Introduction
The make-up and rapid evolution of the Hong Kong market raises complex issues, many of which were discussed in Section 3 in the context of the practices and experiences in the other jurisdictions studied. The recommendations presented in Section 4 have addressed the board and its processes and standards, the enforcement regime (including for both shareholders and regulators), the regulatory oversight of non-Hong Kong incorporated companies, and matters concerning system architecture and policy.
5.1.1 The board
Ten recommendations propose improvements to board processes that will foster transparency and accountability, including in relation to the undertaking of the independent director role.
The findings of the Cadbury Committee pointed to the importance of the board and its role in a company's decision-making. While attention has focused on the effectiveness of the board and its processes, all too often it remains the case that the boardroom remains a black box to shareholders. This Report has considered board evaluation and board refreshment as important mechanisms that underpin accountability to shareholders. It has also considered the one-share-one-vote (OSOV) principle, in particular, its relationship to proposals to allow companies with weighted voting right share structures to list, as well as to existing public regulatory provisions that override the equality implicit in the OSOV principle, including dual voting in the UK.
The idea of independent directors bringing in expertise, improving the quality of board oversight and acting as a guard against potentially damaging conflicts of interest is intuitively a good one. However, despite reform over the years, the independent director system has not worked well in Hong Kong. One possible explanation could be that the independent director concept is a product of an «outsider» system and does not fit well into the «insider» system that dominates the Hong Kong market. The problems include their appointment by controlling shareholders, low compensation, uneven quality and insufficient contribution to their companies. What is more difficult is the culture of not trusting an «outsider» in an «insider» system. Thus, independent directors are often chosen by controlling shareholders from a circle of friends and are not expected to ask difficult questions. There is not a lot one can do to change this culture overnight. However, some changes can help make the system of independent directors work better and more transparently. This requires a holistic approach to the undertaking of independent non-executive directors (INEDs) that encompasses their skills, their responsibilities, their remuneration, and the liability that attaches to their role.
There has been a lot of attention on the requirements and effectiveness of the audit committee since its introduction by the Cadbury Code in the UK in 1992. This intensified after the Sarbanes-Oxley Act mandated in 2002 the creation of audit committees in the United States - the requirements having been further developed by Dodd-Frank and the Securities and Exchange Commission's s implementing rules in 2011. Unlike the United States, the audit committee in Hong Kong is only compulsory under the listing rules, not a legal requirement, and it undertakes its work within the confines of their sub committee status with relatively little independence from the board. Hong Kong needs to do more to fortify the role of the audit committee.
Good corporate governance (CG) standards in the present era are significantly set according to listing rules that may include non-mandatory standards. Many of the largest issuers in each of the jurisdictions studied choose to comply with non-mandatory standards, including many recommended best practices. These issuers can be seen as vanguards that set standards others should follow. This presents opportunities to create stronger associations between successful companies and the adoption of higher CG standards to which others may aspire.
Other listing rule requirements are mandatory, which raises the question of shareholder expectations and what rights if any should be derived from those expectations, particularly where they are not met. This is discussed in the context of enforcement.
5.1.2 Enforcement
Twelve recommendations are concerned with the ability of shareholders and regulators to conduct meaningful, and graded, enforcement where CG standards fall below standards. The presence of a significant enforcement lacuna in respect of issuers in breach of CG standards set by the listing rules is an area where Hong Kong is clearly in need of reform.
Shareholders have been provided with rights in relation to various types of corporate and insider wrongdoing, however, they have a diminished ability to exercise those rights as compared to shareholders in the other jurisdictions studied. On the other hand, they are given no rights in relation to the listing rules, despite it being acknowledged that disclosures required by the listing rules are important in relation to investment decisions. The UK and Singapore both provide for shareholder actions for damages in respect of disclosure breaches of the listing rules. In the United States, shareholders may have claims either under Federal or State fiduciary law. The United States also provides for class action rights and contingency fees. This Report has made recommendations pertaining to each of these issues, one in respect of the listing rules that does not require legislative change, the other concerning improving the means of collective redress.
Shareholders in Hong Kong have generally come to rely on the regulatory agencies to pursue the wrongdoing company on their behalf, more so than in the other jurisdictions studied. To the extent that The Stock Exchange of Hong Kong Limited (SEHK) is effectively enforcing the listing rules and the CG Code is being meaningfully implemented, it may be less urgent to give shareholders the right to enforce listing rules. However, regulatory effectiveness is lacking. Regulatory agencies have been provided with a range of powers but they are not sufficiently comprehensive to create regulatory efficiency and avoid a gap between powers that are either too weak and ineffective, or powers that are too strong and resource consuming. Although the Securities and Futures Ordinance (SFO) covers some areas (such as disclosure of inside information, disclosure of directors' shareholding interest, etc.), the listing rules and the CG Code are important sources of standards. More than three-quarters of listed issuers are incorporated in a jurisdiction outside of Hong Kong and so are not subject to the standards in the Companies Ordinance (CO). The adequacy of the listing rules and their enforcement in these circumstances become of crucial importance, yet this is perhaps the weakest link in Hong Kong's CG system.
