Agenda: Upcoming corporate governance issues for AGM season

Remuneration will remain in the spotlight this annual general meeting (AGM) season, according to investors.

Ed John is the executive manager, governance, engagement and policy with the Australian Council of Superannuation Investors (ACSI). He says this topic is always in the headlines during AGM season, especially the issue of whether remuneration matches performance.

“I think one ongoing challenge is demonstrating whether short-term incentives are truly at risk,” he says. “We see some companies where ‘at-target’ bonuses have almost become part of fixed pay and there’s very little volatility in outcomes over time.”

John says ACSI will be looking very closely at short-term incentive outcomes. “Where companies disclose them in a transparent way it’s much easier, as you can see where performance hurdles have been met – whether it’s safety or employee-focused measures or profitability measures,” he says.

“Sometimes underlying performance measures aren’t well articulated. We often have to hold discussions with ASX300 boards to get more colour.”

The use of underlying earnings as a performance measure is one issue ACSI has seen emerge. John says this isn’t necessarily the wrong measure to use but where you have one-off exclusions, then investors look very closely at what is excluded for the purposes of remuneration outcomes.

“Impairments or one-off costs being excluded from bonus outcomes has been a major source of angst in the shareholder community,” he says. “Boards explaining why individual items have been taken above or below the line is vital, otherwise it looks like management have been given a free ride”

Director elections are another key issue and here gender diversity will be in the spotlight. Last year, ACSI adopted a target for women to comprise 30 per cent of all ASX200 boards by the end of 2017.

“We have a policy around zero-women boards in the ASX200, John says. “We’ll be recommending against long-standing directors in those companies that have made no progress on this issue.”

Australian Shareholders’ Association CEO Judith Fox MAICD will also be watching what happens around this issue. “It will be very interesting to see what ACSI does with companies that have no female directors on board,” she says.

Another area of interest to ASA is that of withdrawn resolutions. “There were more withdrawn resolutions than usual last year,” Fox says. “We are also likely to see companies who received first strikes coming forward with different remuneration plans, such as Woodside did.”

Last year, the ASA voted against Woodside’s remuneration citing a number of departures from ASA’s voting guidelines.

Fox adds that the workload of directors is another issue that may come up during AGM season. “But this is something we’ll have to wait and see about closer to the time,” she says. Meanwhile, John says the question of director accountability will likely arise, particularly for companies that have experienced poor performance over an extended time period.

“We don’t blame individual directors for collective decisions but there is a clear issue of accountability – especially in cases where boards have exercised poor judgment on key issues.”

What private health insurers can do to improve governance

Growing levels of complacency in the private health insurance sector indicate more work is needed around governance and risk management, according to APRA.

“We see a risk of complacency developing in the private health insurance space, which may lead to less than optimal risk management and governance practices in the industry,” APRA’s senior manager, policy development, Peter Kohlhagen, said at the recent Health Insurance Summit in Sydney.

“A tendency towards complacency can be a consequence of long periods of relative stability over the years, both within the industry and in the Australian economy generally. Complacency is the enemy of resilience.”

Since assuming responsibility for the prudential regulation of private health insurers in July 2015, APRA has undertaken a review of the private health insurance prudential framework to ensure it remains fit for purpose and able to support the APRA mandate both now and into the future.

Kohlhagen said part of APRA’s responsibility concerns improving governance, because “a resilient insurer has robust governance arrangements designed to facilitate effective decision making in the long-term interests of the insurer.”

Its review found there was significant variation between insurers in terms of the maturity of processes with regard to risk management and governance.

It said the variation wasn’t about differences between larger and smaller insurers, rather it had observed some good practices but had also identified a number of areas where practices needed to be strengthened and embedded in the operations of insurers.

In July, APRA issued a letter to the private heath insurance industry of the risk management review, which outlined details on areas for improvement. For example, while it found that most boards considered risk management was important – and APRA found that this was the case – the formal use of risk management processes and risk data by boards was not widespread.

Some of APRA’s recommendations outlined in the letter related to:

• Information flow to the board, including analysis and reporting on risk.
• Independent review of the risk management framework.
• Establishing enterprise wide risk management frameworks and internal control environment.
• Reviewing risk assessment processes.
• Strengthening both the first and second lines of defence.
• Enhancing project management, business continuity management and outsourcing disciplines.

With regard to governance, APRA also said it encourages all private health insurers to review the existing cross-industry prudential standards.

