Thank you Michael (Robinson, of Guerdon Associates) and Aaron (Bertinetti, of CGI Glass Lewis) for that introductionand for the invitation to come and give this keynote address at your remuneration forum today.
I'd like to thanks CGI Glass Lewis and Guerdon Associates for sponsoring this event, which is now in its seventh year. I'd also like to acknowledge Allens Linklaters for hosting the forums.
As proxy advisers to institutional investors and remuneration advisers to boards, respectively, this is clearly an issue that's of great interest to you and your clients, many of whom are also here today. It's a credit to you that you're able to bring together company directors and institutional investors to talk frankly on executive pay matters in a Chatham House environment, and I'm grateful for the opportunity to take part.
Today I'd like to talk to you about the Gillard Government's response to the Corporations and Markets Advisory Committee (CAMAC) review on simpler remuneration disclosures and the regulation of clawback.
But first, I'd like to take the opportunity to briefly outline the Government's general approach to remuneration policy so you get a feel for where we've come from and where we're headed.
Recent changes to Australia's executive remuneration system have been driven by the Government's recognition that we need a system that's not only internationally competitive and rewards executives for their work, but also gives shareholders an appropriate say in the level and composition of executive remuneration.
'Two strikes'
Moving along, you will no doubt be familiar with the 'two strikes' test, which the Gillard Government introduced in 2011 as the centrepiece of reforms to strengthen the accountability and transparency of Australia's executive remuneration framework.
These reforms came out of growing community concern over the size of executive pay packets during the global financial crisis, and were a response to the 2009 Productivity Commission inquiry into executive remuneration.
The two strikes rule is designed to better align the interests of shareholders, boards and executives. It strengthens the non-binding vote by giving shareholders recourse in the event that boards fail to respond to their concerns on remuneration matters. Moreover, it sends the message that boards have to engage with shareholders to provide sufficient justification for their executive remuneration decisions.
Understandably, it has received a lot of attention coming out of last year's AGM season, particularly where a number of companies received a second strike and subsequently faced a board spill. In light of some negative commentary in response to this, I think it's probably worth taking a look at the facts.
A year after the two strikes test was introduced, of the more than 2,000 listed companies in Australia, only 108 – or around five per cent – received a first strike against their remuneration reports.
In 2012, only nine of the 108 'first strike' companies – or less than half of one per cent of listed companies – received second strikes, and of these only three (Globe International, Rey Resources and Penrice Soda) faced a spill of their board after the majority of shareholders passed a spill resolution.
However, in a demonstration that the two strikes mechanism is balanced and working well, the boards of both Globe international and Penrice were ultimately returned, while the whole board of Rey Resources resigned after the meeting so there was no need for a spill meeting to be held.
What this shows is that companies are making the effort to ensure that executive pay is reasonable, and making the effort to justify to shareholders the amount of executive pay determined. At the same time, shareholders are being reasonable in approving the level of pay when it's justified.
I note claims that the rule could be used in matters not directly related to the remuneration, but believe the issues at hand remain largely linked to the performance of board s expressed through the remuneration report.
As owners of a company, shareholders expect executives to be rewarded based on the performance of a company – these reforms aim to ensure that remuneration remains closely linked to company performance and the value that executives bring to a company.
At the same time, the reforms are not intended to place unnecessary regulatory burdens on companies.
Rather, they're designed to strike the right balance between strengthening our framework, and maintaining the principle that the level and composition of executive remuneration should remain a matter for boards to determine.
We want to ensure that executives who bring value to a company continue to be appropriately remunerated for their work, while also ensuring that the board will be more accountable to shareholders.
And the success of these reforms should not be judged by the number of strikes recorded. Rather, we should look at the overwhelming majority of companies for which strikes were not recorded.
The fact that so many companies did not have first or second strikes recorded suggests that company culture has already begun to change for the better – resulting in better engagement between boards and shareholders, and more transparency around the decisions they make on executive pay.
Indeed, I note the Australian Shareholders' Association and many institutional investors have said two strikes has had substantial market-wide benefits and brought greater shareholder accountability and board engagement.
And last year, Chartered Secretaries Australia said the Government's reforms had greatly improved shareholder engagement, and that this was a good governance outcome.
Going forward, remuneration reporting practices are likely to evolve over the next few years in response to the introduction of the two strikes test. The Government has no plans to change the rule, but we'll monitor the changes that companies choose to make to improve their communications with shareholders as a result.
CAMAC review of remuneration disclosure
This brings me to the focus of my address today.