The debate as to whether certain powers to set standards and enforce them should be removed from Hong Kong Exchanges and Clearing Limited (HKEX) remains controversial. This Report has made recommendations on how to close the enforcement lacuna and improve regulatory efficiency without invoking changes to the fundamental dual responsibilities model of regulatory oversight. A number of the recommendations seek to either activate extant powers of the Securities and Futures Commission (SFC) or SEHK that are not well utilised, or to bring other administrative powers to bear on CG sensitive topics. An example of the latter is the suggestion that various disclosures made by issuers and their directors should be made on forms that bring the disclosure within section 384(3) of the SFO. This section is concerned with the provision of false or misleading information to regulatory agencies in the performance of their statutory functions. Section 384(3) is not fixed to any particular disclosure but is designed to be used by regulatory agencies to safeguard their undertaking. Although applying the section to a new use does not require any legislative change, it has not been extensively utilised. This Report recommends that both the SFC and the SEHK can and should use this legislative facility more actively.
This Report has also considered the roles of the sponsor and the compliance adviser in relation to listing applicants and newly listed issuers as part of a set of ex ante mechanisms, including the listing rule requirements applying to listing applicants, which can be strengthened to support a better CG system.
5.1.3 Architecture and policy
Six recommendations address regulatory architecture and policy development that would work better to serve the interests of shareholders and the market.
Hong Kong's three-tier regulatory structure, which has operated since 1989, has been a subject of regular reviews and criticisms. This includes the report of the Panel of Inquiry on the Penny Stocks Incident in 2002, the report of the Expert Group in 2003, attempts by the Financial Services and Treasury Bureau and the SFC over 2003 to 2005 to remove parts of the listing rules from the oversight of the SEHK to the SFO where they would be subject to the oversight of the SFC and, most recently, following the SFC/HKEX joint consultations on listing governance in 2016 and 2017. At each of these junctures, suggestions to alter the existing oversight of the listed market are highly controversial.
While some of the shortcomings identified by this Report arise out of the dual responsibilities model of regulatory oversight of the listed market, the problems are not exclusive to the model. This Report has explored other more practical ways in which the current system can be improved without a major overhaul, including a number of enforcement-related recommendations that sit within the existing dual filing regime. None of the recommendations made require fundamental changes to the model. However, the suggestion is made that for the model to function efficiently there must be an appropriate balance between market self-discipline and regulatory oversight that is not static but is dynamic and responsive to market developments.
5.1.4 Non-Hong Kong incorporated companies
A major residual challenge is how to regulate companies that are not incorporated in Hong Kong. Given the substantial presence of Mainland enterprises listed on the SEHK, the relationship between Hong Kong and the Mainland is of particular interest. Although there is a memorandum of understanding (MoU) between the SFC and the China Securities Regulatory Commission (CSRC) that facilitates cross-border cooperation, where criminal investigation is involved the CSRC does not have power to conduct investigations - only the Mainland police have such power but there is no MoU between the SFC and the Mainland police. Mainland enterprises that are not also listed or incorporated in Mainland China are not subject to the oversight of Mainland agencies including the CSRC. While the use of MoUs between the CSRC and the SFC have been helpful in building important relationships that foster mutual understanding and cooperation, they are fundamentally limited by the scope of the MoU and the powers possessed by the parties to the MoU.
The problem of cross-border cooperation is not unique to Hong Kong - regulatory agencies in the United States have experienced similar difficulties both before and after MoUs have been established. However, Hong Kong possesses a unique advantage by virtue of being a separate legal jurisdiction from the Mainland yet co-existing with the Mainland under the sovereign state of China. It already has one arrangement in place with the Mainland regarding the reciprocal recognition and enforcement of judgments, and this may provide a basis on which to develop a further arrangement that specifically covers the public capital market - indeed, this seems necessary in order to go beyond the inherent constraints of the MoU approach
Although there is nothing Hong Kong can do unilaterally to resolve the cross border enforcement difficulties non-Hong Kong incorporated companies present, other measures can and have been taken locally that apply to issuers wherever incorporated. Gateway mechanisms in the listing rules include requiring companies to, where necessary, amend their articles to provide for minimum standards of shareholder protection, and providing for a higher level of responsibility on sponsors of listing applicants incorporated in Mainland China. The listing rules, and the provisions of the CO concerning statutory derivative action and unfair prejudice also apply to all issuers wherever incorporated. These arrangements already go further in certain regards than other markets, such as the United States, where foreign private issuers are subject to reduced disclosure requirements and where an important base of many shareholder lawsuits - State laws - is absent. Nine of the recommendations in this Report assist with ex ante enforcement concerns against non-Hong Kong incorporated companies. One additional recommendation is specific to cross border enforcement in the context of Mainland enterprises.