Over the course of 2018, corporate Australia’s ability to maintain constructive relationships with key stakeholders, to understand and meet community expectations, and to implement appropriate governance and risk management practices has been tested.
In particular, the ongoing Financial Services Royal Commission, APRA’s CBA Prudential Inquiry (APRA Report) and the consultation process for the upcoming 4th edition of ASX’s Corporate Governance Principles and Recommendations have focussed attention on these issues and signalled the prospect of a changing regulatory landscape that will include increased regulatory intervention and enforcement action, with greater penalties for contraventions. This is informing corporate Australia’s ongoing thinking about how to maintain (or in some cases, win back) trust from key stakeholders, and to improve governance and risk management practices in order to mitigate the impact of this new environment.
In this context, and as a follow-up from our March 2018 report - Directions 2018: The rise of the intangibles and a new recipe for trust, we thought that it would be an opportune time to check-in on what is currently top of mind for Boards and senior leaders in Australian business in a Directions ‘pulse-check’ survey, which we conducted in November 2018.
Impact of the APRA Report
The release of the APRA Report attracted widespread attention from Australian Boards and senior leaders. It was therefore no surprise to see that key focus areas identified in the APRA Report - namely compliance and non-financial risks - remain front and centre for a large number of organisations. In response to our survey, half our respondents indicated that their organisations had undertaken a review of compliance and non-financial risks following the release of the APRA Report, and many others responded that a review was underway.
As the APRA Report essentially provides a checklist of what (and what not) to do, it has provided Boards and senior leaders with a useful tool to more deeply examine their organisations in a structured, methodical way, and to make appropriate changes to board and other governance processes and the use of performance metrics. This was supported by our survey results. For example, of the survey respondents who confirmed that their organisations had undertaken a review of compliance and non-financial risks following the release of the APRA Report:
- 37% identified that the review changed the way their organisations report risks to the Board;
- 34% identified that the review changed the status of the compliance and risk functions within their organisations;
- 17% identified that the review changed the metrics by which the performance and remuneration of employees and executives are assessed; and
- 12% specified an “other” response, with most identifying that changes were a work in process as relevant reviews continue.
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Culture – who should be accountable?
Our survey results indicate that Boards and senior leaders have maintained their mindset when it comes to accountability for misconduct and its inter-relationship with corporate culture - an issue that has been examined extensively throughout the Financial Services Royal Commission.
64% of our survey respondents, up from 60% of our survey respondents in March 2018, agreed that directors or senior management should be held personally accountable for an employee’s misconduct where such misconduct can be directly attributed to the organisation’s corporate culture – but only where there has been a demonstrated failure to put in place appropriate policies to manage misconduct.
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While the Board of an organisation is ultimately responsible for overseeing an organisation’s corporate culture, many of our survey respondents indicated that, once appropriate policies and practices are in place, it is the role of the management within the organisation to “walk the talk” in order to foster, maintain and monitor the desired culture. As discussed in our March 2018 report, employees’ behaviour is more likely to be influenced by the conduct of their direct managers and/or top performers in their business unit, rather than directors or other senior leaders in the organisation.
A consistent theme across the ‘other’ responses to our survey was the need for senior management to be “more in the spotlight”, with misconduct identified as an “executive issue to address, reinforced by the Board”.
This highlights the importance of information flows and accountability between the Board, senior management and their business line reports in relation to issues impacting corporate culture, and the subcultures that can exist within organisations. Various recent events have illustrated that the Board is expected to take ultimate responsibility for, and address, misconduct and associated cultural issues if there are ‘red flags’ or other warning signs within the organisation. A key ongoing challenge for directors is to ensure that the right questions are being asked in order to identify material or systemic issues within and across the organisation, as there will be a persisting risk that a Board will not be in a position to take appropriate action if it is not being properly informed of incidents and associated issues in a timely manner.
The ability of a Board and senior management to prevent misconduct resulting from a poor corporate culture (or subculture) can be further hindered if remuneration and incentive structures create a misalignment of interests. For example, as the Financial Services Royal Commission has demonstrated, if senior management or employees are incentivised through variable pay structures that are linked to sales targets or other short term financial metrics, this can lead to the achievement of revenue or profit targets being prioritised over sustaining longer term customer relationships and outcomes, and the associated compliance and risk management issues may be overlooked.
