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Recent developments in corporate governance in Hong Kong and the PRC

Recent developments in corporate governance in Hong Kong and the PRC

Corporate Governance Review by the Standing Committee on Company Law Reform

A review of corporate governance has been conducted by the Standing Committee on Company Law Reform (“SCCLR”), with the aim of identifying areas of possible improvement in Hong Kong’s corporate governance environment.

Founded in 1984, the SCCLR was formed to advise the Financial Secretary on amendments to the Companies Ordinance and related ordinances to ensure that Hong Kong’s company law continues to meet the needs of the business community. Members include lawyers, accountants, company secretaries, businessmen, academics, representatives of government departments and regulatory bodies.

Phase 1 of the review was completed in July 2001 and a public consultation paper – “Corporate Governance Review by The Standing Committee on Company Law Reform – A Consultation Paper on Proposals Made in Phase I of the Review” was published with a view to addressing public concerns regarding corporate governance standards in Hong Kong.

The 2001 Consultation Paper contained a total of 21 proposals regarding directors, shareholders and corporate reporting. Some of these proposals are being taken forward in the form of proposed amendments to the Companies Ordinance, whilst others (e.g., empowering the SFC to conduct derivative actions for minority shareholders) are subject to further consultation.

The findings of the following four consultancy studies on corporate governance were also published: –

(a) A Comparative survey and analysis of the development of corporate governance standards in other jurisdictions;

(b) A survey of the attitudes of international institutional investors towards Corporate Governance Standards in Hong Kong;

(c) The roles and functions of audit, nomination and remuneration committees; and

(d) An economic analysis co-relating the performance of listed companies with their shareholders’ profile.

The first three studies were conducted by Professor Judy Tsui of the Hong Kong Polytechnic University and Professor Ferdinand Gul of the City University of Hong Kong. The fourth study was conducted by Professor Larry Lang, Mr C K Low and Dr Raymond So of the Chinese University of Hong Kong.

The SCCLR on 11 June 2003 issued its Corporate Governance Review Phase II Consultation Paper which details further proposals to enhance Hong Kong’s corporate governance regime. Publication of this Consultation Paper is one of the targets detailed in the Corporate Governance Action Plan announced by the Secretary for Financial Services. The SCCLR’s proposals relate to different aspects of directorship (including directors’ roles, duties, qualifications, training and remuneration, as well as connected transactions, board procedures and board committees etc.); shareholders’ rights and conflicts of interests; corporate reporting with focus mainly on external auditors and corporate regulation.

On proposals relating to “Directors”:

SCCLR recommends the adoption of a set of non-statutory guidelines on directors’ duties, and re-affirms its previous proposals to improve the general legal position on self-dealing by directors, as well as proposals on shareholders’ approval for significant transactions involving directors.

For transactions between directors or connected parties with an associated company, the SCCLR is inclined to adopt, in relation to the definition of “associate”, the test of control through the exercise of dominant influence to determine whether the company is associated with another company. The approval of disinterested shareholders would be required in relation to such transactions.

The Consultation Paper also contains extensive recommendations on Board procedures, the structure of the Board and the role of non-executive directors. SCCLR holds the view that the Listing Rules should make audit committees mandatory, with at least one independent non-executive director on the committee with financial expertise. The establishment of nomination and remuneration committees should remain as a best practice.

Noting the importance of directors’ qualifications and training, SCCLR recommends that the Code of Best Practice (of the Listing Rules) should contain a requirement that a listed company should disclose the arrangements made to train its directors.

With increasing public concern over directors’ remuneration, SCCLR recommends that listed companies should disclose individual director’s remuneration packages by name in their annual financial statements.

On proposals relating to “Shareholders”:

SCCLR re-confirms its previous proposals on self-dealing by controlling shareholders, but seeks views on how “controlling shareholders” should be defined for the purpose of connected transactions. SCCLR also makes a number of proposals to enhance the effectiveness and transparency of company general meetings.

On proposals relating to “Corporate Reporting”:

SCCLR puts forward recommendations to enhance and strengthen the functioning and quality of external auditors. These include imposing a duty on employees (in addition to directors) to provide information to auditors and that there should be mandatory rotation of the lead and concurring partners every five years.

On proposals relating to “Corporate Regulation”:

SCCLR seeks the views of the public on whether, in principle, statutory backing should be given to the Listing Rules together with tougher statutory sanctions including civil fines against non-compliance. SCCLR also seeks views on whether the regulation of unlisted companies needs to be improved.

The SCCLR will consider comments received from the public on the proposals before making recommendations to the Government on specific measures to upgrade Hong Kong’s corporate governance standards. The public consultation will end on 30 September 2003.

Following is a list of major proposals in “A Consultation Paper on Proposals made in Phase II of the Corporate Governance Review”

(1) Proposals relating to different aspects of Directorship

* The SCCLR reconfirms some of its previous proposals (Chapter 3 sections 8 , 9 & 10) as follows –

(a) The Companies Ordinance should set out the general prohibition against directors voting at board meetings on transactions in which they have an interest, with exceptions for immaterial transactions.

(b) For transactions or arrangements above a certain threshold value involving directors or persons connected with directors, the approval of disinterested shareholders voting on a poll should be obtained.

(c) Requirements for disinterested shareholders’ approval for connected party transactions should be extended to transactions between a company and an “associated company” and not limited to transactions between the company and “subsidiaries”. The views of the public are being sought on whether the test of control through the exercise of dominant influence should be adopted for the purpose of defining “associated companies”.

