CGj presents a synopsis of some of the Institute’s latest guidance notes from the fourth quarter of 2024, covering a wide range of topics from tax ethics to AI adoption, and provides a brief summary of all guidance notes published between October and December 2024.

As a vital part of its thought leadership and professional development initiatives, the Institute regularly publishes guidance notes to keep governance professionals and practitioners updated on the latest advances in governance, risk and compliance. In the fourth quarter of 2024, the Institute issued guidance notes addressing the following:

• global minimum tax and tax ethics for governance professionals
• recent British Virgin Islands company regulations and developments
• best practices for listed issuers in handling loans and lending arrangements
• applicability of international merger control rules to Hong Kong transactions
• impact of arbitration clauses on winding-up applications
• management of private funds and discretionary accounts, and
• AI adoption.

Tax ethics

The Institute’s Wealth Management Interest Group published its fourth guidance note, titled Global Minimum Tax and Tax Ethics for Governance Professionals, in October 2024, offering practical advice to assist governance professionals navigate the evolving tax landscape, and to help promote fair and transparent tax practices.

This guidance note highlights the importance of tax ethics as a governance issue. ‘With the evolution of business (for example, cross-border e-commerce), companies may generate huge profits in a jurisdiction without any physical presence there and no taxes could be charged under the traditional tax regimes,’ the guidance note explains. ‘Some multinational enterprises (MNEs) have shifted profits to low-tax jurisdictions with minimal business activities solely to enjoy low tax rates.’ This tax planning strategy used by MNEs to exploit loopholes in tax rules is known as base erosion and profit shifting (BEPS).

To tackle this inequitable tax avoidance scheme, the Organisation for Economic Co-operation and Development proposed an international tax reform measure, namely the implementation of the global minimum tax (GMT) under Pillar Two of the BEPS 2.0 Project. A number of jurisdictions, including Hong Kong, have committed to the adoption of Pillar Two rules.

Pillar Two requires MNEs with consolidated revenue exceeding €750 million to pay at least 15% tax in each jurisdiction where they operate. Governance professionals must stay informed about these changes to guide their organisations effectively, as the guidance note emphasises.

To promote ethical tax practices, the guidance note recommends that governance professionals stay updated on evolving tax regulations, educate their organisations on the distinction between legitimate tax planning and aggressive tax avoidance, encourage transparent and fair tax strategies that align with modern tax ethics, recognise that what was once acceptable may now be unethical or illegal and seek advice from tax professionals to more competently handle complex rules and ensure compliance.

The guidance note further advocates for regular reviews of tax arrangements and accurate documentation of all tax-related decisions, as well as collaboration with tax experts to ensure ethically sound and legally compliant tax strategies.

Loans and lending arrangements

The latest guidance note issued by the Institute’s Securities Law and Regulation Interest Group, titled Governance and Best Practices for Listed Issuers in Handling Loans and Lending Arrangements, is a two-part publication that offers practical advice on how governance professionals can support listed issuers in this area. It also explores common pitfalls and regulatory enforcement actions relating to loan and lending practices.

Part one of the guidance note highlights the increased scrutiny by Hong Kong regulators of loans, advances, prepayments and similar arrangements, following a number of misconduct cases that led to significant losses. These fund transfers, often involving associated parties or being disguised as loans, may lack legitimate commercial rationale and expose issuers to risks.

Governance professionals play a crucial role in fostering best practices to ensure compliance with regulatory expectations. The guidance note outlines fundamental principles for effective governance, including ensuring transactions are backed by a legitimate commercial rationale, implementing robust risk management practices, maintaining strong internal controls and adhering to the Listing Rules.

The guidance note further suggests that directors should perform due diligence on the borrowers, as well as assess recoverability and monitor repayments. They must also ensure accurate disclosures and proper oversight at both issuer and subsidiary levels. Additionally, issuers are urged to maintain contemporaneous records to demonstrate compliance during regulatory reviews.

It also stresses that proper risk assessments and approvals are critical, particularly for loans with significant financial impact or those classified as connected transactions under the Listing Rules.

Part two of the guidance note highlights the common pitfalls relating to loans and lending arrangements. Key pitfalls identified include:

• Pre-loan stage: failure to conduct proper due diligence, approving loans on questionable terms, insufficient safeguards and lack of records.
• Post-loan stage: inadequate monitoring of repayments, repeated renewals without justifiable reasons and a lack of effective internal controls.
• Recovery stage: insufficient recovery efforts, failure to recognise or provide for bad debts and significant impairment of loan receivables.

