All articles in Volume 14 Issue 1

Andrew Charlton

Weathering the financial market storm

Fears are growing about the health of the global economy and the possibility of further market instability throughout 2016. Dr Andrew Charlton, co-founder of strategy and economics advisory business AlphaBeta, considers how directors should respond.


Global stock markets have recorded their worst start to the year in living memory, with nearly three trillion dollars slashed from the value of equities around the world in the first few weeks of 2016.

Many Wall Street veterans are fond of the saying, “As goes January, so goes the year,” and while this old adage may sound glib, fears for continued volatility in 2016 are widely shared. According to a new survey from US bank, Wells Fargo, nearly 75 per cent of respondents expect market volatility to continue for much of 2016.

Three factors are expected to contribute to volatility in 2016.

First, the Chinese economy is worrying markets. A series of policy missteps in the last few months have undermined confidence in Chinese authorities and precipitated heavy falls in local equity markets. China is facing a trifecta of economic challenges including an extremely unbalanced economy, chronic over-capacity and high debt. Already China’s economy has fallen to its lowest pace of economic growth in 25 years, and the outlook is highly uncertain.

Second, markets are also being spooked by the possibility of rising US interest rates. For the last several years, low interest rates have boosted asset prices. But the Federal Reserve has signalled up to four rate increases throughout this year, potentially spelling more pain for equities.

Third, the rising US dollar is creating instability around the world, especially in emerging markets. In recent years, many companies in emerging markets have dramatically increased their dollar-denominated debts. Now companies holding these debts are being hit by the double whammy of rising interest rates and the rising dollar. "Emerging markets were part of the solution after the Lehman crisis. Now they are part of the problem," said William White of the OECD.

Advice for directors

So how should directors respond to the possibility of further market instability throughout 2016? A few principles are important to keep top of mind:

  1. Confirm the soundness of your balance sheet: In the recent turmoil, companies with weak balance sheets have been hit hardest. Directors should ensure their CFO has reviewed risks to their balance sheet. That means keeping a close watch on debt and creditors. The unfortunate case of Dick Smith should be a warning to directors: it took less than a year for the management team to accumulate debts which ultimately brought down the company.

  2. Ignore the noise: While keeping a close eye on market developments, directors shouldn’t overreact to the constant stream of news. Much of the daily fluctuations in financial markets are simply noise. This can be distracting and push management teams to act irrationally and not in the best interests of shareholders long-term goals. It is essential to stay focused on what matters and remind your management team they are in it for the long term.

  3. Understand your exposures: Directors need a clear view on their exposure to sources of volatility, such as currency exposure, commodity prices, trade creditors or key customer risks. Work through scenarios that could expose your business or its counterparties to sudden weaknesses and put policies in place to address those risks.

  4. Re-evaluate business strategies: John Maynard Keynes famously said: “When the facts change, I change my mind.” Major business decisions including capital investments, acquisitions and significant changes in strategy should be re-evaluated in the context of changing market conditions. This isn’t a time to throw the baby out with the bathwater, but it is important to adjust business cases to reflect significant changes in market conditions such as a sharply lower currency, lower economic growth, and stalling asset prices.

Volatile conditions call for calm judgement. Directors should be carefully considering new risk factors as they emerge, but not overreacting to them.


Governance trends in 2016

Louise Pocock

What does the year have in store for directors and governance leaders? The Governance Leadership Centre’s Louise Pocock considers the key governance trends for 2016.


Governance driving performance

In recent years, we have seen a shift in thinking about corporate governance – from an administrative “box-ticking” exercise to a driver of organisational performance. This year, we are likely to see more analysis around what makes an effective board and how governance affects organisational performance.

Board composition

Board composition, and its impact on the performance of boards and organisations, is likely to remain a key issue. While the debate around diversity in Australia is still largely focused on gender, we may see a broadening to other dimensions of diversity such as background, ethnicity/race and age. There will be continued debate in relation to the value of independent directors, which the AICD's Governance Leadership Centre (GLC) will contribute to through its research in the area.

Digital disruption

With the continued disruption of traditional business models across many sectors, digital disruption and the imperative for businesses to adapt and innovate is likely to be front of mind for boards. Many boards will face important strategic decisions necessary to ensure that their businesses remain competitive in a dynamic environment, and to ensure that innovation at all levels of the organisation is being fostered and captured.

