CSj looks at useful resources for governance professionals seeking to upgrade their compliance with Hong Kong’s Corporate Governance Code.

Changes to Hong Kong’s Corporate Governance Code and related listing rules become effective this month, including tougher requirements on board diversity and the nomination and election of independent non-executive directors (INEDs). In this context, CSj looks at the latest review by The Stock Exchange of Hong Kong Ltd (the Exchange) of listed company compliance with the Corporate Governance Code and Corporate Governance Report, and at other resources now available to listed companies hoping to raise their governance standards.

The Exchange has been conducting reviews of listed issuers’ compliance with the Corporate Governance Code and Corporate Governance Report (the Code) since 2007. The 2017/2018 review (the Review) is a useful resource for governance professionals seeking to keep up to date with the regulator’s assessment of the level of compliance with Hong Kong’s corporate governance regime.

‘The Review is a part of the Exchange’s continuing effort to maintain high corporate governance standards amongst issuers. By identifying shortfalls in issuers’ corporate governance reporting and providing guidance on ways in which such reporting may be improved, we hope and expect that the Review would contribute to better future reporting,’ the Review states.

Separation of roles of chairman and chief executive

As with previous reviews, the results of the Review demonstrate issuers’ high level of compliance with the Code. Whilst the compliance rates are similar to previous years, the Exchange notes a 2% rise in the number of issuers that complied with all 78 Code Provisions (CPs), and chairmen’s attendance at general meetings has improved by 4%.

The CP requiring the separation of the roles of chairman and chief executive (CP A.2.1) retained its place as the CP with the lowest compliance rate among listed companies in Hong Kong (see ‘The five CPs with the lowest compliance rates’). It states that: ‘The roles of chairman and chief executive should be separate and should not be performed by the same individual. The division of responsibilities between the chairman and chief executive should be clearly established and set out in writing.’

The common reasons for deviation from this CP (see ‘Reasons disclosed for not separating the roles of chairman and chief executive’) were similar to those disclosed by the issuers in the previous review. The most common reason for departure from the CP was that vesting the roles of chairman and chief executive in the same person provided the group with strong and consistent leadership and allowed for more effective formulation and implementation of long-term business strategies. Other reasons included that the person holding the dual capacity of chairman and chief executive had profound experience and knowledge in operations of the business, or that practical considerations including the size and business nature required the company to deviate from this CP.

The Review indicates that generally more comprehensive explanations are being given by listed companies who deviate from A.2.1. In previous reviews, the Exchange has recommended that issuers deviating from A.2.1 should give more detailed explanations of how they have addressed the challenges inherent in having the same person fulfilling both these roles – in particular, the leadership’s lack of checks and balances.

While some of the sample issuers made bare assertions that their structures would not impair the balance of power without offering details, over half of the sample issuers did address the governance issue of balance of power and authority on the board. Some gave examples of how strong independent elements on the board, delegation of authorities to management, supervision by the board and board committees mitigate the governance risks.

‘It is important to note that the separation of the roles of the chairman and chief executive promotes good corporate governance’, the Review states. ‘In addition to balancing the powers and authority on the board, thereby mitigating the risk of ‘groupthink’, it also promotes stability in a company. By separating functions, the chief executive can focus on strategy, operations, and organisational issues while the chairman can oversee management, lead the board, and promote good governance.’

Board diversity

In addition to examining the sample issuers’ compliance with the CPs, the Review also reviewed their disclosures under the Code’s Mandatory Disclosure Requirements (MDRs) and Recommended Disclosures (RDs). The Review observed a varied level and quality of disclosure in these areas.

In particular, MDR Section L.(d)(ii) requires issuers to disclose their board diversity policy or a summary of the policy (if they have one), including any measurable objectives. The Exchange had noted from previous reviews that some issuers did not disclose their board diversity policies, despite claiming to have such policies, whilst others may have provided ‘boiler-plate’ style policies.

The Review found that, while a majority of the sample issuers disclosed that they were in compliance with CP A.5.6, which requires issuers to have a diversity policy, some are still failing to disclose such a policy. ‘Issuers should note that not explaining a deviation from a CP is a breach of the listing rules,’ the Review states. ‘We have contacted sample issuers that failed to disclose their diversity policies without giving considered explanations individually and will take follow up action as appropriate.’

At the other end of the spectrum, a small number of the sample issuers were able to go beyond the requirements in the Code and provided a skills matrix to demonstrate existing composition of the board, as well as describing the matters taken into account in their board diversity policies.

The Review emphasises that it is important for issuers to set measurable objectives for implementing a board diversity policy and to disclose the progress on achieving those objectives. ‘We appreciate that diversity milestones vary from company to company, depending on the nature of the business, stage of development and diversity profile of the board. Issuers are encouraged to determine their measurable objectives to reflect the particular needs of the board and disclose any milestones they have achieved,’ the Review states.

The Review also points out that CP A.5.6 has been upgraded to a listing rule, effective 1 January 2019. ‘Issuers are reminded as from January 2019, they must have a board diversity policy and they must also disclose the policy or a summary of it in their corporate governance reports,’ the Review states.

Preparing for Hong Kong’s new corporate governance regime

The new listing rule on board diversity is part of a number of corporate governance measures announced in the Exchange’s Consultation Conclusions on Review of the Corporate Governance Code and Related Listing Rules (consultation conclusions) published in July 2018. In addition to tougher disclosure requirements on board diversity, the changes are designed to make the election process of INEDs more transparent to enhance the board’s accountability to shareholders. There are also new requirements for disclosure of potential INEDs’ time commitment, perspectives, skills and experience, as well as diversity considerations. The listing rules on INEDs’ independence criteria have also been strengthened.

In addition to the Review discussed above, issuers can also make use of the tools published on the website of the Hong Kong Exchanges and Clearing Ltd (HKEX) (www.hkex.com.hk) designed to help companies prepare for the new corporate governance regime. These include the webcast entitled ‘INEDs’ Role in Corporate Governance’ and the new set of guidelines entitled ‘Guidance for Boards and Directors’.

More information is available on the HKEX website: www.hkex.com.hk.