5 Insights for boards King IVTM update Comments on the Municipalities supplement 1
The draft King IVTM Report (King IV) was released on 15 March 2016 (available at https://c.ymcdn.com/sites/iodsa.site)ym.com/ resource/resmgr/king_iv/king_iv_report_draft.pdf). The draft sector supplements were released on 11 May 2016. Various local and international developments in corporate governance, including in relation to integrated thinking and integrated reporting, remuneration, development of board roles and responsibilities and related board structures, and stakeholder engagement practices have prompted the need to update King III. The draft King IVTM sector supplements are open for comment until 11 July 20016. Any individual or organisation can submit comments using the electronic portal on the Institute of Directors in Southern Africa s website (http://www.iodsa.co.za/page/ KingIVcommentary). 2
1 What is Draft King IV TM proposing? The draft King IV TM Report is particularly significant for the public sector in that, for the first time, it has been drafted with a clear intention of being applied to most types of public sector entities, including municipalities and municipal entities. Previous versions of the King TM Code have been viewed as predominantly oriented to application by companies and other types of commercial entities in the for-profit sector. This included certain stateowned companies (SOCs) but not state-owned entities more generally, as evidenced by development of the Protocol on Corporate Governance in the Public Sector (2002) ( SOE Protocol ). That is not to say that public sector entities have not to-date taken cognisance of the King TM Codes. The SOE Protocol expressly states that it seeks to amplify and not supersede the principles contained in the King TM Code, and that it should be read in conjunction with the King TM Code. Commenting on the need to review the SOE Protocol in its 2012 report, the Presidential Review Committee on State-Owned Entities noted that King III TM does not adequately give effect to unique and nuanced principles governing SOEs. However previous efforts devoted to applying the principles of King III TM or previous King TM Codes in the sector have largely been executed on a best-endeavours basis or, in some cases, with only vague reference to the King TM Code in entities annual reports and without regard for substantive application. In Local Government, the application of King III TM was perhaps even more limited, with the Metros taking the lead. Against this background, the draft King IV TM Code (Part 5 of the King IV TM Report) has been developed as a high-level framework that drives a principlesbased approach focused on achievement of targeted governance outcomes. Specifically, 17 governance principles are identified linked to four high-level governance outcomes. This design is expected to encourage mindful application of the principles, as entities applying the King IV TM Code are expected to tailor their governance practices (guided by the King IV TM recommended practices) to achieve these 17 principles which King IV TM states are universally applicable with a view to realising the governance outcomes. King IV TM also states that its principles are intended to be complementary to existing laws and regulations applicable to public sector entities. In this context, Part 6 of the draft King IV TM Report comprises sector supplements, including two draft public sector supplements intended to be read in conjunction with the other 8 Parts of the Report. The purpose of the sector supplements is oriented to providing specific guidance on practices supporting achievement of the principles, where appropriate, recognising that practices will differ, both between entities and across different sectors. The supplements also provide high-level direction on reconciling King IV TM with the extant governance regulations applicable in the sector. Importantly, the King IV TM Report recognises the need for proportionality in application of the Code. It is envisaged that the practices applied by different entities across different sectors will need to be adapted and/or varied as appropriate to their size, resources and the complexity of their strategic objectives and operations. 1 http://www.iodsa.co.za/page/kingivcopyright 2 http://www.iodsa.co.za/?page=kingcopyright 3
2 the What are the notable aspects of draft King IV TM and draft sector Supplement for Municipalities? The following draft King IV TM Principles are of key importance for municipalities: Ethical Culture Principle 1.1 Council should set the tone and lead ethically and effectively Principle 1.2 Council should ensure that the organisation s ethics is managed effectively Performance and value creation Principle 2.2 Council should ensure that the reports and other disclosure enable stakeholders to make an informed assessment of the performance of the municipality and its ability to create value in a sustainable manner. Adequate and effective Control Principle 3.1: Council should serve as the focal point and custodian of corporate governance in the municipality. Principle 3.2 Council should ensure that in its composition it comprises a balance of the skills, experience, diversity, independence and knowledge needed to discharge its role and responsibilities. Principle 3.5 Council should ensure that the performance evaluation of the council, its structures, its members, the executive mayor and the municipal manager and municipal secretary or corporate governance professional result in combined improved performance and effectiveness. Highly relevant to the intended application of the draft Code