Our survey responses regarding accountability, and the factors outlined above, highlight the complexities that surround creating and monitoring corporate culture and holding individuals accountable for cultural “failings”.
Material areas of concern for Boards and senior leaders
Given the nature and extent of the revelations throughout 2018 regarding various instances of corporate misconduct, poor compliance practices and some bad outcomes for customers, it is not surprising to see the issues which currently represent the key areas of concern for Boards and senior leaders.
Protecting brand and reputation was identified as the greatest area of concern, with 86% of respondents to our ‘pulse check’ survey either selecting “strongly agree” (54.7%) or “agree” (31.3%), similar to our March 2018 survey. This was followed by maintaining an appropriate corporate culture, which was identified as a material area of concern by 85.2% of respondents (51.0% “strongly agree” and 34.2% agree’”). These issues were followed by managing IT/Cyber risks, with 72.3% of respondents identifying it as a material area of concern, although the priority of this issue has declined, with the “strongly agree” responses down 14.5% to 36.8%.
There was also a noteworthy, and perhaps slightly worrying, shift in focus away from some of the critical elements that contribute to the future strategy and success of an organisation – promoting innovation, developing the talent pipeline and succession planning. In March 2018:
- 32.6% of our survey respondents “strongly agreed” that promoting innovation was a material area of concern, as compared to only 23.3% in November 2018, a decrease of 9.3%; and
- 32.0% of our survey respondents “strongly agreed” that developing the talent pipeline was a material area of concern, as compared to only 19.3% in November 2018, a decrease of 12.7%; and
- 27.8% of our survey respondents “strongly agreed” that succession planning was a material area of concern, as compared to only 19.3% in November 2018, a decrease of 8.5%.
Capacity of the organisation to be agile and adapt also significantly decreased are an area of key focus, with the number of survey respondents “strongly agreeing” that it was a material area of concern dropping from 49.0% to 25.5%.
These results indicate that, while there is currently an increased focus on reputation, some risk and governance issues, other strategic and “operational” issues are more “neutral” areas of focus for Boards.
Interestingly there was also a decline in the focus on ensuring an organisation has a social licence to operate, which was down 11% to 46.9%, as compared to our March 2018 survey. This may be a result of the broad criticism of the concept, as part of the consultation process when ASX introduced the concept of maintenance of a social licence to operate in its consultation paper regarding the upcoming 4th edition of ASX’s Corporate Governance Principles and Recommendations. These concerns reflect recent commentary that it is difficult to precisely and objectively define what maintaining a social licence to operate entails, and will inevitably vary depending on the type, size and industry of each particular organisation.
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Where to now?
It is clear that the various consultations, commissions and reports, in particular the Financial Services Royal Commission and the APRA Report, have brought many critical conduct and compliance issues to the surface and highlighted the need for corporate Australia to do better in some areas. Close to 60% of our survey respondents identified that the top of mind implications of these consultations, commissions and reports are their impact on the compliance and risk functions and processes within their organisations, and the broader repercussions on the Australian economy and business conditions.
We expect to see a continued focus by Boards and senior leaders on compliance and non-financial risks (including corporate culture) as many organisations work to hold (and in some cases, regain) trust from stakeholders and their corporate reputation once the Financial Services Royal Commission wraps up and its final report is released next year.
It is clear that recent events have triggered a shift in tone across corporate Australia. Regulatory changes and greater (more aggressive) scrutiny from regulators and other stakeholders will require many organisations to continue to focus on enhancing and embedding better internal processes around non-financial risks and corporate culture in order to ensure their compliance policies and practices are fit for this new environment.
While these issues have in many cases been all-consuming for Boards and senior leaders in 2018, only time will tell if this focus will enhance, or be at the expense, of the overall future performance of Australian businesses. It may well be that once the immediate issues highlighted by the Financial Services Royal Commission and APRA Report are resolved, there is a re-balancing, with key contributors to future performance, growth and innovation re-emerging as the top areas of focus for Boards and senior leaders.