The ability of a company to adopt good CG standards depends on a number of factors including the skills and experience of the directors, the systems and procedures they implement, and the CG culture of the company as a whole. It is relatively clear that many of these factors will be set from the outset of a company's admission to listed status, and that where they are set to relatively low standards it will be a significant task to move the company toward the standards expected of a public company. One may make the analogy that it is difficult to repair a badly constructed boat when it is already at sea -not always impossible, but difficult nonetheless.
In the UK the FCA has increased the intensity of its supervision of sponsors of listing applicants to ensure that CG structures cannot undermine the UK listing regime. The liability of a sponsor to fines not limited in amount imposed by the FCA is clear.
In the United States, there is no sponsor concept, however, the underwriter has a clear statutory liability in the United States under the 1933 Securities Act. This means it has a greater interest to ensure disclosures in an offering document, including as to a company's actual CG practices, are accurate, complete and not misleading. Extensive CG-specific disclosures are required in the registration statement and liability will attach to mis-disclosures.
While the above distinctions reflect differences arising out of the strongly disclosure¬based approach in the United States, it has also been characterized as reflecting the ex post approach in the United States compared with the relatively more proactive regulatory approach in the UK, which tends toward ex ante mechanisms - ex ante means of regulating corporate behaviour are an important alternative means of improving shareholder rights.
In Mainland China, the exchanges can enforce listing rules and trading rules against sponsors (see Appendix IV.3.4). CSRC can enforce the Administration Measures for Initial Public Offering and Listing of Stocks (2015) against sponsors. In Singapore, the SFA (sections 253(4)(d) and 254(3)(d)) has imposed criminal and civil liability on sponsors.
Hong Kong
Like the UK, the SFC has also increased its focus on the quality of sponsor work in recent years, recognizing that the quality of sponsor work is an important gateway mechanism for ensuring an adequate quality of companies listed on the SEHK. As part of the sponsors role, before a listing applicant can be admitted to listing its sponsor (each of them if there is more than one) will be required to submit a declaration to the SEHK as to the adequacy of the company's procedures, systems and controls as well as the experience, qualifications and competence of the directors.
However, unlike sponsors in the UK and underwriters in the United States, the prospectus liability attaching to sponsors is unclear. According to the SFC, sponsors are under CWUMPO potentially liable to primary (though not secondary) market investors as persons who have authorized the issue of the prospectus. However, as discussed in Appendix I.3.1, there appears to be no legal grounds for the SFC's position, which remains untested in court. This might suggest a need to make proposals to reform a sponsor's prospectus liability as a means of improving the quality of sponsor work. However that suggestion seems unnecessary in the present context as sponsors are already potentially liable under sections 277 and 298 of the SFO in respect of mis¬disclosures in the prospectus, and under section 384(3) of the SFO if their declaration to the SEHK is found to be false or misleading. In addition, the SFC has significant leverage over sponsor firms under sections 193 and 194 of the SFO to procure compliance with expected standards of conduct.
Despite the increased regulatory attention on sponsor work, there have been no legal actions brought against sponsors to date, the SFC instead relying on its administrative powers to discipline under section 194 of the SFO, for example, as was engaged in relation to Mega Capital (Asia). Moreover, anecdotal reports suggest that the quality of sponsor work remains a real concern. The SFC has stated it is currently investigating 15 sponsor firms whose sub-standard work is connected to billions of dollars in investment losses, including against well-known firms such as UBS Group, Standard Chartered, Morgan Stanley, Bank of America and KPMG.
Discussion
Ex post means of redress is weak in Hong Kong for shareholders - it is of interest to note that whereas in the United States private litigation is greater than actions undertaken by the SEC, the reverse is true in Hong Kong where CG related actions are primarily undertaken by the SFC. Setting the tone of an issuer's CG standards from the outset is arguably more critical to shareholder in such a context as they are unlikely, unwilling or unable to litigate. More recently, the SFC has also re-emphasized the importance of a multi-dimensional approach that includes gatekeeping and supervision (while also bringing greater focus on corporate wrongdoing).
As regards gatekeeping, while sponsors are required to make a declaration generally covering the company's procedures, systems and controls, listing applicants are not themselves currently required to make any disclosures in their listing documents as to their CG practices or standards, except as regards their CG measures to resolve actual or potential conflicts of interests between the applicant and its controlling shareholder/director. In practice, listing applicants do typically elect to make statements pertaining to their CG processes, for example, as regards the establishment of sub-committees of the board, such as the audit committee mandated by the listing rules. If the listing rules were amended to require statements as to the listing applicant's CG processes, including what provisions of the HK CG Code it intends to comply with and which not, this would give rise to disclosures that would be subject to liability under CWUMPO and the SFO as well as the SFC's powers under the SMLR.
The foregoing leads to Recommendation C4.7.1 «Disclosure of CG standards in listing document».
In the immediate period post-listing, an issuer is normally making adjustments as it becomes accustomed to its new status. As discussed in Appendix II.1.1, GT has suggested that when a company first lists there is a four-year move from box-ticking to meeting the intent of provision. In Hong Kong, the listing rules require the appointment of a compliance adviser for not less than a full financial period, and this period may be extended. However, it must be noted that the compliance adviser role is essentially passive as the responsibility to consult rests with the issuer. In addition, the entity appointed as the compliance adviser does not need to be drawn from among the sponsors of the listing, and most commonly it is not. Taken together, these characteristics weaken the compliance adviser role. First, because it is passive. Second, because the sponsors who undertook the regulatory responsibilities in the listing application and are intimately familiar with the workings of the company in essence walk away from having an ongoing regulatory function leaving it to an outsider. This contrasts with the position in Mainland China where a sponsor of a newly listed issuer is required to be involved in supervising the issuer's compliance issues for a period of two to three years after admission to listing. While not identical to the compliance adviser role used in Hong Kong, it is has a similar purpose, namely, assisting the issuer in relation to new regulatory requirements imposed on it by securities laws and regulations. This facilitates issuer's to develop their approach to compliance during this initial period.
Given the role of the compliance adviser to advise on matters such as regulatory announcements and notifiable and connected transactions, their function can impact on the development of the initial CG standards of an issuer. This presents a case to explore, whether the compliance adviser role would be strengthened by (1) giving it a more active engagement and responsibility, possibly on a wider range of CG-related concerns, and (2) requiring the role to be undertaken by one of the sponsors to the listing application. As regards the former, the changes made to the sponsor regime in 2013 introduced obligations on the listing applicant that ensured the sponsor had proper access to records, third parties and material changes that enable it to fulfill its regulatory responsibilities. The latter, which has the effect of keeping the sponsors skin in the game, connects with the concerns already discussed as regards the quality of sponsor work - if the sponsor's regulatory liability continued post-listing as compliance adviser this might bring greater focus in their review of the listing applicant's CG processes and standards pre-listing.
As an expanded compliance adviser role would effectively then become an extension of the sponsor's regulatory purpose, consideration should also be given to requiring the compliance adviser to provide a declaration as to CG matters in a manner similar to that given by sponsors in their Appendix 19 declaration.
The foregoing leads to Recommendation E4.7.2 «Develop role of compliance adviser».