Long-term value creation and sustainability

As concerns about short-termism grow, the role that boards can play in driving long-term value creation will become increasingly important. There will also be pressure on boards to ensure that their companies are providing information to the market that allows investors to assess long-term corporate sustainability and financial health, including greater transparency around environmental, social and governance (ESG) considerations.

AGMs and shareholder engagement

It is likely that shareholder attendance at AGMs will continue to fall. Boards will need to be more innovative in terms of how they engage with investors, and are likely to increasingly make use of technology to promote shareholder engagement (e.g. webcasting AGMs and social media). The AICD’s Director Sentiment Index, released late last year, showed that, for the first time, a larger proportion of directors considered AGMs to be dysfunctional (35 per cent) than working well (32 per cent). The debate about the efficacy of the AGM may have reached a “tipping point” in terms of the need for AGM reform.

Corporate culture

The board has an important role to play in setting corporate culture, and this year we are likely to see growing recognition of the importance of good corporate culture. This is particularly so in the wake of events last year such as the Volkswagen emissions scandal, which revealed issues with Volkswagen’s governance and corporate culture. Last year ASIC took a strong interest in culture and is pushing for law reform in this area.


Directors’ tips for executives

A good relationship between the board and the executive is crucial in achieving governance best practice. It needs to run like a well-oiled machine.

The Australian Institute of Company Directors speaks with three leading directors and asks them to share their top tips for optimising the relationship between the board and the executive.


David Bacon

David Bacon FAICD
Chairman, Pacific Link Housing

  1. Good communication
    Unfortunately, in many organisations, a common understanding of what good communication actually means is sometimes elusive. Of crucial importance is the ability of the CEO and the chairman to communicate in an open and honest manner, building respect and trust. One of the best ways of achieving this is through the provision of complete and timely information to the Board. There’s nothing worse than a data dump the size of an old style yellow pages directory the night before a board meeting and expecting a sensible discussion and a good decision. Likewise, if the board wants information for consideration at a meeting, don’t expect quality with a request the night before or on the morning of.

  2. A skills-based board
    Experience, respect and understanding from directors go a long way in building the relationship with management.

    A highly skilled and experienced board will engender respect and an environment where management seeks and values the knowledge and views of their directors. Good directors can also be an excellent resource for counselling and mentoring young executives who are keen to learn, provided appropriate protocols are in place. This in turn contributes to a positive relationship between the board and management and a culture of trust and respect.

  3. Good governance structures
    Good governance and management structures lead to a positive culture which encourages and rewards openness and honesty. Clear understanding by both the directors and the management team of each other’s roles, and where the line of separation between the board’s role and operations, is needed. Of particular importance here are the organisation’s instrument of delegation and a formally adopted document articulating matters reserved for the board.

    Conflict and a decline in relationships usually occur when there is a lack of clarity – whether that’s in business or personal life. In business, if everyone is clear about the organisation’s direction and who is responsible for what, then relationships between the board and management will be positive and the chances of success are enhanced.

Naseema Sparks

Naseema Sparks FAICD
Director, ingogo

  1. Practice mutual respect
    Though the roles of the management and board differ, they must work as a cohesive team. Irrespective of the situation a company finds itself in, every board and management member has something of value to offer; their own unique perspective based on a wealth of expertise and experience. Respect and listen to everyone.

  2. Communicate openly
    Nothing destroys trust between a management and board more than factional and “out of school" communication. Keep communication open, honest and around the table. Appreciate differences of opinion and encourage constructive discussion and debate. A good chairman will understand how to manage diverse views for the benefit of the business, the people and for shareholders. Most importantly, “play the ball, not the person”.

  3. Get to know the team
    Healthy and productive relationships are not only built during working meetings. Understanding the individual behind the role is both valuable and rewarding for everyone around the table. Boards may only meet 8 to 10 times a year, whereas management meet every day - getting to know each other personally is important to working together.

Sylvia Falzon

Sylvia Falzon GAICD
Non-Executive Director, Regis Healthcare

  1. Challenge and empathise
    While board and executive teams need to challenge each other, having empathy can often yield a better outcome. Putting yourself in the other person's shoes may provide a perspective or understanding you may not have considered.

