Introduction
Hong Kong's emergence as a global financial centre has brought far greater attention to its role in the global market place and the standards it engages as compared to other leading global centres. Markets compete on a range of factors, amongst which the corporate governance (CG) system is of particular importance because it impacts on market integrity, and hence market success. Where the affairs of publicly listed companies are undertaken in a way that fall short of expected CG standards, or where the mechanisms of control and redress are inadequate to curb misbehaviour, confidence in the market may be damaged, and the market becomes less efficient. CG is therefore an integral part of a market that a CG system must serve.
This Report was commissioned by the Hong Kong Institute of Certified Public Accountants (HKICPA) to make recommendations on how Hong Kong's CG system may be further developed to improve the long-term competitiveness of the Hong Kong public market. The recommendations are to be based on an independent, comparative study of shareholder rights, remedies and protections and board processes within the context of public listed companies. As many listed issuers are not incorporated in Hong Kong this presents special issues as regards standard setting and enforcement.
To assess the strengths and weaknesses of Hong Kong's CG system in the global context, this study investigated the CG system in Hong Kong and each of the United Kingdom (UK), the United States, Mainland China and Singapore. The CG system in each of these jurisdictions has undergone developments and experiences, successes and failures that are shaped by its historical, political, legal, market, and social and cultural contexts. The different influences of these factors are important to recognize for the purposes of forming recommendations within a Hong Kong framework - what works, or fails, in one jurisdiction might fail, or work, in another.
The comparative analysis undertaken in this Report has led to a total of 28 recommendations being put forward. Reflecting one of the guiding concepts of this study to produce practical and implementable recommendations, only two require a change to legislation, with another four possibly requiring legislative change subject to the outcome of a further consultative process. All recommendations are consistent with overarching objectives of fostering competition and regulatory efficiency.
The remainder of this Part I of the Executive Summary provides an overview of the study's main findings. Part II outlines each recommendation made and provides a summary Table of all recommendations found in Section 4 of this Report. Part III summarizes the approach taken to the topic of CG and the formation of recommendations. Part IV summarizes the analysis that gives rise to the 28 recommendations via an abridged text of the detailed analysis found in Section 3 of this Report.
Standing of Hong Kong's CG system
In general, Hong Kong's CG system is keeping up with international best practices in most areas. The approach to evolving its CG system has been inclined to follow developments in other markets, particularly the UK and to some degree the United States. This typically means that changes to Hong Kong's CG system lags rather than leads international best practices. Its evolution in recent times can be broadly captured under three main areas: statutory law, the non-statutory listing rules, and gateway mechanisms for new issuers including those companies not incorporated in Hong Kong, as follows.
The rights of shareholders under statutory law in relation to director misfeasance and mis-disclosure are generally on par with or better than international best practices, as supported by important statutory reforms including the Securities and Futures Ordinance (SFO) (introduced 2003) and the new Companies Ordinance (introduced 2014). However, as discussed below, the lack of availability of collective redress and the standing of the listing rules remain areas of concern insofar as they have not evolved in line with developments in other markets and so leave shareholders in Hong Kong listed issuers comparatively disadvantaged.
The standards of CG that are expected of listed issuers have developed generally in line with international best practices. Board practices are subject to mandatory listing rule requirements and a «comply or explain» CG code that the SEHK subjects to progressive development. While in some areas the CG system is well developed and goes further than other markets, such as the non-statutory regulations governing connected party transactions, the adequacy of enforcement discipline and availability of shareholder remedies remain a concern.
Gateway mechanisms designed to protect and further the interests of shareholders have also been progressively improved, including in respect of non-Hong Kong incorporated companies. This has been a result of the SFC and the HKEX working together as regards listing standards, the development of policies for non-Hong Kong incorporated companies tailored to specific jurisdictions, and the regulatory requirements imposed on sponsors.
Overall, the dual responsibilities model has worked well in response to significant developments in the market, including Hong Kong's global position in the IPO market and the highly significant shift to the listing of Mainland enterprises such that these firms now account for the majority of market capitalisation and trading. The correct balance of the role of the SEHK as the frontline regulator and the SFC's oversight role remains subject to intermittent discussion and disagreement as regards how the roles should evolve in response to these developments.
