Governance in the corporate world is changing. We are experiencing a remarkable and revolutionary shift toward a new version of corporate capitalism. The collapse of trust and confidence in business following the global financial crisis, generational changes in the workforce, the expansion of analytics and technology for holding management accountable, consumer pressures, renewed investor interest in environmental, social and governance improvements, and the desire to preserve businesses’ license to operate in an environment of increasing disruption and business risk are critical drivers behind this shift.

Never more evident than in the financial services industry, the response of governments and industry bodies has been a predictable increase in legal compliance, tracking and reporting burdens for financial service entities. From “soft laws,” such as Basel III, the international regulatory framework for the regulation, supervision and risk management of banks (2017) developed by the Basel Committee on Banking Supervision, to revisions to the UK Corporate Governance Code (2018) to hard laws, such as the Senior Managers Regime (2016), which increased the personal accountability of executives within financial services institutions.

The Impact of Regulation Changes

Following on from the UK experience, Australia got its own version of the SMR. In 2018, the Banking Executive Accountability Regime was enacted as part of amendments to the Banking Act 1959 (Cth), along with revisions to the Australian equivalent of the UK Corporate Governance Code, known as the ASX Corporate Governance Principles and Recommendations. The revised principles take effect on January 1, 2020. While compliance with the principles is a relevant issue for listed entities, the principles have had a ripple effect on corporate governance practices across unlisted business entities, social enterprise and government organizations.

The companies and organizations that are tackling these increased responsibilities successfully are the ones that have taken a more strategic, whole-enterprise approach to governance that extends across and links the silos of responsibility within their organizations. Governance is no longer “top-down,” focusing on corporate boardrooms. Responsibilities and accountabilities extend across every tier of organizations, from the bottom to the top.

In Australia, in addition to the recent wave of regulation, the financial services sector was the subject of an excoriating 12-month examination of their past conduct and dealings with customers at the Royal Commission into Misconduct in the Financial Services, Banking and Superannuation Industries. The Interim and Final Reports of that Royal Commission found evidence of both legal misconduct and conduct falling below community expected standards of behavior. Identifying the root cause of this conduct as greed, cultivated by remuneration schemes that incentivized sales by staff and the institutions, over and above looking after the needs of customers, Commissioner Hayne nevertheless determined that the primary responsibility for that conduct lay with the boards and senior executives of the financial institutions themselves.

Commissioner Hayne called on boards and executives of Australia’s financial institutions to give serious consideration to how their decisions impact the whole organization and its wider group of stakeholders, including its customers. He contended that taking into account the voice of customers in their decision-making was not inconsistent with the legal duties of directors and executives articulated under the Corporations Act 2001 (Cth). His chief argument was that taking account of customer concerns was logically in the long-term interests of any financial services institution. There are two issues that Hayne’s approach raises. First, there is no time period, short or long term, applying to the legal duties imposed by the Corporations Act in Australia. Time is not mentioned as a consideration when assessing whether directors have satisfied these obligations.

Second, unlike in the UK, there is no specific legal requirement under the Corporations Act for directors and officers to consider the voices of stakeholders, apart from shareholders, in fulfilling their duties and responsibilities. It all depends on how you interpret the extent of these legal duties themselves and whether it is possible to prove that you can serve the interests of stakeholders simultaneously with the interests of shareholders. In my view, this is a wholly technical argument that loses sight of the fact that the duties of directors and officers are owed to the corporation, not to individual shareholders.

The Role of a Social License Under the Corporations Act

Be that as it may, the change toward recognizing that corporations have a social license to operate and responsibilities attending that license is proving to be a difficult subject for Australian companies to grapple with. The debate for a social license was most recently addressed by the ASX Corporate Governance Council as part of its review of the Corporate Governance Principles and Recommendations (3rd edition published in 2014). As part of its consultation paper accompanying proposed revisions to the Principles, the Corporate Governance Council spoke of a listed entity’s social license to operate as one of its most valuable assets, which can be lost or seriously damaged if the entity, its officers and employees act unlawfully, unethically or in a socially irresponsible manner.

The chief benefit of a social license is the longer-term approach to creating value for shareholders that requires the board and management of company to have regard for the views and interests of a broader range of stakeholders than just its shareholders and to be seen as good corporate citizens in their dealings with those stakeholders. Financial analysts have long argued that a longer-term approach of this kind ensures corporations are more robust and improves their financial performance. Critical to this ambition, a company must articulate a set of core values or a central purpose that helps define the type of organization that the company is aspiring to be. This notion of purpose and addressing the interests of stakeholders has also been actively promoted by Larry Fink, CEO of the global investment company BlackRock Inc., in his 2017 “Sense of Purpose” and 2018 “Purpose & Profit” letters to CEOs and by the Business Roundtable on August 25, 2019, via a blog post signed by 350 CEOs of America’s most powerful companies entitled “Redefined purpose of a corporation: welcoming the debate.”

