In the second and final part of his article on public governance, Gordon Jones FCIS FCS, author and Hong Kong’s former Registrar of Companies, turns his attention to the governance of not-for-profit entities and public bodies.

Initially, the corporate governance debate focused on public companies, in particular listed companies, because of the need for such companies to improve their accountability and transparency, consequential to a number of high-profile scandals involving these companies. However, as corporate governance affects all entities formed to provide products and services, there is a danger that its application to other corporate or quasi-corporate entities, particularly not-for-profit entities and public bodies, is either forgotten or given a lower priority.

These entities tend to be either companies limited by guarantee or statutory bodies, providing public services, in many cases receiving a government subvention. In recent years, the concept of corporate governance has extended from the private to the public sector as a direct consequence of the desire for greater efficiency and economy in the deployment of public resources, and higher expectations regarding accountability and transparency in this sector.

Governance control mechanisms in public corporations

Increasingly, a large number of public services in Hong Kong, like elsewhere in the world, are not directly delivered by the government, operating through the civil service and departments, but through ‘quasi autonomous non-governmental organisations’ (quangos). These usually take the form of statutory organisations or government-controlled and subsidised corporations which assume a number of the features of a genuine commercial entity, for example they have directors and are expected to operate ‘commercially’. These entities are not, however, subject to the discipline of shareholder investment and the capital markets which are the main drivers of corporate governance
in companies limited by share capital, particularly public listed companies. Furthermore, those entities receiving
a government subvention have the protection of a continuous financial ‘cushion’ courtesy of the public purse, and poor and inadequate governance will not have the same consequences as in the case of, for example, a public listed company.

It is difficult, if not impossible, and would not be appropriate, to adopt a ‘one-size-fits-all’ approach towards corporate governance in the public sector, given the fact that public sector bodies vary considerably in size and operate in different statutory, regulatory and managerial frameworks. Nevertheless, certain fundamental principles are common to all such entities. In this respect, a study by the International Federation of Accountants (IFAC) provided a comprehensive international benchmark for public-sector governance.

The IFAC study noted that ‘public-sector entities have to satisfy a complex range of political, economic and social objectives, which subject them to a different set of external constraints. They are also subject to forms of accountability to various stakeholders, which are different to those that a company in the private sector has to its shareholders, customers etc’. The stakeholders in public-sector entities may be many and varied, ‘each with a legitimate interest in public-sector entities, but not necessarily with any “ownership rights”’ (see Governance in the public sector: a governing body perspective, International Federation of Accountants, August 2001).

The levels of corporate governance of such entities should be at least as good as, if not better than, say, a major public company, particularly given that, in many cases, they are discharging important public services and receiving not inconsiderable amounts of public-sector subsidy and subvention, both direct and indirect. The promotion of good corporate governance in such entities, therefore, poses particular challenges. Given the absence of the external pressures of shareholder and market disciplines which exist in the cases of commercial companies, much will depend on external pressures from other sources. In the public sector, specific user groups, those directly responsible for funding, for example the government and the public at large from which public resources ultimately derive, assume a greater importance as stakeholders. However, the pivotal role of the governing board and the core issues of accountability are as relevant to the public sector as they are to the private sector. In this respect, accountability for the use and stewardship of public funds and assets (including direct subventions and designated streams of public revenue, and other benefits, such as free or concessionary land grants and nominal rents) is a particularly important concept in public governance.

Not-for-profit entities and public bodies in Hong Kong

Not-for-profit entities and public bodies in Hong Kong can be classified under four main categories:

  1. limited liability companies formed and registered under the Companies Ordinance (CO), which are generally companies limited by guarantee (a number of these are registered under section 21 of the Companies Ordinance which gives them special dispensation not to use the word ‘limited’ in the company name)
  2. organisations formed under the Societies Ordinance
  3. entities registered under specific specialist ordinances, for example the Trade Unions Ordinance, the Cooperative Societies Ordinance, the Registered Trustees Incorporated Ordinance, etc, and
  4. entities formed under their own specific ordinances, for example over 40 special incorporation ordinances for educational, religious and charitable bodies such as the English Schools Foundation, and major statutory bodies for example the Securities and Futures Commission, the Trade Development Council, the Consumer Council, the Hong Kong Tourism Board, the Hong Kong Productivity Council, etc.