Key areas for reform
There are a number of areas of concern in which Hong Kong must do significantly better to protect its market and the shareholders who invest in it. The weaknesses in Hong Kong's CG system primarily revolve around: the articulation of regulatory responsibilities, particularly between the SFC and the HKEX/SEHK; the role of the board and the quality of disclosure and transparency; and the ability of shareholders to seek redress in respect of an issuer and its directors that fail to meet expected standards. However, factors that influence a CG system are rarely mutually exclusive. For example, the ability of a shareholder to exercise or enforce their rights may depend on what they know (information transparency), their ability to influence decisions (involvement/equality), and the means by which they can hold management responsible (accountability), which together reflect the efficacy of a CG system (effectiveness).
For the purposes of this Report, the recommendations have been grouped together under three main divisions: the board and its processes and standards; the enforcement regime (including for both shareholders and regulators); and matters concerning CG system architecture and policy. A number of the recommendations made in each of these divisions intersect with the particular issues presented by non-Hong Kong incorporated companies.
Board processes
Mechanisms that protect shareholders from potential abuses of the board must be improved. This includes important functions expected to be undertaken by the audit committee and independent directors, and CG-related transparency generally. Each jurisdiction studied is dealing with similar types of issues related to the role of board sub-committees and independent directors, board evaluation and refreshment, and executive remuneration. The experience in each jurisdiction is markedly different, with some reforms having a positive effect, others not. In some instances, the market response to reform can be to game it to bring about an alternative outcome from the one intended by regulators, thus producing unexpected consequences - this has been the case in the United States as a result of shareholder activism and incentive-based remuneration for executive directors. Nevertheless, Hong Kong can do more to keep up with best practices internationally.
This Report makes ten recommendations concerning board processes.
Enforcement (shareholders)
While the study indicated that shareholder rights are, as regards strict legal rights, well established in Hong Kong law, it is subject to three important caveats. The first is the ability of a shareholder to acquire information relevant to the identification of the infringement of a right. The second is the ability of the shareholder to pursue that right in practice. The third is in relation to what matters should a shareholder have rights of redress.
These three caveats reveal the areas where Hong Kong is most clearly in need of meaningful reform. While shareholders have been provided with rights under the law, such as derivative actions and civil suits in respect of certain types of information, claims are rarely brought. Unlike some other markets, shareholders have no rights in relation to breaches of listing rule disclosure requirements, despite having (together with regulators) an expectation that directors and issuers will comply with them. While many CG failings currently do not amount to legal causes of action, shareholders cum investors do consider the CG practices of an issuer in the total mix of information available to them, so one would expect this to have some relevance to establishing the scope of their rights and protections.
This Report makes two recommendations concerning shareholders rights.
Enforcement (regulatory agencies)
The position of shareholders is considerably exacerbated by the existence of an enforcement lacuna between the powers of the two regulatory agencies, the SFC and the SEHK. Hong Kong has clearly fallen behind international best practices in this regard as the powers of regulatory agencies are either too weak and ineffective, or too strong and insufficiently graduated in relation to a wrongdoing that does not warrant (or may not give rise to) court action.
This represents a serious shortcoming in regulatory efficiency as compared to all the other markets studied. It leaves many important CG standards set by the listing rules subject to ineffective enforcement. A number of the recommendations made in this Report are directed to improving regulatory efficiency by enabling earlier behaviour correction via more effective means of consequence management to improve regulatory efficiency but without invoking changes to the fundamental dual responsibilities model of regulatory oversight. For example, it is suggested that various disclosures made by issuers and their directors should be made on forms that bring the disclosure under the potential liability of section 384(3) of the SFO - this section is not fixed to any particular disclosure but is designed to be used by regulatory agencies to safeguard the undertaking of their statutory functions from being supplied with false or misleading information.
This Report makes ten recommendations concerning the enforcement powers of regulatory agencies.
