Corporate governance is a topic familiar to all of us. We all know that there have been problems in the market recently; we know that more needs to be done to improve corporate governance in Hong Kong. Right now, the Exchange's Listing Committee is working on a further round of corporate governance reforms. I will not attempt to anticipate the outcome of the work of the committee. What I would like to do instead is to step back and look at how we got to where we are today. Over the past decade, a great deal of effort has been put into corporate governance. We need to understand what has been achieved, and what has not yet been achieved, if the current round of reforms is to be successful.
In discussing these issues I would like to make two points. The first point is that good corporate governance is not solely a matter of rules and regulatory enforcement. These things are necessary, but they are not sufficient. It is precisely the market with the world's highest standards and the strictest rules - the US - that has had the recent wave of corporate scandals: Enron, World.Com, Tyco and the rest. I think that this may be because corporate governance is partly a matter of culture, of ethics. And ethical behaviour will not improve through rules alone. You cannot legislate for morals: corporate directors have to want to behave well. How to achieve this is a major challenge which I will discuss further in a moment.
The second and related point is that responsibility for good corporate governance cannot rest with one body, even with a regulator like the stock exchange. Other parties have important roles to play. The Securities and Futures Commission (SFC) has statutory powers. It also administers the Takeovers Code. The Government provides policy direction; it prepares and through the Legislature enacts law and regulations. The professionals, such as accountants, lawyers, valuers and their professional bodies; the institutions such as the Institute of Directors and the Hong Kong Securities Institute; the sponsors; and the issuers themselves - all have a part to play. Investors in Hong Kong could also do more to help themselves, although they need to be provided with the tools to do it, in particular the rights of action to provide remedies for abusive conduct by listed issuers. Good corporate governance therefore requires cooperative action by all members of the market community.
- OBJECTIVES OF CORPORATE GOVERNANCE
We all know that corporate governance is important, but what is it exactly? Different people have different definitions. Some commentators include within corporate governance almost all aspects of issuer regulation: disclosure, board procedures, rules for the approval of corporate transactions, and so on. I believe if we think in terms of final outcomes and intermediate targets we can understand better the purpose and nature of corporate governance.
The final outcome that we desire in the stock market is that issuers make decisions that are fair and add value for the shareholders. But we cannot mandate such final outcomes directly. We cannot, for example, judge whether every corporate transaction is fair, in the best interests of shareholders particularly the minority shareholders, etc. It would be too laborious to do this case by case. More importantly, it would be very subjective. Regulators can of course proscribe extreme behaviour such as fraud or theft - regulation can set boundaries to corporate behaviour. But most transactions fall into the grey middle ground where different persons might have different views as to whether the transaction is fair. Finally, the regulator may not be qualified to judge the commercial merits of a transaction. Such judgement is better left to the market.
So, within the boundaries, we as regulators do not and cannot attempt to mandate final outcomes. What we do instead is insist that the outcomes are arrived at after due process. We therefore concentrate on intermediate targets - the processes of decision-making and accountability by which the company is governed. Through the rules we try to mandate processes that will allow due expression to the views of the various stakeholders in the company. As regulators we can mandate these processes: we can impose rules as to the composition of the board, board meeting procedure, shareholder meeting procedure, voting procedure, notice periods, etc. And we can observe whether the processes are followed or not; we can take action if they are not followed.
Our job as regulators probably ends when the processes of corporate governance are properly observed. It will then be to the stakeholders collectively, ie it will be up to the market, to determine the outcome. Our hope is that if the processes are sound and are followed, the outcomes will be good as well.
Corporate governance is therefore about processes. A definition that I find useful is provided by the former International Capital Markets Group. According to the ICMG, corporate governance concerns,
"… the processes used to direct and manage the business and affairs of the company with the objective of balancing:
- The attainment of corporate objectives
- The alignment of corporate behaviour with the expectations of society
- The accountability to recognised stakeholders. …The processes of corporate governance involve:
- Responsibilities - who should do what
- Accountabilities - to whom those with responsibilities must account and how
- Checks and balances - the system of supervision and control procedures and communication flows" .
I have said already that you cannot mandate ethical behaviour. Can the regulator then do anything to promote good corporate culture? Certainly it can. One thing that the regulator can do is to promote awareness on the part of company directors. Directors have to know the rules, but they also have to be alerted to the expectations of the market community. The regulator can help alert them through educational and promotional activities such as briefings and seminars. Market professionals such as accountants can help with these activities. They can also educate their clients in corporate governance informally through their daily work as auditors and reporting accountants.
