New corporate governance principles to restore transparency & trust in business
Restoring trust is the issue of the moment. Proposed changes to the current ASX Corporate Governance Principles could go a long way to improving transparency and trust, through enhanced corporate reporting.
These principles are not amended very often. The proposed new Recommendation 4.4 states that:
“A listed company should have and disclose its process to validate that its annual directors’ report and any other corporate reports it releases to the market are accurate, balanced and understandable and provide investors with appropriate information to make informed investment decisions.”
This may not, on the surface, seem revolutionary. But it confirms the need for directors to focus corporate reporting on the information needed by investors to make informed investment decisions.
Some context is crucial. Australia has lagged behind much of the developed world in corporate reporting in recent years. John Stanhope, Chairman of the Australian Business Reporting Leaders Forum, has rightly described the Australian reporting requirements as a ‘mosaic of incrementalism’.
Stock exchange rules or best practice corporate governance codes in countries like Japan, South Africa, Brazil, the United Kingdom, France and India have already adopted integrated reporting principles. In a world of mobile capital, our capital market needs to be competitive for new investment, as well as stable given global uncertainties.
Things are changing. Australian investor groups which have traditionally not been active in the corporate reporting space, are now increasingly vocal in wanting to understand how Boards actively oversee management teams to ensure they are delivering on strategy, managing risk and focused on creating long term sustainable value.
With the massive growth in funds under management in our superannuation sector – now $2.5 trillion – super funds with long-term investment horizons want to understand the real drivers of longer term and sustainable value creation.
The proposed new Recommendation 4.4 makes it clear that the board needs to put in place and disclose how the directors validate that the information provided is ‘accurate, balanced and understandable’. Directors will likely rely on a mix of internal controls, management review and sign-off, internal audit and in some areas independent assurance to achieve the required level of comfort.
The accompanying commentary to Recommendation 4.4 is also salient as it includes important information to assist directors in structuring their key report to shareholders – the directors’ report – and specifically the Operating & Financial Review (OFR) within it.
In a first for Australia, the commentary recommends that directors consider the principles of integrated reporting, and notes that the International Integrated Reporting Framework may assist when considering what information is material for investors and other key stakeholders and so should be reported.
Importantly, this allows directors to determine the level of disclosure including how much forward-oriented information they think will be sufficient to enable readers to assess the broader health of the company – including issues such as customer loyalty, engaged and innovative workforce and responsible supply chain.
This ‘outlook’ disclosure will no doubt be a ticklish part of the debate. But for corporate reporting to genuinely inform, it must allow the reader to assess a company’s ability to execute its strategy in the future and so whether past earnings are likely to be sustainable.
Australia has been slow to move towards integrated reporting but things are changing. A KPMG report late last year showed that some 25 percent of our top 200 companies are adopting, or moving towards adoption of the principles of integrated reporting in their annual report. By doing so, companies are better able to spell out the challenges and opportunities they face in the future in a genuinely useful manner for their key stakeholders, rather than focusing on analysis of past financial results.
Groups like ACSI and the G100 have been active in their support of this shift in direction. The AICD issued a policy statement in October 2017 recommending that directors consider the principles of integrated reporting when preparing corporate reports to better meet investor information needs. Stanhope too argues that using these principles can enable companies to demonstrate they are doing the right thing by their stakeholders.
Other proposed changes in the draft 4th Edition of the ASX Corporate Governance Principles and Recommendations seek to address highly topical governance issues such as diversity, values, culture, cyber, carbon risk and licence to operate.
These are crucial areas for boards to consider and then position their response within the entity’s corporate reporting – thereby improving communications with investors and other key stakeholders – and continuing their journey towards re-building public trust.