Executive Summary IV Abridged Text of the Analysis

This abridgement is provided as a means of enabling a faster and less detailed reading of the main Section 3 «Discussion and analysis of jurisdictions studied» of this Report and the recommendations that it gives rise to, as detailed in Section 4 «Recommendations». As such, this abridgement does not comprise a sufficient analysis to support the recommendations but it does enable the reader to understand the driving forces behind the recommendations. This section assumes a reader with a moderate degree of knowledge of the Hong Kong corporate governance (CG) context. To aid readability, case law descriptions, abbreviated terms, detailed cross-referencing and footnotes found in Section 3 have not been repeated here, and the reader is invited to refer to Section 3 and the «Abbreviations» section at the end of the Report for the relevant details.

Introduction to the analysis in Section 3

Parts I to III of the Executive Summary have outlined the scope and purpose of this Report (discussed in Section 1 of the Report), the methodology and limitations of the study (discussed in Section 2 of the Report), and the recommendations that have been made (presented in Section 4 of the Report).

Section 3 of the Report, which is the subject of this abridgement, comprises a focused and selective discussion that provides a segue between the detail of each jurisdiction described in Appendices I to V and the recommendations made in Section 4. It commences, in Section 3.1, with a discussion of common themes, trends, issues and considerations that weigh on the assessment and development of any recommendation considered or proposed. The bulk of Section 3 (Sections 3.2 to 3.7) contains the comparative analyses that lead to the recommendations in Section 4.

Overarching considerations (Section 3.1)

Thematic topics and trends in regulating CG standards (Sections 3.1.1 and 3.1.2)

Despite the variation across the different jurisdictions' legal and regulatory architecture, and basic concepts about the nature of the corporation and the relative role of managers and owners in relation to it, a number of common topics were identified from the key differences and observations of interest, a subset of which have led to recommendations.

The extent of involvement of regulatory agencies in a CG system is an issue in all jurisdictions to some extent. The mechanisms of enforcement that are effective in deterring undesirable behaviour and procuring desired behaviour have very much been in issue over the past two decades, particularly since the statutory codification of listing rules undertaken in the United Kingdom (UK) and Singapore, and following the 2008 global financial crisis. This also encompasses the question of what persons should be able to bring enforcement actions, be it shareholders seeking remedies, regulatory agencies imposing administrative fines or other forms of sanction, or issuers themselves imposing controls on directors. An interesting theme has been the different approaches the jurisdictions take toward ex ante and ex post forms of redress.

The role of the board and the execution of its responsibilities has also been a common theme, particularly as regards the role of sub-committees intended to undertake specialized tasks and the role of independent directors. Particular foci include the audit process, executive remuneration, and shareholder involvement in the appointment or reappointment of directors. Looked as a whole, there is a push in most jurisdictions to open up the black box of board processes to greater scrutiny, through disclosure and accountability mechanisms that empower the shareholder vote. While these are common issues, each jurisdiction has tackled the problem slightly differently.

The developments in the CG system across the jurisdictions are typically driven, and constrained, by the approach to evolving the regulatory design of its securities industry, as well as its legal and regulatory infrastructure, and political, conceptual and cultural factors. This encompasses sectoral, twin peaks and super-regulator models that place regulators and Exchanges in different roles in relation to each other. These differences are important to recognize for the purposes of the present study - what works, or fails, in one jurisdiction might fail, or work, in another. For example, attitudes in the UK toward the proper scope of CG are relatively well aligned among stakeholders as compared to the United States where there is significantly less alignment. Together, these differences have a significant influence on the extent to which CG-relevant behaviour is driven by the perceived risk of legal, regulatory or reputational liability.

The role of culture (Section 3.1.3)

Culture is also an emerging topic of interest that has gained considerable attention since the 2008 global financial crisis. Culture can be a highly relevant factor that influences whether compliance with a CG requirement is undertaken on the basis of seeking to achieve the underlying objective of a regulatory requirement, or on the basis of a «box¬tick» approach. The latter approach is often synonymous with the validation of an act and a corresponding perceived diminution of culpability. However, there is little consistency or clarity across the jurisdictions as to what culture means or how to influence it. Culture is instead often used as a residual explanation when other modes of explanation are insufficient.

The methodology of assessment (Section 3.1.4)

One can also find various forms of assessing or measuring CG standards in each jurisdiction. This Report identifies two different approaches to assessment - a «Framework Approach» based on the percentage of CG rules technically complied with, and an «Empirical Approach» based on canvassing the views of stakeholders. Each comes with various methodological issues - for example, a simple binary measure of whether or not a particular requirement (such as might appear in a CG Code) is met is oblivious to the difference between box-ticking and objective-fulfillment. It is important to appreciate the information provided by, and the limitations of, each of these different approaches to measurement because they are frequently used to inform the policy-making process as regards developing CG standards. They are also used by different interest groups to justify, or resist, changes to a CG system.

Cost-benefit considerations, maintaining competitiveness, and effectiveness (Sections 3.1.5 to 3.1.7)

Whatever ideas might emerge from the systems studied, they must be considered in view of their overall effectiveness. Does a proposed change work to close out the potential disjunct between a right-minded principle, the practice that in fact subsequently evolves in response, and the outcome that eventuates? If it does not, a CG rule or principle can become a false validator of the behaviour actually undertaken. It may also operate as a distraction from the objective sought to be achieved. It is important to ask what is the overall cost to a CG system in light of the benefits a proposal is expected to deliver. The actual regulatory costs of different CG systems (however hard to estimate) do impact on regulatory efficiency and the overall success of a market. While the availability of effective mechanisms of enforcement is a recognized issue in all jurisdictions, enforcement costs vary significantly, including the different costs associated with ex ante and ex post approaches. Thus, the mere addition of more rules that may give rise to more enforcement actions do not, without clear justification, necessarily represent taking a step forward when compared with other solutions. Maintaining competitiveness in the international context must also be considered. Together, these factors require a more fundamental recognition that CG is ultimately part of a wider market system that a CG system must serve.

Non-locally incorporated companies (Section 3.2)

Application of local laws and regulations, and cross-border enforcement and cooperation (Sections 3.2.1 and 3.2.2)

Section 3.2 considers the question of how to regulate non-locally incorporated companies listed in Hong Kong. Most listed issuers fall into this category. There are two major challenges with the regulation of these companies: setting the appropriate CG standards for these companies in view of the conditions imposed in the jurisdiction of their incorporation, and the enforcement of standards imposed in Hong Kong against the companies and their directors and senior management.

While many requirements may be imposed on a non-locally incorporated issuer, the ability to supervise it and collect evidence will affect the discovery of a breach. The nature of the breach, whether it is breaching a law or a non-statutory code, will be relevant to the available mechanisms of enforcement including, where investors have suffered loss, the possibility for compensation. While the breach of a law in one jurisdiction is generally enforceable in another, this is not the case with non-statutory codes such as the listing rules. Even within the scope of legal breaches, cross-border enforcement may not be possible if a local law provision encroaches on a provision of the foreign law. Mainland China does not have foreign companies listed on its stock exchanges, so does not have to deal with these problems.

Listing rules are often used as a means of closing the gap between the CG standards imposed by the law on companies (and its directors) incorporated in different jurisdictions. Hong Kong and the UK both use listing rules to narrow the gap between the disclosures required to be made by domestically incorporated companies that are subject to local legislative requirements and foreign companies that are not. However, because the listing rules in the UK have statutory backing whereas they do not in Hong Kong, there is a difference in the legal effect where the listing rule provision is breached. For example, a breach of provisions in Hong Kong's listing rules that seek to level the playing field as regards directors' duties and annual reporting requirements has no direct legal consequences per se beyond the scope of the listing rules. In contrast, the statutory backing given to the listing rules in the UK and Singapore change the direct consequences of a breach - regulators possess the power to impose fines, and shareholders who suffer loss have a basis for a damages claim where there has been a disclosure breach. Listing rules that have statutory backing thus also serve to close the enforcement gap between laws and what were previously non-statutory codes.

A different approach is taken in the United States where listed issuers are required to make disclosures on Forms that bring the disclosures within the jurisdiction of Federal securities law - while a particular breach of an Exchange requirement is similar to Hong Kong in that it has no direct legal consequences per se, a breach of Federal securities law, including mis-disclosure on a Federal Form, is a serious matter giving rise to legal liability.

Another type of approach to the problems presented by non-locally incorporated companies is to require the company to amend its articles/bye-laws on issues of sufficient importance. This approach is taken in Hong Kong where the law of the home jurisdiction of the listing applicant does not provide standards of shareholder protection at least equivalent to Hong Kong.

Regulatory agencies in each of the jurisdictions studied have entered into one or more MoU (memorandum of understanding) with relevant foreign agencies. However, MoUs are ultimately limited by its scope and the powers and constraints imposed on the regulatory agencies in each jurisdiction, and this has in practice proved to be limiting where cooperation on enforcement has been sought. Cooperation may therefore depend on de facto assistance as opposed to de jure actions, as illustrated in the China Sky case in Singapore.

