corporate-regulation

This article appeared in The Australian Financial Review on 5 August 2019 (subscription may be required).

ASIC’s shift to a ‘why not litigate?’ posture, the release of the APRA Capability Review and APRA’s draft remuneration standard represent that reaction.

The shift we see towards more prescriptive standards belies the fundamental strengths that have underpinned our internationally respected governance framework.

Only a decade ago, Governments across the world were compelled to use taxpayer money to prevent a collapse of the global banking system, money that could have been invested in education, health and infrastructure. Under APRA’s watch, the systemic strength of the Australian banking system was evidenced to be world-leading.

This is not an argument to perpetuate the status quo, however, given the conduct on display at the Royal Commission. There is a clear need for change and Governments, regulators and boards need to respond appropriately to lift the standards of governance practice.

But that does not mean a shift towards a more prescriptive, black letter law approach to our governance challenges.

There is a need for greater accountability in cases of misconduct. When boards fail to meet their obligations, they should be held to account. Penalties have increased and boards are on notice.

However, the AICD is concerned when accountability for governance shifts from the board and organisation to a regulator. That is conceivably the effect if APRA is granted a veto power on board appointments as proposed by the Capability Review.

Is the regulator better placed than an entity to determine who should join their board? Should the regulator be held accountable when there is an underperforming director or poor governance outcomes in an organisation?

The veto power is a precedent that fundamentally shifts stewardship arrangements, impinging on the rights of shareholders and members to hold directors to account. The reaction is amplified with the release of APRA’s draft remuneration standard.

The AICD supports the principles that underpin APRA’s proposals. Boards should have greater oversight of the remuneration structures in their organisation. Longer vesting periods for bonus arrangements are sensible. And a balance between financial metrics and non-financial outcomes is needed to measure executive performance.

These concepts are consistent with good governance principles and boards are grappling with their implementation.

However, rather than a principles-based approach to this issue, APRA’s proposals apply a uniform approach that undermine the responsibility of a board to structure remuneration strategies aligned with the company’s needs and strategy.

Expanding the board’s role to approve remuneration arrangements and outcomes for a significantly expanded number of employees is unworkable. Boards should set the principles for remuneration structures but delving into the detail of pay structures deep in an organisation blurs accountability and confuses the vital oversight role of boards.

The unintended consequence will be more remuneration consultants providing opinions to help boards wade through the complexity of remuneration issues, which already dominate board agendas.

We must also consider how the proposed requirements intersect with the existing two-strikes rule for listed companies. Boards do not create remuneration structures in isolation. Boards are already under pressure to balance competing demands from different sets of stakeholders – investors, proxy advisers, regulators and customers.

Some may argue that these proposals are limited to the Financial Services sector in response to Royal Commission. We start from the assumption that these prescriptive standards eventually will translate into other sectors.

In his first major policy speech after the May election, the Prime Minister spoke of ‘provoking the animal spirits’ in our economy by removing regulatory and bureaucratic barriers to businesses investing and creating more jobs. With the rate of economic growth at the start of this year slumping to its slowest pace since 2009 and the GFC, we cannot afford initiatives that add to the regulatory burden facing companies.

If our goal is to prevent misconduct from occurring again, then we will be disappointed with prescriptive reforms. Misconduct will occur in large complex organisations. What boards are tasked to do is to create an environment where strong internal controls promote compliance, identify misconduct when it occurs, and provide remedy swiftly. Most importantly, boards must hold themselves and executives to account when there have been failures.

The task of restoring trust in our governance frameworks is challenging. It is essential that we succeed, for the benefit of society.

It will require a commitment to principle: that the role of regulators is to regulate and enforce the law, that boards oversee and govern, and that executives manage the organisation. And we’re all held to account.