I would like to emphasise here that it is essential that directors have a proper understanding of the operations and business of the issuer and that they are fully aware of their responsibilities under statute, the Listing Rules and other regulations. The development of a deep pool of well qualified and knowledgeable directors is a further challenge for Hong Kong and one which requires a collaborative response.
Another means to promote good corporate culture is transparency. Transparency applies not only to the business affairs of the company, but also to its governance affairs - how well it implements corporate governance principles. As regulators we can require companies to describe their compliance with corporate governance codes and explain any divergence therefrom. Again, accountants can help here. Transparency empowers the market community with information about the company, so that the community can feed back its judgement to the directors. This gives directors incentives for good corporate governance.
If the responsibility for final outcomes rests with the company's stakeholders, then we need to ask whether the stakeholders have the means to pursue the outcomes they desire. As I have already said, some stakeholders may still find some outcomes unfair even though due process is followed. The answer to this is to provide stakeholders, especially minority shareholders, with remedies against unfair behaviour. Such remedies can include the ability to take legal action directly against the company and/or its directors. The threat of legal action is a powerful incentive for directors to behave well. One of the strengths of the US securities regime is the ability of public shareholders to sue the directors for abuse of their rights. In Hong Kong, in practical terms no such remedy currently exists.
- HISTORICAL DEVELOPMENT
This brings me to the situation in Hong Kong. What progress have we made in building standards of good corporate governance in the Hong Kong market?
Development
I think that the idea of corporate governance first came into people's minds in Hong Kong in 1992 following the publication of the UK Cadbury Report. Based on the recommendations of the Cadbury Report and others, during the 1990s the Exchange strengthened the corporate governance provisions in its Listing Rules. These were some of the milestones.
- In 1993, the Exchange introduced a non-mandatory Code of Best Practice in the Listing Rules.
- In 1994, the Exchange amended the Listing Rules to require issuers to disclose in their annual accounts and listing documents additional information on (a) directors' emoluments and senior management compensation, (b) details of directors and senior management, (c) management discussion and analysis.
- In November 1994, The Exchange announced guidelines on the qualifications, appointment and role of independent non-executive directors.
- In 1995, the Exchange amended the Listing Rules to require all listed issuers to include a statement of compliance with the Code of Best Practice in their interim and annual reports.
- In 1996, the Exchange amended the director's declaration to require fuller disclosure of information to be used in the assessment of the individual's suitability to serve as a director of a listed company.
- In May 1998, the Code of Best Practice was revised to encourage (a) every director to keep abreast of his responsibilities as a director of a listed company, (b) every listed issuer to establish an audit committee with written terms of reference.
During the 1990s, the Hong Kong Society of Accountants also convened a number of working groups on corporate governance, and produced guidelines on audit committees.
- OUTSTANDING ISSUES
After more than a decade of effort on corporate governance, where does the Hong Kong market now stand?
I think that standards have risen substantially. There is generally a much higher awareness of corporate governance now than even a few years ago. Many Hong Kong and Mainland China-based companies are well-regarded by international investors. The work put in by the regulators, the professionals and professional bodies, the academics and others has achieved positive results.
However, there have been a number of high-profile corporate incidents over the past couple of years, such as Euro-Asia and Bank of China. In the context of poor sentiment, these incidents have impacted overall confidence in the market. There have been some concerns expressed by the market on corporate governance, which include the following :
- Connected transactions not in the interests of minority shareholders are a problem.
- Remuneration of the directors of poorly performing companies is sometimes unreasonably high.
- A number of listed companies are illiquid, do not have genuine public floats, and are susceptible to manipulation.
- There are concerns about the regulation and disclosure of China-related issuers.
- There is a lack of confidence in the regulation of sponsors and IFAs, etc.
Causes
What are the reasons for the current market perception of the standards of corporate governance in Hong Kong?
One likely cause is that the regulators are not able to enforce in a meaningful way the boundary of seriously unacceptable behaviour that I mentioned earlier. Hong Kong has no corporate regulator equivalent to the UK Department of Trade and Industry or the Australian Securities and Investments Commission with the powers and resources to enforce company law. The Registrar of Companies, Commercial Crimes Bureau and the SFC generally lack either the powers or the resources, or may not have attempted to use effectively some of the powers available which might act as deterrents.
Because the regulatory framework is not strong ex post, the regulators put in a lot of effort ex ante, ie in pre-vetting of transactions. This approach inevitably risks causing delays and sometimes may tempt the regulators to become involved in judgements about the merits of a transaction, a moral hazard which as regulators we are keen to avoid.
