The year in review — A look at Australian corporate governance in 2017 and what’s ahead in 2018

Each year brings with it new corporate governance challenges and opportunities for Australian organisations, and 2017 was no exception. For 2017, the focus on corporate governance has been driven by high profile regulatory actions against leading companies, corporate scandals, shareholder class actions and increased scrutiny of executive remuneration.

The Effective Governance team has put together their thoughts on Australian corporate governance in 2017 and what you can expect to see in 2018. If you require further advice or assistance with solutions in any of the areas highlighted below, or any other areas, please contact us.

Banks and other financial institutions

Commonwealth Bank

Unfortunately, CBA has lurched from one governance failure to the next[1] with the most recent revelations being that the bank breached the Anti-Money Laundering and Counter-Terrorism Financing Act 2006 (Cth). In August, the Australian Transaction Reports and Analysis Centre (AUSTRAC), which has regulatory responsibility for anti-money laundering and counter-terrorism financing, accused CBA of failing to comply with the laws on almost 54,000 occasions between November 2012 and September 2015. This highlights a very serious level of systemic non-compliance within the bank and points to a lack of oversight by the board and senior management.

CBA’s inaction over money laundering added to the calls for a Royal Commission into the banking sector and resulted in a shareholder class action[2] in October 2017. As such, CBA is sure to remain in the headlines in 2018.

Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry

On 30 November, the Australian Government announced it would establish a Royal Commission into the banking, superannuation and financial services industry. Calls for a Royal Commission had been growing after a number of cases of misconduct by the major banks such as CBA, ANZ, NAB and Westpac in recent years. With respect to corporate governance, the Royal Commission headed by the Hon Kenneth Hayne AC QC will consider whether the ‘misconduct and misbehaviour’:

  • ‘can be attributed to poor culture and governance practices’;
  • or results ‘from other practices, including risk management, recruitment and remuneration practices’.[3]

The Royal Commission’s interim report must be delivered by no later than 30 September 2018, with the final report due by 1 February 2019, so it is expected that with the spotlight on the financial services sector there will be more revelations about governance practices. This will mean that boards and senior management teams may have to reassess how they operate including the organisation’s policy framework and ‘people risk’, which stems from an organisation’s culture.

Superannuation fund trustees/boards

The Australian Government is committed to enhancing the sustainability and performance of superannuation funds around Australia. As such, the continued focus on the prudential framework supporting these funds, trustees and customers is understandable. The Australian Prudential Regulation Authority (APRA) is charged with supervision of this industry and 2017 saw the regulator continue its efforts to ensure a robust framework is maintained and continually improved for the benefit of fund members. For example, the most recent version of Prudential Standard SPS 510: Governance (SPS 510), which commenced on 1 July 2017, requires the board of a registrable superannuation entity (RSE) licensee to have in place policies on appointing, nominating and removing directors, director tenure and board size. Indeed, in 2017, we assisted a number of RSEs to strengthen their governance frameworks including policies around board composition and tenure as well as assessing their boards in accordance with SPS 510 and other leading practice standards.

APRA has been very vocal in outlining how it proposes to enforce Prudential Standards and improve performance of super funds. In 2018, APRA will continue its quest to ensure fund trustees are fit for purpose, have robust governance frameworks in place, are transparent with members on products and investment strategies, ensure RSE licensees comply with the law, embrace the need for independent directors, comply with tenure policy and most importantly have a skills-based board, which is something we support wholeheartedly.

Safe harbour protection

On 12 September 2017, Federal Parliament passed Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill 2017. This bill amends the Corporations Act 2001 (Cth), by creating a ‘safe harbour’ for directors from personal liability during insolvency. The safe harbour protection (or carve-out) provisions of section 588GA of the Corporations Act allows directors to trade while insolvent if it is likely to achieve a ‘better outcome’ than immediate insolvency. The better outcome test is crucial to any decision to enter into safe harbour. Section 588GA(2) states regard may be had to whether the person is:

(a)      is properly informing himself or herself of the company’s financial position; or

(b)      is taking appropriate steps to prevent any misconduct by officers or employees of the company that could adversely affect the company’s ability to pay all its debts; or

(c)       is taking appropriate steps to ensure that the company is keeping appropriate financial records consistent with the size and nature of the company; or

(d)      is obtaining advice from an appropriately qualified entity who was given sufficient information to give appropriate advice; or

(e)       is developing or implementing a plan for restructuring the company to improve its financial position.