The final step in ensuring that Australia's executive remuneration framework remains at the forefront of international best practice is to promote better disclosure of the details surrounding remuneration.
This will ensure that shareholders have the information they need to convey their views through the non-binding shareholder vote, and to hold directors accountable for their remuneration decisions.
In our response to the PC's executive remuneration recommendations, the Government announced its intention to ask CAMAC to consider how best to revise the remuneration disclosure requirements contained in the Corporations Act.
The CAMAC report was publicly released in May 2011. It contains a range of recommendations designed to simplify and improve the quality of remuneration reports, and provide more relevant information to shareholders – while noting that boards are best placed to determine the particular remuneration arrangements that would promote the interests of the company and its shareholders.
The Government also released a discussion paper on proposals to 'claw back' remuneration in the event of a material misstatement.
Following on from the CAMAC review, the Government announced the next tranche of proposed reforms on the remuneration disclosure framework for public consultation in February last year. Then on 14 December last year, I released an exposure draft Bill for public consultation setting out the Government's response to the CAMAC review and to the claw-back discussion paper.
The proposals would implement several recommendations made by CAMAC and are designed to strengthen the transparency of executive remuneration disclosures, and enable shareholders to better understand the company's remuneration arrangements.
The Government will improve disclosures contained in remuneration reports. Unnecessary disclosure requirements will be removed to simplify remuneration reports, and clearer categorisation of pay will be introduced to better enable shareholders to understand the company's remuneration arrangements.
These reforms will require companies to improve the disclosure requirements in their remuneration report, including:
- providing a general description of the company's remuneration governance framework;
- disclosing all termination payments or 'golden handshake' payments made to key management personnel; and
- clearer categorisation and breakdown of remuneration, differentiating between present pay, future pay, and so‑called 'crystallised' past pay, for each key management personnel.
The reforms also remove some existing requirements, such as the need to disclose the value of lapsed options, instead disclosing the year in which the option was granted.
Additionally, the reforms relieve certain unlisted entities from the obligation to prepare a remuneration report at all.
These draft laws will further enhance transparency around executive pay and simplify disclosure requirements in annual remuneration reports.
I'll now briefly outline each of these reforms.
Remuneration governance framework
Firstly, the two strikes test introduced last year significantly enhanced the role of the remuneration report. Remuneration reports are now a very valuable means of communication between the company and its shareholders. For this reason, our reforms are designed to improve the information content in the remuneration report to facilitate the two strikes mechanism.
To that end, we propose to remove disclosures which are less relevant; to simplify remuneration reports; and improve relevant disclosures for other areas, such as termination payments, and dividends paid to directors and executives on unvested shares. These reforms will enable shareholders to better understand the company's remuneration arrangements — and will in turn help facilitate the 'two strikes' mechanism.
I think we would all agree that remuneration information is best disclosed in the context in which it has been set.
Companies with a good understanding of their shareholders' need for the details of performance‑based pay also provide an explanation of the processes and systems that underlie how it's set.
The Government agreed with CAMAC that it's not necessary to legislate which specific details of the framework need to be disclosed.
This recognises existing requirements such as those arising from listing rules, ASX corporate governance guidelines and elsewhere in the Corporations Act.
For simplicity, companies will be able to cross‑reference existing disclosure that describes the processes for setting remuneration. This amendment simply ensures that, as a minimum, all disclosing entities will be required to provide this information.
Reducing the regulatory burden for certain unlisted companies
Second, the Government is committed to ensuring that companies are required to invest resources in producing information only when the cost is justified by the benefit it will bring to shareholders.
As unlisted companies are not subject to the two strikes mechanism, the remuneration report is less significant to their shareholders. For that reason, we propose to relieve these entities from the obligation of preparing a remuneration report. This should significantly reduce the regulatory burden for these companies.
In a step further, we have simplified the reporting requirements so that companies will report the fact that options held by key management personnel have lapsed, and identify the years in which they were granted.
However, there will be no obligation to report a value for those lapsed options, which is of little or no use to shareholders. So this will simplify the legislative framework without substantially diluting the information available to shareholders.
'Claw-back'
Thirdly, this next phase of reforms has been developed after extensive consultation on a proposal for 'claw-back'.
It's legitimate to question whether directors and executives should be entitled to keep remuneration which was based on materially erroneous financial information.
And similar questions have been asked around the world. The new global standards on pay in the financial sector require that any unvested performance-based component of remuneration must be able to be reduced or eliminated if long-term performance objectives are not realised.
