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3. Discussion and analysis of jurisdictions studied. 3.7.1 Impact of regulatory design

At one level, the UK's CG system is straightforward in its overall design and functioning. The FCA is empowered by statute to make rules that have statutory backing, and it has incorporated in its listing rules and the DTR many rules that pertain to CG standards, as discussed in Appendices II.3.3 and II.4.1. This includes the listing rule requirement to make disclosures based on the non-statutory UK CG Code published by the FRC, thus giving that code a measure of statutory backing.

Nevertheless, the number of fundamental changes cum developments in the system since 2000, particularly post 2008, currently render the system in its operational details prone to complexity and a degree of overlap insofar as a requirement in one set of laws or regulations may refer to another, which itself maybe supported by another law, regulation or guidance, each level of which will have a different legal standing and different legal consequences upon breaching them. For example, it has been said that a print-out of the FCA Handbook stands over a metre tall and that the introduction of a twin peaks model effectively created two such stacks of similar but not identical regulations. To this of course could be added the various instruments and so on made pursuant to the CA 2006, FSMA 2000, and the FSA 2012. As a result, at present there is no one consolidated text of financial services law in the UK.

Despite the elegance of the overall system structure, for example, as compared to the overlapping regulatory agencies in the United States, the system has been criticized as overly complex and overly regulated, the FSA having once been characterized by the then Prime Minister Tony Blair as «hugely inhibiting of efficient business by perfectly respectable companies that have never defrauded anyone». It is more than of merely historical interest to note that Callum McCarthy, the Chairman of the FSA in 2005, commented in support of the UK system that whereas Citibank in the United States had about 30 regulators in full-time residence representing multiple regulatory agencies, HSBC in the UK has only one regulator overseen by a team of six staff who are not onВ¬site, a situation that has dramatically changed in recent years.

While the status of the UK CG Code is in general a highly valued component of the UK system, the means of its derivative support is not as strong as it could be, and indeed compliance with the code is wanting, as discussed in Appendix II.1.1. Although very differently implemented in terms of the code's legal standing, there is a significant similarity in approach taken in the content of the UK CG Code and the HK CG Code, as summarized in Annex 1 to Appendix I.4.

The CG system in the United States is, in its application, in many ways more complicated than in the other jurisdictions studied. As a matter of regulatory architecture, the powers given to the SEC are clear, although the exercise of those powers in relation to CG concerns is not infrequently subjected to challenge in the courts.

At one level the division between the scope of authority between the SEC and the Exchanges is clear-cut: the former is only concerned with disclosures in the context of public securities laws whereas the latter is only concerned with information pertaining to the eligibility and the continuing obligations under the listing requirements, with many of the detailed CG-specific requirements being laid down in the Exchange's listing requirements. However, these two levels of the system dovetail in important ways to bring Exchange requirements into a Federal disclosure regime, as discussed in Section 3.3.1 «Legal status of CG disclosures», it being noted that all listing requirements are approved by the SEC - similar to Hong Kong where all the SEHK's listing requirements are approved by the SFC.

The powers of the SEC are significantly wider than the SFC, the SEC being empowered to, inter alia, make regulatory law (effectively the equivalent of subsidiary legislation) and to impose fines - while the SFC is also empowered to make subsidiary legislation, including in relation to the SEHK, this is subject to the negative vetting of the Legislative Council and this aspect has in practice led to the power not being used except where the Legislative Council has already agreed in principle to the proposal. As discussed below, where attempts have been made to use this power to widen the arc of the SFC's regulatory oversight of the SEHK, this has not proceeded.

A significant factor in the complexity of CG regulation in the United States is the many cases brought in the State courts that are called upon to adjudicate disputes. These cases are frequently decided around a combination of State law and fiduciary law, which in some ways makes outcomes possibly harder to predict than, for example, the statutory code-based approach in the UK. Certainly, the depth of cases and the occasional development of law in higher courts present a challenge to directors to keep abreast of, often leading to directors taking a conservative approach that tends toward safer more established mechanisms of good CG, as has been discussed in Appendix III. 7.2. In Singapore, the system gives a lot of powers to the MAS, including the power to approve listing rules made by the SGX, which is similar to the power enjoyed by SFC. However what is different is that the MAS also has power to issue CG Code and to enforce the listing rules and the Code which is not the case with SFC. This has meant that MAS working together with the CCB and the AG office have been able to enforce the standards more effectively, the China Sky case being the case in point.

Similarly in Mainland China, the CSRC has power to issue and amend Code of Corporate Governance and enforce it. Again, this means that where CSRC is willing to enforce the standards, it has been able to do so effectively. As discussed, the UK also gives the power to issue and enforce listing rules and the CG Code to one independent regulator, namely the FRC in the case of the Code and FCA in the case of listing rules.

Hong Kong

Hong Kong is the only jurisdiction in this study that still gives the power to make and enforce both listing rules and the CG Code to the HKEX, a market player, rather than an independent regulator, such as the SFC - while a similar power appears to be enjoyed by the Exchanges in the United States, in practice many of their CG requirements arise out of requirements imposed by legislation or the implementing rules of the SEC.

