A special relationship? Independent non-executive directors and the company secretary
Regulators and senior company secretaries give their views on how the company secretary can support the effectiveness of independent nonexecutive directors.
Within a unitary board system, corporate governance relies on independent non-executive directors to provide independent oversight and constructive challenge to executive directors. Given the concentrated shareholding structure prevalent in Hong Kong, the independent director role is all the more crucial and regulators here have been gradually fine-tuning the requirements of the listing rules regarding their number and the criteria determining independence.
Since December 2012, for example, the listing rules have required independent non-executive directors to account for one third of the board. Moreover, Hong Kong has elaborate requirements relating to the independence of such directors from the companies they serve. Recent amendments to the listing rules added to these requirements by introducing Code Provision A.4.3 to the Corporate Governance Code requiring independent non-executive directors who have been with a company for more than nine years to get shareholders’ approval to continue to serve.
Some commentators have cast doubt on whether these measures will have the desired effect. In the following article (see pages 12–14), for example, CK Low FCIS FCS, Associate Professor in Corporate Law, Chinese University of Hong Kong Business School, argues that the requirements designed to ensure the independence of independent directors from the company’s executive and its controlling shareholders may be missing the point. Independence is a ‘state of mind’, he argues.
There is much more consensus, however, regarding the importance of independent directors’ access to accurate, timely and high-quality information. This has been recognised by Hong Kong Exchanges and Clearing (HKEx) – it amended the listing rules in 2012 to introduce a code provision, on a ‘comply or explain’ basis, stating that management should provide all directors, including independents, with monthly updates on the company’s performance and business outlook. That same raft of changes to the listing rules also focused on the role of the company secretary in the information chain. The newly created Section F of Hong Kong’s Corporate Governance Code, for example, made explicit the company secretary’s role and responsibility to facilitate induction and the professional development of directors.
Bridging the information gap
‘The role of independent directors has changed over the past 20 years from just showing up at board meetings to meet the basic requirements of the listing rules to making meaningful contributions to the company in implementing best corporate governance practices,’ says Ernest Lee, Partner, Ernst & Young, China. ‘Greater commitment in terms of time and effort are expected of independent directors to meet the governance objective these days. In addition to their own expertise and experience, independent directors should also possess a minimum level of accounting knowledge to enable them to raise questions when reading the more complex financial statements,’ he adds.
Mohan Datwani FCIS FCS(PE), HKICS Director of Technical and Research, says the company secretary plays a facilitative role and serves as a bridge between the management and independent directors in all information exchange. ‘If you look at the role of the company secretary, he or she is actually part of the management team and serves the board in all communications. That means that the company secretary has a dual role; on the one hand to instil good corporate governance practices and on the other hand to facilitate the communication among all board members, including independent directors,’ he says.
One of the key ways in which company secretaries support the board is by managing the induction process for newly appointed directors. This is especially important for independents. Paul Stafford FCIS FCS, Corporation Secretary and Regional Company Secretary AsiaPacific, The Hongkong and Shanghai Banking Corporation Ltd, points out that independent non-executive directors need to undertake their own due diligence before any board appointment, but, since they will generally not be as close to the company’s business as their executive colleagues, they will be looking for a deeper understanding of the company in the induction process to supplement the due diligence they have already undertaken.
‘Independent directors rely heavily on the company secretary to obtain adequate information to help them discharge their duties properly,’ says April Chan, Company Secretary, CLP Holdings. ‘All directors are expected to make contributions to their best and therefore a tailor-made induction programme for each independent director is necessary. They need to familiarise themselves with the business and its operating environment – including the political landscape. Independent directors come from different backgrounds and have different expertise so the induction programme has to be tailored to meet their areas of focus.’
For all incoming directors, a formal induction programme comprises basic information explaining their responsibilities as a director and providing an overview of the company and its business. An information pack will also be given to the incoming director giving details of the disclosures that directors are obliged to make to the company in order to comply with relevant rules and regulations. In addition to these materials, a good induction programme will usually arrange meetings between the incoming directors and the executive directors and the department heads of the company’s main business units to provide them with a detailed and in-depth understanding of the business. ‘Depending on the independent director’s individual expertise and experience, meetings may be arranged with department heads, such as that for sustainability, to discuss issues of most concern,’ says April Chan.
Induction programmes should therefore be very interactive, Mohan Datwani adds. ‘If the company has an in-house compliance officer, the company secretary might call in the compliance officer to brief the independent director on the compliance issues. Similarly, meetings or site visits could be arranged for an incoming independent director, so these inductions are not only classroom-based,’ he says.