The residual problem of cross-border enforcement and conflicts of law are not unique to the Hong Kong-Mainland relationship. Rather, the emphasis is different owing to the preponderance of Mainland enterprises listed in Hong Kong. The observations made on the potential problems presented by non-locally incorporated issuers are addressed through a number of the recommendations made in other sections of this Report. Listing rules that seek to subject non-locally incorporated issuers to local CG standards ultimately depend on the effectiveness of listing rule enforcement. This ties in with the discussion in Sections 3.3.1 and 3.7.3, which explores means of improving the enforcement of listing rules that would operate equally against both locally and non- locally incorporated issuers. Those sections give rise to several relevant recommendations in this regard. Recommendation A4.5.1 «Legal status of CG-related disclosures» together with Recommendation C4.5.2 «Status of listing rule compliance and related disclosures (continuing)» propose giving legal backing to CG disclosures by bringing them within the provisions of the Securities and Futures Ordinance (Cap. 571) (SFO) that deal with providing false or misleading information to regulatory agencies. Recommendation A4.6.2 «SFC to develop use of conditions when exercising existing SMLR powers» and Recommendation A4.6.3 «Calibrate SFC's powers under the SMLR» propose that the Securities and Futures Commission (SFC) use alternative powers that sit within the scope of its existing powers in respect of breaches of the listing rules, the relevant powers being derived from the Securities and Futures (Stock Market Listing) Rules (Cap. 571V) (SMLR).

As cross-border enforcement remains problematic, more effective gateway mechanisms that ensure or facilitate that only companies able to comply with CG standards are admitted to listing becomes a relatively more important component of improving Hong Kong's CG system. The discussion in Section 3.7.8 explores those gateway mechanisms and makes two recommendations. Recommendation C4.7.1 «Disclosure of CG standards in listing document» proposes that issuers be required to make a statement in the listing document that discusses its CG practices in view of the requirements under the HK CG Code. Recommendation E4.7.2 «Develop role of compliance adviser» proposes expanding the role of the compliance adviser on the basis that establishing good CG practices from the outset of an issuer's entry to the public market creates better prospects for CG standards following the end of this initial period.

The position of Mainland enterprises that are either incorporated in the Mainland or in offshore jurisdictions requires separate attention due to the significance of their presence in the Hong Kong market both in terms of their relative number and contribution to total market capitalization and trading volume. Hong Kong and the United States have both experienced difficulties in procuring cross border enforcement in respect of Mainland enterprises - the assets of these enterprises may be primarily or solely located in the Mainland, and their directors may be Mainland citizens who have returned to the Mainland. For example, the United States has a number of Mainland enterprises that have «gone dark» and are effectively beyond the reach of effective cross border enforcement. In response, enforcement agencies have sought other means of solving the problem. This includes entering into MoUs, the limitations of which have already been noted, or case-specific solutions, such as the SFC has recently procured in relation to the suspended issuer Hanergy Thin Film Power. Unlike the other markets studied, Hong Kong already has a reciprocal recognition and enforcement of judgments arrangement in place with Mainland China, however, it is very limited and does not cover the public securities market. Building on that arrangement, the proposal in Recommendation E4.6.5 «Explore a narrow-channel cross-border enforcement arrangement» suggests taking advantage of Hong Kong's unique position to seek an enforcement arrangement specifically tailored to the public capital market. If able to be achieved, this would contribute to the efficiency of the Hong Kong market and could create a competitive advantage over the United States for quality issuers.

Information (Section 3.3)

Legal status of CG disclosures (Section 3.3.1)

Disclosures related to CG concerns are subject to different types of legal or regulatory liability in each of the jurisdictions studied. Because this impacts on the types of enforcement mechanisms that are available, it will have a general influence on market discipline and, consequently, the quality of information disclosures.

Both the UK and Singapore have moved to the model of giving statutory backing to disclosure requirements, albeit implemented slightly differently. In the UK, information transparency is achieved through a mix of the Companies Act 2006 (Cap. 46) (CA 2006), the Financial Conduct Authority's (FCA) statutorily backed listing rules that incorporate by reference the UK CG Code issued by the Financial Reporting Council (FRC), and the Disclosure Guidance and Transparency Rules (DTR). In Singapore, it is achieved through a mix of the Companies Act (Cap. 50) and the Securities and Futures Act (Cap. 289) (SFA) that create rights of enforcement in relation to breaches of the listing rules including by the Monetary Authority of Singapore (MAS), Singapore Exchange (SGX) and aggrieved investors.

In Mainland China, the China Securities Regulatory Commission (CSRC) can directly enforce the CG requirements in the Securities Law, the CG Code (which is mandatory), the listing rules and a large number of guidelines.

In contrast, the strongly disclosure based system of the United States does not give any legal effect to breaches of listing rules per se. However, many standards set by Exchanges on a mandatory or recommended practice basis dovetail with Federal requirements, and such disclosures are required to be made on a Federal form thus bringing disclosures within the Federal law system. This has a significant bearing on the overall quality of disclosures because a false disclosure may amount to a Federal offence. Merely breaching an Exchange requirement would in general be subject to more limited consequences.

In Hong Kong, standards of information transparency are set by both legislative and code based provisions. Part XIVA and sections 277 and 298 of the SFO provide for enforcement by the SFC (through the Market Misconduct Tribunal (MMT) or the criminal courts). Investors who have suffered damage may also bring a civil action under similar provisions. In addition, the SFC has «reserve powers» under the SMLR in relation to false disclosures to suspend or cancel a companies listing. While the foregoing are clear and mostly effective, they are mainly aligned to the preservation of market integrity and investor protection, as compared to many provisions of the listing rules, including the HK CG Code, that prescribe disclosures relating to specific CG concerns. While breaches of the listing rule's disclosure requirements are capable of invoking the foregoing laws, typically they do not.

The enforcement of CG-related disclosure requirements is weak in Hong Kong compared to all the other jurisdictions studied. One of the concerns surrounding CG-related disclosures is that they may represent a box-tick approach to compliance, as opposed to meeting the objective of the relevant requirement. It is suggested that box-tick approaches to compliance are to a significant extent supported by an ineffective enforcement regime. Several parts of Section 3 address how to improve this situation. The discussion in Section 3.3.1 leads to Recommendation A4.5.1 «Legal status of CG-related disclosures», which proposes giving legal backing to specified CG disclosures by bringing them within the existing provisions of the SFO that deal with the provision of false or misleading information to regulatory agencies. This would cover disclosures made pursuant to MBLR Chapters 4 (periodic financial reporting), 14 (notifiable transactions) and 14A (connected transactions), and Appendix 14, each of which have previously been identified by The Stock Exchange of Hong Kong Limited (SEHK) as important parts of the listing rules intended to improve the CG of listed issuers.

Disclosure of listing rule compliance (Section 3.3.2)

Closely following on from the analysis in the previous section, it is a legitimate expectation of shareholders that a listed issuer will comply with the laws and regulations that apply to it - this is further backed by the undertaking directors must give to the SEHK to procure compliance with the listing rules. However, issuers listed in Hong Kong are not required to self-report breaches. This gives rise to anomalies as regards the perceived importance of CG disclosures given that other matters do need to be disclosed, some of which need to be disclosed on an ongoing basis (such as under Chapter 13 of the listing rules or, where there is no applicable safeharbour, under Part XIVA of the SFO). The recent CITIC case provides an illustration of one such anomaly (albeit the relevant events took place prior to the introduction of Part XIVA).

Issuers listed on the New York Stock Exchange (NYSE) or Nasdaq are required to report to the Exchange non-compliance with the Exchange's CG standards. Similar rules on disclosing compliance and explaining breaches of listing rules are found in Singapore. While the latter may be relevant to legal action under the SFA, this is not necessarily the case in the United States. Mainland China also imposes on issuers an obligation to report breaches.

The discussion gives rise to recommendations that foster the provision of timely advice to investors of non-compliance. Recommendation C4.5.2 «Status of listing rule compliance and related disclosures (continuing)» proposes that breaches must be reported and that an annual certification of compliance is required. The annual certification could encompass assurance that the issuer's procedures, systems and controls are adequate to enable the board to comply with their obligations. This recommendation builds on the suggestion (in Recommendation A4.5.1 «Legal status of CG-related disclosures») that any report or certification is to be given on a basis that brings it within the provisions of the SFO that deal with the provision of false or misleading information to regulatory agencies. Because issuers may adopt, disclose and subsequently depart from CG practices that are not mandated by the listing rules, Recommendation S4.3.2 «Disclosure of non-compliance with issuer's disclosed CG practices» proposes that departures from disclosed practices are disclosed to shareholders. Subsequent sections build further recommendations designed to give stronger effect to the listing rules.

