On 16 November 2018, The Stock Exchange of Hong Kong Limited (the “Exchange”) published the findings of its latest review of listed issuers’ corporate governance practices and updated its guidance material on environmental, social and governance (“ESG”) reporting.
Latest review of listed issuers’ corporate governance practices
Since the introduction of the Corporate Governance Code and Corporate Governance Report (the “Code”) in 2005, the Exchange has conducted nine periodic reviews of issuers’ corporate governance practice disclosures to maintain high corporate governance standards, with the last report published in October 2017 in respect of the issuers’ 2016 corporate governance reports (the “2016 Review”).
The Exchange conducted its tenth review and published its findings on 16 November 2018, which involved analysing the disclosures made by 400 randomly selected issuers (the “Sample Issuers”), of which 300 had a financial year-end date of 31 December 2017, and 100 with financial year-end date of either 30 June 2017 or 31 March 2018 (the “2017/2018 Review”).
Scope of the 2017/2018 Review
The scope of the 2017/2018 Review includes:-
- examining Sample Issuers’ compliance with the Code Provisions (“CPs”);
- reviewing Sample Issuers’ disclosures under the Code’s Mandatory Disclosure Requirements (“MDRs”) (sections G to Q); and
- reviewing Sample Issuers’ disclosures under the Code’s Recommended Disclosures (“RDs”) (sections R to T).
Examining sample issuers’ compliance with CPs
Issuers are expected to comply with, but may choose to deviate from, the 78 CPs in the Code. Where an issuer deviates from any of them, it must give considered reasons.
The results of the 2017/2018 Review demonstrate issuers’ high level of compliance with the Code, as with previous reviews. In the 2017/2018 Review, 36% of the Sample Issuers reported full compliance with all CPs, representing a 2% rise from the 2016 Review. Nearly all the Sample Issuers complied with 70 or more CPs.
The five CPs with the lowest compliance rates were A.2.1, A.4.1, E.1.2, A.5.1 and A.2.7. The compliance rates of these CPs and the reasons for deviations are examined further below.
A.2.1: Separation of the roles of chairman and chief executive
CP A.2.1 provides 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.
In the 2017/2018 Review, the Exchange focused on whether the issuers have addressed the governance issue of lacking in checks and balance.
The compliance rate of this CP is 64%, representing a 1% rise from the 2016 Review. The common reasons disclosed for departure from this CP (Sample Issuers may have given more than one of the reasons) are that:-
- the same person provides the group with strong and consistent leadership, allows for more effective planning/formulation and execution/implementation of long-term business strategies (61%);
- the issuer has considered the governance issue of balance of power and authority on the board and believes that the structure of the company, including strong independent elements in the board, delegation of authorities to management, supervision by the board and board committees, is sufficient to address this potential issue (53%);
- the board has confidence in the person who acts as chief executive and chairman, e.g. because the person is knowledgeable, well-known and/or has a good understanding of the operations of the issuer (17%);
- contributions are made by all executive directors/independent non-executive directors, who bring different experience and expertise and who meet regularly to discuss issues affecting the issuer’s operations (17%);
- due to the size of the group, the scope and/or nature of its business and/or a practical necessity arising from the corporate operating structure (3%); and
- others (16%).
The Exchange commented that separation of the roles promotes stability in a company as the chief executive can focus on strategy, operations and organisational issues while the chairman can oversee management, lead the board and promote good governance.
A.4.1: NEDs being appointed for a specific term, subject to re-election
CP A.4.1 provides that non-executive directors (“NEDs”) should be appointed for a specific term, subject to re-election.
The compliance rate of this CP is 85%, representing a 3% drop from the 2016 Review. Those Sample Issuers deviated from this CP explained that the NEDs are subject to retirement by rotation in accordance with their articles of association, by-laws or equivalent constitutional documents.
The Exchange considered that issuers should treat CP A.4.1 and the practice of retirement by rotation separately and should specify the period of appointment of NEDs at intervals of no more than three years, notwithstanding that these measures serve the same purpose of preventing entrenchment by ensuring that companies periodically seek shareholders’ re-election of directors.
