally. The measurable objective for achieving gender diversity in board composition should be 30% for organisations in the S&P/ASX 300 Index.
The commentary suggests that the board or committee may wish to consider setting key performance indicators for senior executives on gender participation within their areas of responsibility and linking part of their remuneration to the achievement of those KPIs and also that gender diversity should be considered in the context of succession planning. The Council states that at this stage it considers also requiring gender pay audits/disclosure of gender pay audits (to address the gender pay gap) to be 'too prescriptive' at this point in time.
The commentary has also been amended to 'recommend' that 'boards of listed entities consider other facets of diversity in addition to gender when considering the composition of the board. In particular, having directors of different ages, ethnicities and backgrounds can help bring different perspectives and experiences to bear and avoid "groupthink" or other cognitive biases in decision making'.
Changes have been made to Principle 8 and its supporting principles to better align executive pay with organisations' values and risk appetites.
The commentary to recommendation 8.1 now identifies remuneration as a 'key driver of culture' as well as a focus for investors. When setting remuneration, the commentary now specifies that consideration should be had not only to the need for remuneration to incentivise executives and directors to pursue the growth and success of the entity, but also to the need to ensure that incentives don't reward 'conduct that is contrary to the entity's values or risk appetite'. In addition, the commentary now states that consideration should be given to the implications of being perceived by the community to be paying excessively.
Likewise, commentary under recommendation 8.2 now states that performance-based remuneration (for executives) should be linked to clearly specified performance targets, aligned to the entity's short, medium and longer term performance objectives and should be consistent with its circumstances, purpose, strategic goals, values and risk appetite. In addition it states that discretion should be retained, where appropriate, to prevent performance-based remuneration rewarding conduct that is contrary to the entities values or risk appetite.
[Note: ASIC's report on 2017 and 2018 AGM seasons expressed concern that a relatively high number of ASX 200 companies (25 companies in the ASX 200 in 2017 and 11 companies in the ASX 200 in 2018) continued to decide resolutions by a show of hands rather than by conducting a poll. See: Governance News 05/02/2018; 13/02/2019.]
[Sources: ASX Corporate Governance Council media release 27/02/2019; ASX Corporate Governance Principles and Recommendations: Fourth Edition; Consultation response; mark-up: comparison of the fourth edition to the consultation version; mark-up: comparison of the fourth edition to the third edition; [registration required] The AFR 27/02/2019; 27/02/2019; 27/02/2019; ACSI media release 27/02/2019; Investor Daily 27/02/2019; The Conversation 04/03/2019; Financial Standard 28/02/2019; [registration required] Governance Institute Report: Corporate Governance Principles and Recommendations]