On 2 May 2018, the ASX Corporate Governance Council announced the proposed fourth edition of its Corporate Governance Principles and Recommendations (“CGPs”).

The proposed fourth edition arrives at a time of various challenges to corporate governance practices, including the ongoing Hayne Royal Commission, APRA’s report into CBA, BEAR and new whistleblowing, anti-corruption and modern slavery laws.

The ASX Corporate Governance Council presents the proposed fourth edition as “anticipating and responding to” some of these governance issues.

Directors, company secretaries and executives have until 27 July 2018 to respond to the proposed fourth edition before it is set in stone early next year.

This note aims to highlight some of the key changes sought to be implemented in the fourth edition, as well as our initial reactions to it.

Whether or not you plan to respond to the 27 July 2018 deadline, we would be delighted to hear your views on the fourth edition.

So what’s new in the fourth edition?

The draft fourth edition retains the same 8 core principles from the third edition.

The key change in the draft fourth edition is a substantial redraft of Principle 3 to address emerging issues around corporate values and culture, and the “social licence to operate”.

In addition, the fourth edition proposes to introduce 9 new recommendations within the existing 8 core principles.

When will the fourth edition come into effect?

The ASX Corporate Governance Council is targeting a release of the final version of the fourth edition in early 2019 to take effect for an entity’s first full financial year commencing on or after 1 July 2019. Entities with a 30 June balance date will be expected to report their governance practices against the fourth edition commencing with the financial year ending 30 June 2020, while entities with a 31 December balance date will be expected to report against the fourth edition commencing with the financial year ending 31 December 2020.

Our initial reactions to the fourth edition

The ASX Corporate Governance Council should be commended for inviting all stakeholders to comment on the proposed fourth edition.

The Council’s aspiration to maintain strong corporate governance standards is also commendable. It is essential to the strength and longevity of ASX as a capital market.

There are, nonetheless, some matters which we think will require further consideration by the Council and which we have outlined below. We would be delighted to hear your views on these issues, as well as any other aspects of the new CGPs.

1. ASX Corporate Governance Council’s view of Board responsibilities is inconsistent with Australian law

According to the ASX Corporate Governance Council, preserving a listed entity’s “social licence to operate” requires that the entity’s board and management “musthave regard to the views and interests of a broader range of stakeholders than just the entity’s security holders”. The Council suggests that the other stakeholders which should form part of an entity’s considerations include employees, customers, suppliers, creditors, regulators, consumers, tax payers and the local communities in which the entity operates.

With respect, the assertion that directors “must have regard” to certain matters – while well-intended – is inconsistent with directors’ statutory and general law duties. It may also create unintended confusion and have unintended consequences for directors who follow ASX’s guidance. It is axiomatic that the duty of a company director under section 181 of the Corporations Act (and the equivalent general law duty) is to act in good faith in the listed entity’s best interests. Unlike section 172 of the UK Companies Act, section 181 of the Corporations Act does not require mandatory consideration of other stakeholders such as customers, suppliers and the environment. Moreover, there has been careful consideration of the scope of section 181 duty by various bodies including the Parliamentary Joint Committee on Corporations and Financial Services and the former Corporations and Market Advisory Committee, who both concluded that section 181 is satisfactory. In particular, the Parliamentary Joint Committee on Corporations and Financial Services noted that a law which imposes a duty “should give those upon whom the duty is imposed a clear guidance as to whom the duty is owed and how it is to be discharged. A law which does not is bad law, and at the very least magnifies the uncertainties faced by directors.[1]

While the prospect of law reform in this area is increasing, it is hoped that ASX will clarify this inconsistency in the final version of the fourth edition and either amend the recommendation to address this issue, or acknowledge the primacy of directors’ duties when considering the interests of all stakeholders.

2. Additional responsibilities and more red tape

The Council also acknowledges that some of the new recommendations in the proposed fourth edition overlap with new whistleblowing and anti-bribery laws. The Council’s view is that the new recommendations are “unlikely to impose any additional compliance obligations or burdens” that listed entities and their boards will not already have under the new laws. The same cannot be said, however, for the other new recommendations including those regarding the “social licence to operate”. It is undoubted that the new CGPs will impose an additional burden on boards, company secretaries and executives to digest and address new issues. Whether that new burden is incremental or material remains to be seen.