Under the proposal, the Government will progress amendments to the Corporations Act to require listed companies to disclose to shareholders through the remuneration report the steps they have taken to claw back bonuses and other remuneration where a material misstatement has occurred in relation to the company's financial statements.
If the company has not clawed back any remuneration, the board will be required to provide a detailed explanation to their shareholders. If shareholders are unhappy with the company's actions, they would be able to use their powers under the two strikes rule to vote down the remuneration report and potentially spill the board and forcing fresh elections of directors.
These reforms put the onus on listed companies to make sure they have provisions to claw back bonuses and other pay from executives if there has been a material misstatement of a company's financial statements.
This reporting obligation is triggered only where a company's financial statements are materially misstated, thus minimising the regulatory burden on companies.
The Government considered views put to it that the clawback of bonuses should be mandatory in cases of material misstatement.
However, in keeping with the Government's general approach on executive remuneration, we announced a disclosure based approach that will provide the owners with the necessary information.
There was extensive consultation on the claw-back proposal in 2011, and I'm pleased to report that stakeholders were generally supportive of the 'comply-or-explain' approach.
This approach gives boards flexibility, while ensuring that they remain accountable to shareholders.
I note that claw-back provisions in executive contracts are already being adopted by many listed companies and these reforms will ensure that shareholders are able to have a say about the efficacy of those provisions.
We intend to continue to monitor company practice in the area of bonus claw-back, to ensure the ongoing effectiveness of this approach.
Past pay, present pay and future pay
Lastly, following recommendations by both the PC and the recent CAMAC review, the Government will now require companies to disclose realised pay for key management personnel.
Specifically, CAMAC recommended that the remuneration report should specify, for each key management personnel, the actual pay received by that person, including their current pay and any crystallised past pay, in addition to any entitlements granted during the period but deferred as future pay.
CAMAC considered that mandatory disclosure of each of these elements would ensure that shareholders of all companies are given appropriate information on remuneration outcomes.
As you may appreciate, this disclosure model has been the focus of debate in consultations, with a range of views being put forward by stakeholders.
Ultimately, our guiding principle will be that simplification of remuneration reports should not lead to a diminution or dilution of the richness of information that's provided to shareholders.
Next steps
The Government is seeking formal feedback from the corporate and investor community, and their advisers, on the disclosure of remuneration outcomes for key management personnel.
I would encourage you all to consider the proposals and provide feedback to Government on these important reforms. I know Treasury has already been discussing the issues with many of you.
The deadline for submissions is Friday 15 March and I would urge you to participate in the consultation process.
I'm pleased to hear the business community broadly supports the Government's reform objectives and is keen to be part of this process. For our part, we're keen to work together with you to help achieve transparency and simplicity in the disclosure of executive remuneration.
CAMAC referral on the annual general meeting and shareholder engagement
To the extent this has come up in some of the public debate on remuneration disclosure, I thought it might be useful to briefly touch on the current CAMAC referral on the annual general meeting and shareholder engagement, which may be of interest to you.
In December 2011, the Government requested that CAMAC consider a number of matters in this area. CAMAC published a discussion paper The AGM and shareholder engagement in September of last year and written submissions on the paper were invited by 21 December 2012.
One of the key issues raised in the discussion paper was whether the manner in which institutional shareholders utilise the services of proxy advisers requires enhanced guidance or regulation.
This has elicited a range of views, as you might expect, and both the Government and CAMAC welcome feedback on the issues raised.
To this end, CAMAC anticipates holding a roundtable with major stakeholder groups this year on the issues raised in the paper and in submissions. I would encourage anyone interested to contact CAMAC to be involved in this process.
Conclusion
In closing, can I say again forums such as this provide a great opportunity to come together to share ideas and experiences on executive remuneration and corporate governance more generally.
Taken together, the remuneration reform proposals I've spoken about today build on the Federal Labor Government's earlier reforms and our intention to continue to drive cultural change in boardrooms and annual general meetings around Australia.
These reforms are part of a coherent policy framework. They're part of a set of sound corporate governance principles, which are critical to the effective operation of Australia's corporate regulatory system.
Better engagement between directors and shareholders, better understanding of the role of company management and company owners, and better alignment of the interests of principals and agents in the corporate structure, will all drive improved company performance.
This is good for both shareholders and companies. It also has broader positive implications for jobs, productivity and our international competitiveness.
I look forward to working with you to help build an internationally-recognised corporate governance framework for Australian businesses.
Thank you again for the opportunity to come and share some thoughts with you today. I'm happy to take some questions.