Board evaluation (Section 3.3.3)

The proper functioning of the board is a matter of considerable importance. Good CG requires a recognition that directors are appointed by shareholders and on that basis are or should be accountable to them. Board evaluation serves two similar but different purposes. It is a means of generating information for the board's own use in improving the way it works, particularly in view of the duties of directors. When information is disclosed about evaluation, this facilitates shareholders being given insight to the operations, and the effectiveness of the operations, of the board. While this can provide

assurance to shareholders that the board is applying an appropriate check and balance on its own operations, it also assists shareholders in exercising their rights, including in relation to voting on director appointments.

Views on whether board evaluation should be subject to regulatory requirements are mixed across the jurisdictions studied. CG codes in the UK, Mainland China and Singapore all require a formal self-evaluation on an annual basis with the main distinction being the basis of the evaluation and what details needs to be reported on. In the United States, board evaluation is not a feature of CG, which reflects the different nature of the CG system being essentially board-centric and subject to State laws that actively govern a board's fiduciary duties. However, there is commercial support in the United States for evaluation as being a factor in improving CG. In Hong Kong, board evaluation is merely a recommended best practice and is not commonly undertaken and reported on. Previous proposals to develop evaluation had been rejected on the basis that, inter alia, Hong Kong issuers are not ready for it. However, readiness is frequently precipitated by regulatory changes, rather than the other way around.

Analysis suggests that bringing evaluation within a stronger regulatory requirement is desirable. It should provide, in general terms, a reference to the values and priorities of the board in terms of its operational processes and how these evolve over time. This should encompass the role and effectiveness of independent non-executive directors (INEDs) in relation to board operations. Recommendation C4.1.1 «Board evaluation» proposes raising the existing recommended best practice in the HK CG Code to a code provision that incorporates additional requirements including a reporting requirement in the Corporate Governance Report. It also proposes the introduction of a new recommended best practice, modeled on the approach taken in the UK, concerning how the evaluation exercise should be undertaken - however, while defining board performance is an important issue, unlike the evaluation provisions in the UK CG Code, it is not recommended that the factors a board should consider be prescribed by the regulators. This approach is intended to bring focus on disclosure while leaving the commercial aspects of the evaluation to the board.

Audit committee (Section 3.3.4)

The audit committee does, or at least should, play an important role in relation to the quality of financial disclosures. In the UK as in Hong Kong, the essential role of the audit committee is as a subcommittee of the board that reports to the board and possesses limited delegated powers. This is similar to the requirements in Mainland China and Singapore. There are two main consequences of this. First, although the audit committee may have day-to-day influence over the undertaking of the audit work, the primary legal relationship of the external auditor is with the board not the audit committee. Second, although the board will report on the audit committee's work, the audit committee itself makes no disclosures (except where the board and the audit committee have been unable to agree on the recommended appointment, reappointment or removal of the external auditors), although the report on the audit committee in the UK is often regarded as a de facto report of the committee.

This is quite different from the position in the United States, where the Sarbanes-Oxley Act of 2002 (SOX) together with the Securities and Exchange Commission's (SEC) implementing rules have empowered the audit committee in relation to the above two factors. First, the audit committee acts as the primary body directly responsible for the appointment, compensation, and oversight of the issuer's external auditor, not as a subcommittee that makes recommendations to the board. Second, the audit committee itself makes disclosures in an audit committee report, which supports transparency of the audit committee undertaking by placing more responsibility on it and making it directly subject to scrutiny.

The discussion leads to two recommendations. Recommendation A4.1.3 «Disclosures of the audit committee» proposes that the listing rules be amended to require the audit committee itself to make a disclosure in the annual report as to its work undertaken. Recommendation A4.1.4 «Status of the audit committee» proposes that a new comply or explain provision be inserted into the HK CG Code that the board should fully delegate to its audit committee powers in relation to the appointment, compensation, and oversight of the external auditor and report on how it has subsequently managed that delegation.

Involvement (Section 3.4)

Shareholder stewardship, and shareholder votes (Sections 3.4.1 and 3.4.2)

Shareholder involvement is an overarching theme in a number of the jurisdictions studied. The mechanisms by which shareholders exercise their votes, and in relation to what matters, clearly represents a fundamental involvement of the shareholder in a company's affairs.

The UK, Hong Kong and Singapore have all emphasized some form of shareholder stewardship to encourage investors to proactively get involved. This has been done in the UK and subsequently Hong Kong by the regulator introducing a shareholder stewardship code. This is despite the different makeup of the investor base in the two markets, with the UK having a deeper institutional participation in the market than Hong Kong. However, stewardship codes do not appear to have translated into shared responsibility and enhanced collaboration between the board and shareholders.

The UK has taken some bold steps, including via its introduction of dual voting for issuers with a controlling shareholder, which gives independent shareholders an opportunity to directly vote for independent directors, and the requirement that FTSE350 company directors be put up for election every year. The former is of particular interest as it requires issuers subject to the requirement to make changes to their constitution - as discussed in Section 3.5.1, dual voting represents a public law amendment of private rights that interferes with the one-share-one-vote principle.

The United States has experienced a different matrix of problems. Actual in-person meetings of shareholders are now, in effect, only a necessary formality. The SEC's long standing efforts to facilitate shareholder involvement via proxy rules have been unsuccessful - this has led to some suggestions that the United States in this regard has fallen behind standards in other countries, and that it represents an important competitiveness problem for United States issuers. Shareholder involvement also encompasses activist shareholders, which in the United States are aggressive and can exert a dominating effect leading to the appointment of directors that represent specialized interests rather than those of the company as a whole. A few developments over the past decade or so have strengthened the voice of shareholders in companies, including via electronic shareholder forums, the information provided to shareholders on executive compensation, and a move toward amending by-laws to provide shareholders with access to company proxy materials.

There is little evidence of shareholder engagement in Mainland China, and there appear to be no regulatory steps taken that address this, although it has devised means of facilitating beneficial owners to vote via online voting.

There is little to suggest that significant inroads to shareholder participation in a listed issuer will be obtained in Hong Kong through a stewardship approach. Issuers tend to be dominated by controlling shareholders and minority shareholders are relatively passive, a feature that is also found in Mainland China and Singapore. There are two recent interesting shareholder disputes in the market that are exceptions to this (Elliot/BEA and Aristeia/Sina), although these are unlikely to impact on the cultural bias of Hong Kong shareholders.

There have been proposals in Hong Kong that independent shareholders should appoint independent directors via a special vote. Apart from the conceptual problem special voting rights creates for the one-share-one-vote principle, it is unclear whether having a special vote is desirable - the risk is that such directors may pursue the interests of a minority group to the exclusion of the interests of the company as a whole, as has been observed in the United States. It is suggested that laying the foundation for an appropriate level of empowerment is an important precursor to and facilitator of stewardship in the wider shareholder context. This includes shareholder rights in relation to information and enforcement that are discussed elsewhere in this Report. The introduction of a scripless system helps, but only really once it has been extended to non-Hong Kong incorporated issuers (particularly Mainland China and the primary offshore jurisdictions). Accordingly no recommendations are made in these two sections, although it is suggested that stewardship principles may need to be revisited at some future point in time when ground conditions in the market may be more responsive.

Remuneration (Section 3.4.3)

Much attention has fallen on executive remuneration since the 2008 global financial crisis. This is particularly notable in the UK and the United States, though less so in Singapore and Mainland China where remuneration tends to be subject to closer monitoring and control by the State as the controlling shareholder.

The substantive issues turn on establishing appropriate mechanisms for the transparency, evaluation and approval of executive remuneration. The question of linking executive compensation to corporate performance - which has in some instances given rise to short-termism and unwarranted risk taking - is a subset of the foregoing.

Each of the jurisdictions studied employs some form of remuneration committee, with differing requirements as to its composition (usually requiring some degree of independence of its members) and powers (to review, to make recommendations or to determine remuneration with delegated responsibility), and differing degrees of disclosure as to its operations. As regards the latter, the UK CG Code has specified the provisions the remuneration committee should follow when designing performance- related remuneration. The rules governing remuneration committees also vary as regards their source - in the United States it is largely derived from the Dodd-Frank Act and implementing rules of the SEC, whereas in the UK and Hong Kong it is based on comply or explain provisions of a CG code.

A wider question for present purposes is what measures are appropriate to deal with the risk of remuneration-abuse. There are essentially four approaches that have been taken in the jurisdictions studied. One approach has been through the imposition of mechanisms that claw back or defer remuneration - successfully implemented in the UK though not as yet in the United States. Improving transparency as to the determination of remuneration including the operation of the remuneration committee has been an important development in the UK via changes to the UK CG Code. In the United States, the composition of the remuneration committee is the subject of mandatory requirements imposed on Exchanges by the Dodd-Frank Act, but is merely a comply or explain standard in the UK CG Code. Finally, the ability of shareholders to approve executive compensation is an important component of the Dodd-Frank Act, albeit subject to the primacy of State laws on the matter.

The extent to which these developments have been successful is unclear. Some evidence suggests that neither the role of independent directors nor giving shareholders votes has assisted to stem abuse or change behaviour. This is possibly due to a lack of sufficient consensus as between shareholders and regulators.