by entities in the public sector is that it aims to establish a better balance between compliance and performance by the entity s governing body in its governance of the entity. This is especially important for local governments, as many municipalities would seem to largely be compliance-driven, sometimes at the cost of achieving more effective service delivery. The need for integrated thinking in the development and implementation of the municipality s strategy to drive long-term, holistic value creation is embedded in the Code, along with adoption of integrated reporting to enable reporting on the municipality s performance and value creation achieved through execution of strategic objectives linked to long term, holistic value creation. Draft King IV TM emphasises the need for balance in the composition of the Council, both for optimal performance in the governance and leadership of the entity and for overall governing body effectiveness. King IV TM emphasizes the ethical characteristic of independence as one that all members of the Council have a moral duty to observe always acting with independence of mind in the best interests of the 4
municipality and the people it serves. The draft Sector Supplement for Municipalities emphasises the importance of giving precedence to applicable law and regulations addressing public sector governance requirements. The King IV TM principles are intended to be complementary to extant law and regulations applicable to entities in the public sector, and recommended practices intended to enhance governance need to be applied in a manner that does not contradict applicable law or regulation. The King IV TM recommended practices do address some areas not addressed in extant law or regulation, and in some cases may propose a more conservative position than is reflected in extant law or regulation. 3 How would these King IV TM proposals affect Municipalities? Given the intended broader scope of the draft King IV TM Code, Councils will need to consider its applicability to the municipality and whether there is any legal or political obligation to adopt it as best practice, given that there is so much existing guidance and legislation in the sector. The primary point of departure would be to solicit the views of key regulators such as National Treasury, COGTA, etc. in determining the extent to which the code should be applied by municipalities. In the absence of guidance from the relevant authorities that requires otherwise, municipalities would likely not be prohibited from adopting the King IV TM Principles on the basis that these are considered universal principles that lead the achievement of outcomes that demonstrate good governance. As municipalities come under everincreasing public scrutiny in relation to both their performance and their governance practices and governance outcomes, there is clear benefit in building public confidence and credibility by demonstrating investment in good governance through adoption of the King IV TM Code. It is critical, however, that municipal councils give careful and due consideration to the manner of applicability of the King IV TM principles, particularly as to whether there may be any conflicts with requirements of law or regulation given that the latter requirements will always have precedence. Municipal Councils should ask the following questions: How should King IV TM be implemented by the municipality? 5
What governance practices should the municipality adopt to give effect to the King IV TM principles so as to achieve the King IV TM governance outcomes? To what extent are the King IV TM recommended practices relevant/applicable to the municipality and its council and can the outcomes be achieved despite application differences? Are there any areas of conflict between extant law and regulation applicable to the municipality and the King IV TM principles and recommended practices? If so, how do those areas need to be addressed to ensure legal compliance? Do the council and the existing supporting structures have adequate skills and experience to carry out the roles and responsibilities of those charged with governance, as envisaged in the Code? If not, how can this be mitigated? Does each member of the Council clearly understand their governance role? How does the Council hold itself accountable for ethical leadership and effective governance? Are there structures in place to give effect to the municipality s ethics, values and norms, including clear communication and monitoring functions to promote ethical conduct and behaviour? How does the Council ensure through exercising oversight that the municipality is managed effectively and held accountable for its performance? What mechanisms are in place for the Council to disclose the information required by King IV TM? 4 What benefits/drawbacks are there in the proposed approach? Further contextualisation, in the sector supplements, of the separation of legislative and executive powers required in government organisations and how this gives rise to unique governance challenges and opportunities for the public sector, would provide much needed insight and clarity into how best to achieve good governance across a wide range of public sector entities at a principle level notwithstanding the different legislated structures and rules that are applicable. For example, the meaning of the term executive authority in the context of the Constitution, and how that role is interpreted in different settings and how it differs from accounting officer, needs to be clarified to properly explain accountability in the governance setting of a municipality. There are likely to be some challenges in applying the principles of governance fully to a municipal Council, as this represents more than the governing body of an entity and is in fact a local government in its entirety. A main benefit of draft King IV TM is the principle-based approach it advocates for its application. The draft Municipality sector supplement appears, however, to largely default back to legislative compliance as the 6