Non-Hong Kong incorporated companies
Despite concerns as to the ability to set and enforce CG standards against non-locally incorporated companies, the system in Hong Kong works reasonably well when compared to other jurisdictions - cross-border enforcement issues and potential conflicts of law is not unique to Hong Kong. However, the preponderance of Mainland enterprises listed in Hong Kong lends a different emphasis to the problem as compared to the other markets studied and establishing more effective means of enforcement against these companies has become essential.
Improving ex ante mechanisms of enforcement that provide for more effective early- warning identification and correction mechanisms can work well in this regard. Several of the enforcement recommendations made in this Report would subject non-locally incorporated companies to a more effective system of domestic enforcement, the cross¬border problem notwithstanding. The recommendations also propose ex ante mechanisms that place greater emphasis on the gateway mechanisms in place for entry to the market.
This Report makes nine recommendations that assist with ex ante enforcement concerns in respect of non-Hong Kong incorporated companies. A number of the other recommendations made herein would also serve to improve the overall CG standards of non-Hong Kong incorporated issuers just as they would local issuers.
The Report also makes one additional recommendation that is specific to Mainland enterprises, namely, to consider the possibility of exploring with the Mainland a new cross-border enforcement arrangement specifically tailored to the public capital market. Hong Kong is uniquely positioned to develop this type of solution, which would address some of the drawbacks associated with MoUs, and could give the Hong Kong market a competitive advantage to attract quality listings.
Architecture and policy
The way in which policy is developed in each of the jurisdictions is significantly different. This arises not only out of the political, legal and regulatory architecture of each jurisdiction but also out of fundamental concepts about the nature of the corporate and the circumstances when it is appropriate for public interests to override private rights.
Some of the shortcomings in Hong Kong's CG system identified by this Report arise out of the dual responsibilities model of regulatory oversight of the listed market undertaken by the SFC and HKEX. However, the problems are not exclusive to the model and none of the recommendations made in this Report require a fundamental change to the model. The efficient functioning of the model requires an appropriate balance between market self-discipline and regulatory oversight for it to remain fit for purpose and some developments of the model are proposed that serve to improve balance. For example, a number of recommendations would create more efficient enforcement powers, including those of the SFC, that are nevertheless consistent with the dual responsibilities model.
The Report observes differences in the way policy is developed and enforced, and notes that the development of the Hong Kong market has in some ways outpaced policies on market development.
This Report makes six recommendations concerning architecture and policy.
Conclusions and way forward
The analysis and recommendations presented in this Report are intended to be helpful and thought provoking for the Government, policymakers, regulators, market participants and investors. The scope of this study, being shareholder rights, remedies and protections, is essentially focused on the relationship between the owners and managers of a company and how effectively the CG system provides for, inter alia, transparency, equality and accountability. Accordingly, this Report has not sought to explore a number of areas of CG that nevertheless are of interest, such as board diversity, environmental and social governance, and various aspects of internal governance processes by which the board directs and controls the undertaking of the company's business.
A number of the recommendations made in this Report are relatively straightforward to implement, others require further work to be undertaken as to their more specific details and potential ramifications. A few specifically contemplate a further consultation or enquiry process. To a greater or lesser extent, all the recommendations will be subjected to the test and reaction of the market.
The stated objective of this Report is to make recommendations for improving Hong Kong's CG system so that it better serves the needs of the market and improves its long-term competitiveness. However, an important interim purpose is to generate discussion that will lead to an enhanced recognition and understanding of areas that are in need of reform when Hong Kong is examined against best-practices internationally.
A note on funding: This project was entirely funded by the Hong Kong Institute of Certified Public Accountants (HKICPA), which also established the general scope of the study, as part of its efforts to promote better CG in Hong Kong and to enable the HKICPA and its members to consider how Hong Kong's CG should develop in the future. The mandate given to the authors of this Report was to conduct an independent enquiry and accordingly this study was not constrained by any preset views, preferences or desired outcomes, nor did it include any requirement to have regard to the interests of the HKICPA or its members. The HKICPA's Corporate Governance Working Group monitored progress. While there was a diversity of opinion on various recommendations made herein, the final decision on all aspects of the Report, including the contents of, and whether or not to make, each recommendation rested solely with the authors of this Report.