The difficulties encountered in the jurisdictions studied, the absence of a clear mandate from the Hong Kong market that executive compensation needs to be better regulated and the different context of Hong Kong suggests that it may not be appropriate at present to develop a mandatory regime for shareholder votes on executive pay or clawback mechanisms. There also seems little momentum to mandate a greater involvement of INEDs. The Hong Kong context may therefore be better served by leaving remuneration as a commercial matter to be decided by the board and assessed by shareholders upon receiving adequate disclosure - this broadly shifts the discussion to shareholder voting, which is picked up in Sections 3.6.3 and 3.7.7.

The foregoing does leave open the question of how to foster adequate disclosure to shareholders as regards remuneration and its determination. The requirements in Hong Kong as regards the remuneration committee, while broadly similar to international best practices, can be improved. Recommendation A4.1.2 «Transparency of performance related executive remuneration» proposes better disclosure of the considerations taken into account by the remuneration committee in relation to any performance-linked remuneration. Recommendation A4.2.2 «Basis of INED remuneration» proposes that the board be required to consider the linkage between the level of an INED's remuneration and their expected commitment and responsibilities and make an appropriate disclosure in relation thereto. The latter recommendation also arises out of considerations discussed in Section 3.7.10. Both recommendations also tie in with three other recommendations that address the transparency and legal consequences of CG related disclosures: Recommendation A4.5.1 «Legal status of CG-related disclosures», Recommendation C4.5.2 «Status of listing rule compliance and related disclosures (continuing)» and Recommendation S4.3.2 «Disclosure of non-compliance with issuer's disclosed CG practices».

Changes of control (Section 3.4.4)

A proposed change of control of a company represents a fundamental issue for shareholders. The different approaches of the models in the UK, Hong Kong and Singapore (regulating via a code and an administrative tribunal/takeover panel) and the United States (regulating via the application of law, particularly fiduciary concepts in the State courts) reflect a fundamentally different understanding of the role of the board in relation to managing the affairs of the company. Whereas the UK and Singapore have moved toward a statutory backed code, it is suggested that in the absence of a broader policy change toward statutory regulation and any clear indication that the Hong Kong Code on Takeovers and Mergers is lacking in effectiveness, there is no mandate for recommending any similar change to the legal standing of the Code. Should either one of these factors change, a review may then be warranted.

It is noted that although UK corporate law, and to a lesser extent Hong Kong, is steeped in a rich tradition of fiduciary law, it does not often come to the fore in a takeover scenario, unlike in the United States. That fiduciary law is a tool actively used in the United States courts (e.g. Delaware) but less so in Hong Kong, may be of relevance to the CG debate beyond the borders of the takeover context, as discussed in Section 3.7.6.

Equality (Section 3.5)

Voting rights generally, and weighted voting rights (Sections 3.5.1 and 3.5.2)

The principle around which much discussion occurs on the topic of equality is the one- share-one-vote (OSOV) principle. The current protagonist in the debate about OSOV is weighted voting rights (WVR). The UK and Hong Kong traditionally stand on the side of maintaining OSOV on the basis that it is a cornerstone of investor protection, whereas the United States permits WVR. Hong Kong is currently wavering on the issue, primarily out of a desire to compete with New York to attract new listings, and also being aware that Singapore is already leaning in the direction of allowing WVR structures to list.

There is a notable division of opinion on the topic, which sometimes turns on an incomplete appreciation of issues that are rarely acknowledged in the OSOV versus WVR debate. First, jurisdictions that ostensibly adhere to OSOV in fact do support mechanisms that override OSOV via public regulation-based adjustments to voting rights that are intended to protect minority shareholders from abuse. Second, there is a commonly mistaken, i.e. false, connection made between WVR in the United States and class action rights and technology companies. Third, the degree to which developmental objectives on the basis of which a market seeks to compete with other markets is connected with CG standards.

While OSOV has undoubtedly stemmed much abuse, many different mechanisms impact on shareholder protection. Recommendation E4.9.3 «Market development» proposes a clearer and more specific examination of what overarching objectives should drive the development of the Hong Kong market and the alternative mechanisms for shareholder protection that may need to develop in tandem with change, which may or may not go outside of OSOV.

Accountability (Section 3.6)

Information disclosures generally and listing rules (Sections 3.6.1 and 3.6.2)

The ability of shareholders to seek redress where disclosures to them are inadequate as regards the nature, content or the timing of a disclosure, is an important applied element of a CG system. Where absent or subject to significant hurdles, it indicates a weakness in the CG system. Each of the UK, the United States, Singapore and Hong Kong provide for mechanisms of legal redress by way of a civil claim for damages in respect of mis-disclosures, albeit through differing mechanisms and with a different scope (Section 3.6.1). While Hong Kong law does provide shareholders with actionable rights under the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32) (CWUMPO) and the SFO, there remain no instances of civil litigation being brought under them. This is in part due to the difficulties of bringing litigation - unlike the United States, Hong Kong does not possess class action rights, although this was proposed by the Hong Kong Law Reform Commission in 2012. Nor does Hong Kong possess other means of collective redress as are already operative in the UK and Mainland China.

When the position under the listing rules is considered, significant variation across the jurisdictions is observed (Section 3.6.2). The approach in the United States is based on Rule 10b-5 under the Securities Exchange Act of 1934 and State laws governing fiduciary duty, both of which are neutral as to the source obliging the disclosure. In the UK and Singapore, shareholders can sue for breaches of listing rule requirements because of the statutory backing those jurisdictions give to their listing rules. This is not the case in Hong Kong where a civil action cannot be taken in relation to listing rule breaches, unless they also amount to a breach of the law - this is because the listing rules merely operate as a contract between the SEHK and the issuer, as in the United States.

In practice, the burden of establishing a breach of the relevant disclosure laws in Hong Kong is much higher than what is required in the UK to establish a breach under the disclosure requirements of the listing rules, and may also be higher than what is required to establish a claim under 10b-5 in the United States. Two cases that suggest breaches of the listing rules can give rise to legal action are Wong Shu Wing and Styland (2012). While both cases acknowledge the importance to shareholders of information required by the listing rules, both relate to a right that is only exercisable by the SFC, not shareholders, i.e., under section 214 of the SFO.

Breaches of the Hong Kong listing rules are matters only for regulators but discipline, even for serious breaches, is generally weak and does not benefit shareholders. This represents a deficiency in Hong Kong's CG system as compared to other jurisdictions, which in the past has led to some calls to give statutory backing to the Hong Kong listing rules. However, it is possible to improve accountability to shareholders working within the current regulatory architecture. Sections 3.3.1 and 3.3.2 lead to Recommendation A4.5.1 «Legal status of CG-relateddisclosures» and

Recommendation C4.5.2 «Status of listing rule compliance and related disclosures (continuing)», which proposed that issuers and directors should be subject to disclosure obligations in respect of compliance with the listing rules that would be subject to legal sanctions.

While the foregoing recommendations would improve the quality of CG-relevant information provided to shareholders, it still does not give rise to actionable shareholder rights. Two recommendations are made. In Section 3.6.1, Recommendation A4.4.2 «Collective redress» proposes to re-open, and develop, the Law Reform Commission's 2012 proposal on the implementation of class action rights as this may serve to more meaningfully give effect to shareholders' legal rights. The recommendation suggests widening the exercise to consider implementing collective redress on a case management basis, i.e. group litigation as opposed to class action, which is considerably easier to implement although it might not solve all problems. In Section 3.6.2, Recommendation S4.4.1 «Shareholders as beneficiaries of listing rules» proposes making shareholders a third party beneficiary of the contract between the issuer and the SEHK, thus giving shareholders a basis to bring an action in respect of specified provisions of the listing rules.

The several recommendations referred to and made in this section are a part of a larger theme: creating more effective means of legal recourse over the listing rules, whether by creating powers in the hands of the SFC, shareholders, or both. This is returned to in Section 3.7.3.

Board refreshment (Section 3.6.3)

The frequency with which directors are required to present themselves to shareholders for re-election is closely aligned to the concept of board refreshment, which can be looked at as a means of ensuring skills, knowledge and experience on a board remain appropriate to the evolving challenges faced by a company. The flip side of this is the concern that the interests of entrenched directors may overshadow the interests of the company. Each jurisdiction studied, with the exception of Mainland China, recognizes the importance of director rotation, with the UK and the United States expressly identifying it as important to good CG. The HK CG Code comply or explain provision for retirement by rotation is broadly in alignment with the other jurisdictions, the listing rules in none of which impose mandatory requirements. While the UK has more recently introduced a UK CG Code provision that directors of FTSE350 issuers should be subject to re-election annually, in the absence of a shareholder mandate in Hong Kong to do more, there is little in favour of making a recommendation on board refreshment. In contrast, other Sections of this Report suggest more needs to be done in relation to board evaluation (Section 3.3.3) and independent directors (Sections 3.6.4 and 3.7 Part C).