These entities vary enormously in terms of size and complexity ranging from major statutory bodies with massive budgets to very small sporting clubs and religious bodies constituted as companies limited by guarantee. Furthermore, they are organisations responsible for delivering an even wider spectrum of activities and services including agricultural promotion, arts and culture, consumer protection, educational, housing management, labour, medical and health, political parties, private clubs, professional organisations, religious worship, social welfare promotion, securities regulation, sports promotion, tourist promotion, trade promotion, etc. These entities can also be further subdivided into those which receive a government subvention and those which have charitable status.

In corporate governance terms, those entities which receive a public subvention and/ or have charitable status have a greater public interest dimension than those which do not, and should be given priority in any future governance reforms.

This sheer diversity of responsibilities also means that most policy bureaus in the government are responsible in some way for the policy and funding (where necessary) of these entities, in particular statutory public bodies. The diversity of policy responsibility also means that there will also be variations in the attention and priority given by the different policy bureaus to the corporate governance standards of these entities, particularly as the bureaus have many competing claims on their time and resources. As an inevitable consequence, the corporate governance of public bodies will tend
to impress itself on the attention of a bureau’s senior management only if and when problems emerge resulting in adverse publicity. This is a particularly important issue given the critically important role played by the government in the governance of public bodies both as a key stakeholder and, in many cases, the ultimate provider of financial support.

Responsibility for the governance of not-for-profit entities which are not statutory bodies is also very fragmented. The Companies Registry is responsible for guarantee companies formed under the Companies Ordinance and registered incorporated trustees formed under the Registered Trustees Incorporated Ordinance; the Hong Kong Police is responsible for societies formed under the Societies Ordinance; the Labour Department is responsible for trade unions formed under the Trades Unions Ordinance; and the Agriculture and Fisheries Department is responsible for agricultural and fisheries co-operatives formed under the Cooperative Societies Ordinance. These five ordinances are  all very different and, given the very different nature and functions of the entities formed and registered under them, impose very different standards and requirements. In addition, many not-for- profit entities and public bodies are not formed under any of these ordinances but have their own ordinances.

Governance benchmarks

1. Corporate governance for public bodies – a basic framework

Over the past decade, a significant number of studies of not-for-profit entities and public bodies have been taken by various organisations including, inter alia, the government’s Central Policy Unit, Civic Exchange and the Social Welfare Department. However, there were no guidelines on how these bodies should implement good corporate governance practices until the HKICPA published Corporate governance for public bodies – a basic framework in May 2004. This framework arose from the HKICPA’s experience in reviewing the financial reports of public entities within the not-for-profit category for the Institute’s annual Best Corporate Governance Disclosure Awards. In the context of the awards competition, the judges noted the difficulty of assessing the public sector/ not-for-profit organisations category because of the absence of corporate governance benchmarks and generally-accepted standards in the public sector. One of the reasons for the lack of benchmarks was that corporate governance in the public sector has generally received less attention than that in the private sector.

The HKICPA guide attempts to provide a basic framework for public-sector corporate governance by outlining common principles that are applicable to most categories of public-sector organisations, and by recommending good corporate governance practices. However, it stressed that not all of the guide’s recommendations would be applicable to all organisations, particularly very small organisations that did not operate through a traditional governing board structure. Conversely, at the other end of the spectrum, large complex organisations would need to build upon the outline contained in the guide in order to achieve an effective and sufficiently extensive corporate governance system.

2. Practical guide to corporate governance for subvented organisations

The HKICPA guide was supplemented in 2010 by the Practical guide to corporate governance for subvented organisations published by the government’s Efficiency Unit. This covers much the same topics as the HKICPA guide but expounds on these topics in greater detail, with examples drawn from various subvented organisations and comments by the Director of Audit on deficiencies in the corporate governance arrangements in various subvented organisations.