  2. No surprises
    Having an open and transparent relationship ensures news, both good and bad, is communicated quickly. The relationship between the chair and CEO is critical in setting the parameters which guide the organisation.

  3. Check in
    Don't wait for a board review to understand how the relationship between board and the executive is going. The board, via the chair and executive, via the CEO, can get feedback on the relationship when the chair and CEO do their regular catch ups. If actions are required, it's important to follow through.


Winding up your charity

The Shane Warne Foundation last week announced it will cease operations amid controversy regarding its distribution of funds and a subsequent audit ordered by Consumer Affairs Victoria. This follows the charity’s failure to provide “sufficient” information about its financial affairs to the regulator. 

However, the Shane Warne Foundation is not alone and is, in fact, among more than 10,000 charities that have been removed from the Charity Register since the establishment of the Australian Charities and Not-for-profits Commission (ACNC) three years ago. 

The reasons for this are varied, but more often than not they are closed due to a lack of activity, or because they have failed to submit their Annual Information Statements for two years. Other times, charities just run their course. 

 “We know that about eight per cent of boards have discussed winding up in the past 12 months,” says Phil Butler, NFP Sector Leader at the AICD, citing the latest research findings reported in the 2015 NFP Governance and Performance Study.

“There should be nothing wrong with a charity winding up,” adds Butler. “If they’ve achieved their mission or can no longer achieve their mission effectively – it could be the perfect time to wind up.”

Regardless of the reasons, boards and their directors have responsibilities to ensure that the charity is wound up legally, that all liabilities have been considered, and assets have been distributed before cancelling registration as a charity with the ACNC.

Consult your organisation’s governing documents

“If a charity decides to wind up, the board must make sure that it is following the charity’s governing documents and all other legal requirements,” says the ACNC.

Consult your organisation’s rules, constitution and articles of association as well as the rules of your charity’s regulator e.g. incorporated regulators, ASIC or the ATO. These will be critical in determining various processes and the manner in which you make decisions, such as the distribution of assets.

Dot your ‘i’s and cross your ‘t’s

Winding up a charity will involve a number of activities. The ACNC lists the following as the most likely to occur:

  • agreeing to wind up as a board
  • appointing an independent administrator or liquidator if required
  • ending contracts
  • paying debts
  • distributing surplus assets (leftover money and property)
  • closing bank accounts
  • disbanding the governing body (board, committee)
  • cancelling registration as a legal structure (this will depend on the type of structure the charity is)
  • cancelling registration as a charity with the ACNC
  • cancelling the ABN

Consider employees volunteers, the community and the public

“A board may need to get professional advice when deciding whether to wind up the charity or to assist with winding up, especially if it has employees, valuable property or contracts. This professional advice may also help a board consider other options such as merging,” the Commission says. 

The charity will need to be prepared to communicate with a wide range of stakeholders on the issue. This includes telling members, volunteers, employees, clients, donors, the local community in which the charity operates, as well as the wider public.

For further information on engagement with NFP stakeholders, see Principle 10 of the AICD’s Good Governance Principles and Guidance for NFP Organisations.


What I’ve learnt: Cyan Ta’eed

Cyan Ta’eed

Cyan Ta’eed MAICD has been on an exciting journey from graphic designer to successful tech entrepreneur and 2015 Telstra Victorian Business Woman of the Year. She recently spoke with AICD and shared what she’s learnt about start-up funding, nurturing a diverse business culture, and what it’s like to run “Australia’s Coolest Company for Women”.


In 2006 Cyan Ta’eed MAICD and her co-founder (now husband) Collis Ta'eed launched their online business from her parents’ garage. It was, according to Ta’eed, a “clichéd tech company start-up story”, with a desk made of stools, funding troubles, and a fast-paced scramble to secure their place in the market.

“We really underestimated how much of an investment it would be to get it off the ground,” she says. “We got into a fair bit of debt, maxed out credit cards, borrowed money from our parents, and worked like crazy. The next few years we were just hanging on for dear life and learning as much as we could, trying to understand how to run a business which just kept on growing.”

Ten years later, their global marketplace for developers and designers has flourished. Envato now has 170 employees in its Melbourne headquarters, and recently the company celebrated a $300 million milestone for seller earnings.

