What is the issue?

The ASX Corporate Governance Council recently released the third edition of its Corporate Governance Principles and Recommendations. The changes are a refinement rather than a rewrite, of the guidance. However there are some important changes, in particular in relation to risk management, governance reporting, independence of long-serving directors, and gender diversity.

What are the Principles and Recommendations?

The Principles and Recommendations set out the corporate governance framework for ASX-listed entities.

Each listed entity is required by the Listing Rules to provide a corporate governance statement. That statement must report whether the entity has fully complied with the guidance and if not, why not.

The updated Principles and Recommendations will apply to listed entities from 1 July 2014. However, entities should take the changes into consideration in the current reporting season, both as a matter of good governance and to ensure readiness for implementation. Related changes to the ASX Listing Rules will also be made to facilitate the changes; these will come into effect on 1 July 2014.

Risk management

The changes are intended to bring a greater focus onto risk management following the Global Financial Crisis.

Risk committee

The importance of the risk committee has been elevated in the revised guidance, which now states that a listed entity should have one or more committees which oversee risk, or otherwise explain the processes and procedures in place to oversee the entity’s risk management framework.

Risk committees may take the form of a dedicated risk management committee, a combined audit / risk committee or combination of board committees addressing different elements of risk. Committees should be of a size and independence, and have enough technical knowledge and understanding of the industry in which the entity operates to effectively discharge the committee’s mandate.

Internal audit

Internal audit is another area which has gained more emphasis. Entities must now disclose whether they have an internal audit function, how it is structured and what role it performs. If there is no internal audit function, the entity must disclose the processes it employs to evaluate and improve its risk management and internal control processes.

Environmental and social risks

Entities must now disclose whether they have any ‘material exposure’ to economic, environmental and social sustainability risks. Material exposure is defined as a real possibility that the risk could substantively impact the entity’s ability to create or preserve value for security holders over the short, medium or long term. This does not have to be in the form of a sustainability report, although such a report is likely to meet this recommendation.

Governance reporting

‘If not, why not?’

The recommendations have been criticised in the past as being geared to large listed entities, in particular in relation to the ‘if not, why not’ approach. Many smaller entities felt they were being required to justify why they did not comply with recommendations that were clearly not appropriate for smaller and less complex businesses.

In response, certain recommendations have been re-worded to allow entities to demonstrate their compliance with the spirit of the recommendation through alternative governance practices, rather than having to explain non-compliance with the ‘standard’ practice. This applies to key recommendations dealing with the structure of the board, the audit committee, risk committee and remuneration committee, and the internal audit function.

Corporate governance statement on website

The corporate governance statement is currently required to be included in the annual report. Listed entities will now be able to post the statement on their website and include a link in their annual report. This will help to reduce the size of the report, an important practical improvement for many companies with voluminous annual reports.

Declaration of compliance

In commentary provided with the release of the proposed amendments, the ASX described its concern about entities using ‘pro forma’ corporate governance statements which may not reflect the entity’s actual governance practices. To help combat this, entities will be required to lodge a statement confirming their compliance with the corporate governance requirements of the Listing Rules. The form of the statement (to be included in Appendix 4G) has not yet been released but is expected to provide a ‘checklist’ to confirm compliance.

Independence of long-serving directors

The guidance on what should be considered in assessing the independence of a director now includes the length of tenure of a director. While a director who has acted for a substantial period will not necessarily have become too close to management to be considered independent, listed entities are expected to regularly assess the situation for directors with tenure of more than 10 years.

This is a more relaxed position than that advocated by the Council in the consultation draft. It would have required an entity to explain why a director who has served for more than nine years remains  independent.

Gender diversity

The Principles and Recommendations now provide more guidance on effective gender diversity policies and extend the content of a diversity policy.

The policy must include measurable objectives to achieve gender diversity, and the commentary now provides further guidance on what a ‘measurable objective’ is and how it is monitored. It provides specific numerical targets for the proportion of women employed: those entities required to report under the Workplace Gender Equality Act may report their Gender Equality Indicators instead. Entities must  specify how they define ‘senior executive’ when reporting on the proportion of women in those roles.

This enables entities to provide an accurate impression of their gender diversity, in a way that reflects their own circumstances.