The Efficiency Unit guide is aimed at board members and senior executives of subvented organisations, that is, those that receive recurrent subventions from the government to cover part or all of their operational expenses. Nevertheless, those organisations that receive capital grants or non-cash concessions, one- off subventions, and companies in which government holds shares are also encouraged to refer to the best practices promulgated in the guide. As such, it covers a narrower category of organisations than the HKICPA guide.

The Efficiency Unit guide points out that, in the past few years, the Director of Audit has conducted a number of reviews on subvented organisations. As a result of these reviews, varying degrees of inadequacies, as fundamental as the absence of basic accounting practices, in their corporate governance systems, processes and practices have been found in all cases. Examples of these inadequacies include:

  • board structure/ composition – poor composition and mix of board membership and too many board members; the post of chairperson and chief executive officer were filled by the same person; reappointing board members with low attendance rates
  • board operation and effectiveness – lack of guidelines on meeting proceedings; lack of records on votes taken at board/ committee meetings; late submission of papers to board/ committee members
  • strategy, planning and monitoring – not preparing strategic plans in a timely manner; no annual business plan; lack of budgetary control requirements and processes
  • transparency and disclosure – non- disclosure of performance measures; no periodic reviews of performance measures; lack of outcome indicators
  • risk management and compliance – non-compliance with rules on management of investments; requirements for submitting annual reports to oversight agencies not followed; reporting errors in the organisation’s annual accounts, for example ineligible expenditure claims, spending limits exceeded, and
  • corporate citizenship – not providing community services in the organisation’s area of expertise; register of directors’ interests not available for public inspection; no declaration of interests by board members.

Regulation of charities

A significant number of not-for-profit entities with a significant public and social service dimension are charities. In recent years, a number of executives in the charities sector have called for the better regulation of this sector after a public opinion survey by the Hong Kong Council for Social Service (HKCSS) showed that a charity’s reputation (91%) and transparency (86%) were the most important factors in determining respondents’ intention to donate to a charity. However, out of the nearly 5,900 registered charities in Hong Kong, only 147 had made their accounts available to the HKCSS’s ‘Wise Giving’ data base. While this is a very small sample, it appears that expenses for 11 of the organisations concerned accounted for 35% of their expenditure and, in the case of four, more than 50% of their expenditure.

On 16 June 2011, the Law Reform Commission’s Charities Sub-committee published a consultation paper with 20 recommendations proposing that a wide ranging regulatory regime for charities should be introduced in Hong Kong and that a Charity Commission should be set up as the regulatory body for charities (see The Law Reform Commission of Hong Kong Sub-Committee consultation paper on charities). The paper pointed out that the need for greater monitoring of charitable organisations has been widely discussed by the community in recent years, and there is growing public concern that a system should be put in place to both regulate charities and enhance their transparency. The public consultation on the Law Reform Commission’s recommendations ended in October 2011. The government’s response is awaited but, according to a report in the South China Morning Post dated 29 May 2012, the Department of Justice said that it would take six months to assess the report and decide what to do.

The Way Forward

It is clear that much still remains to be done in improving public governance in Hong Kong. However, it is also equally clear that this will not be easy given the fragmentation of policy/ executive responsibility within the government for these entities. Despite this, the broad outlines of a possible approach are discernible.

Appointments to advisory committees and public bodies

The government needs to significantly widen the pool of potential appointees to the boards of advisory committees and public bodies, irrespective of whether they are constituted as statutory organisations or not-for-profit companies. This will ensure that the views of as diverse a group of people as possible are reflected to the government for the purpose of policy formulation.

In parallel with this, the government needs to make the system of appointments to these bodies much more transparent and comply as much as possible with its own ‘six years’ and ‘six committees’ rules regarding the maximum period of time for which a person can be appointed to an advisory committee or public body, and the number of advisory committees and statutory bodies on which they can serve. This will ensure regular infusions of new talent to the advisory process.