(d) These proposals should apply to all listed and unlisted public companies in Hong Kong including companies registered under Part XI of the Companies Ordinance.

* In relation to directors’ duties, SCCLR recommends the adoption of non-statutory guidelines stating the principles of law. (Chapter 3, section 7)

* Board Procedures including the frequency of full board meetings and the delivery of agenda and board papers to all directors should be improved and included in the Code of Best Practice. (Chapter 3, section 12)

* The Listing Rules should be amended to make it mandatory that all listed companies should establish an audit committee. At least one independent non-executive director (INED) on a listed company’s audit committee should have some “financial expertise”. (Chapter 3, section 13)

* The Code of Best Practice should be amended to make the establishment of nomination and remuneration committees in listed companies a recommended best practice. (Chapter 3, section 13)

* The boards of listed companies should have a minimum of three INEDs, and where nomination committees exist, they should take a more systematic approach to identifying suitable NEDs. The Code of Best Practice should provide that listed companies should disclose the system for deciding the remuneration of their NEDs in their annual reports. The Code should also provide that directors of listed companies should disclose the number of other directorships which they hold in their companies’ annual reports. (Chapter 3, section 14)

* On directors’ qualification and training, the Code of Best Practice should contain a requirement that a listed company has to disclose the arrangements made to train its directors, and in particular new NEDs, on both an initial and continuous basis. (Chapter 3, section 15).

* The Listing Rules and the Companies Ordinance should be amended to require listed companies to disclose full details of all elements of individual directors’ remuneration package. The Companies Ordinance should be amended to require unlisted public companies or private companies, if directed to do so by holders of not less than 5% of all the nominal issued share capital of the company, to disclose full details of all elements of individual directors’ remuneration package. SCCLR also seeks views on the need to make specific disclosures on key aspects of a company’s remuneration policy. (Chapter 3, section 16)

(2) Proposals relating to Shareholders’ Rights and Conflicts of Interests

* SCCLR reconfirms its previous proposals (Chapter 4, section 17) that –

(a) Subject to certain exceptions (e.g., transactions entered into by liquidators) connected transactions must be disclosed and subject to a disinterested shareholders’ vote made by poll.

(b) The definition of connected person in relation to controlling shareholder should be incorporated in the law.

(c) The court’s power to determine whether or not a transaction constitutes a waste of corporate assets should be preserved.

(d) Failure to comply with the rule should render the transaction voidable at the instance of the company or any shareholder.

(e) These proposals should apply to all listed and unlisted companies in Hong Kong including companies registered under Part XI of the Companies Ordinance.

* SCCLR seeks public’s view on how controlling shareholder should be defined for the purpose of connected transactions; i.e., whether it should be defined in accordance with a substantial shareholder under the Listing Rules; a controlling shareholder under the Listing Rules; a subsidiary as defined in the Companies Ordinance or a person having the right to exercise dominant influence over the company.

* To enhance the effectiveness and transparency of company general meetings, the SCCLR makes the following proposals –

(a) A Hong Kong company should be permitted to hold a general meeting at more than one location. The meeting should take place at the venue specified by the notice of the meeting which would be regarded as the principal venue, but subsidiary or satellite venues should be allowed. Both visual and audio real time communications should be permitted by legislation.

(b) The timing of the Annual General Meeting (AGM) should be changed to within a certain period after the end of each financial year of the company. For private companies with a share capital and companies limited by guarantee, the period should be nine months and for other public companies, the period should be six months.

(c) Notices should be given personally or sent by post to shareholders unless the shareholders agree to adopt electronic means of communication including the use of personal identification numbers.

(d) There should be a requirement of minimum information to be given in the meeting notices regarding the proposed resolutions.

(e) Absentee voting should be permitted. Electronic voting should be permitted and there should be rules and guidance for such voting procedures.

(f) the empowerment of proxies should be reformed.

(3) Proposals relating to Corporate Reporting with focus mainly on external auditors

* The Companies Ordinance should be amended to remove the requirement for the shareholders to fix the auditors’ remuneration or determine the manner of how it is to be fixed (Chapter 5, section 22).

* To improve auditors’ access to information, the present requirement for directors and officers of the company to provide such information and explanations as the auditors think necessary should be extended to include employees.

* Outgoing auditors should be required to volunteer material information to their successors.

* The Government and the Hong Kong Society of Accountants (HKSA) should undertake work to identify the types of non-audit services which are incompatible with the principles underlying auditor independence and enhance the disclosure of the nature and value of all services provided by auditors to audit clients, defining what falls into the categories of audit, audit-related and non-audit.

* There should be mandatory rotation of both the lead and concurring audit partners every five years.

(4) Proposals relating to Corporate Regulation

* The SCCLR seeks further views from the public on whether statutory backing should be given to the Listing Rules together with tougher statutory sanctions including civil fines against non-compliance and whether the regulation of unlisted companies needs to be improved and if so, how should this be addressed in terms of institutional change. (Chapter 6)

Conclusion

In closing, it is clear from the government initiatives that there is considerable emphasis in Hong Kong on improving corporate governance. The government, the SFC and the HKEx appear determined to work cohesively in achieving this goal – clearly this is a direct response to previous criticisms that there are many people involved in setting corporate governance requirements and a need for one body to take responsibility for corporate governance to make sure that all parties are co-ordinated and working together. It is also interesting to note that investor – led corporate governance initiatives – for example the beginning of shareholder activism at AGMs (previously very rare in Hong Kong) has become increasingly common over recent months in Hong Kong.

Skills

Posted on

2003-09-21