Room for improvement on disclosures on board skills and sustainability risks
Disclosures against the nine new recommendations in the 3rd edition of the ASX Corporate Governance Council’s Corporate Governance Principles and Recommendations have been examined in a new KPMG report. While there was a high level of adoption and acceptance of the new recommendations, ranging from disclosure of a board skills matrix to directors’ induction programs to the company secretary reporting line, the report shows that disclosures on board skills and sustainability risks have considerable room for improvement.
The report, ASX Corporate Governance Council: Adoption of Third Edition Corporate Governance Principles and Recommendations — Analysis of disclosures for financial years ended between 1 January 2015 and 31 December 2015, analysed around 600 Australian entities. Of the board skills matrix disclosures, the report notes that they generally cover functional skills, such as finance, legal and risk, and often also canvassed sector skills, leadership experience and strategic skills. However, people skills and geographic experience were less frequently identified. KPMG found the absence of the latter disclosure 'surprising', particularly in the ASX200, where of the entities with overseas operations, only 49 per cent identified geographic skills.
The report also noted that, with technology transforming all businesses and industries, KPMG expected technology and digital expertise to feature in the majority of board skills matrices, but it was not one of the top six skills identified. While the report also noted that the majority of entities identified the skills the board currently has, it pointed out that few disclosures identified any gaps in the current board's collective skills or addressed which skills it might require in the future.
Governance Institute’s Good Governance Guide: Creating and disclosing a board skills matrix provides some understanding of why few disclosures identify gaps in board skills. The Guide states that
… there can be a tension between the transparency needed to provide insight to board thinking and the need to ensure that any disclosure of gaps in board skills is not seen as detrimental to the company. Identification of inadequate skills or competencies in one area does not of itself indicate a dysfunctional board. It is likely to indicate a board that is actively considering which skills and competencies will add value to meet the strategic objectives of the entity.
KPMG’s report also encourages entities to improve disclosure on the diversity component of the recommendation, including a mix of skills, expertise, background, age, ethnicity and gender to clarify that the board is not subject to ‘group think’.
KPMG identified two key issues with the disclosures against Recommendation 7.4, which asked listed entities to disclose whether they had any material exposure to economic, environmental or social sustainability risks and, if they do, how they manage or intend to manage those risks.
The first issue is that there appeared to be significant differences in the interpretation of what constituted material risk. The report notes that sector-specific reporting showed reporting of very different risk profiles, with some instances of entities in the same sector either identifying a range of material risks or an absence of risks, despite having similar operations that would be subject to a number of similar economic, environmental and social sustainability risks. The report also queried the disclosures from over 20 per cent of companies claiming they did not have any economic, environmental or social sustainability risks, noting this was ‘unlikely’.
The second issue was that many entities provided little or no information to support the way in which they determined whether they had any material risks. KPMG pointed to The Global Risk Report 2016 which identified that three of the top five risks that would have a massive and devastating impact are social and/or environmental risks, and again queried why a majority of companies whose disclosures were analysed for the report did not consider these risks to be material.
The report points to the best disclosures it saw, noting they addressed all three of the issues set out in the recommendation. These ‘best practice’ disclosures took the time to consider for each risk: whether the entity had exposure to the risk; if it did not have a material exposure, why management believed that to be the case; and if it did have a material exposure, either outlining how the risk is managed or referring to another report that sets out that information.
Overall, KPMG considered that there is 'considerable room for improvement' in the way in which entities chose to adopt Recommendation 7.4, in particular for those below the SP/ASX200.
While other new recommendations saw a high level of adoption and acceptance, the KPMG report does point to an overarching concern, which was the reliance on Appendix 4G to indicate that entities had adopted a recommendation rather than providing details in their corporate governance statements. As Appendix 4G was never intended to replace the corporate governance statement, but simply provide a ‘map’ as to where disclosures can be found, listed entities will need to change their approach to disclosure in the following financial year to meet market expectations.
The report is available here.