A second cause is that investors lack legal means to pursue corporate misdemeanours themselves, eg statutory liability provisions, class action suits, contingency fees. Thus the full burden of enforcement falls on the regulator.
Thirdly, the regulators' powers to supervise listed companies and their directors are insufficient. Following the former UK system, most of Hong Kong's statutory investor protection measures are embodied in company law (ie the Companies Ordinance), which tends to be focused on the affairs of private companies, rather than in securities laws specifically governing listed companies. The Hong Kong Companies Ordinance is based on the UK Companies Acts of 1929 and 1948, and is undergoing a process of review and updating. Further, most of the Companies Ordinance applies only to Hong Kong-incorporated companies, while three quarters of Hong Kong listed companies are overseas-incorporated. The statutory disclosure liability (section 40 of the Companies Ordinance) applies only to the prospectus, and is in any case very difficult to enforce.
Finally, I would like to address here one misperception - the alleged conflict of interest in HKEx as a for-profit company regulating issuers. The conflict is illusory: it is in fact not profitable even in the short run to list large numbers of low-performing companies - they consume regulatory resources greater than the listing fees they generate. More importantly, the Listing Committee is independent of HKEx, and is not motivated by HKEx's profitability: its interest is in ensuring as far as possible a quality market. There are also numerous checks and balances on HKEx, including a statutory requirement for HKEx to give precedence to the public interest in case of conflict with its other interests, oversight exercised by the SFC, FSTB, ICAC, etc.
- HOW THE OUTSTANDING ISSUES ARE BEING ADDRESSED
Corporate governance has also been a priority for the Administration for some time. In January 2003, the Secretary for Financial Services and Treasury published a Corporate Governance Action Plan for the year. The Exchange, the SFC and the Administration are all working together to carry out that agenda. Let me list some the main initiatives.
- In January 2002, HKEx issued a consultation paper on proposed amendments to the Listing Rules relating to corporate governance. The paper concerned protection of shareholders' rights in voting and share transactions, directors and board practices, and corporate reporting and disclosure. The consultation conclusions were published in January 2003, and the implementation of the revised rules is in hand. The Listing Committee held a Policy Review Meeting in the past two days and so far good progress has been made.
- In many overseas markets, there are quantitative criteria for continued listing, such as share price, turnover volume, etc. HKEx has issued consultation papers on both the criteria for initial listing criteria and the delisting mechanism (July 2002) and continued listing (November 2002). The consultation conclusions and proposed rule changes taking into account the responses to the consultation are in preparation.
- In May 2003, HKEx and the SFC jointly issued a consultation paper on the regulation of sponsors and independent financial advisers (IFAs). The paper proposes a common regime for corporate finance advisers wishing to act as sponsors or IFAs on the Main Board or GEM, and clarifies their role and responsibilities.
- The SFC is working on enhancements to legislation governing public offerings of securities.
- In July 2001, the Standing Committee on Company Law Reform proposed establishing a statutory requirement for disinterested shareholder approval of connected transactions, a derivative right of action, and strengthening of the unfair prejudice remedy. In May 2003, the Financial Services and Treasury Bureau and the SFC jointly issued a consultation paper on proposals to empower the SFC to initiate a derivative action on behalf of a company.
- The regulation of accounts and the accountancy profession is also under review. The Hong Kong Society of Accountants is to establish an independent investigation board. The SCCLR has proposed establishing a Financial Reporting Review Panel along the lines of the UK panel. The asset valuers are working on the possible establishment of a self-regulatory organisation.
- The Government-appointed Expert Group has reviewed the alignment of responsibilities among the three tiers of the regulatory system. The FSTB is shortly to issue a consultation paper on the proposals.
CONCLUSION
To conclude, corporate governance is about processes that if followed should facilitate the proper and fair management of the company. These processes apply within boundaries set by the rules; the rules are enforced by the regulator. However, enforcement alone is not enough to ensure good corporate behaviour. A culture of compliance is needed as well. The regulator can help promote a good corporate culture, for example by mandating transparency, but others in the market community must play their part as well. Coordinated action by all stakeholders in the market - the Exchange, the Government, the statutory regulator, the professionals, the issuers and the investors - is needed if good corporate governance is to result. The Exchange is currently working on further corporate governance reforms. We will need the support of accountants and other professionals to make the reforms successful and raise standards of corporate governance in Hong Kong.
Thank you for your kind attention.
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