Governance professionals and directors are urged to conduct thorough due diligence and risk assessments for all lending arrangements, as well as to ensure accurate and timely disclosures, and should remain vigilant while upholding the highest standards of corporate governance in their lending practices. ‘Any failure to do so would lead to investigations and possible sanctions, as well as possible civil actions to be taken by the Securities and Futures Commission (SFC) or shareholders for losses incurred as a result of the misconduct,’ the guidance note warns.

Arbitration agreements

The interaction between arbitration clauses and insolvency proceedings presents significant challenges for creditors. A recent HKCGI guidance note – The Impact of Arbitration Clauses on Winding-up Applications – offers insights into the implications of such clauses on winding-up petitions and provides practical advice for governance professionals navigating this complex area.

The guidance note focuses on how arbitration agreements can limit creditors’ ability to file winding-up petitions, especially in jurisdictions like Hong Kong. It highlights the ‘multifactorial approach’ adopted by the Hong Kong courts, which requires balancing factors such as public policy, the terms of the arbitration agreement and the merits of the debtor’s defence. Governance professionals should note that courts may dismiss or stay a winding-up petition in favour of arbitration, unless there are countervailing factors, such as a lack of genuine intent to arbitrate or the abuse of process by the debtor, the guidance note points out.

It also emphasises the importance of understanding jurisdictional differences. For instance, while Hong Kong courts favour arbitration agreements, the recent decision by the UK Privy Council in Sian Participation Corp v Halimeda International Ltd suggests a different approach in other jurisdictions, where arbitration clauses may not preclude a winding-up petition, if the debt is undisputed on substantial grounds. ‘The governance professional should be aware of this difference and seek appropriate advice when enforcing their debt or contractual entitlements, including on whether there is an option to enforce in a jurisdiction that is potentially more friendly to creditors,’ the guidance note states.

Another key takeaway is the practical impact of arbitration clauses on enforcement. The guidance note highlights potential delays caused by arbitration, which can be commercially problematic for creditors, especially in cases where the debtor’s financial position deteriorates or assets are at risk. Governance professionals are advised to consider these risks carefully when drafting contracts and managing debt recovery processes.

AI language models

The rapid adoption of generative AI language models presents significant governance challenges. A recent guidance note by the Institute, titled AI Adoption Issues, provides governance professionals with a comprehensive overview of the major considerations in this area.

Drawing lessons from a November 2024 circular issued by the SFC, which focuses on licensed corporations, this guidance note underscores the importance of robust governance frameworks for AI adoption across sectors.

‘While governance professionals may not directly manage the cybersecurity or operational aspects of AI integration, they play a crucial role in facilitating their organisations to effectively address related risks. This includes providing strategic insights into risk management, compliance and resource allocation to ensure organisations approach AI adoption responsibly and sustainably,’ the guidance note states.

The guidance note also identifies several critical risks posed by AI language models, as outlined below:

• Inaccurate and unreliable outputs: risks such as ‘hallucinations’, whereby the AI generates responses that appear plausible but are factually inaccurate, biases in the data used to train the AI or in the algorithms themselves and performance drift all necessitate regular checks and reviews of AI-generated outputs to ensure reliability and accuracy.
• Cybersecurity and privacy concerns: AI language models pose data privacy and cybersecurity risks, requiring organisations to adopt strong data protection measures.
• Dependency on external providers: reliance on third-party providers for AI solutions can create vulnerabilities. Contingency plans and operational resilience are instrumental in mitigating those risks.

Governance professionals are encouraged to adopt a proportional, risk-based approach to AI governance. High-risk-use cases, such as investment recommendations, require stricter controls to minimise harm from inaccurate outputs. Clear accountability structures and alignment across legal, compliance and technology functions are essential for effective AI governance.

The guidance note outlines four core principles to guide governance professionals in managing AI-related risks.

1. Senior management responsibilities. Facilitate alignment of AI deployment with organisational goals and regulatory requirements, while ensuring oversight mechanisms are in place.
2. AI model risk management. Advocate for robust frameworks for model validation, testing and ongoing monitoring to maintain AI reliability and effectiveness.
3. Cybersecurity and data risk management. Promote comprehensive measures to safeguard data privacy and defend against cyberattacks.
4. Third-party provider risk management. Ensure rigorous due diligence and monitoring of external AI providers to manage legal and operational risks.

‘There is no one-size-fits-all and the governance professional must ensure that AI-related governance matters are subject to continuing review,’ the guidance note concludes.

The guidance notes covered in this article are available in the Thought Leadership section of the Institute’s website: www.hkcgi.org.hk.