Hong Kong Exchanges and Clearing Ltd (HKEX) published a consultation in April this year proposing changes to Hong Kong’s Corporate Governance Code and Listing Rules to enhance standards in a number of key areas of governance. CSj takes a look at the proposals and the views expressed by The Hong Kong Institute of Chartered Secretaries (the Institute) in its submission to the consultation.
Regulatory consultations provide a good weather vane for governance professionals – helping practitioners to not only forecast changes in the regulatory environment but also to get a sense of where wider governance and ethical expectations will be heading in the years ahead.
The latest consultation by Hong Kong Exchanges and Clearing Ltd (HKEX) is a good example of this. The Review of Corporate Governance Code and Related Listing Rules, published in April this year, proposes new measures to enhance corporate governance standards in a number of frontier governance areas. These include proposals relating to corporate culture, director independence, board diversity, communication with shareholders, and environmental, social and governance (ESG) matters.
The Hong Kong Institute of Chartered Secretaries (the Institute) published a submission to the consultation earlier this month.
In a two-part article starting this month, CSj will look at the proposals of the consultation and the Institute’s views in tandem.
The influence of organisational culture on both the ethical behaviour of employees and officers, and the ability of organisations to deliver long-term sustainable performance, has been gaining increasing attention in recent years. ‘A healthy culture plays a pivotal role in good governance, and the board should demonstrate good practice in the boardroom and promote governance throughout the business. The company as a whole must demonstrate openness and accountability, and should engage constructively with shareholders and wider stakeholders about culture to achieve the two-way communication,’ the consultation states.
The HKEX consultation notes that the UK, Singapore, Australia and Japan have recently introduced corporate governance requirements relating to organisational culture. The new requirements focus on the board’s responsibility to establish an appropriate culture which reflects the company’s strategy, values and ethical standards. This is also the focus of the proposed changes to the Corporate Governance Code (the Code), which forms Appendix 14 of the Listing Rules in Hong Kong. The consultation proposes to:
- introduce a new Code Provision (CP) to the Code to require listed company boards to align their company’s culture with its purpose, value and strategy, and
- to introduce new a CP requiring establishment of an anti-corruption policy and to upgrade an existing recommended best practice (RBP) to a new CP requiring the establishment of a whistleblowing policy.
1. Getting culture onto the board’s agenda
The consultation emphasises the role of the board in setting the tone and defining the company’s purpose and strategy. ‘The board is responsible for setting the company’s culture. As the leadership of the company, the board plays an important role in promoting, monitoring and assessing the culture, and making sure the desired culture is embedded at every level of the organisation,’ the consultation states.
It also highlights some key considerations for boards in meeting this responsibility. These include the need to review the company’s remuneration policies to ensure that incentives, financial and non-financial, reinforce maintenance of the company’s desired culture. It is also important for the board to monitor these issues on a continuous basis. ‘The board is expected to conduct periodic reviews to make sure the culture is aligned with the company’s purpose and value, and is able to deliver long-term sustainable growth’, the consultation states.
Another key consideration is how to manage disclosures relating to organisational culture. The consultation emphasises that such disclosures should be precise and succinct. Moreover, there should be a discussion of:
- the vision, value and strategy of the company, alongside the company’s culture, and how all these affect the business model
- how the company’s desired culture affects or contributes to the company’s performance
- the measures used for assessing and monitoring culture (for example, any specific indicators such as turnover rate, whistleblowing data, employee surveys, breaches of the code of conduct and regulatory breaches)
- the measures in place to ensure the desired culture and expected behaviours are clearly communicated to all employees (for example, through developing a code of conduct)
- the forum(s) available for sharing ideas and concerns on any misconduct or misalignment identified and how they are dealt with, and
- the company’s financial and non-financial incentives that support the desired culture.
The Institute welcomes the emphasis on corporate culture being an important element of a corporate governance framework and the recognition that the board of a listed company has a role to play in relation to corporate culture. However, the Institute’s submission highlights some caveats. In particular, given the intangible nature of corporate culture, the submission asks whether the board can be expected to ‘set’ culture – culture is not something that can be codified or set like a budget. ‘It is also unclear how compliance with this CP could be properly measured, rendering it incapable of being properly applied and enforced,’ the submission states.
Instead, the submission suggests that listed companies could be asked to disclose how their boards have sought (in conjunction with the management team):
- to understand the corporate culture of the issuer
- to ensure alignment between the corporate culture and the issuer’s purpose, strategy and values
- to measure the corporate culture, and
- to align incentives and rewards to support and encourage behaviours consistent with the company’s purpose, values and strategy.
‘Such an approach might enable boards to understand the role they can and should play in relation to corporate culture and also lead to more meaningful disclosure,’ the Institute’s submission states.
2. Anti-corruption and whistleblowing
A key part of a healthy organisational culture is the creation of an open and transparent environment in which employees and officers at all levels understand the core values of that culture and can report any breaches. Hence the proposed requirements relating to companies’ anti-corruption and whistleblowing policies in the consultation.