E.1.2: Chairman’s attendance at AGM
CP E.1.2 provides that the chairman of the board should attend the annual general meeting (“AGM”). He should also invite the chairmen of the audit, remuneration, nomination and any other committees (as appropriate) to attend. In their absence, he should invite another member of the committee or failing this his duly appointed delegate, to attend. These persons should be available to answer questions at the AGM. The chairman of the independent board committee (if any) should also be available to answer questions at any general meeting to approve a connected transaction or any other transaction that requires independent shareholders’ approval. An issuer’s management should ensure the external auditor attend the AGM to answer questions about the conduct of the audit, the preparation and content of the auditors’ report, the accounting policies and auditor independence.
The compliance rate of this CP is 90%, representing a 4% rise from the 2016 Review. The reasons disclosed for departure from this CP are:-
- business engagement (59%);
- health/other personal reason (10%);
- others (including overseas engagement, resignation and retirement) (29%); and
- unspecified (2%).
The Exchange considered that an AGM is a major corporate event and the chairman of the board is responsible for ensuring the board works effectively when performing its responsibilities and the chairman is expected to prioritise the AGM over and above his/her other commitments.
A.5.1: Establishment of a nomination committee which is chaired by the chairman of the board or an INED
CP A.5.1 provides that issuers should establish a nomination committee which is chaired by the chairman of the board or an independent non-executive director (“INED”) and comprises a majority of INEDs.
The compliance rate of this CP is 95%, being the same as the 2016 Review. The most common reason disclosed for departure from this CP is that the issuer believed that it was in the best interest of the company that the board collectively reviewed and approved the appointment of new directors.
The Exchange emphasised that issuers should set out the circumstances that are unique to the company to explain any departure from this CP rather than using boilerplate disclosures.
The Exchange added that issuers that do not currently have a nomination committee should seriously consider establishing one in light of the operation of the new corporate governance regime as from 1 January 2019, as the amended Code requires disclosure on, among others, the process of identifying INEDs, the proposed INED’s time commitment and their contribution to the board including diversity.
A.2.7: Chairman’s annual meeting with NEDs without the executive directors present
As at the date of the issuance of the 2017/2018 Review report, CP A.2.7 provided that the chairman should at least annually hold meetings with the NEDs (including INEDs) without the executive directors present.
The compliance rate of this CP is 95%, representing a 1% drop from the 2016 Review. The reasons disclosed for departure from this CP are that:-
- NEDs can individually communicate their views to the chairman (25%);
- the company secretary is delegated the responsibility to gather concerns and questions from NEDs (20%);
- the chairman is an executive director (15%);
- there is no chairman (15%);
- the chairman had other engagements (10%); and
- others (15%).
Amendment to CP A.2.7 became effective on 1 January 2019. The amended CP A.2.7 requires the chairman to hold meetings with the INEDs without the presence of other directors at least annually.
Reviewing sample issuers’ disclosures under the Code’s MDRs (sections G to Q)
Issuers must include a corporate governance report prepared by the board of directors in their summary financial reports (if any) and annual reports (“Corporate Governance Report”). The Corporate Governance Report must contain all the information set out in sections G to Q of the Code, i.e. the MDRs. Any failure to do so will be regarded as a breach of the Listing Rules.
There are 11 MDRs:-
- Corporate Governance Practices
- Directors’ Securities Transactions
- Board of Directors
- Chairman and Chief executive
- Non-executive Directors
- Board Committees
- Auditors Remuneration
- Company Secretary
- Shareholders’ Rights
- Investor Relations
- Risk Management and Internal Control
The results of the 2017/2018 Review demonstrate issuers’ high level of compliance, with 90% or more of the Sample Issuers complied with sections G, H, J, K, L.(a)-(c), N, P and Q. The compliance level of sections I, M and O were relatively low, ranging from 67% to 82%.
For the 2017/2018 Review, the Exchange focused on the quality of the disclosures under section L.(d), i.e. summary of the work of the board committees and disclosure of diversity policy.
