Guidance for Boards and Directors
The Exchange published "Guidance for Boards and Directors" in July 2018 which aims to provide practical advice to boards and directors and sets out some of the expectations of directors. The guidance covers the following six areas: (i) directors' duties and board effectiveness; (ii) board committees' role and functions; (iii) board diversity and policy; (iv) risk management and internal control; (v) the company secretary; and (vi) corporate governance for weighted voting rights issuers.
Directors' Duties and Board effectiveness
The responsibilities of an issuer's board include:
leading, directing and supervising the issuer's affairs to facilitate the issuer's long term success;
establishing strategic objectives with appropriate focus on value creation and risk management;
ensuring transparency, that is appropriate and adequate reporting in annual reports (including financial statements, corporate governance, and environmental, social and governance), disclosures of the board's practice (e.g. terms of references of its board committees) and policies (e.g. shareholders communication, remuneration, nomination, dividend and diversity policies);
being accountable - directors are accountable for their actions/inactions, and where appropriate, take shareholders'/stakeholders' views into account in their decisions; and
ensuring adequacy of resources, staff qualifications and experience, particularly for issuer's accounting, internal audit and financial reporting function.
All directors, regardless of their status as executive directors, non-executive directors or INEDs, are subject to the same legal duty under the law (section 465 of the Companies Ordinance (Cap. 622)) and the Listing Rules: they must act honestly and in good faith in the interests of the issuer as a whole and avoid actual and potential conflicts of interest and duty. However, executive directors, non-executive directors and INEDs have different roles and functions.
Potential directors should spend time understanding the issuer prior to accepting an appointment so that they can start making valuable contributions to the board as soon as they take on a directorship. For example, visiting operations, speaking to members of the workforce at all levels, examining some of the major projects, and understanding the issuer's strategies and competitive nature.
Each new director should undertake induction training. All directors have the responsibly to keep up-to-date with legal, regulatory and industry-specific developments. Issuers, at their expense, should provide training programmes tailored to meet the needs of each individual director.
Directors should understand that there is no expectation for them to be an expert in all areas. However, they should have a comprehensive understanding of the issues discussed at board meetings. They may request further information and/or documentation from senior management in relation to matters to be discussed at board meetings. They may seek assistance from the company secretary or external professional advisers (lawyers, accountants or financial advisers) at the issuer's expense. However, they should perform sufficient due diligence and not rely only on professional advisers or other experts.
Both the directors and senior management have the responsibility to ensure that the board is receiving an adequate amount of information for directors to properly understand a transaction or relevant issues. Senior management should supply directors with a summary of the documents to assist their expeditious identification of any potential issues. Information that senior management may provide directors may include board papers, background information, disclosure documents, budgets for specific projects, forecasts and monthly financial updates.
Directors subject to disciplinary proceedings for failure to discharge their duties and responsibilities may not use as a defence that they did not receive sufficient information from the issuer or that they did not understand the transactions.
Executive directors manage the issuer's day-to-day business operations. They should make sure that management is accountable to the board, and ultimately to the shareholders. They should listen to, and work closely with, non-executive directors and INEDs.
Non-executive directors and INEDs
Non-executive directors are not members of management, nor are they independent of the issuer. INEDs are considered independent under the Listing Rules. Non-executive directors and INEDs should keep up-to-date with the issuer's business affairs and contribute to the board's strategic objective setting. They should examine the issuer's performance in attaining corporate goals and objectives, and monitor performance reporting.
There have been cases where INEDs have been appointed to new listing applicants late in the listing process. These INEDs may not have had sufficient time to acquire a proper understanding of the issuer's affairs, as well as their responsibilities as directors of a listed issuer before listing. The Stock Exchange recommends new listing applicants to appoint INEDs at least two months before listing.
Non-executive directors and INEDs should:
- bring an independent mind to consider strategy, policy performance, accountability, resources, key appointments and standards of conduct;
- take charge where there are potential conflicts of interests;
- be members of the audit, remuneration, nomination and other governance committees (if requested); and
- contribute effectively at board meetings.
Although INEDs may not work in the industry or be experts in the business, they may have other skills and experience (e.g. legal, accounting, real estate or IT) which facilitate the enhancement of the board's balance of skills, experience and diversity of perspectives.
INED's Time Commitment
INEDs should make adequate time available to discharge their responsibilities and should not accept an invitation to be an INED unless they can dedicate sufficient time and effort.