priority. While this is understandable, there is need for greater emphasis on ethical leadership and governance principles to complement the legislation for better governance outcomes. There are numerous examples of governance failures in recent years where technical compliance with legislation has proved insufficient, and in fact may have been used to distract attention from underlying governance issues that might have been avoided if implementation were approached with a focus on best practice and not merely on legal compliance. Furthermore, the legislation sometimes falls short in its application in the context of holding public officials accountable for governance failures, often for technical reasons or where form is given precedence over substance as an outcome. Furthermore, the draft Sector Supplement for Municipalities largely summarises extant law and regulation on governance applicable within the public sector. Insofar as new concepts or guidance aimed at guiding municipalities in their selection of appropriate practice are not introduced through the supplements, this approach would seemingly not hold the prospect of driving substantively improved governance outcomes in municipalities. We agree with the view of the King Committee that conflicts at the principle level, between the legislation and good governance, are unexpected. However the draft supplement also emphasises that, in the event that a recommended practice in King IV TM contradicts an extant legislative requirement, legislation should always prevail. It would be preferable, in our view, to confidently assert that the core principles in King IV TM are in fact considered to be universal and that any apparent conflict with legislation in practice needs to be managed appropriately to ensure the entity achieves the desired governance outcomes while still complying with the law. In summary, the Supplement for Municipalities, in its current form, may risk missing a key opportunity to drive substantive governance enhancements in the sector, perhaps largely because it appears to leave intact the compliance mind-set that is sometimes a significant impediment to implementing good governance in this sector. 7
5 What should Municipalities consider in responding to the King Committee? In formulating a response to the King Committee on the draft Supplement for Municipalities, we would suggest that the Committee might give consideration to providing greater clarification and to context-setting within the supplement. This should include explanation of the governance structures and role-players within municipalities and municipal entities, and their rationale. A good example of an area of complexity is distinguishing between the roles of executive and non-executive mayors, the speaker of the Council, the role of the executive committee for certain types of municipalities, and the role of the Accounting Officer (the Municipal Manager). It is our view that, in practice, a municipal council would be unable to comply with all of the best practice requirements of a Board of Directors, because its role is not identical to that of the Board. It is the legislative and executive authority of the municipality, and is complimented by other legislated roles such as the Accounting Officer (namely the Municipal Manager). If the Supplement for Municipalities were to specifically address some of these areas of complexity, such an approach would enable a more practical and tailored approach to adopting governance practices that are aligned to the core principles of the Code, while still accommodating the complexities of the Municipal Structures Act, MFMA and other relevant legislation. Municipalities will need guidance on how to go about bridging their current practices and structures to the principles and outcomes in King IV TM. We observe also that the wording of the sections in the draft King IV TM Report may not be sufficiently generic to support application of the principles as intended in the context of a municipality. Specifically the generic term governing body as used in the draft King IV TM Report may not be entirely relevant for municipalities since governance responsibilities are in fact spread between the Council, its Mayor / Mayoral Committee and Executive Committee, and the Municipal Manager. Accordingly, use of a broader term such as those charged with governance may be preferable. Furthermore, municipal entities (which are usually structured similarly to SOEs) may require greater attention in this Supplement, or would perhaps be more appropriately addressed by referencing the SOE Supplement. 8
Want to learn more? We want to hear from you Contact us today to set up a King IV TM briefing session with your board. Name: Joanne Henstock Title: Governance and Intergrated Reporting Leader Tel: +27 11 502 0364 Mobile: +27 60 526 2960 Email: joanne.henstock@za.ey.com Name: Alexi Colyvas Title: Executive Director Tel: Tel: +27 11 772 3758 Mobile: Mobile: +27 83 611 8585 Email: Email: alexi.colyvas@za.ey.com Name: Mpho Mookapele Title: Senior Manager Tel: Tel: +27 11 502 0068 Mobile: Mobile: +27 72 215 0739 Email: Email: mpho.mookapele@za.ey.com 9
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