Appointment of independent directors (Section 3.6.4)

The appointment of independent directors has attracted more discussion following the adoption in the UK of a dual voting system, which is unique to the UK of the jurisdictions studied. It has led to suggestions in Hong Kong that independent shareholders should appoint independent directors; this however is a misunderstanding of the UK model, which does not provide that only independent shareholders appoint independent directors - the company as a whole must agree as well. The experience in the United States has been notably marked, if not marred, by the actions of activist shareholders that have led to the directors so appointed pursuing selective agendas not in the interests of the company as a whole. These often carry short-term objectives that in some cases have led to anomalies in the development of appropriate executive remuneration packages (as further discussed in Section 3.4.3). The more significant problem in the United States arises out of proxy rules that can work to deprive shareholders of their voice in company meetings and promote the voice of the independent activist director. Hong Kong does not have this kind of problem to deal with (the problem of not having a scripless system is discussed in Section 3.4.2).

The appointment of independent directors cannot be understood as a panacea to all possible problems. There is no clear argument for introducing special voting arrangements for the appointment of independent directors that would override the rights attaching to shares otherwise enjoyed in the private law context.

While this section does not make any recommendation, it does serve as a staging post for the consideration of more fundamental questions, such as the determination of independence and whose interests does an INED understand themselves as being responsible to further. That discussion is taken up in Section 3.7 Part C.

Effectiveness (Section 3.7, Part A - CG system design)

Impact of regulatory design (Section 3.7.1)

Debates about Hong Kong's CG system significantly turns on the position one takes in relation to the question of market self-regulatory models versus statutory regulatory models. As Exchanges internationally have over the past few decades become increasingly commercialized and privatized, the trend internationally has generally shifted toward favouring statutory regulatory models.

The CG system in the UK is elegant, having one regulatory agency responsible for the listing rules with another responsible for the development of specific CG standards in a CG Code, the FCA and FRC respectively. However, the system has also been criticized as overly regulated and overly complex - while the adoption of a statutory approach to listing regulation has created many benefits, it has also created complexities with many changes to the law, via the CA 2006, Financial Services and Markets Act 2000, and the Financial Services Act 2012, statutory instruments made pursuant to the foregoing, and a complex FCA Handbook.

The CG system in the United States is, in its application, in many ways more complicated than in the other jurisdictions studied. Although the relationship between the SEC and the Exchanges are relatively clear cut, there is a complex relationship between Federal and State laws that impacts on the scope of the SEC's powers and which gives rise to a significant body of case law with outcomes that are harder to predict than, for example, the statutory code-based approach in the UK.

Although flawed in various regards, Hong Kong's CG system is in various ways enviable in its relative simplicity, with a frontline regulator for the listed market subject to the oversight of an industry regulator, the Hong Kong Exchanges and Clearing Limited (HKEX)/SEHK and SFC respectively. Hong Kong is the only jurisdiction in this study that still gives the power to make and enforce both listing rules and the CG Code to the HKEX, a market player, rather than an independent regulator, such as the SFC. While a similar power is enjoyed by the Exchanges in the United States, in practice many of their CG requirements arise out of requirements imposed by legislation or the implementing rules of the SEC. This feature of Hong Kong's CG system arises out of its leaning toward a market self-regulatory model, which is an important underlying reason why the powers available to regulatory agencies in the UK, United States and Singapore in relation to the listed market are in various ways significantly wider than those given to the SFC.

Hong Kong has enjoyed considerable success under the dual responsibilities model. It has also worked well as regards rule making insofar as the content of Hong Kong's CG system in the form of the listing rules (including the HK CG Code) in general compares favourably with international standards. The significant weakness in Hong Kong's system is the lack of meaningful and adequate enforcement in relation to breaches of the listing rules, as already noted above.

Shortcomings in CG standards span a range of seriousness. Between the SEHK's exercise of its disciplinary powers and the SFC's powers lies a significant lacuna that is inadequately covered by appropriate enforcement mechanisms - they are either too weak and so ineffective, or too strong in relation to a wrongdoing that does not warrant (or may not give rise to) court action. Suggestions to give the SFC power have been controversial in the past primarily on the grounds that it interferes with the dual responsibilities model. A change to that model would require the involvement of the legislature.

Rule making and enforcement are two different things, and can be developed along different pathways without disturbing the basic premise of the dual responsibilities model. It is therefore possible to seek to address the enforcement lacuna by working within the dual responsibilities model with suggestions that do not require legislative action but nevertheless create a range of more graded sanctions. Recommendations made in previous sections of this Report work in this manner: Recommendation A4.5.1 «Legal status of CG-related disclosures» and Recommendation C4.5.2 «Status of listing rule compliance and related disclosures (continuing)». Recommendations made in Section 3.7.3 that work in a similar manner concern the SFC's powers: Recommendation C4.6.1 «SEHK to develop use of existing disciplinary power», Recommendation A4.6.2 «SFC to develop use of conditions when exercising existing SMLR power», and Recommendation A4.6.3 «Calibrate SFC's powers under the SMLR».

Recommendations directed to closing out an enforcement lacuna that do not displace the powers of the HKEX or the dual responsibilities model should be more palatable to those who object strongly to moving toward a statutory model of listing governance.

Policy development agencies (Section 3.7.2)

A CG system evolves over time in relation to both market incidents as well as market expectations. Policy development agencies play an essential role in identifying and detailing suggested developments to the CG system. All the jurisdictions studied have a range of bodies in addition to the regulatory agencies that provide input to proposed developments in the CG system. However, numerous voices from a panoply of sometimes competing interests can operate as distraction from real issues needing to be addressed to improve good CG - the greater the number of bodies that do not coordinate with each other may introduce doubts as to the authoritativeness of each.

The governments of both the UK and the United States place a high value on CG. In the UK, Parliament is very active in conducting, either by its own committees or by specially appointed commissions, thoroughgoing enquiries. The FRC performs an important role in relation to the development of CG standards. In the United States, the SEC took the step of establishing the Office of the Investor Advocate, which, inter alia, provides a voice for investors on regulatory CG matters. In Mainland China, policy agencies are active in their policy formulation and implementation but there are doubts as to whether the policy is effective in achieving good CG.

Hong Kong, in contrast to the UK, experiences far less certainty as to whether the recommendations of policy development agencies will lead to developments, there being a number of notable instances where touted changes have failed to occur, particularly as regards proposals touching on the role of the SFC in listed company matters. This is in large part due to a high degree of polarization on the topic of regulatory involvement in the market, and in this sense Hong Kong is similar to the United States where the market has a strong, active and influential voice. Broadly speaking, CG-supportive proposals that originate from independent practitioner-based bodies such as the Listing Committee may stand a higher likelihood of finding their way into the CG infrastructure of the listing rules as compared to those originating from the 1st or 2nd tiers (i.e. Financial Services and Treasury Bureau /the Government, and the SFC) that are concerned with statutory changes, which inevitably may carry more complex implications for a wider set of stakeholders. While at one level that is entirely understandable, at another it reflects a fundamental feature of Hong Kong's CG policy development that is rooted in the market's deep suspicion of government and regulatory interference. Given its status as a global financial centre and participation in the International Organization of Securities Commissions, Hong Kong is also lacking in global thought leadership on CG. While Hong Kong's conservative approach to developing CG may have served Hong Kong well in the past, and there is great value in consulting the practices and developments of other jurisdictions when formulating new CG measures, merely following international or UK best practices may not continue to suffice to meet Hong Kong's particular needs. Hong Kong needs to assert itself more in this regard given that it has become a global financial centre.

While the orderliness and public transparency in the consultation process is generally quite good, there are sometimes lengthy delays and some consultations are delayed or even shelved without adequate explanation, the consultation on class action rights being a notable example of the latter. One exception to transparency is some of the policy and listing rule development work undertaken by the SEHK and the SFC pursuant to their statutory obligations, including the somewhat opaque «High Level Group» formed by an MoU between the SFC and SEHK. In particular, while the development of a new listing rule requires the SEHK to provide to the SFC an explanation of its purpose and likely effect, this is not required to be disclosed to the public following a proposal being implemented. Recommendation A4.9.1 «Transparency of listing rule development» proposes that giving ex post transparency to this process would improve the understanding of listing rules - something that may become increasingly important as courts or tribunals come to be faced with the challenge of interpreting listing rules, the recent CITIC case being one such example. Recommendation A4.9.4 «Response time to public enquiries/consultations» proposes the adoption of a performance standard by regulatory agencies.

The absence in Hong Kong of a designated agency that has the development of CG standards and the interests of minority (i.e. non-institutional) shareholders as its primary concern leaves development in the hands of the SEHK and the SFC. The former must deal with conflicts and the latter has a matrix of regulatory obligations to the market as a whole to which the interests of shareholders may be subjugated - the decision to take or not take an enforcement action that may benefit shareholders being one such example. This division of interests and roles may also serve to propagate the enforcement lacuna referred to in Section 3.7.1.

