THE KING IV CODES | INSIGHTS

INTRODUCTION

The Institute of Directors in Southern Africa (IoDSA) published the draft King IV Report on Corporate Governance on 15 March 2016 and Sector Supplements on 11 May 2016 for public comment. These new draft codes are the next phase in the series of corporate governance codes produced by the IoDSA to guide and benchmark the required standards for corporate governance in South Africa. The latest draft codes are the fourth iteration of the codes since the King Committee was formed in 1992, led by former judge, Mervyn King, and are arguably one of the most drastic reinventions of the codes since their first publication in 1994. Download King IV™ Report

The King III Codes, the King IV’s predecessor, which came into effect on 1 March 2010, was published two years after the Companies Act, 2008 (the “Act”) was promulgated, but before the Act came into effect or its regulations adopted. The King III codes thus lacked insight regarding subsequent developments. In addition, whilst the King III Codes are progressive, they still followed a rule-based model of compliance and the controversial “comply or explain” approach. There have also been numerous global developments since the 2010 codes, such as the publication of the Codes for Responsible Investing in South Africa and the shift towards integrated thinking and reporting and the publication of the IIRC guidelines for integrated reporting and the work of the IRCSA.

The King IV codes aim to address these and other gaps and expand on the successes achieved in the King III, as well as bring the codes in line with global developments. As a proud partner and sponsor of this Report, Adams & Adams hosted a commentary session in Sandton recently. SEMINAR VIDEOS ARE AVAILABLE ON YOUTUBE

THE NEW DEVELOPMENTS 

One of the main goals of the King IV committee was to increase the accessibility of the codes and the simplicity of its principles. This can be seen in the consolidation of the previous 75 principles into 16 succinct outcomes (17 if counting institutional investors). In an effort to move away from compliance governance or the ‘box-tick approach’, the new codes also differentiate between principles and recommended practices and how these can be used to achieve sustainable outcomes. The maxim ‘comply or explain’, has been replaced with the new ‘comply and explain’. In this way, the new codes seek a more qualitative approach regarding compliance and disclosures, with adherence to the basic outcomes being assumed.

In respect of sustainable development, the King III made use of the ‘triple context’ or the ‘triple bottom line’ framework for reporting, the areas of reporting being the economy, society and natural environment. The new codes aim to steer away from the rigidity that this brought about. Rather, the new codes makes reference to the ‘six capitals model’ as the basis for sustainable development, adopting the recommendations of the IRCSA and the work of the IIRC. These six capitals areas are financial, manufactured, intellectual, human, social and relational and natural (environmental). Although not all will be applicable to every organization, to be relevant for reporting they simply need to be used, transformed or provided.

One of the major shifts the King IV aims to bring about is greater stakeholder inclusion in corporate decision making. This is in an effort to reinterpret who the directors in a body corporate serve. In the context of a Company, has largely been accepted to be the company itself (i.e. the shareholders as a whole) however, in doing so, directors were previously required to consider other stakeholders as well, such as employees, customers and the community. This has come to be known as the enlightened shareholder model. The King IV committee distinguish the new code’s position from this model, requiring that directors in the shareholder-inclusive model consider other stakeholders, not merely as instruments to serve the interests of shareholders but as having intrinsic value for board decision-making.

Director remuneration has been a long been a worldwide corporate governance problem, particularly in the post-2008 economic environment. Remuneration of directors is a key area which the King IV committee focused on. The previous codes required any remuneration policy be approved by a non-binding advisory vote of shareholders. The new codes require that both the policy and its implementation be approved by shareholders and where less than 75% approval is achieved for either the policy or the implementation plan, compulsory shareholder engagement is triggered. In addition, with a view to address the endemically large wage gaps between directors and employees, the new codes introduce the requirement that the remuneration committee, social and ethics committee and governing body consider and disclose measures put in place to attain fair remuneration, in the context of overall employee remuneration.

The social and ethics committee was a concept first introduced under the Act and the implementation into corporate governance structures has been slow. Currently, under the Act, this committee is voluntary for most private companies. The King IV codes argue that the committee’s functions goes beyond the statutory duties specified in the Act and extend into all aspects of ethics management in an organization, and beyond mere compliance. Rather than a ring-fenced ethics committee, the King IV codes also argues for greater integration and powers of the social and ethics committee in other areas of policy-making (such as the remuneration committee).

With the publication of the rule by the Independent Regulatory Board of Auditors on 4 December 2015, the King IV committee sought to align the King principles with the increased requirements for auditor independence. King IV therefore recommends that the audit committee oversee and disclose the appointment date of a company’s auditing firm, however does not go as far as recommending audit rotation. The codes also recommend that the audit committee disclose significant audit matters and how these were addressed.

