The banking Royal Commission: where to next?

In the wake of the banking Royal Commission, we may end up looking back at 2018 as being a watershed for corporate governance in Australia.

This year has seen intense debate regarding the governance of some of Australia’s largest companies, prompting questions on practices across the broader corporate sector.

The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, the Australian Prudential Regulation Authority (APRA) prudential inquiry into the Commonwealth Bank of Australia, and recent consultation on the ASX Corporate Governance Principles and Recommendations have all prompted reflection and commentary from politicians, regulators, business leaders, media and investors on how Australian corporations are governed and whether current models and practices must change.

This debate has taken place in a context of declining public trust in institutions — as revealed by the global Edelman Trust Barometer — and a belief that the benefits of Australia’s sustained economic growth have been unequally shared. Indeed, the 2018 Committee for Economic Development (CEDA) Community Pulse survey revealed “a disconnect between Australia’s strong economic track record and the community’s sense of having shared in this growth”.

More broadly, this discussion is feeding into a bigger debate around the role of business in society and whether the current compact needs to change. Going into a federal election year against a backdrop of stagnant wage growth and cost-of-living pressures, this debate is only going to intensify. Over the course of 2018, AICD has been making a concerted effort to engage with directors and stakeholders to ensure we hear a broad range of voices on the contemporary governance issues facing Australia. Some themes emerging from those conversations are discussed below.

Corporate culture

The importance of having a healthy and sustainable organisational culture has featured throughout our discussions, and is a core component of the AICD’s education curriculum.

Both the banking Royal Commission and Royal Commission into Institutional Responses to Child Sexual Abuse have suggested systemic and ethical failures in traditionally trusted institutions.

In the wake of these inquiries, all directors need to be asking what insights they have into corporate culture, and how they can “set the tone from the top”.

In particular, is there evidence of a tolerance for misconduct or non-compliance with the law? And are organisations appropriately identifying and treating vulnerable clients?

More broadly, there has been a recognition that a clear sense of organisational purpose can be critical to help guide decision-making, especially on complex issues where stakeholder interests may be competing. The importance of having ethical decision-making tools has also been stressed.

Directors’ duties

In the wake of revelations from the banking Royal Commission, there has been increased questioning, especially by consumer groups, as to whether the current formulation of directors’ duties remains appropriate. In their eyes, the poor treatment of customers has been — at least partly — driven by the legal framework in which these companies operate.

While Australian courts have traditionally adopted a “shareholder primacy” approach when interpreting the best interests directors’ duty, directors are required to consider the interests of other stakeholders where they reasonably believe doing so will be in the best interests of the body of shareholders as a whole. Directors have been quick to emphasise that, in practice, in order to build long-term value and reputation, stakeholder interests are routinely taken into account, and that no company can be expected to succeed if it adopts a myopic focus on financial returns.

While the 2006 inquiry conducted by the Australian Corporations and Markets Advisory Committee (CAMAC) found no legislative change in relation to directors’ duties was necessary, we can expect this debate will pick up again in 2019.

In particular, proponents for change may look to overseas models, such as the United Kingdom. Under section 172 of the UK Companies Act (2006), directors are explicitly required to consider other stakeholders — including employees, suppliers, the community, and the environment — in carrying out their duty to promote the success of the company. Whether this would actually be a major change is debatable however, given that it would not appear to represent a radical departure from what is already the law and practice in Australia. That said, any attempt to reformulate such a core duty would need to be done carefully and with the full knowledge that any legislative change is unlikely to be a panacea for poor corporate conduct.

Board composition

Stakeholders, including the investor community, have little appetite to overhaul accepted board composition principles. In particular, the consensus remains that boards should collectively have industry knowledge as well as reflect a diversity of skills, experience and perspective, but that this does not necessitate specific employee- or customer-nominated directors.

There has been an acknowledgement that there could be blurred lines of accountability where directors owe their position to a specific set of stakeholders, and that other overseas models — for example, the German “two-tier” board — have emerged from their own specific, historical circumstances.

What is critical is that boards hear and understand employee and other stakeholder views. The challenge is in developing mechanisms to ensure these voices are heard at the board table.

We’ve also heard consistent messages regarding the need to broaden the director pool, including by looking overseas for director candidates with global experience. Others have acknowledged that change is already underway, partly driven by significant progress on gender diversity over recent years.

Remuneration structures

We’ve been struck by consistent director feedback on the need to re-examine current remuneration structures, in the wake of Commissioner Hayne’s interim report. While directors have highlighted the legitimate role that variable remuneration can play in driving performance, there has been widespread acceptance that current structures have become too complex and short-term incentives in need of review.

There has also been an acknowledgement that, in light of the Royal Commission, remuneration frameworks need to be reviewed to ensure they are driving the desired behaviours.

More broadly, remuneration has attracted the political spotlight with the federal Labor opposition committing to introducing CEO-to-average-worker pay ratio disclosure reforms, as well as gender pay gap reporting obligations, if elected. We can expect more such proposals in a political climate favouring efforts to address inequality and the lack of real wage growth. It is important that directors keep an open mind during such debates.

Role of the regulators

Finally, all stakeholders have recognised the important role of the regulators, especially the Australian Securities and Investments Commission, in the overall corporate governance framework.

Commissioner Hayne’s interim report indicates that a more litigious approach by regulators may be necessary in order to rebuild community trust and dispel any market perception that breaches of the law can always be negotiated away.

It has also become clear that companies need to rethink their approach to engagement with regulators. It is important that senior business leaders take ownership for organisational failures and communicate directly with regulators, rather than distancing themselves and leaving such engagement as solely the responsibility of legal or compliance teams.

Where to next?

Looking ahead to 2019, governance will remain in the headlines, particularly with the Royal Commissioner due to submit his final report in February, and a federal election expected shortly thereafter. During this debate, the AICD will seek to be an independent and trusted voice advocating for sensible reforms to build on Australia’s reputation as a global governance leader.