In response to the absence of any singular agency charged with policy development having regard primarily to the interests of shareholders (particularly minority shareholders) on CG matters, Recommendation E4.8.1 «Establish a CG Unit and CG Group» proposes establishing two bodies: one within a regulatory agency, a «CG Unit» that would assist and coordinating CG policy development as well as providing an agency-based contact point for the collection of information; and a «CG Group» of experts external to the agency that would serve as a useful semaphore post between commercial needs/tolerances and regulatory insights/expectations. Such a CG Unit and CG Group may work to produce solutions in addition to the recommendations in this Report that would assist to close out the enforcement lacuna, which includes: Recommendation A4.6.2 «SFC to develop use of conditions when exercising existing SMLR power», Recommendation C4.6.1 «SEHK to develop use of existing disciplinary power», Recommendation A4.5.1 «Legal status of CG-related disclosures», Recommendation C4.5.2 «Status of listing rule compliance and related disclosures (continuing)», Recommendation A4.6.3 «Calibrate SFC's powers under the SMLR», Recommendation A4.6.4 «Statutory backing of certain listing rules», Recommendation S4.4.1 «Shareholders as beneficiaries of listing rules» and Recommendation E4.8.2 «Establish an investor protection agency».

Recommendation E4.8.1 «Establish a CG Unit and CG Group» also connects with the discussion in Section 3.7.3 that leads to Recommendation E4.8.2 «Establish an investor protection agency», which proposes the establishment of a separate enforcement agency (see the discussion in Section 3.7.3) - if such a new agency were established, it may make sense to place the CG Unit and CG Group within that agency rather than any existing agency.

Enforcement agencies (Section 3.7.3)

Section 3.7.1 discussed the enforcement lacuna in Hong Kong's CG system arising out of the different types of oversight and powers given to the SEHK and the SFC in respect of listed issuers. Section 3.7.2 discussed the problems each of the HKEX and SFC has in putting the interests of minority (i.e. non-institutional) shareholders as its primary concern. This section takes as its concern the effectiveness of a CG system as regards the ability of regulatory agencies to undertake meaningful and corrective enforcement actions.

The potential role of the SFC as an enforcer of the listing rules to improve the enforcement of them has been a hotly debated topic in Hong Kong ever since the UK introduced the UK listing authority (UKLA) concept as a functionality within the industry regulator, the FCA. The primary issue in Hong Kong is the position of the SFC in relation to the HKEX vis-a-vis the dual responsibilities model. Proposals to create a Hong Kong listing authority within the SFC have not been successful, nor has a reduced version in which only Chapters 4 (periodic financial reporting), 14 (notifiable transactions) and 14A (connected transactions) of the listing rules would receive statutory backing.

Since UKLA was introduced, there have been a number of other developments of significance in Hong Kong, in particular, the removal of the disclosure of price sensitive information obligations from the listing rules to Part XIVA of the SFO. This appears to have been successful in improving disclosures and case law has already begun to develop as a result of the SFC bringing successful actions under these provisions. While this study has not derived sufficient evidence to lead to a positive recommendation that other listing rules now be given statutory support, based on what has been observed in the other jurisdictions studied and the Part XIVA experience, it is suggested that the ground conditions have sufficiently changed for this discussion to be re-examined. This leads to Recommendation A4.6.4 «Statutory backing of certain listing rules», which proposes reviving the discussion on giving statutory backing to certain provisions in view of today's circumstances.

The power that the SFC has been given over listed issuers under the SMLR is a somewhat blunt instrument: suspending dealings in an issuer's securities or directing the cancellation of the listing. While this may be protective to the market and its investors, it also has the effect of shutting investors out from being able to trade risk. Suspension is an all-or-nothing action that lacks gradation and in that sense has a limited ability to close out the enforcement lacuna discussed in previous sections. The discussion in this section of the Report leads to Recommendation A4.6.3 «Calibrate SFC's powers under the SMLR», which proposes calibrating the SFC's powers under the SMLR to provide for a fine that works as a warning-cum-precursor to suspension that is premised on the same grounds as its existing SMLR powers. This might provide a «win-win-win» for the issuer, its investors and the market as opposed to outright suspension, and might avoid the problems of previous proposals to give the SFC a disciplinary fining power in respect of breaches of the listing rules more generally.

In contrast to the above recommendations, it is also possible to work within the existing regulations to find ways that the regulators could seek to use existing powers more effectively to bring improvements to CG standards. Recommendation A4.6.2 «SFC to develop use of conditions when exercising existing SMLR power» proposes that the SFC use its power to impose conditions on a suspended issuer that would work to address the CG shortcomings of the issuer that gave rise to the problem - for example, to require changes to a board's processes that reduce the likelihood of a recurrence of the problem and that may serve to catalyze change. However, some care would need to be taken to ensure that such conditions do not result in rewriting the listing rules for some issuers so as to create an uneven playing field. The foregoing recommendation should be read together with others that would help to close out the enforcement gap without requiring any change to legislation including Recommendation A4.5.1 «Legal status of CG- related disclosures» and Recommendation C4.5.2 «Status of listing rule compliance and related disclosures (continuing)».

The SEHK can also better use its existing powers. Recommendation C4.6.1 «SEHK to develop use of existing disciplinary power» proposes that the SEHK make better use of its existing power to require issuers to «take, or refrain from taking, such other action as it thinks fit», as well as its power to impose on a suspended issuer conditions on permitting the resumption of trading. The Panel on Takeovers and Mergers has used a similarly broad power to considerable effect. For example, the SEHK's power could be used to require an issuer and/or the relevant director(s) to make a statement as to what measures will be undertaken to ensure non-recurrence of this or similar breaches, and to subsequently report on their implementation. Such a statement could also be required to be reiterated in the annual report and/or on the next occasion the shareholders are asked to re-appoint that director. This may be a more effective means of activating reputational liability than a mere censure and could go a long way to introducing discipline that works proactively to bring about improvements in an issuer's CG practices. This is merely one example of how the power could be used - other uses of the power could be set out in a guidance letter on a non-binding basis.

While the foregoing discussions consider the SFC in relation to developments in the UK, structurally, the SFC sits in a similar position of enforcement as does the SEC. Among the SFC's statutory objectives is the protection of members of the public investing in or holding financial products. Although powers of the SFC may be exercised in a way that has a similar effect in protecting investors, this is not the SFC's sole mandate. A similar issue arises in relation to the SEC. An interesting approach to addressing the problem in the United States was to establish the Consumer Financial Protection Bureau (CFPB) as a new regulatory agency in 2008. This agency has a mandate to protect consumers against unfair, deceptive, or abusive practices and take action against companies that break the law. It has extensive regulatory powers including monitoring, investigating, and enforcing the law. The CFPB may therefore take action in relation to breaches of legal requirements that overlap with the powers of the SEC. Recommendation E4.8.2 «Establish an investor protection agency» proposes a new, unconflicted regulatory agency empowered to bring an action for the benefit of shareholders. For example, Sections 213 and 214 of the SFO could be amended to provide that such agency (and not only the SFC) may bring an action. Introducing a new statutory body is of course complex and requires many things to be considered, including its objectives, powers (including both investigation and enforcement), accountability, governance, staffing and funding. While market participants may object to the proposal in view of the increased liability risk, the primary question is whether the proposal would operate to further CG standards in Hong Kong in a manner that facilitates long-term market development.

Audits of public companies (Section 3.7.4)

All the jurisdictions studied are members of the International Forum of Independent Audit Regulators (IFIAR), with the exception of Hong Kong and Mainland China. The most recent member is the United States following the creation of the Public Company Accounting Oversight Board by SOX to oversee auditors. Importantly, SOX puts explicit responsibility on the Chief Executive Officer for certifying the soundness of accounting and disclosure procedures and goes beyond a mere certification that generally accepted accounting principles are being followed - in many instances it was the case that adherence to those principles were in any case inadequate.

Hong Kong is in the process of establishing the parameters of the role of the relatively new FRC, with the oversight of financial reporting and auditing in Hong Kong currently remaining subject to a self-regulatory regime overseen by the Hong Kong Institute of Certified Public Accountants. The development of the FRC's independence and the means by which disciplinary power is to be exercised over audit firms will be an important factor in bringing Hong Kong into alignment with international practices such that it is able to become a member of IFIAR. However, what is arguably more important in practice is the ability to effectively oversee audits of Hong Kong listed issuers that are based in Mainland China. The problem of cross-border enforcement and the need for effective co¬operation mechanisms, such as MoUs with the regulator in Mainland China, has been discussed in Section 3.2.