However, as stated in the Explanatory Memorandum to the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill:

[H]ope is not a strategy. Directors who merely take a passive approach to the business’s position or allow a company to continue trading as usual during severe financial difficulty, or whose recovery plans are fanciful, will fall outside the bounds of the safe harbour. Directors who fail to implement a course of action, or to appoint an administrator or liquidator within a reasonable time of identifying severe financial difficulty will also lose the benefit of safe harbour.

It should be noted that directors will not be able to rely on safe harbour protection where the organisation is not meeting its obligations in relation to employee entitlements and its taxation reporting obligations.

Further, directors who have previously failed to provide the company’s books and records to a liquidator or administrator will be prevented from relying on those books and records as evidence that they took a reasonable course of action.

In 2018, we will begin to see whether safe harbour protections achieve the desired results of:

  • encouraging directors to engage early with possible insolvency, and take reasonable risks to facilitate the organisation’s recovery rather than prematurely placing the company into voluntary administration or liquidation; and
  • preserving value in an organisation that becomes subject to a scheme of arrangement or is placed into administration and facilitate a successful restructure or sale of the business as a going concern.

We have provided forums in Brisbane and Perth to interested parties on the implications and operation of the safe harbour provisions. We will continue to provide these opportunities where requested.

Charities

Charity consolidation

Effective Governance has been working with charities, in particular their boards, for two decades and we have seen strong growth over that time. However, it should be asked whether that growth is sustainable and whether more charities should merge.[4] When you consider 3,000 new charities are registered each year in Australia it is understandable that government and tax-payers want assurance that services provided by charities are done so in an effective and efficient way with the paramount purpose of delivering high level services to clients. The Australian Charities and Not-for-profits Commission (ACNC) is tasked with regulating charities and we at Effective Governance have an excellent relationship with the regulator, understand its challenges and assist our clients to ensure they comply with governance standards, legal and regulatory obligations.

It is interesting that in the UK, the Charity Commission (the UK’s version of the ACNC) asks new charities seeking registration if they are duplicating a service already being provided – this is not the case in Australia and it could be argued it should. It can also be argued that the provision of the much needed services is what is required, not more charities with duplicated administrative and running costs.

A trend that has been evident over the past few years and will no doubt continue in 2018 is the consolidation of the charity sector through mergers. Such mergers can help to deliver increased funding, knowledge, support and services needed not only to survive in an environment where funding is tight, but also to prosper.

Is the charitable association dead?

We have not only noticed a trend to two or more charities merging. In the past year, we have also seen an increasing number of charities and not-for-profits closing down their state–based associations and replacing them with a national entity in the form of a company limited by guarantee. There are several reasons behind this trend. A key motivation is that the company limited by guarantee legal structure is seen by funding agencies as providing stronger governance arrangements. From a strategy perspective, the charity can become more focused at a national level without have to constantly broker competing state demands. From a waste avoidance perspective, ‘de-federation’ enables charities to generate efficiencies by centralising business and administrative functions. Does this mean charitable associations are dead? Not for the moment at least if for no other reason that there are many smaller charities that fill a niche at a state level. However, we predict it will become increasingly difficult for these smaller associations to attract funding when competing with larger charities which are perceived by donors and funding agencies to be more efficient and effective and have more robust governance arrangements in place. Therefore, for better or for worse, we expect many smaller charitable associations to eventually wither on the vine in the longer term.

With the recent appointment of The Hon. Dr Gary Johns as Commissioner of the ACNC there will be even a greater focus on consolidation, in line with government policy. Effective Governance is well placed to assist charities and not-for-profits negotiate these challenges.

CPA Australia is holding its National NFP Conference 2018 in March. Gary Johns is a key note speaker and the conference has a strong focus on consolidation issues. This focus further highlights the changing environment for these sectors.

