Proposed fifth edition of ASX Corporate Governance principles – seeking a balance for listed entity boards

The proposed recommendations underscore a heightened focus on the concerns of a listed entity’s stakeholders.

Recommendation 3.3

Proposed Recommendation 3.3. has been amended to require listed entities to have regard to the interests of the entity’s key stakeholders, including processes to engage with a broad range of stakeholders and report material issues to the board.

This amendment emphasises an increased focus for listed entities to know who their key stakeholders are, and ensure they have appropriate engagement and reporting processes in place for the management of stakeholder interests.

Commentary

The commentary on Recommendation 3.3 emphasises that having regard to an entity’s impact on and interaction with its key stakeholders can inform decision-making throughout the organisation.

Further Commentary from other Recommendations

The emphasis on stakeholder engagement is echoed in the commentary on other Recommendations:

• Recommendation 1.1’s commentary adds that the board should prioritise building sustainable value for security holders while considering the interests of key stakeholders;
• Recommendation 3.2’s commentary adds that a healthy organisational culture should recognise the interests of stakeholders to create long-term sustainable value; and
• Recommendation 7.4’s commentary adds that entities should consider both foreseeable risks and key stakeholders when developing their risk reporting.

Our Observations

The proposed Recommendation 3.3 supports a view that the interests of stakeholders should be of increasing importance to a listed entity’s effective governance.

The commentary on Recommendation 3.3 highlights that:

• It is in the best interests of the entity and its security holders in the longer term to have regard to its impact on and interaction with key stakeholders; and
• Boards should maintain a culture that focuses on the interests of key stakeholders to create long-term sustainable value.

The proposed recommendations show a strong push for developing, assessing, and maintaining the skills of its Board.

Recommendation 2.2

Proposed Recommendation 2.2 has been amended to clarify requirements concerning the board skills matrix. Listed entities are currently required to disclose either the range of skills of the current board or the skills that the board is seeking. The revised recommendation will require boards to publish a skills matrix, identify the skills of the current directors, and disclose plans to fill any gaps. The proposed Recommendation also adds a requirement for a listed entity to disclose its process for assessing the relevant skills and experience of its directors.

The proposed additions to Recommendation 2.2 reflect a heightened need for transparency in ensuring that boards are properly equipped with the correct skills and experience to make decisions on behalf of the listed entity.

Our Observations

In our view, this proposed Recommendation 2.2 emphasises a push for transparency relating to the board. This better reflects the revised objectives of Principle 2, that a board should regularly review its size and skills so that it can effectively discharge its duties and add value to the entity’s business.

One significant change in the proposed recommendations is a change to gender diversity objectives for boards of listed entities.

Recommendation 2.3

The  proposed Recommendation 2.3 introduces increased disclosure requirements for the board of a listed entity. These requirements recommend that a board:

• adopts and discloses a measurable objective and timeframe for achieving gender diversity on the board;
• discloses progress towards the objective; and
• discloses any other relevant diversity characteristics considered for board membership.

The proposed Recommendation 2.3 also amends the pre-existing targets for board diversity. For entities in the S&P/ASX 300 Index, the recommended objective for board composition should be at least 40% women, 40% men, and up to 20% of any gender, replacing the 30% target for women directors in the fourth edition.

These proposed amendments demonstrate a stronger stance by the Council on gender diversity matters. The addition of a ‘timeframe’ ensures that boards are actively working towards achieving their board gender diversity requirements.

We also note that the recommended increase of diversity targets for entities in the S&P/ASX 300 Index aligns with broader societal shifts, such as the 40:40 Vision Initiative proposed by HESTA in 2020.

Commentary

The commentary for Recommendation 2.3 acknowledges that an entity’s board benefits from diversity amongst its members as this brings different thinking and perspectives that help to avoid “groupthink” or other cognitive biases for decision-making. The proposed commentary also emphasises that gender diversity should be included as a relevant consideration in a board’s succession planning.

Commentary on Recommendation 3.4

Consideration of diversity has been split between Recommendation 2.3, concerning board diversity, and Recommendation 3.4, which relates to broader diversity considerations for listed entities. Recommendation 3.4, emphasises fostering all forms of diversity within the entity.

The commentary on Recommendation 3.4 highlights that a board should:

• Ensure it understands the demographics of its workforce; and
• Consider the Workplace Gender Equality Act’s Gender Equality Indicators to understand the effectiveness of its diversity and inclusion practices.

The commentary for Recommendation 3.4 also suggests combining disclosures in diversity and inclusion policies with those in Recommendation 2.3.

Our Observations

Recommendation 2.3 and the commentary should be considered in the context of the additional emphasis on relevant board skills and experience in Recommendation 2.2.

In our view, while the proposed Recommendations reflect the continuing trend to recognise diversity as beneficial for organisations, they also recognise the public listed entity context in which these matters are being considered, which differs from that of government and not-for-profit sectors..

Recommendation 3.2

Proposed Recommendation 3.2 adds a new requirement for listed entities to disclose (on a de-identified basis) the outcomes during the last reporting period of actions taken by the entity in response to material breaches of the code of conduct.

This recommendation reflects the current broad expectations for directors and senior executives in particular to be accountable for their decisions and their actions. Many listed entities are already making these disclosures. Internally, this encourages entities to reinforce a culture of acting lawfully, ethically, and responsibly within the organisation, in line with the objectives of Principle 3. Externally, this proposed Recommendation may also have the added effect of putting increased pressure on boards to take swifter action in addressing any material breaches to avoid any increased scrutiny or backlash over any perceived inaction.