Board Committees' Role and Functions
The board may delegate its responsibility for performing corporate governance duties to board committees - the nomination, audit and remuneration committees. The audit and remuneration committees must be chaired by an INED, whilst the nomination committee should be chaired by either the chairman of the board or an INED. A majority of the members must or should be INEDs. The committees are increasingly expected to advise the board and perform the board's corporate governance responsibilities.
The chair of the board and each of the board committees should attend general meetings to address shareholders' queries, and where they fail to do so, the issuer should provide genuine and good reasons for their non-attendance.
The nomination committee's principal role is board recruitment. It must assess the optimal composition of the board, taking into consideration the issuer's strategies and objectives. For example, many issuers wish to develop innovative technology, but none of the board members may have the relevant expertise. The committee also examines the skills that are available as a board, and whether they are appropriate for the business' current situation, any challenges it may be facing and any opportunities it may wish to take advantage of.
There should be a policy in place on the process of identifying potential directors. The selection process should be transparent, fair and in line with the issuer's diversity policy, with a wide range of candidates to select from who are not part of the board's circle of contacts. Issuers are encouraged to develop a list of desirable skills, perspectives and experience at the start of the director selection process.
The nomination committee should meet to consider the board's performance, and not only when there are specific board appointments to consider. It may benchmark the issuer's board against the boards of fellow Hong Kong listed issuers. There is a need to regularly refresh the board in order to prevent board entrenchment and attract new thinking, as well as to consider succession planning so as to ensure the issuer's long term success.
The audit committee is responsible for maintaining an appropriate relationship with the issuer's external auditors, as well as monitoring the integrity of the issuer's financial statements, annual and interim reports and accounts, risk management and internal control. The committee is also responsible for ensuring that the internal audit function has appropriate standing within the issuer, and has adequate resources, that is the function is staffed by persons with appropriate qualification, experience, integrity and independence of mind. It should also review and monitor the effectiveness of the function.
Management should fully cooperate with the audit committee who should be provided with sufficient information and reasonable resources to perform its role and function consistent with its terms of reference. The committee is required to take a proactive approach in understanding the issuer's affairs and investigate where there are red flags. Management should liaise with the audit committee and have a comprehensive discussion on a biannual basis with the audit committee and auditors during which they should explain the judgments of key assumptions underlying critical accounting estimates.
Issuers are required under the Corporate Governance Code to explain in the corporate governance report any disagreement the board has with the audit committee's views on the selection, appointment, resignation or dismissal of the external auditors.
The audit committee should review on an annual basis the external auditor's independence. The audit committee should take into account the following when an external auditor provides non-audit services:
- the nature of the non-audit service;
- whether there are safeguards in place which ensure that there are no threats to the audit's objectivity and independence;
- the aggregate fees paid to the external auditors as well as a breakdown of the fees paid for audit and non-audit services for the financial year.
In addition, the audit committee should monitor management's progress on implementing any new key financial reporting standards, and keep abreast of any tax legislative and regulatory developments in respect of financial reporting.
The remuneration committee's principal role is to assist and advise the board on the board's and senior management's remuneration. The committee should have devised a strategy and policy on director remuneration, and formulated formal and transparent procedures to implement such policy. The objective is the motivation, retention and attraction of the best talents for the issuer, so as to maximise shareholder value.
All aspects of remuneration should be considered by the remuneration committee, including:
- salaries paid by comparable issuers, time commitment and responsibilities, and employment conditions of the group;
- the terms of appointment and termination for directors and senior management in order to ensure that the terms are fair; and
- compensation arrangements in respect of dismissal or removal of directors for misconduct so as to ensure that the arrangements are reasonable and appropriate.
Where the remuneration committee disagrees with any remuneration or compensation arrangements and the board passes a resolution approving such remuneration or arrangements, the board should disclose in its next corporate governance report the reasons for its resolution.
Board Diversity and Policy
The performance of a board is enhanced where it is comprised of directors who have a combination of competencies and diversity of perspectives which correspond with the issuer's strategy and objectives.
The board, with assistance from the nomination committee, should consider the skills, experience and diversity of perspectives that a nominee is expected to bring to the board as well as its potential contributions.
Gender diversity is especially important to many stakeholders. However, it is noted that diversity is wider than only gender.
Gender and other aspects of diversity facilitate the board's understanding of their customers' and stakeholders' needs and is positively correlated with the issuer's financial performance, a more effective board and improved risk management. Hong Kong is behind other leading markets in terms of ratio of women on boards, with approximately one third of issuers without a single woman on their boards.