Summary of work of the board committees
Over 95% of the Sample Issuers were able to state the roles and functions, composition and details regarding committee meetings, but the quality of disclosure was varied in areas which call for narrative statements or require policy discussions.
The unsatisfactory disclosures did not separate the roles and functions of the various board committees, did not include narratives on the committees’ work during the year and tended to resort to boilerplate phrases when describing their policies and criteria.
The Exchange commented that informative summaries of the work carried out by each of the board committees promote transparency as shareholders and investors can better understand the work of the board committees. Accountability and board effectiveness would in turn be improved.
Board diversity policy
Section L.(d)(ii) requires issuers to disclose their board diversity policy or a summary of the policy, including any measurable objectives that they have set for implementing the policy, and progress on achieving those objectives.
A majority of the Sample Issuers confirmed that the board had adopted a board diversity policy, while a small number of them were able to go beyond the requirements by providing a skills matrix to demonstrate existing composition of the board and describing the matters taken into account in their board diversity policies. Some Sample Issuers merely reported that they complied with CP A.5.6, i.e. that they have a board diversity policy, but failed to disclose the policy.
The Exchange appreciated that different companies may have different diversity milestones, 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 suit their particular needs and disclose any milestones achieved.
It should be noted that the requirement to have a board diversity policy and to disclose the policy or provide a summary of it was only a CP (A.5.6) for the period covered by the 2017/2018 Review. It has been upgraded to a Listing Rule (Main Board Rule 13.92/GEM Rule 17.104) as from 1 January 2019, meaning that issuers must now have a board diversity policy and disclose the policy or a summary of it in their Corporate Governance Reports.
Reviewing Sample Issuers’ disclosures under the Code’s RDs (sections R to T)
Issuers are encouraged, but not obliged, to disclose information set out in sections R to T of the Code, i.e. the RDs, in their Corporate Governance Reports.
The three RDs set out in sections R to T are as follows:-
- Share Interests of Senior Management
- Investor Relations
- Management FunctionsThe Exchange noted that as some information under the RDs is also required in other parts of the Listing Rules, some RDs were made elsewhere rather than in the Corporate Governance Reports. For instance, 98% and 96% of the Sample Issuers made disclosures on section S(a), i.e. details of shareholders by type, and section S(d), i.e. public float capitalisation, respectively, in their annual reports instead of their Corporate Governance Reports. The Exchange commented that issuers should link the relevant disclosures by cross-referencing to ensure stakeholders can easily identify the information required or recommended in the Corporate Governance Reports.
- For section R, 92% of the Sample Issuers did not make disclosures on the number of shares held by senior management. For section T, 92% of the Sample Issuers made disclosures on the division of responsibilities between the board and management.
The implications are that issuers should:-
- refrain from using boilerplate disclosures;
- elaborate on narrative statements;
- tailor-made the disclosures to suit the unique circumstances of the company; and
- use cross-references to provide clarity and avoid duplications.
Updated ESG reporting guidance
On 16 November 2018, the Exchange has also updated its guidance on how to prepare an ESG report (the “Guidance”) and frequently asked questions on its ESG-related Listing Rules, in response to international developments and the increasing demand for sustainable economic development and effective ESG reporting frameworks. The Exchange recognises that each issuer is unique, and therefore it is not mandatory for issuers to follow the Guidance. Issuers are encouraged to develop its own steps and procedures for ESG reporting to suit their own circumstances.
The Exchange is planning to review its ESG reporting framework and launch a public consultation in mid-2019 on proposed changes to the ESG-related Listing Rules.
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This article is written by ONC Lawyers and was first published on ONC’s website.
This article does not constitute legal advice or a legal opinion on any matter discussed and, accordingly, it should not be relied upon. It should not be regarded as a comprehensive statement of the law and practice in this area. If you require any advice or information, please speak to practicing lawyer in your jurisdiction. No individual who is a member, partner, shareholder or consultant of, in or to any constituent part of Interstellar Group Pte. Ltd. accepts or assumes responsibility, or has any liability, to any person in respect of this article.