Report on Improving Corporate Governance in Hong Kong

Оригинал на английском языке.
Гонконгский институт лицензированных публичных бухгалтеров
Hong Kong Institute of Certified Public Accountants
Авторы: Syren Johnstone и Say H Goo
Обзор текущего состояния (дата издания отчета 15.12.2017) корпоративного права Гонконга, основанного на Ординансе "О компаниях" 2014 года (Hong Kong Companies Ordinance) и Ординансе "О ценных бумагах и фьючерсах" 2003 года (Hong Kong Securities and Futures Ordinance). Исследование недостатков действующего режима и предложения о направлениях развития.

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Понедельник, 13 мая 2019

3. Discussion and analysis of jurisdictions studied. 3.3.4 Audit committee

In the UK there are two main sources that govern the audit committee: the FRC's UK CG Code and the FCA's DTR. As noted in Appendix II.4.3, a number of the provisions overlap, however, only the DTR provisions create binding obligations and breaches of them may give rise to enforcement action and/or an action for damages. Whereas the DTR sets out minimum requirements, the UK CG Code sets out recommendations, and the FCA has given guidance that compliance with certain provisions of the UK CG Code will entail compliance with the corresponding DTR requirement. This includes the composition and functions of the audit committee and the annual disclosures required in relation thereto. The FRC also issues guidance on certain sections of the CG Code including its Guidance on Audit Committees 2016.

The UK CG Code's approach to the audit committee is based on its function as a sub-committee of the board. Thus, the UK CG Code provides that the audit committee's responsibility in relation to the appointment, reappointment and removal of the external auditors is to make recommendations to the board. Since 2012 the issuer is required to explain in the annual report to shareholders how the audit committee has carried out their responsibilities, and the FRC's Guidance on Audit Committees recommends that the relevant section should include specified matters (generally covering the role and work of the audit committee) and be signed by the chairman of the audit committee. In practice, this is often regarded in the UK as equivalent to a report prepared by the audit committee. Where the board and the audit committee have been unable to agree on the recommended appointment, reappointment or removal of the external auditors, the Code requires the annual report to contain a statement from the audit committee explaining the recommendation and why the board has taken a different position. The same approach is undertaken in Hong Kong in relation to disagreements, however, in the absence of such a disagreement, the audit committee does not make any disclosure. The HKICPA's «A guide for effective audit committees» issued in 2002 does recommend that the annual report should contain disclosures concerning the role and work of the audit committee.

In the United States, disclosures are not only required to be made about the audit committee, but are also required to be made by the audit committee itself (see Appendix III.3.2). The composition and workings of the audit committee, as well as the disclosures required to be made in the audit committee report presented in the issuer's annual proxy statements, are subject to SEC rules effective 2003 that implement SOX. Many issuers are already providing audit committee disclosures that go beyond the SEC's requirements. Nevertheless, the disclosures of the audit committee in the audit committee report, and the usefulness of those disclosures, remains a continuing focus of the SEC and the PCAOB (although the PCAOB does not have regulatory jurisdiction over the audit committee).

Unlike the position in the UK, where the audit committee operates as a sub-committee subject to the board's usual powers, SOX and the SEC implementing rules position the audit committee as the primary body directly responsible for the appointment, compensation, and oversight of the issuer's external auditor, and it is the audit committee to whom the external auditor must report. These requirements, together with issues surrounding audit firm tenure, audit firm fee determinations, and audit committee involvement in the selection of the audit engagement partner, continue to be scrutinized.

In addition, the audit committee will need to be cognizant of the code of ethics an issuer is required to establish and apply to senior financial officers in compliance with the requirements of section 406(c) of the SOX. This covers, inter alia, conflicts of interest, disclosure standards, and compliance with applicable rules and regulations. In addition to the code of ethics requirements reviewed above, the PCAOB issues auditing standards that outline the responsibilities and functions of auditors, internal and external, much as the FRC do in the UK and the Hong Kong Institute of Certified Public Accountants (HKICPA) do in Hong Kong despite the somewhat differing nature of each of these bodies in the regulatory architecture of each jurisdiction. The PCAOB's standards have been reviewed recently.

The NYSE rules also specifically require prospective audit committee members to consider and evaluate carefully the existing demands on his or her time before accepting this assignment and, if a committee member serves on more than 3 public companies then the board must consider whether this impairs the ability of the person to serve and must disclose such determination.