The company’s five-member board has evolved from its informal beginnings to become the nucleus for Envato’s company culture and the developer of its strategy. And according to Ta’eed, in the tech field you always need to stay one step ahead of the game.

“For us, innovation is absolutely key. We invest in a great deal of research and development, and that’s because we know that tech always moves so quickly – we’re always looking for the next big high-growth product that we can release. So right now we have three in the pipeline that will be out in the next six months or so. We are constantly experimenting in a lot of different areas,” she says.

Experimentation and growth has always been a big part of the company’s journey – but also for Ta’eed. She is quick to share the challenges and successes, and is generous with advice for other emerging start-ups and entrepreneurs.

“I have really tried to grow on the job. I didn’t have anything like this skill set when I started. I had no idea what an HR function looked like or what business intelligence did. I was really green. I really had to learn and figure it out and hire brilliant people, rely on them and learn from them. There are some areas where we’re really strong and some areas where we are still finding our feet, so we rely on each other. We take intelligent risks and when things go wrong we ‘retro-fit’ it, learn from it and move on.”

Since being announced as the 2015 Telstra Victorian Business Woman of the Year, Ta’eed has been in hot demand on the speaker circuit, emerging as a strong advocate for diversity, workplace flexibility and unconscious bias training – work that helped earn Envato the recent title of “Australia’s Coolest Company for Women”.

Here Ta’eed shares some the key things she has learnt about building a successful and diverse private enterprise.

ON INVESTORS

While Envato was “bootstrapped” and never took external funding when it launched in 2006, Ta’eed says that in the current saturated start-up environment, that would probably be a lot harder to do. “As someone on the other side of that now (who invests in other start-ups), personally I think, if you can, it’s better to get investments from other founders when you’re first starting out, rather than big business. Especially founders who have had success in the space that is relevant to your proposed business,” she says.

“Even though you’ll probably be able to get a smaller sum in terms of investments from successful founder, you’ll also get an understanding of what it’s like to run a successful start-up and hopefully you’ll also get the expertise and the connections and all those other benefits.”

ON COMPANY VALUES

Envato has seven core company values, such as: “Tell it like it is”, “diverse and inclusive”, “not just the bottom line”, and “when the community succeeds we succeed”. Everyone in the organisation contributed to creating the values – from the board to the receptionist – which is why Ta’eed believes they’ve had such a good buy-in from all employees.

“People feel like the values are theirs. They really live it and own it – it has been one of our great successes. I was a bit cynical about values when we first started, but they’ve set the culture in a formal way and they really guide people on best practice,” says Ta’eed.

“We’ve always made it clear that business is not just about making money. We have a profitable business and we’ve been very lucky that our business has grown very fast and has always been very profitable. There are quite a few things we do which do not benefit the bottom line in any way; they’re just the right thing to do. I think that people like that about working here. Hopefully, people feel like working here is more than just about earning a salary but about our own little way of making a positive difference on a broad level.”

ON DIVERSITY IN THE WORKPLACE

In order to nurture a diverse workplace, Ta’eed says that it is the board and management’s job to think proactively about how they can get diversity in our workforce, support their staff and make sure that they feel included.

“It’s a long road but at the very least, management should be across unconscious bias, and should at least have ways that they can combat that and be conscious of it, and have discussions around recruitment. They should ask themselves: why are we making these decisions? Are there valid reasons, or is it unconscious bias?” says Ta’eed.

“What’s important is that everyone feels they are able to contribute and participate in the conversation,” she says. “Envato has been concentrating on this for a couple of years now and we’ve been getting into a really engaged debate on how to progress diversity and inclusion – it’s coming from people all around the business. It’s not minorities talking about minority group issues, it’s the majority talking about minority group issues and being conscious and aware. They’re all tackling it from different angles and they’re at different stages of the journey, but it’s on the agenda. If we can just get there, we’re already ahead of the game.”


Gearing up for change: New lease accounting standard

Alison White and Henri Venter

Deloitte’s Alison White and Henri Venter explore the wide-reaching impact of a new lease accounting standard issued by the International Accounting Standards Board (IASB).


