The ASX Corporate Governance Council is seeking comments on the proposed 3rd edition of its Corporate Governance Principles and Recommendations.

Unlike the targeted amendments in 2010 (which saw new diversity recommendations ‘shoehorned’ in), this latest round of changes represents a major overhaul of the ASX Principles. They reflect the evolution of the corporate governance environment in Australia, including the introduction of the ‘two-strikes’ voting regime for company remuneration reports in 2011.

While the 8 fundamental principles have been preserved, the recommendations intended to give effect to those principles have been revised and streamlined, with stronger links between the principle and supporting recommendations. A number of items of ‘commentary’ in the previous edition have been elevated to recommendations, which will trigger an obligation for companies to report against those matters in their annual reports.

Significantly, proposed new recommendation 8.3 is for listed entities to have a remuneration “clawback” policy, which sets out the circumstances in which the entity can clawback performance-based remuneration from its senior executives. The recommendation goes much further than now shelved government legislation on policy disclosure in certain circumstances. A policy or summary will also need to be disclosed, together with a statement of whether any performance-based remuneration has been clawed back and, where performance based remuneration should have been “clawed back” but was not, an explanation of why not. This recommendation tries to reflect the legislative provisions the Government was planning to include in the Corporations Act before the amending bill lapsed in the run up to the 7 September election, with one important difference. The draft legislation did not mention the word ”clawback”. There is good reason for this. “Clawback” has a specific meaning that is understood when used in other countries, but which was lost in the populist approaches of politicians seeking a sound bite.

When used in the UK, the US or Canada “clawback” means the repayment of remuneration that has vested and received by an employee. It is distinct from a “malus”, which is the forfeiture of unvested remuneration. Malus policies have been applied by Australian banks and insurers in response to APRA regulation. Some companies outside of financial services have also adopted malus policies. Rio Tinto is the only ASX-listed company with a clawback policy, and it has been careful to distinguish this policy from a malus policy.

The distinction is important. UK regulation already requires malus polices in banks. It is now considering regulation requiring clawback (see HERE). If Australia eventually follows the same path, the wording of proposed recommendation 8.3 needs to be clarified. Better for it to be correct in the first place, by appropriately distinguishing between “malus ” and “clawback”.

Other key changes that boards will need to be aware of include:

• An expansion of the criteria for determining director independence – most notably, service on a board for more than 9 years is now expressly listed as an indicator that a director may not be independent
• Greater emphasis on risk management, with a new recommendation for companies to establish a risk committee (either standalone or as part of the audit committee) or, alternatively, disclose the processes employed to identify, monitor and manage material business risk
• Recognising the increasing attention paid by the investment community to ‘ethical investment’, a new recommendation calls for companies to disclose whether and how they have had regard to economic, environmental and social sustainability risks

The diversity-related recommendations have been condensed into one recommendation, with updates requiring companies to disclose how they define ‘senior executive’ for the purposes of reporting diversity statistics.

Each of these refinements will have a significant impact on listed company governance processes. Guerdon Associates will address the implications as they apply to remuneration, board evaluation, and director evaluation and skills in subsequent news articles.

Helpfully, the revisions would relax the application of the Principles to smaller listed entities, on the basis that many small caps are not in a position to satisfy all of the recommendations (particularly those relating to the structure of board committees). Smaller companies will in future be able to report on how they do comply, rather than on why they do not comply.

The Council is calling for comments on the consultation paper by 15 November 2013, with the revised edition likely to be introduced with effect from 1 January 2014.

See the consultation paper HERE and a draft of the proposed revised Principles and Guidelines HERE. The current Principles and Recommendations are available HERE.

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