Release Of The Draft ASX Corporate Governance Principles And Recommendations (5th Edition)

Under new Recommendation 3.1, the board of a listed entity should have regard to its security holders and other stakeholders and disclose its processes for engaging with them.

The updated Explanatory Materials now prompt entities to reflect on how the design and effectiveness of governance structures and practices can provide transparency to stakeholders and support stakeholder confidence.

The concept of ‘stakeholders’ has also been incorporated into the Explanatory Materials for other Recommendations (see e.g. Explanatory Materials for proposed Recommendation 1.1 relating to the board charter, and Recommendation 3.3 relating to ‘indicators of a positive organisational culture’).

Entities will need to consider who their key stakeholders are, and whether their stakeholder engagement processes are appropriate and can be adequately described and disclosed.

For many entities, engagement with stakeholders will already be an established part of decision-making processes.

New Recommendation 4.3 would require a listed entity to disclose:

• when the entity's auditor was first appointed; and
• when the engagement of the auditor was last comprehensively reviewed.

The factors relevant to assessing the independence of a non-executive director (previously contained in Box 2.3 in the 4th edition) have been amended and included in the Explanatory Materials for proposed Recommendation 2.4.

Notably, the prior reference to “last three years” in this context has been deleted and a more flexible reference to “recent” has been adopted.

Under proposed Recommendation 8.2, an entity should have the ability to adjust performance-based remuneration outcomes for its senior executives downwards when appropriate.

Proposed Recommendation 8.3 states that an entity should:

• remunerate its non-executive directors by way of only fixed fees (comprising cash and/or shares or units) and superannuation contributions; and
• disclose its approach to non-executive director ownership of securities.

The recommendation in the 4th edition (Recommendation 8.3) to have and disclose a policy on hedging equity-based remuneration has been removed due to regulatory duplication.

The new Recommendations 8.2 and 8.3 require more specific disclosures than their 4th edition equivalents.

It is common for the performance based-remuneration of senior executives to be subject to provisions allowing the downwards adjustment of remuneration outcomes.

Companies may choose to include this information in the Remuneration Report and include a cross reference to that disclosure.

Proposed Recommendation 3.3 recommends that a listed entity:

• ensures that the board is informed of any material breaches or trends in breaches of key policies supporting its culture (to the extent permitted by law); and
• discloses the mechanisms the board has in place to monitor the entity’s culture.

References to specific policies (such as the code of conduct, diversity policy and whistleblower policy) have been removed in the draft 5th edition in favour of a broader reference to “key policies”.

Although this is a new recommendation, we expect most entities will have processes in place for the board to be informed of material breaches of key policies and to enable directors to monitor culture.

However, entities will need to consider whether these processes are fit for purpose and can be adequately described and disclosed.

Spotlight on: Risk and internal control 

In our view, the draft 5th edition shows a sharpened focus on board oversight and responsibility for risk and governance. This makes sense and is appropriate in light of recent judicial decisions that have focused on this theme, noting that the Star liability judgement is specifically referenced in a footnote on the introductory pages of the Consultation Draft.

This focus is drawn out through the following changes:

• The reference to “environmental and social risks” has been removed from Recommendation 7.4 and replaced with a recommendation to disclose all “material risks”. In part, this change seeks to avoid duplication with mandatory sustainability reporting but also reflects that stakeholders are interested in the broader range of risks impacting an entity. In practice, this disclosure recommendation could be satisfied by a cross-reference to the OFR.
• The oversight of an entity’s risk management framework in Recommendation 7.2 has subtly changed. Previously, the board or a committee had to satisfy itself that the risk management framework continues to be sound. Now, the board or a committee must review the entity’s risk management and internal control frameworks to satisfy itself that the frameworks continue to be sound, including by addressing the entity’s material risks. Again, we suspect this change may be motivated by the recent Star decision and its focus on board oversight of key enterprise risks.
• Previously, if an entity didn’t have an internal audit function, it needed to disclose how it evaluated and continually improved the effectiveness of its governance, risk management and internal control processes. Now, under a broadened Recommendation 7.3, even if an entity does have an internal audit function, it must disclose the processes for assuring the board of the effectiveness of the governance, risk management, and internal control frameworks, and how improvements are recommended.

Spotlight on: Board succession and composition

Broad disclosures on diversity were a key sticking point in the prior version of the draft 5th edition. The version released today does not re-enliven those proposed recommendations but does show a focus on stakeholder interest in the skills and composition of the Board. Notable changes on this theme include:

• A shift towards a broader assessment of Board capability, whereby the Board skills matrix is no longer a mandatory disclosure under Recommendation 2.2 but an optional explanatory tool referred to in the Explanatory Materials. Given stakeholders have become used to the level of transparency the matrix provides, we are curious to see whether market practice will shift away from this disclosure in the future.
• Entities must now disclose how diversity is factored into Board succession planning under Recommendation 2.3(a), which includes diversity of thought, experience, perspectives and gender. Many large, listed entities already take this approach in practice, although a requirement to disclose the ‘how’ is new.