Digital technology

Data breach reporting

The last 12 months have seen huge changes in attitudes to cybersecurity and exposure to hacking at a board level due to recent successes and failures with how to respond to a crisis. It is good to see that there are changes happening to the act that will force organisations to be accountable for when a breach does happen after the passing of the Privacy Amendment (Notifiable Data Breaches) Act 2017 (Cth) in February 2017.

From 22 February 2018, organisations regulated by the Privacy Act 1988 (Cth) will be required to notify any individuals likely to be at risk of ‘serious harm’ as a result of a data breach, together with the Office of the Australian Information Commissioner (OAIC). The new laws pose a risk to your organisation’s reputation where data breaches are handled incorrectly. Overall, 2018 is likely to see more boards developing an understanding of their organisation’s cybersecurity systems and taking responsibility to ensure that those systems operate effectively.

Cryptocurrencies

With the recent ‘hysteria’ over Bitcoin and other cryptocurrencies, we are likely to see cryptocurrencies become a new area of risk for boards. For example, there is likely to be a larger push from customers for organisations to accept cryptocurrency as a payment method. In 2018, directors will need to be better informed when making decisions regarding cryptocurrency. Our advice in respect to speculative trading is always – if it sounds too good to be true it probably is.

Blockchain

A technology we are all like to see more of in future is blockchain or distributed ledger technology (DLT), which uses a shared ledger to permanently record transactions in a way that is practically impossible to tamper with. As such, its potential uses in the coming years are vast. For example, In December 2017, the Australian Securities Exchange (ASX) announced it will become the first major stock exchange to adopt blockchain technology to replace its current system CHESS (Clearing House Electronic Subregister System), which has managed the clearing and settlement of equity transactions in Australia since the 1990s. The new technology should prevent the types of breakdowns that have occurred with CHESS. The ASX’s system will operate on a secure private network where participants are known, have permission to access, and must comply with ongoing and enforceable obligations.

Family businesses

In 2017, there was a noticeably increased level of interest by family businesses in the creation of a family charter, sometimes known as a family constitution, which supports the legal documentation involved in the inter-generational wealth transfer process. It provides guidance for the current and future generations of a family in their understanding of, and interaction with, the family business and the many and varied roles that individual family members can play in the business – founder, director, shareholder, senior executive, employee – as well as family member.

Frequently, the decision to adopt a family charter becomes the beginning of a series of wide-ranging discussions, rather than an end in itself. It can also form a foundation for examining:

  • Family values;
  • The governance arrangements for the business, including the introduction of independent directors and the potential for a family office;[5]
  • Succession planning;
  • Strategic planning; and
  • The establishment of mechanisms to set up future generations of the family for success, rather than the creation of a ‘sense of entitlement’.

This is a trend we expect to continue in 2018. However, it should be noted that family charters should be tailored to support shareholder agreements and estate planning arrangements.

Conclusion

While we do not have a crystal ball to see what the major governance developments and issues will be in the coming months of 2018, we feel that each of the topics discussed will feature at some point. Boards and senior managers must be alert to such trends if they are to deliver good governance to their organisations. Current developments such as the impact of digital technology are already beginning to influence major corporate governance changes. In addition, various other social and societal changes, such as cryptocurrencies, may force major changes to how boards govern – only time will tell.

[1] S. Letts, 2017, ‘Commonwealth Bank’s ongoing systemic failures: But wait there’s more’, ABC News, 15 August, http://www.abc.net.au/news/2017-08-15/cba-updates-settlements-with-clients-and-employees/8805872, accessed 21 December 2017.

[2] Maurice Blackburn, 2017, Commonwealth Bank of Australia class action, https://www.mauriceblackburn.com.au/current-class-actions/commonwealth-bank-of-australia-class-action/, accessed 19 December 2017.

[3] Commonwealth of Australia, 2017, Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry Letters Patent, 14 December, https://financialservices.royalcommission.gov.au/Pages/Terms-of-reference.aspx, accessed 19 December 2017.

[4] F. Smith, 2017, ‘Better together: why charities should merge’, INTHEBLACK, 1 July, https://www.intheblack.com/articles/2017/07/01/why-charities-should-merge, accessed 3 January 2018.

[5] Family offices are established to manage the family’s wealth and assets as well as provide services to members of the family in areas such as education/professional develop, conflict and relationship management, and succession planning.

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