Finally, the government needs to undertake regular reviews of its guidelines regarding declarations of ‘registrable interest’ and ‘conflicts of interest’ in the case of appointees to advisory committees and public bodies to ensure that they are always fit for purpose. Quite separately from this, the government has to show that it is prepared to take appropriate action, as and when necessary, to deal with cases involving conflicts of interest, irrespective of the individuals involved.

Governance of public bodies

The Chief Secretary for Administration’s Office (CSO), which has a key role in coordinating policy formulation and implementation, needs to take a much more proactive role in developing governance standards for public bodies as this frequently cuts across the boundaries between policy bureaus. It is also clear from the Director of Audit’s reports mentioned above that, in a number of cases, the relevant policy bureau/ department did not adequately monitor the governance of these bodies, in particular, the use of funds by subvented bodies.

Governance of subvented public bodies

The very fact that the government has not inconsiderable control over such bodies by virtue of the public subvention ensures that the government has the ability and leverage to implement reforms if necessary, as illustrated by some of the case studies outlined in the box above. As a last resort, the government can always reduce or, in extremis, even remove the subvention. In view of this, the CSO, which is responsible for, inter alia, the Efficiency Unit, should require policy bureaus to:

  • ensure that the statutory and subvented bodies which fall under their policy purview follow the Efficiency Unit’s guide
  • undermining the autonomy of these bodies to manage their own affairs
  • take greater care in appointing appropriate people to the boards and councils of these bodies and monitoring their performance, and
  • actively monitor expenditure by subvented bodies and take appropriate action as and when this proves

Governance of non-subvented public bodies

The CSO and the Efficiency Unit should also consider developing similar guidance on governance for not-for-profit entities and public bodies which do not receive a public subvention, particularly if those bodies are responsible for discharging public services. The HKICPA guide could provide guidance in this respect.

Reform of charity law and establishment of a Charity Commission

Further reform in this area will be dependent on the government’s response to the Law Reform Commission’s recommendations. Assuming that a Charity Ordinance is drafted and a Charity Commission established in Hong Kong, it would be necessary to consider regulatory responsibility for those charities which are also subvented bodies to ensure that there is no regulatory overlap and disputes between the Charity Commission and the relevant policy bureaus.

 

 

Gordon Jones FCIS FCS

Author and former Registrar of Companies, Hong Kong

 

SIDEBAR: What went wrong?

In recent years, the Director of Audit’s reports and newspaper investigations have revealed a significant number of governance failures among statutory and subvented bodies in Hong Kong. Some of these cases are outlined below.

Equal Opportunities Commission. In March 2009, the Director of Audit revealed that the then Chairman of the Equal Opportunities Commission had spent excessively on hospitality and had accepted an inappropriate degree of hospitality while on overseas trips.

Privacy Commission. In October 2009, the Director of Audit revealed that the Privacy Commission was renting 58% more office space than it was entitled to, costing tax payers an extra HK$143,500 per month.

Productivity Council. The same report also highlighted the payment of unauthorised cash allowances for housing benefits to senior staff of the Productivity Council – including the then Executive Director. Also up to 9,000 computers, audio-visual items and pieces of laboratory equipment worth more than $57 million were missing from the Council’s various inventory checks.

Hong Kong Polytechnic University. In 2009, the university sold depreciated stocks, derivatives and bonds during the global credit crisis losing about HK$504 million which was equivalent to almost a third of its total tuition income for that year. In addition, it was noted that 97 staff earned more than $1.8 million, with the highest-paid earning $4.65 million to $4.8 million.

Direct Subsidy Schools. Eight schools in the government’s Direct Subsidy Scheme were found to have underestimated their reserves by 100% when applying for fee rises in 2008/ 2009. Also, 22 schools had failed to set aside the required 10% of their tuition fees for scholarships or other assistance schemes.

Employees Retraining Board. In November 2011, the Director of Audit revealed that the Employees Retraining Board’s Memorandum of Administrative Arrangements with the government and strategic plan had not been updated since 2001 and November 2003 respectively. It had also failed to submit budgets from 2008 to 2011 to the Finance and Administration Committee.

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