Culture and remuneration again emerged as key topics at this year’s AICD Essential Director Update after the banking Royal Commission report earlier this year threw the onus squarely back on boards to take responsibility for and to redress misconduct. Graham Bradley AM FAICD, chair of GrainCorp and non-executive chair of HSBC Bank Australia, presented this year’s update, titled Navigating the new governance environment. Bradley joked it should perhaps instead have been called “Navigating the new governance minefields”.
In Sydney, the event also featured the launch of the Australian Securities and Investments Commission (ASIC) report on director and officer oversight of non-financial risk by the regulator’s chair, James Shipton. Broadly, the report found oversight of non-financial risk was immature and risk appetite statements were not used well by companies.
The event was capped off with a Q&A panel, which featured Bradley, Shipton, AICD managing director and CEO Angus Armour FAICD, AICD head of advocacy Louise Petschler GAICD, and Urbis chair Lisa Chung FAICD. The panel addressed key director questions — innovation, climate risk and whether there should be a cap on the number of directorships an individual can hold.
Corporate culture and conduct
The importance of corporate culture and the board’s role in providing leadership were highlighted in the final report of the banking Royal Commission and Bradley said it has become an expectation that all boards will assess their organisation’s culture. Boards must make culture a regular topic on board or committee agendas. In fact, some companies have made oversight of culture an explicit role in the charters of their board — or their risk or audit committee — to ensure culture is regularly discussed.
Organisations should also articulate the culture they desire and the behaviours they consider acceptable. “Detailed codes of conduct are often less powerful than succinct statements of values to which all employees can relate,” added Bradley.
A dashboard of culture-related metrics to be reported regularly to the board can include measures such as employee survey scores on issues such as whether the organisation lives by its value and whether they can speak up without fear of retribution; customer feedback and surveys, and measures of customer complaints; and regulatory compliance breaches or regulatory notices.
“Most importantly, boards should create multiple opportunities for engagement with the organisation outside of the boardroom, for example during site visits, ‘meet the talent’ events and other informal opportunities for directors to talk with a cross-section of employees,” said Bradley.
Regulatory compliance and litigation risk
In the wake of criticism in the banking Royal Commission that ASIC and the Australian Prudential Regulation Authority (APRA) were at times reluctant to litigate, Bradley said that for the next several years, regulators all over the country and across industry sectors — environmental, energy, health and safety, and building regulators — will feel pressure to litigate first, and negotiate second. As a result, directors should insist management pays additional attention to documenting regulatory compliance, reviews compliance systems and policies, and commissioning external reviews where they have concerns.
Bradley added a warning: “Excessive use of civil or criminal prosecutions could, I believe, inhibit the open and frank dialogue between regulators and regulated entities that leads to early and efficient problem resolution.”
In a Q&A, Shipton said there was a misunderstanding about the “why not litigate” strategy which, he said, is ASIC essentially asking themselves if there is a breach of the law. He said it was “an operational procedural discipline so we’re asking ourselves the right question at the right time to make sure that we use this powerful and important tool appropriately. We are completely wedded to this concept of a multidimensional regulatory approach to achieve our goals.”
Bradley also commented on the Australian Law Reform Commission review of the corporate criminal responsibility regime and demands from some politicians that senior bank executives criticised by the banking Royal Commission be jailed. This raises the risk that directors are held accountable to a criminal standard, even when they are personally unaware of the wrongdoing within the lower ranks of their organisations and have no reason to suspect it.
Turning to climate change, Bradley said the risk of litigation against directors for failing to consider “climate risks and opportunities” was small because of questions regarding how much directors can assess possible impacts in the future, much less anticipate possible political or third-party actions.
Graham Bradley’s Eight Key Questions for Directors in 2020
- Is our desired culture clearly articulated? Do our people know exactly what we expect?
- Do we have effective measures of culture reported and discussed regularly
at the board?
- Have we reviewed incentive compensation? Do we unwittingly encourage poor behaviours?
- Is our regulatory compliance in good order? How have we assured ourselves of this?
- Do we need more oversight of non-financial risks?
- Do we have effective, compliant whistleblower policies?
- Is our D&O policy fully effective? Are we getting the coverage we need?
- Do we need to reconsider or restate our social purpose?
Director liability: how good is your D&O?
Increased directors’ liabilities, elevated statutory penalties, and the new enforcement-focused policy of regulators generally have led to considerable concern about the high cost and continued availability and affordability of D&O insurance for directors, said Bradley.
For directors, this means they should review their D&O policy with particular regard to the extent of coverage. They should consider if the amount is adequate to the risks they may face and whether it’s the right trade-off between increasing premium costs and extent of cover. They should also consider Side C coverage for the company against securities-related class action suits and look at any material policy exclusions.