In Mainland China, an audit committee is not compulsory except for firms controlled or owned by the central government (see Appendix IV.7.3). Otherwise, the requirements for an audit committee are very similar to those in Hong Kong, UK and United States. Thus, whilst audit committees are increasingly playing a positive role, their effectiveness remains a work in progress. This to some extent depends on the effectiveness of independent directors who are the key members of the committees.

In Singapore, the Audit Committee is compulsory for all locally incorporated listed companies (s 201B(1), CA). The requirements are quite similar to the other jurisdictions examined. Listed companies incorporated outside Singapore are subject to similar requirements under the Singapore CG Code. However, unlike Hong Kong, the requirements in the Code are only comply or explain provisions. Surveys conducted in Singapore and Hong Kong found that fraudulent companies have a lower proportion of finance experts (as distinct from accounting experts) in their audit committees. Thus, it was suggested that there might be merit in emphasizing the monitoring role by finance experts in audit committee.

Hong Kong

The position of audit committees in Hong Kong overall is very similar to the position in the UK, but considerably different from the arrangements in the United States in three main regards.

First, in Hong Kong, the provisions governing the establishment and operation of the audit committee do not arise out of primary or regulatory law, as they do in the United States or Singapore (for locally incorporated companies), but are established in the non- statutory listing rules. Core requirements concerning composition of the committee are mandatory, as is the requirement for the board to establish the terms of reference of the committee, although the parameters of such terms are not specified in the listing rules, which instead reference the (non-mandatory) HKICPA's «A guide for effective audit committees» issued in 2002. Many of the detailed operational provisions are not mandatory but are instead laid out in the HK CG Code making them only subject to the comply or explain standard.

Second, in Hong Kong, although the audit committee may have day-to-day influence over the undertaking of the audit work, the primary relationship of the external auditor with the issuer is with the board, whereas in the United States it is with the audit committee independently of the board's usual functioning.

Third, the HK CG Code positions the audit committee's responsibilities around its role as a sub-committee of the board that reports to the board; accordingly, while the code requires the board to make disclosures about the audit committee, the audit committee itself does not make any disclosures, subject to one exception (below). While guidelines issued by the HKICPA do recommend the disclosure of the composition, activity and various functions of the audit committee in the annual report, the guidelines stop short of suggesting the audit committee itself make a disclosure in the annual report. Moreover, for the purposes of the HK CG Code the guidelines only constitute suggestions. Section L(iv) of the HK CG Code contemplates - somewhat indirectly - that an audit committee might itself report on its functioning, however, the board may also do this.

The one exception to the silence of the audit committee's voice reflects a similar provision in the UK: the HK CG Code requires - again on a comply or explain basis only - the audit committee to make a disclosure in the annual report in circumstances where it has been unable to agree with the board on the selection, appointment, resignation or dismissal of the external auditors.

Given the importance to CG standards of the role played by a properly engaged audit committee, it is in some ways surprising that the role performed by the audit committee is open to being determined by the board with no legal constraints thereupon. Together with the relative invisibility of the audit committee's voice in communications with shareholders this suggests that Hong Kong can do significantly better in this regard. This is supported by the greater concern that has been identified over auditors and the quality of financial statements of Mainland Chinese issuers, as already mentioned in Section 3.1 «Overarching considerations», concerns that should not be taken lightly given the increasing predominance of Mainland Chinese enterprises being listed on the SEHK.

However, it is recognized that a number of factors weigh in on this discussion. Not least being the current discussions about the correct positioning and powers of the FRC in Hong Kong's regulatory architecture. Accordingly, two levels of suggestions are made, both of which would require changes at the level of the listing rules.

The relatively simpler one is to expand on developments in the UK and the United States to improve the transparency and voice of the audit committee to shareholders by requiring it to make a disclosure in the annual report. This is often the de facto position in the UK and is required in the United States. Given the concerns expressed in relation to INEDs (see Section 3.7 Part C «Independent directors»), increased visibility of the audit committee through mandated disclosures is one mechanism by which responsibility may be brought more directly to bear on INEDs - under the current listing rules the audit committee must be chaired by an INED, be comprised of a majority of INEDs, and include at least one INED with appropriate professional qualifications!or accounting or related financial management expertise. It may include NEDs but excludes executive directors.