The regulatory oversight of listed issuers including the setting of standards to which they are expected to comply operates under a dual responsibilities model, as discussed in Appendix I.3.2. This arrangement of dual responsibility, which is one type of competitive self-regulation, is to preserve the advantages of self-regulation, which is that a stock exchange (i.e. for the SEHK via the functionality of its Listing Committee) as the participant and facilitator of the market knows the problems in the market and how to fix them better than government or statutory regulatory agencies such as the SFC.

The powers that have been given to the SFC in relation to the listed market, its primary means of oversight being the «reserve power» given to it by the SMLR, are not as extensive as their counterparts in the UK, United States or Singapore. The SFC can make rules that operate as subsidiary legislation, subject to public consultation and to the negative vetting of the Legislative Council. Those powers encompass making rules in the form of listing requirements. While the SFC has exercised its general rule-making power, previous attempts to allow the SFC to exercise this power in relation to listing requirements have been strongly rejected. As noted in Appendix I.2.1, the Financial Services and Treasury Bureau (FSTB) has consulted on the execution of these powers to encompass civil fining and other powers, without success.

The nature of the SFC's «reserve power» is currently a subject of particular interest as a result of the SFC recently having signaled to the market it intends to place greater emphasis on earlier, more targeted intervention. While its powers under section 6 of the SMLR have been rarely used in the past, it has used this power twice in 2017, one of which was appealed (although the appeal was subsequently withdrawn). This appears to be part of the SFC seeking to move from goalkeeper into the playing field. From the outset of the power being given to the SFC it was envisaged that the power «would not normally be necessary» because the SFC and HKEX would be working together to identify serious issues from the beginning of the listing application process. The SFC's present stance has therefore led to concern among some market participants that the SFC's new use of the power may be exceeding its original purposes as a reserve power, however, the power does not cease to be reserve in nature simply because it is used more actively, although there may be other concerns as to the way it is being used.

Discussion

Debates about Hong Kong's CG system significantly turns on the position one takes in relation to the question of market self-regulatory models versus regulator-driven models.

The development of CG-specific requirements of the listing rules currently remains vested primarily with the SEHK, subject to the role of the SFC under the dual responsibilities model. Suggestions that the SFC play a larger role in this regard tend to be met with considerable resistance, both by the HKEX and by some market participants. The strong backlash against the SFC/HKEX Joint Consultation on listing reform (2016) is the most recent case in point.

The argument primarily relied on by those who object to a larger involvement of the SFC tend to refer to the desirability of a degree of self-regulation in the form of a practitioner-based system subject to reserve powers given to the SFC. This is consistent with the foundations of the SFC as contemplated by the Hay-Davison Report. It is also conducive to preserving the advantages of self-regulation as indicated above. Some argue that although the current structure is somewhat unique to Hong Kong it has managed to balance market practitioner and regulatory roles, as highlighted in a second major IMF review in 2014. It has also been sufficient to support the emergence of Hong Kong as a leading market for IPOs including occupying the leading global IPO position from 2009 to 2011 and again in 2015 to 2016.

Those in favour of a stronger statutory regulator tend to point to the developments in the UK, first with the creation of the UKLA, and subsequently with the post 2008 reforms that created the FCA (and PRA), which absorbed the UKLA function. The experience in the UK is in many ways a part of a general shift towards a greater role for public regulatory agencies, beginning with the enactment of the 1933 and 1934 securities acts in the United States in the wake of the 1929 crash. This has been facilitated by the increasing commercialization and privatization of exchange services across many financial markets.

As regards those aspects of the CG system that fall within the remit of the HKEX, there is a fundamental distinction between two separate roles.

The first role is the rule-making power that is managed subject to the oversight of the SFC under the dual responsibilities model. On the whole, this model has worked well insofar as the content of the HK CG Code compares favourably with the UK CG Code and the listing rules contain some of most comprehensive rules on related party transactions in the world.

The second role is the enforcement of the rules such that behaviour deviating from expected standards is subjected to consequences that make it less likely to occur or recur. Here the dual responsibilities model has not worked well. Hong Kong's CG system fails to attach the same risk to breaches of expected CG standards as the other jurisdictions considered in this Report - the personal or commercial consequences in practice are comparatively limited and weak both as regards the powers of regulators and as regards accountability to shareholders. Thus, the significant weakness in Hong Kong's CG system is the lack of meaningful and adequate enforcement in relation to breaches of the listing rules, which reflects a typical weakness of self-regulation.

Addressing the enforcement issue does not necessitate taking away the HKEX's rule making power - HKEX can retain the power to make listing rules subject to SFC's approval, but there is some sense in having standards able to be enforced through other mechanisms.

