NZX (through its NZX Policy division) recently updated the NZX Listing Rules (Listing Rules) and Corporate Governance Code (Code) provisions dealing with director independence. We submitted against a number of the proposed changes in response to NZX's consultation on Director Independence, issued in May 2024 (see our summary of the submission here), and remain concerned with how they've been carried through.
One particular concern is around the director independence "factor" triggered if a director derives a "substantial portion" of their revenue from the issuer (Revenue Factor).
In our submission we outlined why we did not consider the Revenue Factor fit for purpose. In particular, we suggested that the commentary clarify that "annual revenue" excludes director fees. NZX has taken the opposite approach, providing in the updated Code that an issuer should "include compensation for board service (the director fees)" when considering the amount of revenue the director has earned from the issuer.
Following discussions with issuer clients, we have written again to NZX to reiterate our concerns with this change. Our letter to NZX is summarised below.
Relevant rules
Under the Listing Rules, a director will not be independent where that director has a "Disqualifying Relationship". This is defined as any direct or indirect interest, position, association or relationship that could reasonably influence, or could reasonably be perceived to influence, in a material way, the director's capacity to:
- bring an independent view to decisions in relation to the issuer;
- act in the best interests of the issuer; or
- represent the interests of the issuer's financial product holders generally.
The Code sets out certain (non-exhaustive) factors that, if present, may cause the board of the issuer to determine that a director is not independent. Notwithstanding the presence of a factor, the board must still undertake a holistic review of the director's independence with respect to the three "Disqualifying Relationship" limbs outlined above.
Our views
We disagree that the level of a director's personal income should be a mandatory consideration for a board in determining whether that director is independent. The reasons for this include the following:
- Independent director roles should not be the domain of the wealthy only: The implication of the factor (as amended to include director fees) is that unless a particular director has substantial annual income outside of the director fees that they earn from the relevant issuer, there is an inherent risk that they will not be able to bring an independent view to board decisions. We think this is wrong and ignores the fact that a quality director will have a degree of confidence that if they no longer occupy one role, they will relatively quickly be able to find another.
- It is an irrelevant consideration: What proportion directors' fees constitute of a director's annual income is irrelevant as to how a director discharges their duties to the issuer. The shareholders appoint and remove a director – not the company – based on the director's performance. How much the director's fees constitute part of their income should be irrelevant to shareholders. The only time a director would conceivably consider the loss of their fees in discharging their duties is in a takeover situation, which is highly rare for any issuer and in which a director's independence is judged against associations with the offeror.
- Board diversity should be promoted: NZX has publicly sought to encourage greater diversity on boards, including younger directors and greater ethnic and gender diversity. Statistically, these are groups that are less likely to have substantial independent sources of income and therefore more likely to "trigger" the factor as drafted. We think the amendments to this factor are therefore contrary to efforts to promote board diversity.
- "Over-boarding" should not be promoted: In the context of a professional director who earns a large proportion of their income from director fees, the implication of the amended factor is that this director is likely to be more independent the more boards they sit on (because the fees from each board would make up a lower proportion of their annual income). This is contrary to the conventional wisdom that over-boarding should be discouraged.
- We should broaden the pool of independent directors: There is a perception in New Zealand that there is a relatively small pool of independent directors, and it would be beneficial to encourage more people to seek such roles. Along with other well canvassed liability and compliance issues, a requirement to disclose the director's personal income (both directly by disclosing it to other directors, and indirectly by publicly disclosing whether the published director fees form a substantial portion of that director's income) is an invasion of privacy that is likely to further dissuade potential candidates.
- It is inconsistent with the purpose of the factor: We think that the proper purpose of this factor is to allow shareholders to assess the impact of any idiosyncratic financial relationships between the director and the issuer that would not otherwise be apparent to shareholders, in determining whether or not to support that director's election or re-election. Director fees are publicly known, and therefore not relevant to what we consider the proper scope of this factor.
- Not consistent with comparable ASX requirements: The position is not comparable with the equivalent ASX factor which focuses on performance-based remuneration – refer to box 2.3 of the ASX Corporate Governance Principles and Recommendations.
Given the above, in our view NZX should alter its commentary to clarify that director fees paid by the issuer are not required to be included in the calculation of whether a director has earned a substantial portion of their annual income from that issuer.