“In particular CPS 510 on governance and CPS 520 on fit and proper,” APRA said. “And consider where there may be gaps between their own practices and these standards. Insurers that engage with these standards early will be better placed to implement any necessary changes in due course.”

Kohlhagen says APRA is confident that the introduction of enterprise-wide risk management and governance frameworks will help boards and senior management of private health insurers to overcome these and other challenges.

Meanwhile, he says, APRA will maintain a focus on risk governance as it continues to work through a policy road map for the sector.

Protectionism and governance: considerations for directors

Rising global protectionism presents challenges for Australia and businesses directors need to watch this space.

Tim Harcourt, JW Nevile Fellow of Economics UNSW Business School, says President Trump’s focus on trade may have a number of unintended consequences.

“The US president has vowed to boost American manufacturing by cutting the US trade deficit and updating NAFTA [North American Free Trade Agreement],” Harcourt says.

“However, protectionist policies have a habit of not working out.”

Harcourt says the report, Rising Protectionism – Challenges threats and opportunities for Australia, released by the Productivity Commission in July, should be a warning.

“The Productivity Commission has realised that trade needs to work for all, and social institutions – like minimum wages, trade union rights, education and training, and labour market adjustment programs – need to include free trade,” he says.

“The Productivity Commission realises that we need a ‘social compact’ to ensure that the benefits of trade flow to everyone in the community.”

In its report, the commission found almost 100,000 jobs could disappear and households could suffer a $1,500 reduction in annual income if Australia follows a global swing towards protectionism.

The report also found a spike in protectionism fuelled by Trump’s trade doctrine could spark a global recession.

It suggested Australia should prioritise regional trade agreements that, “clearly and measurably persist with lowering barriers to all trading partners, and reinforce efforts to strengthen the rules-based trade system.”

With the trend towards greater protectionism, directors need to carefully consider their corporate governance position, particularly as it has been recognised that aggregate global wealth is diminished with protectionism.

According to Harcourt, directors should be conscious of the protectionist threat but mindful that Australia is not the United States and that the country has benefitted from trade with Asia, particularly in terms of employment and growth.

Currency management strategies to consider for the rest of the year

With the continuing volatility of the Australian dollar, directors need to ensure they have appropriate strategies in place to manage the effect of currency on their operations.

CBA’s chief currency strategist Richard Grace says the dollar’s upside momentum is very much in line with the bank’s long-held forecasts, adding there is combination of factors behind the move.

“First, there is the US dollar weakness as expectations about further US Federal Reserve interest-rate increases start to recede,” he says.

“They’re receding in response to lower-than-expected inflation outcomes in the US. There’s also a bit of fiscal policy inaction weighing on the US dollar after it lifted quite significantly following the election of Donald Trump and his promise of a fiscal agenda and especially the cutting of the company tax rate.”

The second factor, Grace says, is that the global economy is expanding nicely with the International Monetary Fund recently confirming its reasonably rosy growth forecast.

“This is supporting aggregate demand and related to this is the first synchronised upswing for a number of years,” Grace says.

“The US economy is doing fine, the European economy is exceeding expectations in terms of its growth rate and China is likely to continue doing well, particularly given the leadership change at the end of this year. Japan is also performing well as its unemployment rate falls.”

Grace says an environment where the global economy is doing well is generally supportive of commodity prices. “What we have seen is a pickup in Australia’s commodity export prices since the middle of June; according to CBA’s measure they are up 14 per cent and this has helped with the Australian dollar.”

Australia’s unemployment rate is continuing to come down and while the domestic economy is not as strong as it could be, Grace says aggregate growth is holding up reasonably well because of the net contribution to growth from exports.

He adds the currency is running ahead of CBA’s official forecasts so in a few months it will probably exceed them, predicting in several months it may be above US80 cents.

Grace says if directors are importers, they might want to lock in some importing contracts now – or at least over the coming months – as the Australian dollar continues to appreciate.

“But they should certainly hedge against the risk that it falls,” he says. “We are at two-year highs so it’s attractive from that perspective.”

He adds that exporters might want to buy the Australian dollar on any dips. “In a sense, they are converting their US dollar revenues back to Australian dollars,” Grace says.

Currency management plays an important role in a business but Grace says much of the survey data from the Reserve Bank of Australia and what comes out of the Australian Bureau of Statistics suggests Australian firms are very good at managing their exchange rate risk.

“It’s often the smaller firms who tend to hedge less,” he says. “The big firms are reasonably sophisticated at hedging but smaller firms are often limited by time constraints and by not being as well resourced.”