Creating avenues of enforcement outside the agency of the HKEX will also resolve the conflict of interests perceived to be suffered by the HKEX in term of its lack of incentive for enforcement. This is not a novel suggestion as it is after all how the constitutional system in many democratic and developed nations is designed: the law is made by legislature but enforced by an independent prosecutorial and judicial system. Although the SFC is vetting and approving every listing rule, this in itself does not affect SFC's independence in the enforcement of the rules, as SFC has no commercial interest in not enforcing those rules.

One such avenue was discussed in Section 3.6.2 "Listing rules» - Recommendation S4.4.1 «Shareholders as beneficiaries of listing rules» proposes giving shareholders the right to enforce certain rules.

Another mechanism is to give the power to the SFC to directly enforce the listing rules - which does not necessitate removing the power of the SEHK to do so. There is some sense in this suggestion insofar as the SFC's enforcement power works together with the surveillance of listed issuer disclosures it undertakes pursuant to its powers under the SFO, including under section 214 and Part XIVA. The SFC has already taken numerous actions under both sections (see Appendix I.6.5). These kinds of problems in listed issuers represent significant CG failings and the head of the SFC's enforcement division has stated that the more serious corporate abuses are now a priority of the SFC's enforcement policy, effectively putting the preservation of minimum CG standards squarely on the SFC's enforcement radar.

However, shortcomings in CG standards span a range of seriousness. Between the SEHK's exercise of its disciplinary powers and the SFC's powers lies a significant lacuna that is inadequately covered by appropriate enforcement mechanisms - they are either too weak and so ineffective, or too strong in relation to a wrongdoing that does not warrant court action. While suggestions to give the SFC power have been controversial in the past because it interferes with the dual responsibilities model it is possible to close out the enforcement lacuna by creating a range of more graded sanctions that fit within the dual responsibilities model. Some of the recommendations made in previous sections are relevant to this: Recommendation C4.6.1 «SEHK to develop use of existing disciplinary power», which proposes that the HKEX could develop its use of its existing disciplinary powers (see Section 3.7.3 "Enforcement agencies»); Recommendation A4.5.1 "Legal status of CG-related disclosures» and Recommendation C4.5.2 "Status of listing rule compliance and related disclosures (continuing)», which propose to make listing rule disclosures subject to legal sanctions that are more easily able to be applied (see Section 3.3.1 «Legal status of CG disclosures» and Section 3.3.2 «Disclosure of listing rule compliance»; and Recommendation A4.6.3 «Calibrate SFC's powers under the SMLR», which proposes to give the SFC a graded power under the SMLR that would modulate its all or nothing power under the SMLR to suspend trading in a company's securities (see Section 3.7.3 «Enforcement agencies»).

Adopting these proposals would contribute to regulatory efficiency, however, none of them suggest a full-blown reconstruction of the powers of the SFC (which would be necessary if one wished to bring the SFC's powers into full alignment with the FCA, SEC, CSRC and MAS, which would involve a complex and controversial change to primary legislation).

As discussed in Appendix I.1.1, emphasis has been traditionally placed on reputational enforcement mechanisms rather than judicial regulation. That emphasis was established at a time when locally incorporated family-controlled companies dominated the market. However, increasingly over the past two decades, Mainland China SOEs and Mainland China privately held businesses have come to dominate the market. This period has also witnessed a steadily increasing reliance on regulatory enforcement mechanisms operated by the SEHK or the SFC, including ex ante mechanisms. The SFC is already using its position as a regulator overseeing licensed corporations and registered institutions to fortify the standards of professionals in the market that service the needs of companies. This includes developments to the sponsor regime including the burden of sponsors who must, inter alia, provide declarations as to a listing applicant's management capabilities, as discussed in Appendix I.3.2, and, more recently, its triad of guidelines and circulars concerning the duties and responsibilities of directors and advisers in relation to the valuation of company assets in corporate transactions. This directly impacts on the CG standards of issuers to the extent that professionals increasingly bear responsibility to advise and remind the directors of their responsibilities, and are subject to liability if they knowingly, recklessly or negligently assist the directors breach the relevant legal requirements - such liability can include being required to compensate investors under section 213 of the SFO. At this juncture it is worth noting a point that has been made elsewhere in this Report: that despite investors possessing rights exercisable in court, they are rarely exercised and investors in Hong Kong instead look to the regulators to control corporate behaviour and for a remedy where there has been wrongdoing.

Returning to the overall complexity of the system, Hong Kong's system, although somewhat unique, benefits from a level of simplicity not enjoyed by other jurisdictions. There is a perception in the market (including among some of those interviewed for the purposes of this Report) that increasing either the complexity of the system or the regulatory burden could be counterproductive. However, complexity/simplicity and the regulatory burden are two distinct issues, and there is considerable value in maintaining simplicity in terms of the system being readily comprehensible by the targets of concern they are directed toward. Milton Friedman had praised Hong Kong as an example of capitalism in action and possibly the leading example of a free market economy, and regarded this as a "major factor in encouraging Mainland China... to move away from centralized control toward greater reliance on private enterprise and the free market». The importance and consequences of Hong Kong setting and enforcing CG standards therefore should not be underestimated.