The Council further asserts that current governance challenges – such as those arising from the Hayne Royal Commission – can be addressed through “if not why not” reporting requirements. Otherwise, according to the Council, “pressures will inevitably mount for a more prescriptive legislative or rules-based response to these issues”.

With respect, governance regulation has moved beyond a binary landscape of, on the one hand, the current “if not why not” framework and, on the one hand, prescriptive statutory rules. Australia has already shifted to a hybrid model of corporate governance regulation. Companies, boards and executives already face the enactment or proposed enactment of a range of new prescriptive governance rules including remuneration reporting, the “two strikes” remuneration vote, and the BEAR.

The fourth edition is no longer the light touch regulatory alternative to corporate governance prescription. Rather, it is a further layering of red tape on an increasingly complex prescriptive system. It remains to be seen whether the level of red tape being imposed on directors and secretaries of publicly listed companies is appropriate and will encourage efficient and healthy capital markets.

3. Are enhanced board diversity aspirations achievable and relevant?

The revised recommendation 1.5 would require listed entities to disclose their diversity policy. The Council’s commentary states that “A listed entity should have a diversity policy that expresses its commitment to embrace diversity at all levels and in all its facets, including gender, marital or family status, sexual orientation, gender identity, age, physical abilities, ethnicity, religious beliefs, cultural background, socio-economic background, perspective and experience.” Box 1.5 reaffirms this comment, by stating that the diversity policy should “Express the organisation’s commitment to diversity at all levels and in all its facets, including [the same list]”.

While tolerance, inclusion and non-discrimination should be an integral part of the values of any listed organisation (and indeed organisations generally), the commentary could be read as requiring a commitment to achieving diversity across all the enumerated areas. If that in fact is what the Council is advocating, there will be differing views on whether such an outcome is practicable, and whether it is truly in the interests of shareholders and other stakeholders of listed entities to focus on the achievement of diversity to this extent on the board, in senior management, and across other levels of the organisation.

The Council’s commentary on diversity and revised recommendation 1.5 asserts that “having directors of different ages and ethnicities and from different cultural or socio-economic backgrounds can help bring different perspectives and experiences to bear and avoid “groupthink” in decision making”. No evidence is provided for such an assertion that age or cultural diversity results in better board decision-making. (The only report cited by the Council is one which found that companies with gender diversity tended to achieve higher revenue, growth and profitability.) We query whether the Council’s aspiration – however well-meant – is evidence-based.

The diversity commentary may also have unintended consequences. Is it now best practice for a board to appoint a 30 year-old as well as an 80 year-old? To select a board member on the basis of their religious beliefs? Moreover, could it result in finger pointing at diversity as being responsible for underperformance more than it being an effective tool for encouraging listed entities to enhance their performance?

Disclosure of a wider range of “diversity” characteristics also risks encroaching on the private and personal information of directors.

Overview of key changes

Importing the social licence to operate in Principle 3

Principle 3 currently states that a listed entity should act “ethically and responsibly.” In the fourth edition, Principle 3 is reworded as: “Instil the desired culture: A listed entity should instil and continually reinforce a culture across the organisation of acting lawfully, ethically and in a socially responsible manner.

The revised principle will also be supported by 3 new recommendations:

  • Recommendation 3.1 on core values;
  • Recommendation 3.3 on whistleblowing policies; and
  • Recommendation 3.4 on anti-bribery and corruption policies.

Key takeaways:

  • Listed entities should take into account a broader range of stakeholders: According to the commentary added by the ASX Corporate Governance Council the board and management of a listed entity is required to have regard to the views and interests of a broader range of stakeholders not just the entity’s securityholders including employees, customers, suppliers, creditors, regulators, consumers, tax payers and the local communities in which the entity operates.
  • Listed entities must have a statement of core values: In addition to having a code of conduct, an entity must also set and disclose its core values which the Council suggests may include values such as innovation, honesty, integrity and accountability and all staff should receive training on the entity’s core values.
  • Listed entities are required to ensure the board is informed of all material breaches which call into question the code of conduct: the Council sees the board as integral in setting the tone of the entity and accordingly makes it incumbent on the board to ensure that it is informed of any material breaches of the entity’s code of conduct by a director or senior executive and of any other material breaches of that code that call into question the culture of the organisation.
  • A listed entity should have whistleblower policy and anti-bribery policy: See discussion below.