A more complex suggestion would be to reposition the function of the audit committee as one that is managed by legal requirements, as has been done in the United States. While this requirement in the United States has been implemented via primary and regulatory law, it is suggested the equivalent action in Hong Kong - making primary or subsidiary legislation - may be difficult to implement, and would likely be premature in the absence of a clear mandate from the market that this is needed. Accordingly, it is suggested that a more suitable approach for Hong Kong would be to impose a comply or explain requirement on boards that the authority in relation to the appointment, compensation, and oversight of the external auditor be fully delegated to the audit committee. Such a delegation would not, at law, diminish the ultimate legal authority of the board, or alter the board's legal obligations to oversee the execution of any delegated function of the board. However, where full delegation is made, this places greater emphasis on the primary role and authority of the audit committee - i.e., not merely to make recommendations to the board but to itself make binding determinations. This would considerably strengthen the intended function of an audit committee as a safeguard against financial manipulation.

The foregoing leads to Recommendation A4.1.3 «Disclosures of the audit committee» and Recommendation A4.1.4 «Status of the audit committee».

The ability to achieve the intended objectives of these two recommendations depends significantly on the INEDs and the other NEDs comprised in an audit committee. In this regard, reference should be made to other recommendations in this Report that are directed toward improving the quality, independence and accountability of INEDs (and other NEDs): Recommendation A4.2.1 «Sufficient INED time», Recommendation A4.2.2 «Basis of INED remuneration», Recommendation A4.2.3 «INED training», Recommendation C4.2.4 «NED Code and INED reporting», and Recommendation C4.5.3 «Facts regarding director independence».


Содержание отчета

Executive summary
Executive Summary I Key Findings
Executive Summary II Summary of Recommendations
Executive Summary III Approach to the Study
Executive Summary IV Abridged Text of the Analysis

1 Introduction to the study and its purposes
1.1 Purpose of this Report
1.2 The development of CG in Hong Kong
1.2.1 Domestic drivers
1.2.2 Global drivers
1.3 Structure of this Report
1.3 Structure of this Report
1.3.1 Methodology
1.3.2 Analysis
1.3.3 Recommendations
1.4 Scope and limitations of this Report
1.5 Next steps

2 Methodology
2.1 Scope
2.1.1 CG concepts
2.1.2 CG Geographic reach
2.1.3 CG mechanisms
2.2 Work process
2.2.1 Data collection
2.2.2 Initial data organization
2.2.3 Oral evidence
2.2.4 Parity check
2.2.5 Analysis
2.2.6 recommendations

3 Discussion and analysis of jurisdictions studied
3.1 Overarching considerations
3.1.1 Thematic topics
3.1.2 Trends in regulating CG standards
3.1.3 The role of culture
3.1.4 The methodology of assessment
3.1.5 Cost-benefit considerations
3.1.6 Maintaining competitiveness
3.1.7 Effectiveness
3.2 Non-locally incorporated companies
3.2.1 Application of local laws and regulations
3.2.2 Cross border enforcement and cooperation
3.3 Information
3.3.1 Legal status of CG disclosures
3.3.2 Disclosure of listing rule compliance
3.3.3 Board evaluation
3.3.4 Audit committee
3.4 Involvement
3.4.1 Shareholder stewardship
3.4.2 Shareholder votes
3.4.3 Remuneration
3.4.4 Changes of control
3.5 Equality
3.5.1 Voting rights generally
3.5.2 Weighted voting rights
3.6 Accountability
3.6.1 Information disclosures generally
3.6.2 Listing rules
3.6.3 Board refreshment
3.6.4 Appointment of independent directors
3.7 Effectiveness
Part A - CG system design
3.7.1 Impact of regulatory design
3.7.2 Policy development agencies
3.7.3 Enforcement agencies
3.7.4 Audits of public companies
3.7.5 Duties of directors
3.7.6 Role of fiduciary law
Part B - Specific actions
3.7.7 Differentiation of CG requirements
3.7.8 Listing regime standards upon entry
Part C - Independent directors
3.7.9 Determination of independence
3.7.10 Requirements relating to INED performance
3.7.12 Empowerment of INEDs - controlling shareholders
Part D - Other items
3.7.13 Whistle-blowing
3.8 Coda

4 Recommendations
Introduction and approach to the recommendations
Part A - The board
4.1 Processes
4.2 Independent directors
4.3 CG standards
Part B - Enforcement
4.4 Shareholders
4.5 CG disclosures
4.6 Regulators
4.7 Ex ante mechanisms
Part C - Architecture and policy
4.8 Architecture
4.9 Policy
4.10 Summary tables

5 Concluding remarks
5.1 The Recommendations
5.2 The Hong Kong market

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