09-05-2019

3. Discussion and analysis of jurisdictions studied. 3.2.1 Application of local laws and regulations

Different jurisdictions approach differently the question of what local laws and regulations apply to companies incorporated in another jurisdiction («foreign companies» or «foreign issuers») and how to effectively bring foreign companies within an acceptable enforcement regime in respect of the same. As regards specific CG standard-setting, much will depend on the legal nature of the standard, i.e. whether it is a statutory requirement, a regulatory requirement with statutory enforcement options, or a purely regulatory requirement with consequences for breach restricted to regulatory sanctions). In the Sections that follow, it is necessary to remain alert to these distinctions, which will impact on the type and effectiveness of enforcement options.

Companies legislation and related requirements

In the UK, the disclosures required of listed issuers had previously depended on their place of incorporation. UK incorporated issuers are subject to the Companies Act 2006 (Cap. 46) (CA 2006) and to the UK CG Code. The CA 2006 introduced the requirement for business reviews, which was later to be replaced in 2013 with the annual strategic report, as discussed in Appendices II.3.2 and II.7.2. However, at that time foreign companies did not have to comply with the UK CG Code and only 45 out of 171 overseas companies that had a primary listing had voluntarily to comply. These gaps were significantly reduced as a result of changes to the listing rules in April 2010. Provisions of the FCA's listing rules and Disclosure and Transparency Rules (DTR) when read together with the requirement of the UK CG Code Main Principle C.2 represent important, though partial, extensions of the foregoing disclosure requirements to foreign companies, albeit only those with a Premium Listing.

The UK listing rules, LR 9.8.7 R, requires foreign incorporated issuers with a Premium Listing to state how they have applied the Main Principles of the UK CG Code and whether or not they have complied with the provisions of the UK CG Code throughout the reporting period. The Main Principle in C.2 states «The board is responsible for determining the nature and extent of the principal risks it is willing to take in achieving its strategic objectives. The board should maintain sound risk management and internal control systems.» This is a lesser requirement than that applying to UK incorporated issuers, which are subject to the CA 2006 requirement to produce an annual directors' report and strategic report, and if they have a premium listing they will additionally be subject to LR 9.8.6(3) R, which requires the annual report to include a statement by directors as to the current prospects of the company, including identifying the principal risks, and as to whether they have a reasonable expectation that the company will be able to continue in operation and meet its liabilities as they fall due over the period of their assessment.

Requiring a foreign company to explain how they have complied with Main Principle C.2, in a manner that would enable shareholders to evaluate how the principles have been applied, does serve to reduce, although not eliminate, the disclosure gap between UK and foreign companies with a Premium Listing. Whereas the provisions of the CA 2006 are mandatory law, the provisions of the UK CG Code are only subject to a lesser comply or explain standard. However, FCA Rule DTR 7.2.5 R requires companies to describe the main features of the internal control and risk management systems in relation to the financial reporting process. Breaches of the disclosure requirements are actionable by the FCA and investors may seek damages.

While this development in the listing rules served to reduce the different standards expected of Premium Listing issuers according to their place of incorporation, the required standards remain different across Premium and Standard Listings, the latter category representing issuers with a secondary listing in the UK. Furthermore, other provisions in the CA 2006 such as the provisions on statutory derivative action and unfair prejudice still do not apply to foreign companies that are listed on the London Stock Exchange. However, the listing rules do give investors the right to bring an action for damages where there have been mis-disclosures by the issuer, irrespective of their place of incorporation.

In Singapore, the SFA gives statutory backing to the listing rules, which gives enforcement powers to the MAS and Singapore Exchange (SGX) and standing to bring a legal action to any person aggrieved by a breach of the listing rules (see Appendix V.2.1). On the other hand, the Companies Act (Cap. 50) (CA) only applies to locally incorporated companies. This means that derivative action and unfair prejudice remedies are only available to shareholders of overseas companies under the common law (see Appendix V.7.1).

In the United States, Federal legislation and regulatory law will generally apply to foreign companies unless it is regarded as a foreign private issuer (FPI). As discussed in Appendices III.3.2, III.3.4, and III.8.2, a company will be regarded as an FPI according to the degree of its connection with the United States including the ownership of shares by United States residents and the location of its officers and assets. These tests are not dissimilar in nature from those used when determining whether a SEHK listed issuer is subject to, and hence whether its shareholders receive the protection of, the Hong Kong Code on Takeovers and Mergers. Where a United States issuer is regarded as an FPI, certain registration and disclosure requirements will not apply, including, for example, Regulation FD (Fair Disclosure). The situation is more complex for the application of Dodd-Frank and which CG provisions of the Exchange listing rules are to be applied or disapplied. In general, both New York Stock Exchange LLC (NYSE) and National Association of Securities Dealers Automatic Quotation System LLC (Nasdaq) allow FPIs the flexibility to follow their home country CG practices, though they may choose to voluntarily comply with the domestic CG standards. However, in each case the issuer must give a disclosure notice that sets out the significant differences and remain subject to the audit committee requirements.

