Is Hong Kong serious about corporate governance reform?
Hong Kong has the potential to be a world leader in corporate governance, believes Gordon Jones FCIS FCS, Hong Kong’s former Registrar of Companies, but it will not realise this potential if it continues to allow vested interests to obstruct the corporate governance reform process.
At 6pm on 2 May 2012, some 40 Fellows and Associates of The Hong Kong Institute of Chartered Secretaries (HKICS) gathered at the Hong Kong Club to hear Gordon Jones FCIS FCS, Hong Kong’s former Registrar of Companies, talk about his new book Corporate Governance and Compliance in Hong Kong.
The audience that evening may have been expecting a review of how Hong Kong’s corporate governance regime took its present shape. Mr Jones, after all, in his capacity as Registrar of Companies and a member of the Standing Committee on Company Law Reform (SCCLR), has been closely involved in the evolution of the current regime. Moreover, with the revised Companies Ordinance making its way through the Legislative Council, a revised corporate governance code and new statutory price-sensitive information disclosure requirements in place, the audience may have been feeling fairly upbeat about the direction and pace of corporate governance reform in Hong Kong.
Mr Jones’ speech that evening, however, was not an opportunity for backslapping and self-congratulation. He highlighted a number of areas, which are discussed more fully in his new book, where Hong Kong lags significantly behind global best practice and further reform is required.
Selection of INEDS and gender diversity on boards
Good corporate governance structures and processes cannot compensate for a lack of ability and integrity in a company’s directors. Mr Jones stressed the need to adopt a much more systematic approach to identify and recruit the right talent for a company’s board. In addition to independence, a director’s ability, knowledge of the company’s business and personality are also very important criteria in determining appointments. Nomination committees should be the norm, not the exception, for listed companies. New code provision A.5.2 in the Corporate Governance Code requires all listed companies to establish a nomination committee or give reasons for not doing so.
A subset of this issue is the underrepresentation of women on company boards. Currently women fill only about 9% of the directorships of Hang SengIndex companies in Hong Kong and the situation is far worse in other companies. However, board diversity is currently not addressed anywhere in our legislation or even in our Corporate Governance Code. Mr Jones suggested that the code should include a provision along the lines of code provision B.2 in the UK Corporate Governance Code: ‘The search for board candidates should be conducted, and appointments made, on merit, against objective criteria and with due regard for the benefits of diversity on the board, including gender’.
Corporate directorships, Mr Jones pointed out, have been abolished in virtually all other major commercial jurisdictions, apart from the UK. Moreover, the Financial Action Task Force on money laundering has highlighted the continued existence of corporate directorships in Hong Kong as a weakness in our anti-money laundering defences. Corporate directorships are currently permitted in private companies which are not part of a group of companies comprising a listed company. In 2008, they were reviewed in the context of Companies Ordinance Rewrite exercise, but it was decided to continue to allow private companies to have corporate directors as long as all such companies have at least one natural person as director (clauses 447 and 448 of Companies Bill).
Mr Jones believes that corporate directorships should be prohibited in Hong Kong since they negate the key corporate governance principles of accountability and transparency. He believes the decision to follow the UK practice here was a mistake since in the UK all private companies have to file audited accounts. This is not the case in Hong Kong. Consequently many private companies in Hong Kong have a double layer of opaqueness – having no natural directors and no filed accounts.
Initial public offerings
Recently, there have been a number of major cases involving very sub-standard IPOs, for example, Rusal, China Agriculture Holdings, Hontex etc. In addition, the SFC’s Report on Sponsor Themes Inspection Findings (29 March 2011) revealed a large number of deficiencies regarding sponsors of IPOs. To ensure the maintenance of standards and the quality of stock market listings, it is essential that the sponsors of IPOs are made liable for the contents of listing prospectuses. On 9 May 2012, the SFC launched a two-month public consultation to enhance the regulatory regime of sponsors by, inter-alia, tightening due diligence requirements and introducing criminal and civil sanctions.
Mr Jones considers this to be potentially one of the most serious corporate governance challenges facing Hong Kong. Currently, in the event of a serious audit failure and corporate meltdown, auditors face unlimited liability. The collapse of a major audit firm would have very adverse consequences for Hong Kong’s reputation as a major international financial centre and competition and choice as well as the accountancy profession. However, on the other hand, auditors need to remain accountable for errors and the key issue is how to strike an appropriate balance. The Hong Kong Institute of Certified Public Accountants favours a statutory cap on the amount of liability auditors face, but setting an appropriate level for the cap would be very complex and contentious. In the interim, less controversial proposals such as permitting limited liability partnerships and allowing auditors to contractually limit their liability under the Companies Ordinance may need to be considered.
Public sector governance
Currently, the legal and regulatory framework for not-for-profit entities and statutory public bodies is very fragmented and there are considerable variations in the corporate governance standards adopted by these bodies. The government’s appointments to statutory bodies seem to be consistently made from a ‘small circle’ of appointees while the selection process lacks transparency and there are questions as to how the ‘independence’ of the appointees has been determined. In addition, as evidenced by the Lau Wong-fat case, the guidelines on how to deal with conflicts of interest in the highest body in the government’s policy-making structure clearly require revision. In any reforms, priority needs to be given to subvented and charitable bodies given the degree of support they receive from the public purse and privileged status.
Two steps forward, one step back?
As Hong Kong’s survival as an international financial centre depends on its reputation as a quality market, Mr Jones stressed that it cannot afford to allow standards to slip. ‘Good corporate governance, underpinned by the continued maintenance and enhancement of quality and standards, is Hong Kong’s competitive advantage. If we abandon these in a possibly chimerical quest to increase listings from jurisdictions with sub-standard legal and regulatory requirements, we lose this advantage and ultimately our market position’, he argued.