Duties of directors and role of fiduciary law (Sections 3.7.5 and 3.7.6)

Directors and the fiduciary duties imposed on them by law have historically formed an important basis of the relationship between the board and shareholders. The UK has codified such duties in the CA 2006 and this can be seen as part of a wider trend in the UK toward giving statutory backing to important matters, such as had previously been done in relation to the listing rules. A similar codification of fiduciary duties had been considered but rejected in the rewrite of the Hong Kong Companies Ordinance (Cap. 622) (CO). The common law applying to fiduciaries continues to apply, and this is the case in Hong Kong, the United States and Singapore. The civil legal system Mainland China means that fiduciary duties are found in the Company Law. Given the foregoing mix of approaches and that codification has recently been considered in Hong Kong, this Report makes no recommendation in this regard, however, it does suggest that the situation might need to be reviewed in the future in light of the experience in the UK, for example, upon the development of a sufficient body of case law.

In the United States, fiduciary law is a flexible tool that plays an important role in the regulation of CG. This has given rise to a large number of State (mainly Delaware) court cases that play a significant role in establishing CG principles and how CG is understood and applied. Not only directors but also controlling shareholders can be subject to fiduciary duties where they own a majority interest in the company or exercise some measure of de facto managerial control over the company's business affairs, including through the appointment of its agents to the board. Fiduciary law may also be invoked in relation to actions taken by fiduciaries that amount to a purposeful breach of the listing rules or a breach of the SEC's disclosure obligations.

While directors' duties in Hong Kong are also based on fiduciary duties, this is not a route under which directors are typically held to account. Instead, in the post SFO era focus has fallen on misfeasance and misconduct provisions of section 214 of the SFO, which has forestalled earlier suggestions that the SFC be given a statutory right of derivative action, particularly as the SFC has successfully used section 214. The advantage of this statutory route is that regulatory efficiency is probably greater as fiduciary cases may be more difficult to establish and fiduciary law as applied by the courts may be difficult to predict and are perceived as creating commercial uncertainty - certainly, this has been the experience in the United States. However, the regulatory inefficiency is that only the SFC is able to bring an action under that provision - shareholders need to rely on the derivative action under applicable law. Because the SFC needs to consider a range of matters, such as those related to market integrity, the available resources of the SFC, and policy issues, this can lead to some plausible (from a shareholder's viewpoint) actions not being taken. This discussion links to the discussion in Section 3.7.3 and Recommendation E4.8.2 «Establish an investor protection agency», which proposes to establish an unconflicted investor protection agency outside the SFC. The introduction of provisions in the CO that allow unfair prejudice proceedings to be brought by way of statutory derivative action, including in respect of non-Hong Kong incorporated issuers, assists to develop the avenues available to bring directors to account.

Effectiveness (Section 3.7, Part B - Specific actions)

Differentiation of CG requirements (Section 3.7.7)

In the UK, a number of provisions of the UK CG Code are expressed only to apply to FTSE350 issuers, with modifications for smaller companies. Compliance with these higher standards is quite good. As requirements that set standards, smaller companies are also free to comply with them. In contrast, the provisions of the HK CG Code apply equally across all issuers listed on the same board irrespective of factors such as size.

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 in Hong Kong. This could be done by establishing standards that will apply to certain larger issuers, for example, those admitted to a relevant index, such as an HSI or HSCEI constituent stock. Recommendation C4.3.1 «Relevant issuers to be subject to «Elevated Standards» proposes escalating selected recommended best practices to code provisions, recommended disclosures to required disclosures, and possibly certain comply or explain provisions to mandatory requirements to create «Elevated Standards». As many of the relevant issuers will already be compliant, the development would serve to send a signal to the market that companies subject to the Elevated Standards are leading examples of good CG practices.

Other means of recognizing companies with higher standards were explored in the study. For example, it might be possible to establish a CG index based on companies that meet specified CG criteria. However, attempts at doing this in various other jurisdictions have not been successful.

Listing regime standards upon entry (Section 3.7.8)

There are several important gateway mechanisms to ensure the quality of companies seeking a listing on an Exchange. Where a company with low CG standards is brought to an Exchange listing, it may be difficult, time consuming or simply unworkable to change their processes and corporate culture.

Every jurisdiction studied places considerable emphasis on the quality of disclosures, with attendant liability where they amount to mis-disclosures. The UK, Singapore and Hong Kong all engage the sponsor concept as part of the gateway controls. Recognising the importance of sponsor work to the listing regime, the UK and Hong Kong have over recent years increased their regulatory supervision of sponsor work. There is no such concept in the United States beyond the disclosures required in regulatory filings, where significant focus falls, in addition to the company, on the underwriter. However, unlike sponsors in the UK and underwriters in the United States, the prospectus liability attaching to sponsors in Hong Kong is unclear. The quality of sponsor work remains a concern, which suggests that supervisory oversight of their work undertaking needs to be improved.

Compared to the availability of legal enforcement in the UK and the United States, in Hong Kong, where a shareholder is unlikely, unwilling or unable to litigate, setting the tone of an issuer's CG standards from the outset is arguably more critical to ensure. Listing applicants in the United States are required to make extensive CG-specific disclosures in the registration statement and liability will attach to mis-disclosures. In Hong Kong, listing applicants make only basic and limited disclosures concerning their CG practices. The declarations required to be made by sponsors to the SEHK address in general terms the ability of the directors to undertake their responsibilities and the company's internal controls and processes, as well as the disclosures made in the listing document cum prospectus. However, the CG disclosures required of, and that are typically made by, listing applicants fall well short of the standards imposed on listed issuers. Recommendation C4.7.1 «Disclosure of CG standards in listing document» proposes that the listing applicant be required to make a statement in the listing document cum prospectus that discusses its CG practices in view of the requirements under the HK CG Code. This would serve to bring those statements within the laws on disclosures in public offerings.

While the sponsor role has received much attention over the past few years, the role of the compliance adviser has not. In terms of ex ante mechanisms, the compliance adviser role is important in assisting the newly admitted issuer settle in to its new public company status. This is underlined by research that suggests newly admitted issuers may take a few years before they are able to meet the intent of a CG provision, and in the interim rely on a box-tick approach. Considering the changes to the sponsor regime, the compliance adviser regime remains weak in two areas: its role is passive, which contrasts with the active role of the sponsor that was strengthened in the reforms introduced in 2013; the sponsor and compliance adviser roles are completely independent, which means that sponsors that have brought the company to listing and are intimately familiar with it can and often do walk away upon the company being admitted to listing, leaving the compliance adviser role possibly being taken up by a relative outsider. This is unlike 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. Recommendation E4.7.2 «Develop role of compliance adviser» proposes a development of the compliance adviser role to make it more actively engaged and to require it to be undertaken by a sponsor on the listing application. The latter requirement has the effect of keeping the sponsor's skin in the game and this might bring greater focus in the sponsor's review of the listing applicant's CG processes and standards pre-listing.

Effectiveness (Section 3.7, Part C - Independent directors)

Determination of independence (Section 3.7.9)

Each of the jurisdictions studied require the board to comprise a minimum number of independent directors: at least one-third in the UK, Singapore and Hong Kong; at least half in the United States. The concept of independence is specified by the Exchanges and is broadly concerned with similar issues in each jurisdiction, with each jurisdiction providing (with the exception of the United States) for a period of appointment after which independence is to be questioned or explained. Where they differ is in the determination of independence. In the UK, Singapore and the United States independence is for the board to assess. This is different from Hong Kong and Mainland China where it is for the SEHK and CSRC, respectively, to assess and approve.

While the UK is clearer in its empowerment and accountability of INEDs, including through dual voting (discussed in Sections 3.5.1 and 3.6.4) and the relationship agreement with controlling shareholders (discussed in Section 3.7.12), it may to some degree be weakened by the self-determination by the board of independence, which is only subject to the comply or explain standard.

In this regard Hong Kong appears to be doing well when compared to the other jurisdictions studied. However, in Hong Kong, the written confirmation of independence submitted by directors to the SEHK, which it relies on, is only subject to the limited sanctions available to the SEHK - discipline for providing false or misleading information is therefore weak. In the United States, a filing as to independence is also required but there it is made on a form subjecting the disclosure to Federal law. Recommendation C4.5.3 «Facts regarding director independence» proposes bringing INED disclosures of facts relevant to the SEHK's assessment of independence under the SFO provisions dealing with providing false or misleading information to regulators. This is appropriate given the importance attached to the independence of INEDs and their expected role.

Requirements relating to INED performance (Section 3.7.10)

INEDs perform a special role on the board and there is some variation in the jurisdictions studied as regards the parameters that should be placed on INEDs that may affect their performance. A basic concern is ensuring they have sufficient time, qualifications and are sufficiently engaged to properly discharge their duties. Exchanges in the UK, the United States and Singapore touch upon the question of how many non-executive posts at different companies an individual can undertake, and each leave this to the board to decide noting that the board may consider adopting policies to place a cap on the same. In Mainland China, there is strict limit of five, in addition to other prescriptive requirements that mandate attendance at board meetings and training organized by the CSRC.

In Hong Kong, the question of an INED's other posts is left to the board. The obligation on an INED to disclose other commitments as found in the UK CG Code is absent from the HK CG Code. Interviewees felt less concerned about that difference and more concerned about the number of posts some INEDs hold, raising queries over how they could possibly undertake their role meaningfully, particularly during financial reporting seasons. The HKEX is currently consulting on these issues.