The IASB has issued IFRS 16 Leases (the new Standard), introducing a new model requiring lessees to recognise all leases on the balance sheet, except for short-term leases and leases of low-value assets. These changes are also expected to be issued by the Australian Accounting Standards Board (AASB) shortly and are effective for periods beginning on or after 1 January 2019 i.e. 30 June 2020 year-ends for many Australian entities.

The pervasive use of leases means that we expect the changes to impact most entities and especially those with significant operating leases of property, aircraft, manufacturing equipment, mining equipment, and logistics services.

The financial impact

An entity leases a building for five years with annual rentals of $1,000,000. Assume a discount rate of 7.93 per cent. Currently the entity recognises $1,000,000 as an operating cost each year.

Under the new Standard the entity capitalises the obligation to make rental payments at its present value ($4,000,000) and recognises a corresponding asset for the right to use the building.

Balance sheet ($000) At inception Year 1
Lease asset 4,000 3,200
Lease liability (4,000) (3,317)
Net equity - (117)

The entity computes interest on the lease liability and amortisation on the asset over the lease term. These costs replace the operating cost and result in higher earnings before interest and tax (EBITDA).

Profit ($000)   Year 1
Rental cost   -
EBITDA   -
Amortisation of lease asset   (800)
Interest expense on lease liability   (317)
Profit before tax   (1,117)

As we can see in the above example, it is likely that profit will be lower in the earlier years of a lease as a result of higher interest accruing on the lease liability in those earlier years (akin to an amortising mortgage), however the overall effect will depend on the portfolio of leases an entity holds. Profit, in aggregate over the life of the lease doesn’t change.

Commercial implications

This new Standard is more than an accounting change. Recognition of increased lease liabilities on balance sheet is likely to focus more attention on leases at board and management levels, including consideration of whether leasing is the most efficient means of obtaining access to assets and whether, and which, assets should be bought rather than leased.

Entities also need to consider a number of other commercial implications, including:

  • Impact on gearing and loan covenants
  • Impact on key ratios and communication with stakeholders
  • Impact on remuneration schemes, including bonuses and share-based payments
  • Existence of data and systems to calculate the impact and satisfy ongoing reporting requirements.

Many stakeholders both internally and externally will be impacted, including treasury, IT, acquisitions, human resources, legal, tax, investors, analysts and financiers. Stakeholder engagement at the appropriate time will be important to ensure that the impact is fully understood.

Other accounting standard changes

Furthermore, this new Standard is not the only significant change in accounting standards requiring consideration and application. New accounting standards for revenue and financial instruments will be effective a year earlier. These standards will also have wide- reaching commercial implications, especially the revenue requirements, such that a lease implementation project has to be part of a broader integrated financial reporting change programme.

Call to action

Board audit committees have an important role in overseeing the implementation of the new Standard, including understanding the impact, how potential risks are addressed and assisting in setting the tone for an effective implementation.

Although the effective date is three years away, we recommend that entities use this time to analyse the requirements, consider the wider implications of the changes and consequently make any required changes to their systems and processes.

Alison White is a partner in Deloitte’s Assurance & Advisory division and leads the Accounting Technical group. Henri Venter is a director in the Accounting Technical group.


Australia’s first Small Business Ombudsman

Kate Carnell AO FAICD has been announced as the inaugural Australian Small Business and Family Enterprise Ombudsman.

Carnell's appointment was announced this week by Small Business Minister Kelly O'Dwyer, who described it as "a major win for small business owners who will have access to advice and support”, and an "independent advocate to ensure the government creates the right conditions for small businesses to grow".

Carnell has held the position of CEO of the Australian Chamber of Commerce and Industry (ACCI) since 2014, which represents more than 300,000 businesses across Australia. She is the former CEO of beyondblue, the Australian Food and Grocery Council and the Australian General Practice Network.

She began her career as a small business owner, running her own pharmacy for 15 years before joining politics and becoming ACT Chief Minister. According to Minister O’Dwyer, Carnell is well-positioned to translate the voices of small Australian businesses and family enterprises into targeted policy messages for government.

Commencing the role as an independent Ombudsman in March for a five five-year period, Carnell will act as a:

  1. Commonwealth advocate for small businesses and family enterprises.
  2. Concierge for dispute resolution service to allow businesses to resolve disputes without resorting to costly litigation.
  3. Contributor to the development of small business Commonwealth laws and regulations.