He also acknowledged that, compared to many other jurisdictions in the region, Hong Kong has some very significant advantages. Corporate governance is not just about complying with laws and regulation but also, and more importantly, about corporate culture, education and mindset. It’s about the free flow of information, capital and talent; integrity of the market and its participants; transparency; and a level playing field. In Hong Kong, these elements are underpinned by the existence of the rule of law; an independent and robust judiciary; an effective, efficient and clean civil service; and strong, independent regulators. However, these cannot be taken for granted and must be strenuously defended.
Since its creation in 1984, the SCCLR has been an important part of that infrastructure. For example, most of the reforms currently under legislative review as part of the Companies Ordinance Bill originated in the SCCLR’s review of Hong Kong’s corporate governance regime. While this demonstrates that the corporate governance reform process in Hong Kong is very much alive and kicking, Mr Jones pointed out that the Companies Ordinance Rewrite exercise has also demonstrated the difficulty Hong Kong has when it comes to following through with ‘good ideas’ in corporate governance.
For example, one very obvious weakness that has been on the radar screens of regulators in Hong Kong for quite some time is the fact that the overwhelming majority of listed companies are not subject to the requirements of the Companies Ordinance as they are ‘non Hong Kong companies’. However, the enforcement options under the nonstatutory listing rules are very limited and lack teeth. This led to proposals in January 2005 to give statutory backing to listing rules regarding financial disclosure, connected transactions and price-sensitive information (PSI). Seven years later, Hong Kong has only been able to implement this reform for PSI.
The Securities and Futures (Amendment) Ordinance 2012, which shifts enforcement of PSI disclosure requirements from the stock exchange to the Securities and Futures Commission (SFC), was passed by LegCo on 25 April 2012. It is not certain whether this is going to be the end of statutory backing, or if it is still the intention to give statutory backing to other key requirements in the listing rules. Until and unless this question is answered, the ability to take effective regulatory action against listed companies will remain limited.
This is certainly not an isolated example. In 2003, the SCCLR proposed that the Companies Ordinance should require listed companies to prepare a separate directors’ remuneration report. Seven years later, in May 2010, this proposal finally made its way into draft legislation circulated for public consultation as part of the Companies Ordinance Rewrite exercise. The Financial Services and Treasury Bureau argued against this proposal suggesting that it would give an unfair advantage to non-Hong Kong companies not subject to these requirements. As a result, the proposal was dropped. Mr Jones considers that this is a spurious argument as it would be a very easy matter to duplicate these requirements in the listing rules as is the case with numerous other requirements in the Companies Ordinance.
Furthermore, proposals to adopt provisions in the UK Companies Act 2006, which were endorsed by the SCCLR, regarding directors’ connected transactions have also been dropped. In this respect, proposals to permit shareholders to inspect directors’ service contracts and requirements regarding shareholders’ approval for a company to enter into a transaction for the purchase/ sale of a major asset to/ from a director have been deleted from the Companies Bill.
Both of these requirements would have strengthened Hong Kong’s corporate governance regime but no reasons for their deletion have been given. These examples (and they are not isolated cases) demonstrate, Mr Jones believes, that the problem in Hong Kong is not the lack of reform proposals but a very patchy record when it comes to following through on the good ideas raised by the law reform process. Hence the question of how serious Hong Kong is about corporate governance reform is a very relevant one. Mr Jones believes the government and regulators must show that they have: first, an overall vision for corporate governance reform; secondly, the leadership and commitment necessary to see through any necessary reforms; and last, but certainly not least, the political courage to face down vested interests as and when necessary. In many, if not most, cases, we know what has to be done but do we have the ability, conviction and courage to do it?
In addition, the government needs to get its own house in order. Mr Jones pointed out that the core principles of corporate governance – such as transparency and accountability – are just as relevant for governments as they are for companies. Governments, after all, like listed corporations, are stewards of public funds. Mr Jones reminded his audience that governments should lead by example. ‘The government cannot expect companies to abide by standards they themselves do not honour,’ he said.
Gordon Jones’ speech was delivered at the ‘Fellows’ Sharing’ event organised by the HKICS at the Hong Kong Club on 2 May 2012. This was the first of a series of ‘Fellows’ Sharing’ events designed to provide greater opportunities for senior members of the profession to share their expertise and experience in a relaxed and sophisticated environment. Look out for future events in this series in the ‘Institute News’ section of CSj, and on the HKICS website (www.hkics.org.hk).
Gordon Jones’ new book, ‘Corporate Governance and Compliance in Hong Kong’ was published by LexisNexis earlier this year and is available in bookshops.
SIDEBAR: Career notes
Gordon Jones joined the Hong Kong government in October 1973 and served in a large number of branches in the government secretariat. On 1 May 1993, he was appointed the Registrar of Companies for Hong Kong. During his time as the head of the Companies Registry, he played a key role in the modernisation and computerisation of the department’s operations, and company law and corporate governance reform, including initiating the rewrite of the Companies Ordinance.
Since retiring from the civil service in May 2008, he has been able to indulge his interests in history, writing, music and hill walking. He is currently involved in a number of pro-bono activities including Opera Hong Kong, where he is a director and chairs the Artistic Committee, and the Hong Kong Institute of Certified Public Accountants, where he chairs the Regulatory Accountability Board.
Mr Jones is a Honorary Fellow of Lingnan University, the Hong Kong Institute of Directors and Hong Kong Securities Institute, and a Fellow of the Institute of Chartered Secretaries and Administrators and The Hong Kong Institute of Chartered Secretaries.