NZX recently released proposed changes to its Corporate Governance Code (Code) for consultation (in tandem with an updated version of its ESG Guidance). Both were issued as the second instalment of NZX’s Code consultation process.

There are no real surprises. The key themes are a bit more rigour and further strictures, but clearly retaining the ‘comply or explain’ basis of the regime. NZX has been at pains to strike the right balance between recommending certain actions, and allowing directors to manage their company as they see fit (as the law requires). There are also some special mentions of the new climate reporting regime - perhaps the most interesting element of the proposed changes. We explain more below.

Once finalised, the proposed changes are intended to take effect for a listed entity’s first full financial year commencing on or after 1 April 2023.

Corporate governance: keeping all the balls in the air

Good corporate governance helps directors, when running the company’s business, to meet standards required by law, and its shareholders, and to maintain its corporate reputation amongst those the company cares about.

A company’s governance structure reflects the framework of rules, relationships, systems and processes within and by which authority is exercised and controlled in companies, encompassing the mechanisms by which companies and those in control of the company and its business are held to account.

There is a lot for directors to think about:

• Companies, listed or not, all exist and operate within the company law regime. Two key principles are that the board manages the affairs of the company, and while doing so, directors must act in what they believe are the best interests of the company.

• Further expectations are placed on companies and their directors by other statutes (a long list, but they include laws relating health and safety, trade practices, employee relations, financial reporting - and soon, climate-related reporting).

• There is also the Financial Markets Conduct Act, and the regulatory regimes created under it including the NZX Listing Rules. The Listing Rules reflect the requirements that underpin an effective exchange (relating to continuous disclosure and proper governance, among other things).

• NZX, as operator and regulator of NZ’s stock exchange, is concerned to maintain the reputation of its market, manifested in the behaviour of companies listed on it, commensurate with other exchanges.

• Wider societal expectations of companies now matter, reflected in a company’s corporate reputation, considered from the point of view of investors, customers, employees and, increasingly, a wider group of other stakeholders. Each of these group care about a range of factors, not related purely to financial performance. It is now apparent that reputation has little to do with a company meeting its legal obligations, but rather with doing what is ‘right’.

Corporate governance might therefore be described as what helps directors to keep all the balls (properly) in the air.

NZX checking its Code remains effective, and in touch with international developments

The Code opens with an explanation of its purpose: to promote good corporate governance, recognising that boards of directors are in place to protect the interests of shareholders and to provide long term value.

NZX is now checking that the Code remains effective for issuers who have used it since the Code was last reviewed and updated in 2018. NZX is also taking the opportunity to respond to stakeholder feedback in relation to key areas of the Code, and to consider international developments (particularly new ASX requirements) in the context of NZ market conditions.

No surprises in what is proposed for the Code

• No change to the “comply or explain” framework, but “explain” will need more. NZX will encourage issuers to provide greater and more substantive explanation when a recommendation in the Code has not been adopted (or is only partially adopted). This is likely to require more of issuers who have previously provided shorthand or standard ‘explain’ responses. The need to explain properly is the price of enjoying the flexibility provided by a “comply or explain” regime, and addresses a known issue with current practice.

• Changes to independent director requirements, and more to come: The Code will recommend that issuers explain how a director, in certain situations (including where a disqualifying factor is present, or if the director has been an independent director for 12 years or more), is nonetheless considered “independent”. In a small market, where finding quality independent directors can be challenging, clear detail on what “independence” means is crucial. More is coming on this topic, and NZX plans to undertake a “deep dive” into director independence requirements in 2023.

• Hybrid shareholder meetings encouraged: The Code will encourage issuers to hold hybrid shareholders’ meetings (where both physical and virtual attendance is facilitated). This seemed inevitable and, in our view, appropriate.

• Continued focus on diversity, and not just gender diversity: It will be recommended that Issuers within the S&P/NZX 20 report against a gender diversity target: not less than 30% of members who self-identify as female, and 30% who self-identify as male (to align with the ASX requirement). All issuers will also be encouraged to consider a broader range of diversity factors – not just gender, so that the governance environment better reflects wider society. Diversity has always meant ‘diversity of thought’ and regulating how to achieve that is difficult. There is more to it than gender diversity, but gender diversity needed to happen and it was a good place to start. NZX is now starting to encourage movement on other factors.

• Remuneration to consider non-financial goals: There are changes to commentary in the Code relating to executive remuneration, suggesting that issuers take into consideration those of the issuer’s non-financial goals it has identified as integral to its strategy and values. This is perhaps the natural consequence of companies stating that they are ‘purpose-driven’ or ‘values-led’.

• Financial and non-financial reporting now dealt with separately: Non-financial reporting (and in relation to ESG factors specifically) previously formed part of the wider requirement about financial reporting. Now, financial reporting will be dealt with in a stand-alone Code recommendation, and non-financial reporting in another, allowing NZX to include bespoke recommendations in relation to non-financial reporting.

Paving the way for climate reporting

“Non-financial reporting” is clearly intended to encompass the climate reporting regime (as noted in the commentary to the new recommendation). Most listed issuers will be required to report against the climate standards, now being developed by XRB.

NZX, in this Code review, is doing its bit to pave the way for “maximum compliance” with that regime. For example:

• The Code’s commentary in relation to risk management now suggests issuers disclose a summary of their risk management framework - an essential element of the TCFD reporting framework on which the climate reporting standards will be based.

• Issuers will be encouraged to make ESG disclosures in their annual report or on their websites (with a link to that page to be included in their annual report).

• Issuers will also be encouraged to disclose the process by which their non-financial reporting is prepared, to the extent it has not been subject to formal review by an external auditor (recognising that the climate standards are intended to include a level of assurance in relation to climate reporting concerning GHG emissions).

New NZX Corporate Governance Institute

NZX has confirmed in the consultation document that it intends to proceed with establishing this Institute, to provide recommendations to NZX relating to NZX’s corporate governance regulatory settings. The Institute will initially be convened for an establishment phase of one year, after which NZX will assess its effectiveness and determine whether to continue the Institute on a permanent basis.

Overall, strikes the right balance

We are not surprised by any of the changes to the Code proposed by NZX. Many were either inevitable, or needed to happen. We will watch with interest what is proposed in relation to director independence in 2023. Perhaps the most interesting element of the proposed changes is the very clear direction given to issuers about getting on with climate reporting. This is undoubtedly the most critical element of “ESG” and we consider the clear regulatory focus on this topic to be appropriate. NZX has probably here erred on the side of regulatory direction over board freedom to manage, but the right balance has been struck.