While the benefits of a social license are increasingly accepted, there is still nervousness and uncertainty around embracing it within the Australian business community. That nervousness bubbled over and impacted the ASX Corporate Governance Council’s revision of Australia’s corporate governance principles. The final version, released in February 2019 but taking effect from January 1, 2020, removed all references to the social license to operate from the 4th edition of its Corporate Governance Principles and Recommendations. The apparent explanation was that the business community, as evidenced by submissions received during the public consultation process, was not ready to embrace the concept, in large part because they did not know what it meant and further, that legal reform was a necessary precursor to a wider embrace by corporates themselves. It is interesting to speculate whether the response would have been the same if the Business Roundtable edict had been published a year earlier. In any event, this approach has been endorsed by the Australian government, who criticized Australian businesses earlier this month for focusing too much on environmental and social issues at the expense of productivity and jobs growth.

Enshrining the social license to operate as law in Australia seems like an enormous step at the present moment. Unlike the FCA, the regulator in the UK, the Australian Securities and Investments Commission (ASIC), the regulator in Australia handles conduct complaints made against companies, their officers and directors and is empowered to take enforcement action through the courts if deemed necessary. While companies are still finding their feet as to what is and is not included in a social license, ASIC is already monitoring corporate compliance with environmental disclosure laws and the metrics by which climate risk is being assessed and included in financial statements. The prudential regulator, the Australian Prudential Regulation Authority (APRA), is also making increasing public statements about the critical importance of properly assessed prudential allocations for climate risk. Both ASIC and APRA point to the importance of guidance notes from the Financial Stability Board’s Taskforce on Climate-related Financial Disclosures.

The point to be made here is that if Australian companies do not address the social license issue in the near future, the initiative could be taken away from them by way of prescriptive regulation of specific social and environmental issues and the metrics for measuring them, when those companies might otherwise prefer that it be left to them to assess and self-determine. Law in this respect is a hard-nosed vehicle for achieving what companies could otherwise claim authority or direction over if the business community communicated its broader acceptance for a softer approach, such as compliance with the principles and recommendations on social licence as found in the ASX Corporate Governance Council’s Corporate Governance Principles and Recommendations.

What These Principle Changes Really Mean For Corporate Governance

Here is the delicious irony of those principles. All references to social license have been removed, BUT the proposed recommendations to support the existence of a social license remain largely intact in the new edition of the principles. So, Principle 3, “Instill the desired culture,” requires listed entities to articulate their core values (Recommendation 3.1), codes of conduct for directors, executives and employees (Recommendation 3.2) and to implement whistle-blower, anti-bribery and corruption policies (Recommendations 3.3 and 3.4).

The notion of a social license would logically impact on the articulation of an entity’s core values (Recommendation 3.1). Recommendation 3.1 does not tell entities what to include in this articulation. The commentary raises a range of possible considerations, but leaves it up to the entities to determine what is appropriate and relevant for their context and aspirations. In short, this recommendation gives entities the opportunity to, in a sense, try out for themselves what they consider to be their core values and, over time, to make adjustments to their definition of their own social license. No blunt edicts from government. No forced investigations for now by Australian regulators. If legislation does eventually follow, companies will also have the compelling argument of experience to bolster their arguments as to any legislative definition and requirements attending a social license.

Similar to the UK, the ASX CGC principles and recommendations adopt a “comply or explain” approach. In Australia, they are known as the “if not, why not” rules. They require listed entities to articulate whether they have complied with the principles and, if they have not, to explain why they have not complied. However, they differ from the UK Corporate Governance Code in one critical respect. The ASX CGC principles and recommendations are not monitored and enforced by any regulating or market-based agency. They are drafted by the ASX Corporate Governance Council, itself an amalgam of corporate governance stakeholders. The UK Code was drafted and issued by a government agency, the FCA. In all other respects, they are very similar. Both ASX and LSE listing rules require companies in their respective markets to make a statement of how they applied the principles. However, in the case of the UK, it appears that the real imprimatur in the UK Corporate Governance Code comes from its regulatory agency source, the FCA.

For now, the soft regulation approach in Australia has been rejected, and we are at an impasse. Australia’s conservative corporate world is not ready for legislation in this area. However, this should not be an excuse for organizations to sit back and do nothing. With the January 1, 2020, commencement date for the 4th edition of the ASX Corporate Governance Principles and Recommendations fast approaching, companies should quietly embrace the opportunity to craft the nuts and bolts of their own, as yet undeclared, social license to operate in accordance with the spirit of Recommendation 3.1 and to articulate the broader responsibility to stakeholders that they believe this entails.

The 4th edition of the Principles and Recommendations contains lots of valuable guidance on values and linking values to executive pay without once mentioning the “license” word. There are also examples in the UK Code, which is attempting to get companies to move away from a tick-the-box approach to social license compliance to more meaningful reporting around values and executive pay. Go on, as they say in Australia, and do yourself a “corporate” favor.