12-05-2019

3. Discussion and analysis of jurisdictions studied. 3.3.3 Board evaluation

Following the UK Walker Review in 2009, which recommended that the board should undertake a formal evaluation of its performance, the UK CG Code subsequently introduced a provision that the company should undertake an evaluation of its own performance and disclose the findings of the evaluation annually. The evaluation is to be undertaken by non-executive directors and led by the senior independent director and should bring within its consideration certain other matters imposed on the board under the UK CG Code including as regards (1) the skills, experience, independence and knowledge of the company on the board, (2) how the board works together as a unit, and (3) other factors relevant to its effectiveness. For FTSE350 issuers, not less than every 3 years, the board should obtain external assistance for the evaluation. Board self¬evaluation provides an important nexus for the board to consider its own processes with a view to identifying and improving on weaknesses. While the Code does not provide that the results are made known to shareholders, the board is required to state how the evaluation was conducted.

Board evaluation is not a feature of CG in the United States. However, as noted in Section 3.1 and in Appendices III.1.1 and III.7.2, the CG system is essentially board¬centric with specific State and Federal laws protecting the interests of shareholders who are more properly described as beneficiaries of the fiduciary powers exercised by directors, without possessing the power to direct them.

In Mainland China, board evaluation is compulsory under the Code of CG for listed Companies (see Appendix IV.7.3). Such evaluation must cover the performance and evaluation of the board of directors, the supervisory board and the independent directors, including their attendance at board of directors' meetings, their issuance of independent opinions and their opinions regarding related party transactions and appointment and removal of directors and senior management personnel, as well as the composition and work of the specialized committees of the board of directors.

In Singapore, the Code of CG requires that there should be a formal annual assessment of the effectiveness of the Board as a whole and its board committees and the contribution by each director see Appendix V.7.3). In practice, board evaluations are often compromised in Government-Linked Companies (GLCs) and family-owned companies (as the SingPost case shows (see Appendix V.7.3), when the members of nomination committee in charge of board evaluation are not independent, and the committee is assessing its own performance. Although the CG Code recommends that performance criteria should be consistent from year to year, and that where circumstances deem change necessary the onus should be on the board to justify the decision, the lack of independence of the nomination committee makes it difficult for the evaluation process to be effective and changes to be made. The adoption of a code of conduct and ethics in SingPost case has only come about because the director had been inadvertently exposed. The engagement of an outside unconnected party beyond the board's control should facilitate a more objective evaluation process. Policies governing conflicts of interest are undermined by the structure of the nomination committee and its relationship to the board. Finally, the committee that evaluates board performance should not consist of directors or connected parties to ensure objective and impartial board evaluations. Another weakness in Singapore's system is that the requirement for board evaluation is only a comply or explain provision which makes real meaningful and effective evaluation difficult.

Hong Kong

In contrast, in Hong Kong board evaluation is merely a recommended best practice. It is not accompanied by any guidance as to what factors should be considered, there is no disclosure requirement, and there is no element providing for external assistance.

The HKEX consulted on this in 2010 to 2011 with a view to moving evaluation to a code provision and bringing within its scope the evaluation of individual directors as well as the board as a whole. However, neither proposal proceeded despite many respondents recognizing that it would align Hong Kong with international best practice. Among the responses the HKEX considered to have merit in deciding not to proceed was the view that "Hong Kong issuers are not ready for board evaluation ... because established corporate and cultural values would reduce individual performance evaluation to a mere box-ticking exercise». This is an example of using "culture» as a residual explanation when other modes of explanation are insufficient, as discussed in Section 3.1.3 «The role of culture». It is a peculiar, if not irrelevant response that essentially places an important aspect of board function in a black box and ignores the concept that directors are appointed by shareholders and on that basis are or should be accountable to them. Readiness is frequently precipitated by regulatory changes, rather than the other way around. Moreover, there are other mechanisms that, over time, can seek to address the box-tick concern.

Discussion

Formal board evaluation does not appear to be a common practice that is undertaken or reported on in Hong Kong.

An event-driven instance of this being done in recent years (in 2014) was the report produced by an independent board committee, comprised solely of independent nonВ¬executive directors (INEDs), of the MTR Corporation in response to "intense public concern and criticism» in relation to certain revelations concerning delays in the Guangzhou-Shenzhen-Hong Kong Express Rail Link project. External experts were also engaged for the purposes of certain elements of the review. While it does not serve the present purposes to review the report in any detail, it is notable that the report made observations concerning the operations of the board as well as internal control processes, in particular in relation to the means by which information is communicated and made available to relevant persons, as well as the timeliness of making public statements. It is also of interest to note that the report commented on the effect of the failings on the credibility of the company, which is in some ways a reminder of the reputation-based liability of CG shortcomings discussed elsewhere in the present Report. The MTR report made a series of recommendations designed to address the relevant shortcomings.

A number of the interviewees expressed support for some form of board evaluation, however queried who will be watching the reviewers and whether it will in fact lead to a change in behaviour. A primary source of concern, should some form of evaluation requirement be introduced, was what basis or what metrics would be appropriate to use or recommend, and what details should be reported on. Because for commercial reasons it would be unwise to provide too much information to the market, there was a concern that the exercise could become another box-tick exercise and there was some uncertainty as to what use board evaluation might serve. In the absence of information being given to shareholders, board evaluation would not be a means of opening to shareholders the black box of the boardroom and its decision-making processes. A secondary concern was the question of how to effectively measure the long-term performance of the board and to avoid the risk that an evaluation of board performance be appropriated by short-termism. These concerns may in part explain why results of evaluation are not reported in the UK and why there is no formal requirement of board evaluation in the United States.

How to define board performance is an important issue. This affects the scope of the exercise as well as what metrics are used to assess performance. It is suggested that this should be regarded as a primarily commercial matter for the board to decide - if appropriate in consultation with external advisers - and that it will suffice if the board makes the disclosures as set out in the required code provision. Based on feedback from interviewees and having regard to important differences between the nature of the UK and Hong Kong markets, it is not recommended that the factors a board should consider be prescribed, unlike the evaluation provisions in the UK CG Code. While this would not preclude a list of factors being provided for reference with guidance notes, as some interviewees had countenanced, there is a concern that such factors could come to take on more weight than originally intended. Some interviewees considered that to require this might be infringing on commercially sensitive matters. Thus, in the context of the Hong Kong market the definition of performance should be regarded as a commercial matter to be decided by the board and its adequacy assessed by shareholders.

Given the two primary purposes of board evaluation - encouraging the board to improve its processes and assisting shareholders to understand whether the board as a whole is operating effectively - it also does not seem necessary to specify what a board is required to do in a self-evaluation but merely to require it to advise shareholders what its policy is toward self-evaluation.

It is suggested that a board evaluation provide to shareholders, at the minimum, a reference in high-level terms as to the values and priorities of the board in terms of its operational processes and how these evolve over time. This should encompass the role and effectiveness of INEDs in relation to board operations. Such policy disclosure should indicate the board's approach to the evaluation of individual directors.

Where board evaluations amount to cut and paste exercises from previous years (or other issuers) this might send a signal to investors that the board is not undertaking a penetrating consideration of how effectively it operates.

The foregoing leads to Recommendation C4.1.1 «Board evaluation».