All issuers in Hong Kong are generally subject to the same CG standards under the listing rules, including the HK CG Code, irrespective of their place of incorporation. However, the position of domestic and foreign issuers under the Companies Ordinance (Cap. 622) (CO) and certain other regulations that impact on CG is not the same. As discussed in Appendix I.4.1, although a non-Hong Kong incorporated issuer is not subject to the statutory directors duties under the CO, the listing rules provide that directors of non-Hong Kong incorporated issuers are expected to meet the same directors' duties of skill, care and diligence to a standard commensurate with that established under Hong Kong law. In furtherance of this requirement, directors are required to give an undertaking to the SEHK to comply with the listing rules and the Hong Kong Code on Takeovers and Mergers (and certain provisions of the SFO) to the best of their ability. Other provisions of Hong Kong law and regulations that impact on director responsibilities need to be considered separately, for example, the CG protections afforded by the Code on Takeovers and Mergers depends on whether an issuer (and so its directors) is determined as subject to the Code according to a set of non-exhaustive tests, which may yield a different determination at different points in time.

As regards annual reporting obligations of the issuer, the Hong Kong regime bridges the gap via two routes under the listing rules. Locally incorporated issuers are subject to the CO, which requires a directors' report. Although this only applies to Hong Kong incorporated companies, both domestic and non-Hong Kong incorporated issuers are subject to the mandatory financial disclosure requirements of Appendix 16 of the listing rules, which specifies that annual reports must include, inter alia, a directors' report that complies with the CO. This requires a description of the principal risks and uncertainties facing the company and an indication of likely future development in the company's business. In this regard, Hong Kong does a better job than the UK at levelling the financial disclosure obligations of issuers as regards the requirements of domestic companies legislation subject to the caveat that a breach by a non-locally incorporated issuer of the Appendix 16 requirement is merely a breach of the listing rules and as such would not carry the same consequences as a breach of the DTR requirement concerning internal control and risk management systems. This reflects a difference in the UK and Hong Kong systems as regards the enforceability of the listing rules (see further below).

As compared to other jurisdictions, Hong Kong law provides strong shareholder protections against director mismanagement insofar as the CO provisions on statutory derivative actions apply to non-Hong Kong companies that have a place of business in Hong Kong - because this includes having a share transfer or registered office in Hong Kong this will cover all listed issuers in Hong Kong. Section 732 of the CO provides that shareholders can, with leave of the court in Hong Kong, bring unfair prejudice proceedings against directors in the name of the company by way of statutory derivative action, including in respect of non-Hong Kong incorporated listed issuers. One case has already been successfully commenced under this provision against a listed issuer incorporated in the Cayman Islands.

Interests of directors

Under the Hong Kong CO, sections 536(2) and 540 require directors and shadow directors of public companies to disclose the interests of any entity connected with the director or any shadow director. This facilitates the oversight of director interests in company transactions, arrangements and contracts. This requirement is higher than the corresponding provision of section 182 of the CA 2006 in the UK. This reflects a particular feature of Hong Kong, which is characterized by considerable interconnectedness, often complex and convoluted, among family-controlled and other dominant shareholders of listed companies. However, these requirements do not apply to non-locally incorporated companies. Instead, the gap is managed by listing rule requirements. This brings the discussion back to a point already touched on, namely, the standing of the listing rules and the consequences of breaching them. The sanctions associated with breaches of the SEHK's listing rules are weaker than those available in the UK, in particular as regards the right of a shareholder to bring a claim for damages. The relevance of an effective enforcement regime is discussed below.

Disclosures generally

The two boards operated by the SEHK, and the issuers listed on them, whether by way of primary or secondary listing, and wherever incorporated, are subject to the HK CG Code that applies to the relevant board on which they are listed. While, for regulatory purposes, this approach equalizes the disclosure position across all issuers, the consequences for breach by non-Hong Kong incorporated issuers is in general limited to the disciplinary sanctions available to the SEHK (for a discussion see Appendix II.7.2), which are regarded as somewhat toothless. There are nevertheless two important differences between the approaches in the UK and Hong Kong. First, breaches of the HK CG Code can only be committed in respect of disclosure requirements, not with regards to the substantive provisions of the Code. In the UK issuers with a Premium Listing will breach the Code if they fail to apply the Main Principles and report to shareholders how they have done so (issuers with a Standard Listing are subject to the same requirements unless they choose to opt out). Second, in contrast to the limited sanctions for breaches able to be imposed by the SEHK, because non-compliance in the UK amounts to a breach of listing rules that have statutory backing, the sanctions able to be applied by the FCA include the power to fine, and investors may have a civil right for damages where there has been a disclosure problem.