During the nomination process, there should be increased transparency on the considerations for diversity (including gender). Issuers will be subject to a new mandatory requirement to disclose their policy for the nomination of directors adopted during the year in their corporate governance report.
Risk Management and Internal Control
An effective risk management and internal control system is important not only as it ensures regulatory compliance but is also linked to greater financial performance.
Board and Management's Role
The board has the responsibility of risk identification and control. During the board's discussion on the issuer's long term strategic objectives, the board should also deal with internal control issues, including the issuer's risk appetite, risk and return trade-offs, risk management and internal control systems. The board, which sets the tone of the issuer, is instrumental in determining and developing the issuer's risk culture.
Management has the responsibility of carrying out and implementing (including designing and monitoring) the board's risk management policy and procedures, and confirming their effectiveness to the board.
Risk Management Policy and Procedures
Formally documented risk management policy and procedures should be in place and endorsed by senior management and the board. Further, an audit plan which reviews the internal control systems and deals with identified risks, should be in place. There should be testing of the effectiveness of systems, including performing walkthroughs for notifiable and connected transactions. Based on issuers' findings, any weaknesses should be fixed.
In the Guidance, the Hong Kong Stock Exchange sets out suggestions in order to assist issuers to better understand the possible steps to identify risks:
- analysis of the source of potential internal and external risks that can occur in the issuer's business, e.g. cyber security or labour risks;
- prioritisation of the potential risks through internal management discussions;
- creation of a risk register which is a record of all the risks the issuer faces and is populated with risks that may prevent the issuer from attaining its strategic objectives, and is subject to regular review and update (at least annually); and
- plot the risks into a matrix in the form of a "heat map" in which there should be a list of the issuer's top 10-20 risks based on which the board can consider and review the internal control systems so as to mitigate such risks.
Appropriate Approach to Risks
Issuers should ensure that there is an adequate balance between excessively focusing on the elimination of risks and paying sufficient attention to risks (such as treating risk management as a mere compliance issue).
Issuers should make adequate disclosure in their corporate governance reports on the board's annual review of the issuer's risk management and internal control.
Selecting the Company Secretary
The issuer should consider whether a candidate for company secretary is of the right calibre and of sufficient seniority for the issuer in light of its size and complexity of operations.
Role and Function
Company secretaries are key advisers on corporate governance and other regulatory compliance issues, and must keep abreast of regulatory and legal developments applicable to the issuer. In discharging their duties, they should:
- assist the issuer with the creation and maintenance of a sound and effective corporate governance framework, especially risk management and internal control systems to ensure regulatory compliance;
- be aware of legal and regulatory developments that may affect the issuers' business and operation;
- be pro-active and consider issues that may develop and provide advice to the board;
- make sure that the board undertakes continuous training on regulatory developments applicable to their business developments and needs; and
- provide compliance advice to the board and senior management during a decision-making process.
Company secretaries are a vital channel of communication between:
- the board and senior management - the company secretary keeps the CEO and the board (including INEDs) informed of information provided by senior management and communicates the decisions of the board to senior management;
- the issuer and its shareholders - through email or in the annual general meeting; and
- the issuer and regulators (such as the Stock Exchange) - company secretaries should work with the board and senior management when the issuer receives enquiries from a regulator, and assist in replying in a timely fashion.
External Service Provider
Where an outsourced professional or external service provider is acting as company secretary, the board should ensure that such person has sufficient resources to closely follow the issuer's daily affairs so that it can perform its duties properly.
An issuer that appoints an external service provider as company secretary should take appropriate steps to mitigate potential issues related to the following factors:
- the external service provider may lack day-to-day knowledge of the issuer's affairs;
- any time gaps in communication, especially where the matter is time sensitive (e.g. enquiries from the Stock Exchange to the issuer on potentially price sensitive market rumours); and
- certain external service providers may be engaged as company secretary for many listed issuers - issuers should consider whether providers would be able to allocate sufficient time to the issuer's affairs.
When appointing an external service provider, issuers should assign a senior executive as a contact person to work closely with the provider.
For further guidance, the Hong Kong Stock Exchange refers to the Hong Kong Institute of Chartered Secretary's March 2018 Company Secretary Appointment Guidelines for HKICS Members - Good Practice as to the Number of Appointments as 'Named' Company Secretaries of Hong Kong Listed Issuers.