APRA and corporate governance, 2005

  • Date:01 Jul 2005
  • Type:CompanyDirectorMagazine
Markets are at the heart of all economies. In an excellent recent book, Martin Wolf, chief economics commentator of the Financial Times, looks at the role markets play in wealthy economies in particular.

APRA and corporate governance

Markets are at the heart of all economies. In an excellent recent book, Martin Wolf, chief economics commentator of the Financial Times, looks at the role markets play in wealthy economies in particular.

In Why Globalisation Works, Wolf notes that all modern economies have markets not just for goods for which there is an immediate need to buy or sell, such as fruit or rugs, but ones for things that take a long time to reach their fruition, such as borrowing, lending, investing and insuring. These markets require quite elaborate rules as the basis for the trust necessary for people to believe there is a high probability they will deliver as promised.

Corporations exist within markets for capital, for labour and for the goods and services they buy and sell. On the capital side, their long-term promise of returns requires a market that has rules as the foundation for the necessary trust. So it is that we have the Corporations Act, the ASX listing requirements and other elements of the regulatory framework for business. New rules have been introduced recently to cover the way in which directors govern public companies on behalf of shareholders. America has introduced its very rigid Sarbanes Oxley Act, while we have adopted the more liberal ASX Principles of Good Corporate Governance and Best Practice Recommendations.

Financial markets present special problems. Banks usually hold assets of longer term than their deposits and so can be vulnerable if depositors wish to withdraw en masse. Insurance policyholders and the holders of financial assets are not necessarily able to switch institutions without loss if they see some reason to do so. It is to deal with these problems that the Australian Prudential Regulatory Authority exists.

APRA regulates all banks, insurers and holders of the public's financial assets with a highly evolved system of monitoring backed by legal powers. It acts to protect the financial creditors of the institutions, while the ASX Principles are there to protect the interests of investors.

In the wake of the HIH royal commission, APRA is proposing in addition to regulate the boards of all institutions under its prudential supervision. Their second draft policy on this is now available for public comment on their website.

APRA's proposed approach is to adopt the governance framework in the ASX Principles as a standard that all institutions it supervises must adopt. This may well be accepted by many institutions, as the Principles are essentially a consensus statement of the mainstream way in which governance is done in Australia (although AICD would say it is over-egged in regard to director independence and undervalues director expertise). Many institutions are more concerned about proposals by APRA to tighten prudential supervision.

APRA's governance proposals may help promote stability among the smaller institutions it oversees, such as some of the credit unions and friendly societies and many of the 150 out of 154 general insurers not listed on the stock exchange.

The greatest strength of the ASX Principles is the "if not, why not" principle. This says that if some aspect of the standard approach is not well suited to a particular company's circumstances, the company is free to adopt an alternative of its own. The condition is that it must present an explanation to shareholders and the market as to why the alternative suits its situation better.

"If not, why not" is well established in governance codes in Great Britain, Canada and several European countries. It is a means of accommodating the huge variety of businesses in which the public invests. It also reflects the lack of empirical basis for the standard approach.

While a broad consensus exists that it is generally good for companies to have a majority of non-executive directors who are not associated with the business and for the chairman to be one of them and separate from the CEO, there is no solid proof that this is better than the alternatives, and there are cases of very successful businesses with different governance structures.

Structure is an important word here. Structures are what are being regulated in the governance field, because they can be seen. Competence, behaviour, judgement and integrity count far more at board level but are invisible, so they are not regulated.

APRA has left "if not why not" out of its proposed rules. Apparently, it may make exceptions in some instances on a temporary basis if a very persuasive case is made to it in private. We don't think this allows enough flexibility to accommodate the vast variety of business. It elevates the ASX Principles to something like holy writ, when they actually only reflect a consensus opinion of what is good for mainstream companies.

APRA supervised entities make up a large part of the total ASX capitalisation. If they lose "if not, why not", it might be lost for all other listed companies as well.

APRA is saying companies must be governed with the structure used by HIH, a spectacular failure, and must not follow the governance model of Macquarie Bank, a spectacular success. How clever is that?

AICD is working on a submission following exposure of APRA's second draft policy. We will have more to say on this matter.

My view is where institutions are in the clear according to APRA's prudential measures, as most large listed ones are most of the time, their boards should not be constrained by rules additional to those of the ASX and ASIC. APRA would be best to keep its governance regulation in the background, like the headmaster's cane behind the door.

If the government is determined APRA must regulate corporate governance for all the institutions it supervises, it should adopt a more liberal and transparent means of accommodating the "if not, why not" principle.

If a business wants to use an alternative to some aspect of the standard governance approach, it should be able to apply to do so. Applications might be evaluated by an independent panel of competent people. Their decisions and reasons should be made public and available over the internet, and precedent should apply.

In this way, and through disclosures to the stock market under "if not, why not", we might arrive at a better and wider range of acceptable ways to govern companies in Australia.


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