Listed companies are currently required, on a comply-or-explain basis, to make disclosures relating to their anti-corruption policies, whistleblowing procedures, as well as compliance with relevant laws and regulations, under the HKEX ESG Reporting Guide. The audit committee is also recommended to establish a whistleblowing policy and system for employees and those who deal with the issuer under the Code. The consultation proposes to tighten these existing requirements, as mentioned above, by introducing new a CP requiring establishment of an anti-corruption policy and to upgrade an existing RBP to a new CP requiring the establishment of a whistleblowing policy.
The Institute agrees with these proposals. The Institute has been promoting the benefits of having effective whistleblowing channels for some years. ‘Whistleblowing serves as an important mechanism for issuers to learn of issues and to manage them, as part of risk mitigation,’ the Institute’s submission states. It adds that a properly designed whistleblowing policy should also contain protections for the whistleblower against retribution.
Regarding the establishment of an anti-corruption policy, the Institute believes that this is fundamental to good corporate governance. The implementation of this proposal by listed companies in Hong Kong will also, the Institute submits, enhance the reputation of Hong Kong as an international financial centre. The submission also welcomes HKEX’s aim to publish guidance on this area of practice. It points out, however, that in certain markets or jurisdictions where issuers carry on business, there may already be legal provisions concerning whistleblowing and anti-corruption. In such cases, the HKEX guidance must be subject to those overriding obligations.
The consultation proposals relating to board independence were reviewed in the May edition of this journal. To recap, the consultation proposes to:
- create a new CP to require issuers to have a policy to ensure that independent views are available to the board and to review the policy’s effectiveness annually
- revise an existing CP to require independent shareholders’ approval for the re-election of an independent non-executive director (INED) who has served more than nine years (Long-Serving INED), and to require additional disclosures of the factors considered in recommending the INED for re-election
- create a new CP requiring the appointment of a new INED at the next annual general meeting (AGM), if all INEDs on the board are Long-Serving INEDs, and to disclose the length of tenure of the Long-Serving INEDs on a named basis, and
- introduce a new RBP that an issuer generally should not grant equity-based remuneration (for example share options or grants) with performance-related elements to INEDs as this may lead to bias in their decision-making and compromise their objectivity and independence.
The Institute agrees with proposal three. The Institute’s submission points out that there are significant benefits to bringing fresh perspectives to the board via the appointment of a new INED, particularly where the existing INEDs are all Long-Serving. Moreover, the extra disclosure requirement also has the Institute’s support. The Institute’s submission points out that this will facilitate access to the information by shareholders in the interests of greater transparency.
The Institute also has caveats, however, regarding the other proposals. For example, the Institute questions whether having a policy stating that independent views are available to the board (proposal one above) will be of any use. The Institute’s submission points out that there are two aspects of ‘board independence’: independence of an individual director from other influences (such as their connections with family shareholders or professional advisers) and the independence of directors from the company. ‘The reasoning for the proposal discusses the former, but the proposal of the Consultation Paper appears to relate to the latter,’ the submission states.
‘Boards are not independent and every director, including the “independent” directors, is there to serve the company, the submission points out. ‘Moreover, HKEX has developed and greatly expanded the role and importance of INEDs and that is the route by which independent views and input are available to the board,’ the submission states.
The submission also has reservations regarding proposal two – requiring independent shareholders’ approval (and additional disclosure) for the re-election of Long-Serving INEDs. The submission points out that a balanced board is one which includes, amongst other areas of individual differences, a mix of long-serving and more recently appointed directors. ‘No one would suggest that the management of a company would best be entrusted to a senior executive team which did not have a considerable measure of experience and knowledge of the business. Equally, no one should expect the oversight of the business and its management to be entrusted to a board which was not allowed to possess and retain a similar level of experience and knowledge,’ the submission states.
There is also a danger, the submission suggests, that this proposal moves towards creating two classes of shares – those held by ‘independent’ shareholders and those that are not. Moreover, it points out that all directors owe a similar duty to the company and all its shareholders. ‘A provision which requires certain directors to be appointed by only certain shareholders cuts across this,’ the submission states.
Regarding proposal four, (discouraging the granting of equity-based remuneration with performance-related elements to INEDs), the Institute’s submission suggests that this issue needs to be seen in the wider context of INEDs’ remuneration. ‘Whilst appropriate in itself, this proposal should really be accompanied by a further measure to ensure that INEDs are properly paid for the work they do, the responsibilities they bear and the potential liabilities they incur,’ the submission states.
The Consultation Paper – Review of Corporate Governance Code and Related Listing Rules – is available on the HKEX website: www.hkex.com.hk. Next month’s CSj will review the HKEX consultation proposals and the Institute’s views regarding board diversity, nomination committees, stakeholder engagement and ESG matters.