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A high level synopsis of the draft King IV Code on Corporate Governance

Mon, 23 May 2016 18:27
by online writer
Business

 

There have been significant corporate governance and regulatory developments, locally and internationally, since King III was issued in 2009 and this was the main reason behind the decision of the King Committee on Corporate Governance to introduce a revised Code. King IV is principle-based and follows an outcome-based rather than rule-based approach. It speaks to the expressed view that the application of the Code should contribute to the performance and health (sustainability) of the company. King IV aims to establish a balance between conformance and performance.

The Code seeks to reinforce corporate governance as a holistic set of arrangements that concerns itself with ethical leadership, attitude, mind-set and behaviour. There is a clear focus on transparency and targeted disclosures in all areas, specifically in the introduction of far more extensive executive remuneration disclosure requirements than ever seen before. King IV brings a more refined focus in terms of the obligation of the organisation to be accountable and transparent as well as the accountability of the company to broader stakeholders within the society.

This philosophy is centred on three paradigm shifts in corporate governance from “financial capitalism to inclusive capitalism, from short termism to long term sustainability and from silo reporting to integrated reporting.” The Board must take ultimate responsibility for the company as a juristic person and needs to be accountable. King IV emphasizes the role of the company in society and its obligation to behave as a responsible citizen.

The Board must assume ultimate responsibility for this obligation and has to embed this ethical character and culture in all the strategy, plans, processes and performance of the company. It is critical that the Board understands their obligations with regard to ethical character and culture and the Code specifically states that this obligation cannot be delegated. The intrinsic value of the broader stakeholder, as opposed to only the shareholder, in the creation of value remains prominent in King IV.

The philosophy of integrated thinking is embedded throughout the Code and the practice recommended by the Code is to present the company’s material information in an integrated manner by issuing a report annually. King IV will include sector supplements that provide specific guidance to SME’s, NGO’s Public Sector Organisations and entities, municipalities and pension funds, in addition to the traditional audience of listed, public and large private companies: King IV is more prescriptive with regards to the content of the terms of reference/charters of board and audit committees. These must set out the composition and rotation of membership, the overall role and associated responsibilities of the committee, the delegated authorities (including the extent of the committee’s decision-making powers), tenure, resources and access to information and meeting procedures.

The group governance framework now has to include the delineation of the rights and role of the holding company, the extent of delegation by a subsidiary of certain functions to a holding company’s committee, the extent of adoption of governance and operational policies across the group, engagement by the holding company with subsidiary boards before directors are elected to the subsidiary boards, and structures and procedures with regard to information-sharing amongst group entities. This will undoubtedly require companies, at the appropriate stage in the future, to review their charters and framework documents to ensure compliance with King IV’s recommendations. King IV applies a principle-and-outcome based approach, and moves away from a tick-box approach. The 75 King III principles have been consolidated into 16 principles, each linked to very distinct outcomes.

The focus in King IV is clearly on ensuring that the application of the principles achieves specifically identified outcomes. Each principle is supported by a limited number of recommended practices, and requires specific disclosures. In line with international developments, remuneration has received far greater prominence in King IV. King IV recommends the establishment of a social & ethics committee (SEC) as a prescribed Board committee as best practice for all organisations. King IV recommends that the role of this committee be extended to include matters pertaining to ethical behaviour and ethics management. It proposes greater integration between the role and function of the SEC and other Board committees. Interestingly, the social and ethics committee has been tasked to oversee fair and responsible executive remuneration practices in light of overall employee remuneration.

In the context of the “Fourth Industrial Revolution”, King IV has deliberately separated technology and information. King III first officially introduced IT Governance to Corporate Governance and demanded a greater level of IT risk awareness at director level. King IV recognises information separate from technology as a corporate asset and confirms the need for governance structures to protect and enhance this asset. King IV has a strong focus on opportunity management and is proposing a name change from risk committee to risk and opportunity committee. Perhaps more significant, the Code recommends the overlap of membership of the risk and audit committee’s where these function as separate committees, for better functioning. If the roles are combined in a single committee, the meeting agendas to address audit, and risk and opportunity, should be separate. While this might seem administrative in nature, it does increase the prominence of the risk and opportunity oversight role of the Board. King IV has acknowledged the need to assess and confirm the external auditor’s independence, but does not specifically address audit firm rotation.

King IV suggests that the audit committee oversees auditor independence, considering the impact of non-audit services, audit firm tenure and audit partner rotation. King IV proposes a number of specific disclosures which may be included in the audit committee report, including any significant audit matters considered and how the committee has addressed the matters. King IV has refined the concept and requirements of combined assurance by introducing the five level Combined Assurance Model. The lines of defense are separated by the level of risk ownership as well as independence of assurance. Where King III included a separate principle in which a governance framework should have been agreed between the group Board and its subsidiary Boards, King IV deals with group governance differently in that it allocates responsibility for the implementation of a group governance framework to the holding company Board.

The concept of independence has evolved from King III where a list of disqualifications from independence was provided. King IV takes a more practical approach and focuses on the perception of independence by an informed third party, rather than factual independence or a tick-box approach. King IV emphasizes the fact that independence is predominantly a state of mind which is a moral characteristic and legal duty of all directors.

From a strategy and performance point of view King III encouraged the Board to play a prominent role in the strategy development process, which has been controversial in that many Board members felt that management should develop the strategy, with the Board providing oversight to the process. King IV clarifies this position and specifically requires the Board to approve the formal strategy and then provide oversight over the policies and plans that are developed from the approved strategy.

It is anticipated that King IV will be issued during November 2016.