The King IV recognize the evolving risks encountered by modern globalized corporations and codes and that the traditional view that risks are ‘the effect of uncertainty on objectives’ is outdated. Mindfully taking risks into account makes it possible to identify opportunities that can be captured. The King IV codes argue that risk alone is not to be discouraged in business, but rather excessive risk taking, and the duty to identify what would be excessive rests with the governing body. The new codes therefore introduce the concept of ‘risk and opportunity governance’.

The previous King III codes came into effect six years ago, the same year as the unveiling of the first generation Apple iPad. In the space of time between the King III codes and the new draft codes, tech companies have boomed and gone bust and countless technology trends have emerged and disappeared. Whilst the King III codes already addressed some of the issues caused by this ‘fourth industrial revolution’, the King IV codes recommend greater technological pro-activity in body corporates and business model innovation to cope with technology changes and challenges. The codes also recognize information as a growing resource in business and the opportunity for capitalizing on internal information and data to increase intellectual capital. However, the codes also recognise the growing threat of cyber-security risk with more business’ resources going on-line, and require specific oversight and management of these risk areas.

Globalisation coupled with the strategic tax planning by multi-national enterprises (MNE’s) have led to huge savings in tax for MNE’s as a result of profit shifting, and correspondingly massive losses for revenue collectors. This has had devastating fiscal effects, particularly in developing nations, as was recognized in 2000 when global political leaders agreed that developing countries needed to strengthen their tax systems. The practices employed have, however, continued, which some describing these practices as tax ‘avoision’, being tax evasion (which is legal) of such a nature that the outcomes achieved are akin to tax evasions (which is illegal). Recent public reactions, such as the outcry in reaction to the Panama papers, have shown that these practices are no longer morally accepted by the public and are regarded as linked with corporate citizenship and reputation. The King codes recognize this and argue that the audit committee should be responsible for the tax strategy of an organization and go beyond mere compliance to take into account corporate citizenship, stakeholder considerations and reputational repercussions. In respect of group governance, the new codes also place greater responsibility on holding company boards for implementing group governance policies and frameworks.

 

COMMENTARY ON THE KING IV CODES

The developments recommended in the King IV are very commendable and innovative. The scalability and accessibility of the new codes (beyond large companies to SMME’s and other body corporates, such as municipalities) will set the tone for governance standards as a whole. Some of this had led to comments that the codes reach too wide and will be difficult to apply in all the intended circumstances. Whether or not this is correct will be determined, in part, by the application and uptake in use of the sector supplements.

The codes also build on the previous codes identification of IT governance as a key area of risk. However, the lines drawn in the new codes do not yet, arguably, reflect the reality of IT governance and the variety of risks that have emerged. It is argued that, rather than recommending that governing bodies find these tools themselves, that more robust recommendations are made in respect of IT risks, as was done with cyber-security risks. Other risks areas that could be introduced are change control, repetitional risk and social media and informational compliance (with the Protection of Personal Information Act – PoPI – looming).

It is also argued that the codes do not adequately address intellectual property as an area requiring specific attention. Although intellectual capital forms part of the six capitals model, it is given little voice in the codes, with its primary mention being in the technology and informational governance portion of the new codes. It is argued that intellectual property risks extend wide enough to require greater mention and recommendation in the codes, particularly in light of the corporate governance consequences which arose in the matter of Makate v Vodacom (Pty) Ltd 2016 (4) SA 121 (CC), where agreements entered into by directors resulted in potentially massive liabilities for Vodacom, which outcome could have been avoided.

Lastly, the new codes do not yet fully address the growing need for corporate transformation, with the only provision which tackles this definitively being principle 3.2, which prescribes this as one of the factors to consider in ensuring governing body diversity. It is argued that corporate governance codes present a unique opportunity to advocate for transformational outcomes and a forum (such as a transformation committee) that substantively and address the risk, both economical and reputational, of failing to achieve such outcomes, together with the opportunities that would arise from effectiveness in this area.

 

THE CURRENT PROCESS

A draft version of the King IV codes was made available to the public for comment on 15 March 2016. A copy of these codes can be accessed here. The deadline for public commentary was on 15 May 2016, and this has not yet been extended.

A draft version of the King IV Sector Supplements was made available to the public for comment on 11 May 2016. A copy of these codes can be accessed here. The deadline for public commentary on the Sector Supplements is 11 July 2016 and those wishing to comment will be able to access the document via an electronic portal, which will also provide a mechanism for submitting comments.

The commentary process is open and transparent and all comments submitted are made public on the IoDSA’s website.