Although Singapore's Securities and Futures Act does not apply to companies not incorporated in Singapore, it does apply to companies listed on the SGX, whether incorporated locally or otherwise. Most CG provisions, e.g. disclosure of shareholding interest by substantial shareholders, directors and CEO, disclosure by corporations, insider dealing, compliance with listing rules etc apply to corporations see Appendix V.8.1). Furthermore, the listing rules apply to all listed companies regardless of their place of incorporation. This is similar to Hong Kong, except in Singapore the provisions on continuing disclosure obligations (s 203 SFA) in the listing rules can be enforced by the MAS under s 232 SFA (see Appendix V.1.6). This contrasts with the position in Hong Kong where the continuing disclosure obligations regarding inside information have only been able to be enforced by the SFC directly following their removal from the listing rules to Part XIVA SFO in 2013. However, the residual continuing obligations in the Hong Kong listing rules remain enforceable only by the Hong Kong Exchanges and Clearing Limited (HKEX), unless they amount to, for example, director misfeasance.

Enforcement of listing rules

One of the issues that must be touched on in relation to the foregoing is the question of the legal status of the listing rules and how this affects their application to locally and non-locally incorporated issuers. The relevance of an effective enforcement regime was discussed in Section 3.1.7 «Effectiveness». Where listing rules have been given statutory effect, as has been done in the UK and Singapore, it means that the closure of any gap between laws and the listing rules will be more effective insofar as the mechanisms of enforceability will be established in the law. It may also create rights for shareholders affected by wrongdoing. The question of statutory backing is an important topic, and this is returned to in Section 3.7.3 «Enforcement agencies».

Reference is also made to Section 3.3.1 «Legal status of CG disclosures» which considers the enforceability of listing rules by regulatory agencies and alternatives for supplying a measure of legal backing to requirements of the listing rules.

Reconciling foreign laws and domestic regulations

Domestic, non-statutory codes are in general neutral as to the place of incorporation of the issuer, subject to the caveat that complying with a domestic regulation must not be in breach of the law of the place of incorporation of the issuer. In the UK, a listed overseas company must comply with disclosure requirements only in so far as (1) information available to it enables it to do so, and (2) compliance is not contrary to the law in its country of incorporation. Where applicable, a listed overseas company must, if required by the FCA, provide a letter from an independent legal adviser explaining why compliance with LR 1.4.2 is contrary to the law of its country of incorporation. Whereas DTR 7.2 only requires UK incorporated companies to provide corporate governance statements, LR 9.8.7A R extends this to foreign issuers, save for companies that are required to comply with similar provisions imposed by a European Economic Area country.

In Hong Kong, the problem of incompatible laws and listing rule requirements is primarily addressed by the SFC/HKEX «Joint policy statement regarding the listing of overseas companies», the objective of which is to preserve high standards of regulation, enforcement and corporate governance, and the related country guides. Overall, this approach appears to have served its purposes well.

Very few issuers listed in Hong Kong are incorporated in Hong Kong, and this means that the law of the relevant foreign jurisdiction will govern the calling of shareholder meetings. While historically this was dealt with by only allowing listing applications from companies incorporated in jurisdictions with equivalence in this regard, since 2007 the SEHK has allowed a wider range of jurisdictions as being acceptable. LR 19.05(1)(b) of the SEHK's listing rules require overseas issuers to provide standards of shareholder protection at least equivalent to Hong Kong. Where the applicable home jurisdiction law does not provide such protections, then the company will need to amend its articles to provide equivalence to the Hong Kong CO in this regard.

As further discussed in Section 3.4.2 «Shareholder votes», the ability of shareholders of companies in the United States to meaningfully exercise their rights is subject to some complication due to the proxy statement process. Delaware is an interesting case study for the purposes of equivalence to standards in Hong Kong (in connection with applications for listing on the SEHK) given that it is an acceptable jurisdiction for the purposes of listing on the SEHK. Although the SFC and HKEX regard Delaware shareholder protection standards as not materially different from Hong Kong's, before a Delaware incorporated company could be regarded as giving shareholders rights equivalent to those in Hong Kong it remains necessary for it to establish that members have the right (1) to convene general meetings and add resolutions to the agenda and (2) to speak and vote at meetings, and this may require amendments to the company's articles. This requirement overcomes a problem that shareholders of many Delaware companies have yet been able to bridge - in that sense, should a Delaware-incorporated company list in Hong Kong it would operate to a higher level of CG standards than do many other Delaware companies. This reflects a higher expected standard in Hong Kong.

Mainland China does not have foreign companies listed on its stock exchanges, so does not have to deal with these problems. However, many of its companies, whether incorporated in Mainland China or off-shore jurisdictions, are listed in Hong Kong, Singapore, London and New York, and there have been some serious concerns as to the CG standards of certain of these companies. As a result, Mainland China does need to consider ways in which the regulators in Mainland China can assist foreign regulators to enforce foreign standards. Where the Mainland companies are also listed in the stock exchanges in Mainland China, CSRC will have jurisdiction over these companies and can assist foreign regulators through mutual assistance arrangements. However, where the Mainland companies are not also listed in Mainland China, CSRC will have no jurisdiction over them and may have a limited ability to render assistance to the foreign regulators. It is suggested that Mainland China needs to develop ways to ensure that a Mainland China regulator can render assistance to foreign regulators, including Hong Kong.