On a related topic, Bradley said directors should ensure they have an up-to-date Deed of Indemnity and Access from their company. It should contain fit-for-purpose protection should they become embroiled in litigation, and include their coverage of civil penalties, rights to maintain professional privilege over legal advice, and rights to indemnity from the company, which may extend beyond that covered under its insurance policies.
Executive remuneration post-Hayne
The 2018 annual general meeting (AGM) season brought some “extraordinary” votes relating to remuneration, said Bradley, adding that not all negative votes should be assumed to condemn remuneration policies, although most do. “Investors can use (or misuse) their power to vote against remuneration reports for reasons unrelated to remuneration,” he said. “An example is GrainCorp, which received an 18 per cent vote against the remuneration report, with not a single criticism by investors or proxy advisers of our remuneration policies, but a single large shareholder voting against for reasons that were completely unrelated to remuneration.”
Last year’s AGMs also saw a rise in shareholder activism by investors in attempts to requisition resolutions directing boards in relation to management or governance matters. Companies targeted recently included BHP, QBE, Rio Tinto, Qantas, Origin Energy, Woolworths, Westpac and Suncorp. “Activist pressure of this kind will undoubtedly continue in 2020,” said Bradley.
Commenting on APRA’s proposed remuneration standards (CPS 511), which include a proposed limitation of “financial measures” in performance pay, Bradley said he would favour
“a less rigid guideline that allows boards discretion to tailor their remuneration policies and be answerable for their chosen policies”.
Many of the issues he covered in this year’s update are also highly relevant for the not-for-profit (NFP) sector, said Bradley, including corporate culture, regulatory compliance, D&O insurance, risk management and social purpose. He urged directors to draw on the AICD’s revised guidebook on good governance principles for NFP boards.
Corporate social purpose
Amid debate on whether companies should be required to have a social purpose, Bradley said the case for imposing new and wider social obligations and purposes on companies has not been made. He drew a sharp distinction between having a social purpose — self-defined by the company itself and controlled by its board and management — and having a “social licence to operate”, which implies the licence is given or defined in some way by the community. “Such an externally-imposed licence would come with externally defined conditions and expectations,” he said.
The law allows directors to take into account the interests of stakeholders other than shareholders, while still complying with their duty to act in good faith in the interests of the company as a whole. “Arguably, the best interests of the corporation require directors to attend to shareholder welfare in the longer term,” said Bradley. “Almost always, this can only be achieved when boards factor in all relevant stakeholder concerns, including the interests of employees, customers, local communities and increasingly nowadays the environment.”
He added that it was unnecessary to create a legal duty to do so, as the UK has done. “It would serve to complicate the role of directors, and expose them to a wider ambit of potential litigation.”
Climate change litigation risk: how real is it?
Bradley outlined the background to legal opinions on the risk of future litigation against directors for failing to consider climate risks and opportunities.
“How big a risk is this for directors in reality? My answer is small,” he said, adding that the risks to a business from climate change will be mainly one of three types:
- Physical impacts on assets and businesses caused by changing weather patterns.
- Regulatory risk resulting from government policies which impact adversely on business operations.
- Adverse impacts from third parties such as investors or climate activists.
“For me, the key issue in any case against directors will be how foreseeable any of these types of impacts might be and how reasonable is it to ask directors to weigh contending scientific evidence and to foresee the likely impacts that may occur long into the future, much less anticipate possible political or third-party actions,” said Bradley.
He noted directors should consider several new reporting frameworks in relation to long-term climate change, including the recommendations of the Taskforce for Climate-related Financial Disclosures (recently endorsed by ASIC in updated guidance), and Australian Accounting Standards Board recommendations for assessing the materiality of climate risks in relation to asset carrying values. “There is no doubt that expectations are rising that directors will turn their minds to these matters, however fraught with uncertainty they may be,” said Bradley. “Recent statements by regulators may serve to encourage more ‘lawfare’ against boards by climate change activists.”
AICD hot topics
Top questions from AICD members at the Sydney forum included the tension between governing and executive demands on directors, how boards can better drive innovation, how they should be responding to the mega-governance challenge of climate change, and why female representation on Australian boards remains below 50 per cent.
Should there be a cap on the number of directorships one person can hold and still offer good governance? The show of hands in the audiences was in favour of a cap, given concerns about increasing director workloads, “overboarding” and increasing expectations of demand, highlighted in the ASIC report on the demands on chairs of risk committees. The consensus of the panel was that it’s an individual decision by the board whether directors are making an appropriate individual contribution.
“I don’t favour a general or legislative cap; not all boards are as big or as complex,” said Bradley.
Petschler said it was important to consider a director’s capacity to flex when there is a crisis or an intense period of work.
“Some boards are much more complex, with diverse businesses,” said Chung. “It depends what role you serve, whether you chair subcommittees. It’s a discussion boards should have in consultation with directors.”
An EDU 2019 webinar will be held on 7 November and a recording can be accessed until August next year.