After the induction process, the ongoing support and advice provided by the company secretary to independent directors serving on the board is equally important. This helps bridge the information gap between executive and non-executive directors. April Chan emphasises that it is important for the company secretary to build trust and a good working relationship with all directors, including the independents. ‘The company secretary needs to have an impartial mind and a neutral stance in order for the directors to feel that the company secretary is reliable and willing to follow up the issues with management. The trust-building process is a long journey but also very fruitful,’ she says.
If a good rapport has been established with the independent directors, it will be easier to introduce new corporate governance initiatives to the board. ‘Consulting them on proposed corporate governance practices and getting their early views/consent on the feasibility of such practices is often key to the successful introduction of a new corporate governance practice. You want more allies when the plan is being discussed at the board,’ she says.
As mentioned in the introduction, regulators have adopted a number of different measures designed to boost the effectiveness of independent directors. Currently, the regulatory regime relating to such directors focuses on ensuring that boards have enough of them and that they are genuinely independent from the company’s executive and its controlling shareholders, but are these rules effective? And are there other reform ideas Hong Kong should consider?
One suggestion originating in the UK’s 2003 Higgs review (Review of the Role and Effectiveness of Non-Executive Directors) is that boards should appoint a senior independent director (SID) from among their independent non-executives. Higgs felt that the SID would give shareholders a point of contact alternative to the chairman or chief executive.
In addition, the SID would be expected to:
• serve as the ‘deputy’ to the chairman of the board as and when required
• chair meetings with other independent directors (in the absence of the chairman) encouraging open dialogue, particularly regarding the chairman’s performance, and
• act on the results of performance evaluation of the chairman.
Respondents to this article expressed doubts as to whether this innovation could be usefully introduced in Hong Kong. ‘My concern is that it may not be very practical taking into account the culture of local companies,’ Mohan Datwani explains. He adds that any SIDs would need a very well-defined role on the board, and that more research and consultation would be needed before such a practice was added to our regulatory regime whether as a recommendation or requirement.
April Chan points out that the concept of the SID is counter to the principle that all directors should be regarded as equal. Moreover, she points out that each committee under the board, such as the audit and remuneration committees, has a chairperson to lead meetings and therefore this proposed function of the SID would be redundant.
David Graham, Head of Listing at HKEx, also expressed concerns about the practicality of this board model and pointed out that the UK’s proposal to introduce SIDs was greeted with scepticism with some corporate leaders seeing the role as unnecessary or divisive. The creation of an additional SID position could potentially increase bureaucracy and distract from the authority of the chairman of the board.
Independent election of independents
Another reform proposal relating to independent directors concerns the manner in which they are recruited to the board. David Graham points out that regulators in the UK have introduced a dual-voting structure in which independent directors of premium listed companies with a controlling shareholder are elected with the approval of both the shareholders as a whole and the independent shareholders.
‘The dual-voting structure was only introduced in the UK this year, we should wait and see how the issuers and shareholders are embracing this new structure and the effects it has on corporate governance before we consider the appropriate way forward for Hong Kong,’ he says.
David Webb has been lobbying to exclude controlling shareholders from independent director elections in Hong Kong, and, in the following article, Professor CK Low puts forward a ‘negative voting’ proposal – a process through which the election or re-election of independent directors requires not only the majority support of shareholders, but also requires no more than a certain percentage of ‘dissenting or opposing’ votes from independent shareholders.
In December 2010, HKEx sought market views on whether to introduce a cap on the number of independent nonexecutive director positions an individual may hold and, if a cap is to be imposed, what the maximum number of such positions should be (see Consultation Paper on Review of the Code on Corporate Governance Practices and Associated Listing Rules of December 2010). ‘The overwhelming response we received from the market was a strong objection to a cap on the number of directorships that an individual can hold,’ says David Graham. ‘Given the market’s strong resistance, we decided not to pursue this issue further at this time.’
April Chan believes that this question should be left to the discretion of the individuals and the companies concerned. ‘Independent director candidates are required to disclose the directorships they hold in other organisations, including NGOs, to the company in the first place, and it would be up to the nomination committee to judge their competence and time available for the company,’ she says.
However, a certain number of directorships may even be seen as an asset to the company since the independent director could leverage on this experience in other companies and exposure to other industries, she adds. By the same token, she supports company secretaries taking up independent director roles in other companies so that they could look at corporate governance issues ‘from both sides of the table’.
Jimmy Chow, Journalist, and Kieran Colvert, Editor, CSj
In March 2014, the HKICS published a guidance note on the company secretary’s roles and responsibilities under Section F of the listing rules to facilitate induction and professional development of directors (see ‘Guide on Directors’ Induction (An Overview)’ in the publications section of the HKICS website: www.hkics.org.hk).
In January 2013, the Institute of Chartered Secretaries and Administrators (ICSA) published a guidance note on the role of non-executive directors (see ‘ICSA Guidance on Liability of NonExecutive Directors: Care, Skill and Diligence’ on the ICSA website: www.icsa.org.uk).