The acknowledgement that  disclosures should only be made on a de-identified basis emphasises a need for entities to consider other key obligations and regimes, such as confidentiality requirements under whistleblowing, or privacy laws. This is further reflected in the Commentary on this proposed Recommendation.

Commentary

The commentary of proposed Recommendation 3.2 suggests that indicators of a healthy organisation culture include:

• having “a speak-up culture” promoting listening to staff and respectful treatment of whistleblowers;
• appropriate escalation of issues from management to the board or board committee;
• having a culture recognising and having regard to the interests of stakeholders (see above); and
• having a risk culture supporting early reporting and timely remediation of risk with learning outcomes.

The commentary also stresses the need for the Code of Conduct to be supported by the entity’s other cultural processes, for the board to be swiftly informed of material breaches, and for appropriate and proportionate disciplinary actions.

As noted above, the commentary adds that disclosure of outcomes should generally be on a de-identified basis, excluding disclosures related to matters which cannot be properly de-identified

Our Observations

In our view, the additional disclosure requirements and commentary on corporate cultural matters are welcome.

The proposed Recommendations under Principle 4 demonstrate an increased focus on the integrity of corporate reports, particularly concerning audit and assurance.

Recommendation 4.2

Proposed Recommendation 4.2 adds that disclosures in periodic corporate reportsshould include the extent to which the report has been audited, or otherwise the subject of assurance, by an external assurance practitioner.

Recommendation 4.3

Proposed Recommendation 4.3 adds in a requirement for a listed entity to disclose:

• the tenure of its audit firm and audit engagement partner at the end of the reporting period; and
• when the appointment of the external auditor was last reviewed and the outcome of that review.

This proposed Recommendation places a greater emphasis on ensuring the integrity of audits for the purposes of a listed entity’s corporate reporting and the need for the board and the auditors to be accountable.  

The focus on integrity of audit is also reflected in other Recommendations under Principle 4.

Commentary on Recommendation 4.1

While Recommendation 4.1, which requires a listed entity to have a board audit committee, is largely unchanged, the commentary for the Recommendation adds in that the role of the audit committee includes to make recommendations and in relation to the integrity of the entity’s financial reporting and the entity’s audit and assurance policies and practices.

Our Observations

In our view, the amendments to the Recommendations under Principle 4 reflect the growing demand for listed entities to exhibit transparency and efficiency in their audit procedures.

These proposed changes to Recommendation 4.2 and 4.3 are aimed at enhancing transparency in the disclosures of a listed entity and promoting both the fact and appearance of audit integrity.

Recommendation 7.2

Proposed Recommendation 7.2 adds a requirement for the board or board committee to review the entity’s risk management and internal control frameworks at least annually to satisfy itself that the frameworks continue to be sound and address the entity’s material risks. Regulated entities already undertake these reviews, and the requirement is consistent with stakeholder expectations. 

By advocating for boards to regularly evaluate their internal risk management frameworks and controls on an annual basis, this Recommendation aims to reduce the likelihood of significant risk failures and enhance a listed entity's ability to promptly address any such risks, including challenges related to cybersecurity and climate change.

Commentary on Recommendation 7.2

The Commentary further adds that board should consider crisis management and business continuity processes which would assist with the coordination of the entity’s response to risks.

Recommendation 7.4

Material changes have also been made to proposed Recommendation 7.4 which would require a listed entity to disclose its material risks (including its material environmental, social and governance risks).

This proposed Recommendation broadens disclosure requirements from a narrow ESG focus to a more holistic approach to risk management.

Commentary on Recommendation 7.4

The commentary continues to note that importance of ESG risks (including climate changed-related risk), without being proscriptive, in anticipation of the introduction of mandatory climate reporting which may precede the commencement of the Fifth Edition for very large entities.

Our Observations

The proposed recommendations are consistent with expectations for listed entities to disclose all material risks, while continuing to call out ESG risks for particular focus.

The proposed recommendations remove duplication with regulatory remuneration reporting requirements and also formalise current practice in remuneration for non-executive directors.

Recommendation 8.2

The proposed Recommendation 8.2 will formalise common (but not universal) current practice by requiring that listed entities should not give performance-based remuneration or retirement benefits to non-executive directors.

Recommendation 8.3

Proposed Recommendation 8.3 adds requirements for listed entities to:

• have remuneration structures which can clawback or otherwise limit performance-based remuneration outcomes of its senior executives after award, payment or vesting; and
• disclose (on a de-identified basis) the use of those provisions during the reporting period.

These proposed recommendations are designed to enable companies to recoup pay awarded for performance-based remuneration if it later emerges that the decisions or actions underlying such awards were ethically or legally dubious or were driven by personal financial interests.

Our Observations

The proposed Recommendation 8.2 concerning remuneration for non-executive directors may prove challenging for smaller listed entities and start-ups seeking to attract experienced NEDs to riskier enterprises.

The clawback requirements in proposed recommendation 8.3 are consistent with requirements already in place for many regulated entities and encourage long-term management of an entity’s business, but again, we think that this recommendation will need to be applied judiciously in known high-risk entities where risk-taking should be rewarded and not discouraged.