In the UK, some CG requirements only apply to FTSE350 companies. This includes: the requirement that FTSE350 issuers have a board of which at least half excluding the chairman are INEDs; a recommendation that directors of FTSE350 issuers should be subject to annual re-election; and the requirement that FTSE350 issuers establish a remuneration committee with delegated responsibility for setting remuneration for all executive directors and the chairman, including pension rights and any compensation payments.
The response to the higher requirements for FTSE350 issuers is in general quite good. For example, compliance with the minimum number of INEDs requirement is high, with only 26 FTSE350 issuers being non-compliant in 2016. The FRC has also reported that its suggestion to implement clawback arrangements on executive pay have been taken up by 91% of FTSE350 issuers in respect of the annual bonus and by 78% in respect of long term plans. This is perhaps not surprising given the market's general expectations of the standards of these larger companies.
Hong Kong
In contrast, the HK CG Code applies equally across all issuers listed on the same board irrespective of factors such as size or, as discussed earlier, place of incorporation. Nevertheless, larger or better known/established issuers frequently adopt standards higher than what is required by the applicable regulations.
Discussion
As discussed in Appendix I.1.1, Hong Kong has traditionally relied on reputational rather than jurisprudential means of liability as regards CG standards, with some of the larger issuers leading CG standards. Based on the premise, which appears supported by research, that CG matters to investors, particularly institutional investors, there seems some merit in exploring whether there is a case for imposing higher standards on larger issuers. Based on the UK data, compliance may be forthcoming provided the requirements are established with the mandate of the market.
Three mechanisms by which this could be introduced are as follows.
First, changes could be made to the HK CG Code and/or the listing rules that only apply to certain larger issuers, for example, those that have been admitted to a relevant index, such as an HSI or HSCEI constituent stock. A simple means of doing this is to focus the changes on the escalation of recommended best practices to code provisions and selected recommended disclosures to become required disclosures for the relevant companies to establish «Elevated Standards». However, as there are relatively few recommended best practices in the HK CG Code following the HKEX's review in 2012, consideration should be given to incorporating specified comply or explain provisions as mandatory requirements in the Elevated Standards for the relevant issuers. A benefit of this approach is that many of the relevant issuers will already be compliant, so the development would serve to entrench those voluntary practices. At the same time it would send a signal to the market that companies subject to the Elevated Standards are leading examples of good CG practices.
Second, changes could be made to the criteria by which an issuer may be admitted to a relevant index. However, admission to indices is, with good reason, primarily quantitatively based on objective criteria. In contrast, compliance with some measure of CG is likely to be open to less objective considerations - for example, even a quantitative requirement such as a majority of INEDs on the board contains an embedded qualitative factor, namely, the assessment of independence. This approach is therefore untenable.
Third, it would be possible to establish a CG index based on companies that meet specified CG criteria. Such indices have been established in eight jurisdictions, however, they have not been successful and the concept is still evolving. A fundamental problem is, as already alluded to, the problem of developing objective and measurable CG benchmarks, and dealing with embedded non-objective criteria. A more significant problem is that the CG indices are not sufficiently differentiated in performance from the main benchmark index of their markets due to a significant overlap in the constituent stocks. In consequence of this, investment products such as exchange-trade funds tailored to the indices have not developed.
Accordingly, only the first of the above three approaches would appear to be tenable.
The foregoing leads to Recommendation R C4.3.1 «Relevant issuers to be subject to ‘Elevated Standards'».