Gender diversity

The revised CGPs recommend substantial changes to Recommendation 1.5 which are primarily directed at achieving better gender diversity outcomes within listed entities.

Key takeaways:

  • Listed entities to set measurable gender diversity objectives: The ASX Corporate Governance Council suggests that for a diversity policy to be effective, the listed entity should be setting numerical targets to be achieved within a specified timeframe. It suggests that the board or committee of the board consider setting key performance indicators for senior executives on gender participation in the workplace.
  • The measureable objective should be to achieve a board with at least 30% of its directors being of each gender: Recommendation 1.3 recommends that entities in the S&P / ASX 300 set measurable objectives for achieving gender diversity in the composition of their boards so that not less than 30% of its directors are of a particular gender. The effect of this is to encourage greater participation of women on the boards of listed entities. However, with S&P / ASX 200 already at 28% and for the top 300 it is at 24.6% the recommendation is not revolutionary. Nevertheless, the 30% target does bring the CGPs in line with the Global diversity campaign the “30% Club”, which was formally launched in Australia in May 2015 to achieve 30% female representation on ASX 200 boards by 2018.
  • Listed entity’s gender diversity objectives should be targeted to enhance gender diversity at all levels of the workforce not just the board: the measurable objectives should target at achieving gender diversity in the composition of the entity’s senior executive team and workforce generally, as well as in the composition of the board.

Heightened awareness of carbon risk

The commentary in Recommendation 7.4 has been expanded to give greater focus to “carbon risk”. The ASX Corporate Governance Council highlighted that an entity’s “social licence to operate” imports certain environmental and social responsibilities.

Key takeaways:

  • Listed entities should give more consideration as to how their business may be affected by climate change risks: The Council urges entities to consider carefully the environmental and social risks faced by them which will in particular include considerations as to the source of environmental risk relating to climate change, which as the Council notes will impact many listed entities even where they are not directly involved in mining or consuming fossil fuels. For example, entities should consider how their operations are impacted by things such as changes in climate patterns, the risks arising from changes in legislation or government policy and the need to facilitate the shift to a lower carbon economy.
  • Listed entities should implement further measures where there is material exposure to climate change risk: The Council suggests that listed entities with material exposure to climate change risk implement the recommendations of the Financial Stability Board’s Task Force on Climate-related Financial Disclosures.
  • A board’s skill matrix should consider whether skills in tackling climate change is required: The addition commentary added by the Council to Recommendation 2.2 lists climate change as an emerging issue and one that should be considered by a board when developing the skills matrix.

Whistleblower and anti-bribery policies

The fourth edition anticipates the introduction of new laws to better protect whistleblowers and to improve anti-bribery and corruption measures.[2]

The ASX Corporate Governance Council suggests that the recommendations are intended to complement rather than conflict with the proposed new laws. The Council notes that 10% of listed entities are not established in Australia and may not be subject to the new laws, and so the fourth edition aims to fill the gap by requiring all entities to report on governance arrangements for whistleblowers and anti-bribery and corruption measures.

Key takeaway:

  • Listed entities to adopt whistleblower and anti-bribery policies.

Cyber-security

Further commentary has been proposed in Recommendation 2.2 regarding an entity’s board skills matrix.

Key takeaway:

  • Board skills may need to include competence in cyber-security: The proposed amendments include that a listed entity should cover the skills needed to address emerging governance and business issues including cyber-security and climate change (as noted above).

Integrated reporting

New Recommendation 4.4 has been added stating that “[a] listed entity should have and disclose its process to validate that its annual directors’ report and any other corporate reports it release to the market are accurate, balanced and understandable and provide investors with appropriate information to make informed investment decisions.”

Key takeaways

  • Listed entities should consider adopting integrated reporting and consider processes for validating periodic disclosure: The commentary around Recommendation 4.4 asks directors to consider the principles of integrated reporting which would give investors information about the listed entity’s future prospects, risks and opportunities, strategy and business model. This will require listed entities to revisit their periodic reporting processes and systems and consider whether further resources and procedures should be put in place to ensure periodic reports are appropriately “validated”.