Learnings from the ASX Corporate Governance Principles 4th edition

From climate change to remuneration, the fourth edition of the ASX Corporate Governance Principles and Recommendations raises significant new issues for boards.

The countdown is on. The updated fourth edition of the ASX Corporate Governance Principles and Recommendations (Principles), which was hotly debated a year ago and released in February, is set to apply to listed entities for their first full financial year, starting from 1 January, 2020. The new guidelines raise significant issues for boards and senior executives that are relevant beyond the listed market.

The changes to the fourth edition endorse best practice, but there are also missed opportunities. The changes mean boards will need to rewrite their charters and risk management frameworks to meet the new standards of the fourth edition. We examine some major themes.

Values, purpose and risk appetite

Articulating, socialising and measuring the culture, purpose and values of an ASX-listed company clearly now falls to the board and should be treated with high priority alongside strategy-setting and risk management. Boards are expected to assess whether their company’s culture and values are in line with the set “risk appetite” — that is, the level of risk the company is willing to accept. These changes demonstrate an attitude shared by many: that delivering long-term returns is inextricably and positively linked to having a clear set of company values and purpose.

Risk management

The importance of Principle 7 relating to identifying and managing risk requires re-emphasising given the current regulatory climate. Boards need to ensure their risk committees are of sufficient size and independence, and that the members have, between them, the necessary expertise in the industry in order to effectively perform their roles, including monitoring the adequacy of the company’s risk management framework.

Although the concept of “social licence to operate” was not adopted in the fourth edition, the term “social risk” is introduced. This recognises that boards are beginning to view non-financial risks, such as those impacting on reputation and community expectations, as not only ethical or moral issues, but risks that can lead to real reputational and financial loss.

Climate change makes a prominent feature in the recommendations. “Big emitters” will firstly need to ask themselves whether they have proper measures in place for measuring their exposure and, secondly, whether they have had any material exposure in the relevant reporting period that might require disclosure. We also see for the first time “emerging risks” — such as digital disruption — as issues that a company’s risk management framework will need to adequately address.

Remuneration

There is clear pressure from regulators to include non-financial metrics in executive remuneration assessment frameworks. The fourth edition reflects this, which no doubt creates a challenge for boards as it requires executive remuneration to be aligned with the company’s values, culture and risk appetite. This will prove difficult as boards have generally not been open to changing established practices around setting remuneration and there appears a lack of shareholder consensus on this point.

Missed opportunities

The introduction of a gender target of at least 30 per cent for S&P/ASX 300 companies is a major change. Considering the fourth edition will apply for several years to come, it is also arguably a missed opportunity to encourage other forms of diversity and inclusion in the workplace, such as cultural diversity. Accordingly, we query whether this change will actually fall short in terms of meeting community expectations in the next few years. To its credit, the fourth edition does recognise the need to grow gender diversity from the bottom up in the occupational workforce. This would ultimately allow progression into senior management and directorship by women with invaluable industry and company expertise.

The banking Royal Commission has precipitated a growing concern that boards may not be properly performing their oversight function, possibly from a lack of subject matter expertise among directors. It may be that the fourth edition has missed a timely opportunity to reinforce the link between industry expertise and good risk management.

It must be noted the Principles were introduced in 2003 as voluntary recommendations, to apply on an “if not, why not” basis to forestall highly prescriptive legislation. It remains to be seen whether the fourth edition alone is enough to meet the ever-increasing community expectations of corporate Australia, given the challenges of implementing the fourth edition in practice.