Recommendation A4.2.1 «Sufficient INED time» proposes that issuers should at the very minimum adopt a policy that is disclosed to shareholders, with deviations from it also being explained.

Other than time, a variety of factors influence the ability of an INED to be effective. Some of these are unique to the individual, such as their experience, skills and personality. Other influences are driven by the issuer itself, including the extent of active engagement and training about the company's business, board processes that incorporate or distance INEDs such as practices on board paper briefings, and level and nature of remuneration. Non-executive directors (NED) that are not independent are less frequently discussed but nevertheless present a similar matrix of problems and concerns as discussed in relation to INEDs, albeit without emphasis on their role as an assurance of investor confidence.

Together, these give rise to an inherent de facto relationship between independence, the responsibility given and undertaken, remuneration and perceived liability, as shown in the following diagram.

Factors impacting on the INED role

Almost all of the interviewees expressed concern that a number of INEDs of listed issuers in Hong Kong do not fully appreciate their role on the board and take up INED roles as trophy posts.

Enforcement against INEDs is weak in the UK as well as the United States, and Hong Kong is no different in this regard - the regulatory enforcement lacuna is discussed in Section 3.7.1. While it is tempting to conclude there should be more enforcement, it is suggested that the public framework of responsibility and accountability of INEDs in Hong Kong could be evolved in a manner that better supports their function. Changes in the UK (see Section 3.7.12) and the United States (see Section 3.3.4) that give INEDs greater responsibility and visibility support this suggestion, as does the requirement in Mainland China that INEDs must themselves make disclosures in the annual report. Disclosure by INEDs also serves to provide an insight onto the black box of the board and make INEDs more visible and so accountable to shareholders.

Recommendation C4.2.4 "NED Code and INED reporting" proposes the introduction of a mandatory requirement that INEDs make a statement in the Corporate Governance Report as to their activities relating to the undertaking of their role over the course of the year, and a comply or explain provision that the issuer should implement an "NED Code" to support and facilitate the effectiveness of the NED role. A Model NED Code would be set out in the HK CG Code establishing the matters that should be addressed, although it is up to each issuer to determine its policy in relation to each item. Such matters would include, for example, the NED's expected involvement, sufficiency of a NED's time, basis of remuneration, knowledge of the business and training, etc. The Code based approach provides a clearer forum for establishing the expectations placed on INEDs and other NEDs.

INED qualifications (Section 3.7.11)

The foregoing Section 3.7.10 is closely connected to a topic that has been a concern in all jurisdictions studied, namely, the precursors to NEDs being able to contribute as effective challengers on the board. Discussion frequently circles around director training and whether undertaking that role should be determined solely by commercial considerations (and the enforcement mechanisms and vested interests of directors to comply with them), or whether the ability to be appointed to and undertake a director post should be subject to a formal training, qualification or certification requirement imposed by a regulatory body. Where enforcement is weak, as is the case in Hong Kong as a result of an enforcement lacuna (see Section 3.7.1), support for the former position is correspondingly weaker.

Not all jurisdictions have meaningfully distinguished between the different demands placed on executive and non-executive directors. The UK's Turner Review and Walker Review (albeit focused on financial institutions) suggested that INEDs should undergo an induction process, receive regular training, and be provided with dedicated support. Neither the UK, Singapore nor Hong Kong distinguishes between the training needs of different directors, although the UK CG Code does provide that NEDs should have access to independent professional advice.

In Hong Kong, it is a comply or explain requirement that directors engage in continuous professional development. While this was elevated from a recommended best practice following the HKEX's 2010/2011 consultation proposals, the proposal did not distinguish INEDs as possibly requiring different types of training. Only where there has been a breach of the listing rules might the SEHK require a director to undertake training. In March 2017 the SEHK began to release training videos for directors. Whether the videos constitute a meaningful learning tool that works to change the behaviour of directors in the marketplace is open to doubt. It is rather predictable that the body of directors that the market is most concerned about - inattentive or inactive INEDs and other directors who have little regard for CG standards - are unlikely to study and learn from the videos such that their behaviour changes. The release of the videos thus may serve as a false validator that something is being done about director training.

Mainland China is the only jurisdiction studied that has a regulatory requirement for certifying director candidates. As regards INEDs, the CSRC and the Exchanges all provide ongoing director training, with the Exchanges requiring certification from INEDs in this regard. This is relevant to note in the Hong Kong context where many issuers, and their directors, are from Mainland China - which for directors individually presents a less regulated environment as compared to if they were listed in the Mainland since they do not need to undertake training or certification in Hong Kong.

Most interviewees supported the idea of mandatory training for INEDs. Those who have received such training found the training to be useful in preparing them for the job as independent directors. INEDs do face a different set of tasks from executive directors that may require, for example, reading outside board papers prepared by management, engaging in site visits to understand the company's operations, conducting one-on-one conversations with management people not on the board, and attending industry and related conferences especially for directors who are not industry experts.

Hong Kong's CG system places some emphasis on the role of INEDs. Concerns over INED involvement and capabilities combined with a weak system of enforcement suggest that Hong Kong needs to do better in this regard. Recommendation A4.2.3 «INED training» proposes that INEDs be required to undertake training that is specialized to their role, that this must be subject to a minimum number of certified hours of training experiences that must be disclosed if not met, but that issuers are free to determine what training constitutes an INED CG training experience.

Empowerment of INEDs - controlling shareholders (Section 3.7.12)

All the jurisdictions studied recognize the potential risks of controlling shareholders or their connected parties entering into transactions with the issuer and have imposed controls on these types of transactions, either via listing requirements and/or codes that set CG standards, or via fiduciary duties.

The UK has gone further to provide in the listing rules that the controlling shareholder must enter into a «relationship agreement» with the issuer in which it gives undertakings as regards arms' length transactions and compliance with the listing rules. An important feature of the agreement is that any one independent director can assess whether the controlling shareholder's undertakings have been breached - if they have, subsequent connected transactions will require the approval of independent shareholders until further requirements are satisfied.

This is interesting to consider in the context of Hong Kong where there are perceived shortcomings in the oversight (by shareholders and regulators) of connected party transactions. The UK's relationship agreement is in theory an empowering device for INEDs, particularly as a dual voting procedure is used for the election of independent directors (see Sections 3.4.1 and 3.4.2). However, in the absence of a special voting procedure for INEDs in Hong Kong, it is suggested that a relationship agreement may be of little use in practice. While it may be tempting to put this forward as a reason for introducing special voting rights for the election of INEDs, this would be the tail wagging the dog. As discussed in Sections 3.5.1 and 3.6.4, dual voting represents a public law amendment of private rights that interferes with the one-share-one-vote principle. Moreover, there are other means of addressing that problem, as discussed in Section 3.7.3 (regarding enforcement agencies) and Section 3.6.2 (regarding enforcement by shareholders).

Effectiveness (Section 3.7, Part D - Other items)

Whistle-blowing (Section 3.7.13)

Whistle-blowing has been in place in the United States for almost half a century, initially under the umbrella of protecting the labour market. Over the last two decades, both the United States and the UK have introduced whistle-blowing laws that cover, in varying degrees of specificity, CG standards. The UK provisions cover CG matters established in primary legislation and, because the listing rules have statutory effect, potentially also many of the detailed CG requirements in the FCA's listing rules. The provisions in the United States arise out of the SOX and specifically recognize breaches of regulatory laws promulgated by the SEC. An important distinction is that the UK has considered and rejected financial incentives for whistle-blowers, whereas the United States embraces incentives. There is in reality some uncertainty whether incentives work, or to what degree their effectiveness depends on the characteristics of a particular jurisdiction. Mainland China also provides for whistle-blowing protection, however, this is not targeted but is directed at citizen's rights more generally.

It appears to be common ground that whistle-blowing plays a potentially important role in increasing transparency and uncovering and possibly preventing fraud and wrongdoing. Hong Kong also recognizes whistle-blowing as a tool, but its implementation is piecemeal and, compared to the steps taken in the UK and the United States, it is also weak in terms of protection from retaliation. There is no overarching law to protect whistle-blowers; some laws do provide limited protections in limited contexts; the HK CG Code merely positions it as a recommended best practice; and the regulators support whistle-blowing, but in principle only.

This raises the question, in the context of this study, whether the implementation of whistle-blowing in relation to CG practices should also adopt a specialized-context approach. While the introduction of requirements in the HK CG Code would be helpful, this does not go far enough given that the potential consequences arising from poor CG may extend beyond non-statutory codes and involve director misfeasance and corporate fraud that have legal and possibly other far reaching consequences on investors and the market more generally. Recommendation E4.9.2 «Whistle-blowing» proposes that a consultation or public report should be undertaken that explores whether to implement laws that encourage whistle-blowing from employees by providing protection to whistle¬blowers, and whether this should be limited to specific circumstances such as, for the purposes of this Report, corporate misfeasance.