Subject to final say by the Securities Commission, the much-debated Corporate Governance Best Practice Code proposed by the New Zealand Stock Exchange (NZX) is expected to be approved in its current form by the end of the year. Halfway between rules and principles the new code will make it harder for listed companies to wriggle through the compliance gaps that arise from rules-based approach – especially where honesty is left to interpretation or individual discretion.
In addition to approving the NZX’s Code, the Securities Commission has its own role to play in corporate governance reform. Earlier this year, the Ministry of Commerce charged the regulator with consulting widely with business to develop set of corporate governance principles that reflects global thinking.
The Government’s somewhat late in the day decision to enter the corporate governance debate clearly indicates that existing rules and codes were far from broken. With the consultation closely mirroring the work already done by the NZX, the outcome is unlikely to result in any new legislation. What this consultation process will do is help fashion benchmark for shaping the behaviour of New Zealand businesses – outside the scope of the stock exchange.
In practice, corporate New Zealand has been more exemplar of sound practice than ‘catch-up Charlie’ in the corporate governance stakes. That said, what’s accelerated the last 10 to 20 years of incremental tweaking over corporate governance practice is need to be seen to be keeping pace with the global thinking.
Complying with the new code hardly begs quantum step for most listed stocks, but neither is it business as usual. Beyond the more detailed matrix of outcomes, the NZX code is expected to increase the time and costs of compliance. Based on back-of-the-envelope calculations by Listed Companies Association (www.listedcompanies.org.nz) chairman John Blair, one extra management salary – required to deal with additional compliance demands – together with extra board time and communication to shareholders – could cost major company an additional $250,000 year.
But as compliance is not determined by size, he fears that even small companies will incur similar sorts of costs. He suspects many shareholders will view added compliance as an onerous burden bringing no real benefit.
If there is any real wild card to fall out of the Government’s consultation process it could be dealt to companies further down the corporate food chain – the unlisted variety. It’s been suggested that the NZX code could in effect be imposed (in some undisclosed form) on all unlisted companies.
Not surprisingly, much of the current concern centres around the practicality of imposing code of ethical conduct – with associated penalties – without stifling business growth or foreign investment. For example, would this force local firms into producing copies of their compliance documentation or environmental statements, just so they’re eligible for some tenders? While this will add to the cost of the tender process, there’s no way of validating the reality behind what could be tick-the-box exercise. Alternatively, will this encourage more ethical investment in New Zealand?
So what immediate calls to action are the key governing principles proposed by the Securities Commission likely to trigger? Here’s look at the main ones as identified by the Listed Companies Association (LCA). These findings form the basis of an LCA-organised corporate governance seminar in Auckland on November 5.
* Board composition: Owing to issues of independence, immediate changes – on final approval of the code or governing principles – are expected around board and board sub-committee composition. The requirement for predominance of independent representation means boards will take wider and longer study of the people they’re offering directorships to.
Prohibited relationships aside, there are grey areas as to how literally the independence factor will extend, especially where shares are not widely held.
Some boards fear that over-zealous interpretation of this code could be counter productive, especially if it denies companies the advice and services of effective and knowledgeable board members.
It may take few test cases before we know how literally independence is to be interpreted, especially where majority stakeholders want significant board representation. Then there are co-ops (like Fonterra), companies owned by local or central government or even unlisted family-owned businesses. It remains unclear how they would fare under these rules.
• Continuous disclosure: Continuing the practice of self-governance, new disclosure requirements represent curious compromise between rules and compliance-based approach. In principle the code recognises the importance of keeping the capital market informed. When it comes to meaningful guidance on market rumour, companies can no longer get away with saying – “no comment”.
In practice most lawyers have struggled to interpret how much disclosure this code expects. There will be innumerable situations when disclosing will be, at best, line-ball. For example, Fisher & Paykel Appliances managing director John Bongard admits the company wouldn’t have revealed plans to establish global alliance with the world’s biggest appliance maker, US-based Whirlpool Corp, so soon if the new continuous disclosure regime (governing publicly listed companies) hadn’t required them to.
So it’s up to the NZX to give guidance on whether practice meets expectation. Under the new code, listed companies are required to disclose how they’re abiding by key principles. Those that can’t are expected to explain why not. Ironically though, adherence to much of the code relies on the one thing that can’t be legislated for – honesty.
Here’s another quandary for the NZX to resolve. As most waivers and rulings typically happen during mergers and acquisitions and other corporate activity – the timing of their disclosing remains unresolved. In worst-case scenario – where waivers do need to be disclosed immediately – we could see transactions delayed by reluctance to have waivers published.
• Auditor independence: Most publicly listed firms already have independent audit committees. But the need to shuffle their auditors downstream could be pending dilemma – especially if the pool of available auditors continues to shrink. If auditors are being rotated between handful of firms, it’s reasonable to ask how fresh any new set of eyes will really be.
• Matters of judgement: There is lingering uncertainty over the proposed process for approvals, waivers and rulings. Some boards question whether the NZX’s transition from self-sanctioning co-op into commercial organisation will affect the decisions it makes.
For example, will the body – to be known as “NZX Discipline” – that will make disciplinary findings against listed companies and order range of sanctions and financial penalties without any appeal mechanism – have the maturity and necessary market expertise to make the right call?
Determining whether transaction is material requires considerable sound judgement, and the jury’s out on whether the NZX is capable of providing it, especially within its current structure. Others question whether it’s appropriate for the NZX to penalise third party in quasi-criminal sense. M
