Where were the investors?
CSj looks at new proposals by the Securities and Futures Commission (SFC) to encourage proactive engagement between investors and publicly listed companies in Hong Kong.
Hong Kong, like many developed markets around the world, operates a disclosure-based regulatory regime. Under this model, regulators ensure that companies make adequate disclosures to stakeholders and they – in particular shareholders – are supposed to provide the necessary discipline to maintain corporate governance standards in the market. Where a company is failing to uphold basic corporate governance standards, investors either use their voting power to force managerial or board changes to get the company back on track, or they vote with their feet and disinvest in the company.
The success of this model, together with the ‘comply or explain’ enforcement mechanism used by Hong Kong’s Corporate Governance Code, is dependent on investors paying attention to the corporate governance standards of their investee companies and taking their share ownership responsibilities seriously – in particular participating and voting in general meetings. Where investors are passive passengers in their investee companies, the ‘market discipline’ element of Hong Kong’s disclosure-based regulatory model and the ‘comply or explain’ system breaks down.
‘Currently one element missing in Hong Kong’s corporate governance regime is shareholder engagement,’ the Securities and Futures Commission (SFC) states in its recently published consultation on its proposed Principles of Responsible Ownership. ‘In Hong Kong, there is no requirement, or means of encouragement, for institutional investors to engage with investee companies, to vote or even to disclose how they exercise their voting rights.’
Regulators have been driving the corporate governance reform agenda in Hong Kong for many years and the SFC hopes that its proposed Principles of Responsible Ownership, published last month and subject to a three-month consultation, will help to increase investor pressure for better corporate governance in the Hong Kong market.
Does Hong Kong need a stewardship code?
Since the global financial crisis, there has been a renewed focus on the concept of investor stewardship. In 2010 the UK brought out its Stewardship Code which emphasises that for investors, stewardship is more than just voting at the AGM. Shareholders stand at the top of the accountability chain of command. Directors hold managers accountable and shareholders hold the board accountable for the fulfillment of its responsibilities. Ideally, therefore, shareholders should be monitoring and engaging with companies on matters such as strategy, performance, risk, capital structure and corporate governance.
Is it time, then, for Hong Kong to catch up with this trend? Here in Asia, Malaysia and Japan have already introduced stewardship codes and in Australia industry bodies have promulgated shareholder engagement principles for institutional investors. The SFC’s proposed Principles of Responsible Ownership put forward seven principles of responsible ownership which ask investors:
- to establish and report to their stakeholders their policies for discharging their ownership responsibilities
- to monitor and engage with their investee companies
- to establish clear policies on when to escalate their engagement activities
- to have clear policies on voting
- to be willing to act collectively with other investors when appropriate
- to report to their stakeholders on how they have discharged their ownership responsibilities, and
- when investing on behalf of clients, to have policies on managing conflicts of interests.
The UK’s Stewardship Code has provided a useful model for many other jurisdictions’ codes and best practice guidelines on shareholder engagement, and the SFC acknowledges that it drew upon the experience of the UK and other jurisdictions around the world when drafting its proposed proposals. It emphasises, however, that the proposals are tailored very specifically to the Hong Kong market.
‘In discussing the approaches taken by other jurisdictions we are not suggesting their positions are necessarily the right direction for Hong Kong to take as we are mindful that cultural differences can dictate the manner and extent of a shareholder’s engagement with the investee company. However, the experiences of jurisdictions with similarly established financial markets to our own serve as a useful starting point in guiding Hong Kong as we embark on a similar exercise,’ the consultation states.
One obvious difference between the UK and Hong Kong markets is the dominance of closely-held companies in Hong Kong. The majority of Hong Kong companies are family-owned, or dominated by a single or small number of majority shareholders. These shareholders are typically highly engaged in the running of the business. In most cases they sit on the board, or, where they are not formally so appointed, the directors are mindful of their interests. In this scenario, while ‘shareholder engagement’ may be a non-issue, ‘investor stewardship’ is still highly relevant. Apart from anything else, there are the minority shareholder interests to consider and, like most jurisdictions, Hong Kong has been evolving towards a more diversely held market.
One characteristic which differentiates the SFC’s proposed principles from overseas models is that they are not solely focussed on institutional investors. The SFC consultation points out that shareholder engagement, irrespective of the size of their shareholdings, will have an impact on the governance of the investee company. ‘These benefits apply whether or not the person exercising these rights is an institutional investor or a beneficial owner. Accordingly we consider that any guidance should be aimed at all investors and we have drafted the principles on that basis,’ the consultation states.
The SFC recognises that certain elements of the principles, such as disclosure, reporting and accounting to stakeholders, will not apply to individuals. It also recognises that in recent decades there has been a notable increase in institutional ownership of publicly listed companies in Hong Kong. These institutional investors, such as retirement funds, insurance companies and mutual funds, are by far the biggest owners of shares of listed companies in Hong Kong.
‘The way in which such institutional shareholders use their rights is of fundamental importance to the health and stability of an investee company and ultimately to our economy,’ the consultation states.
The SFC therefore solicits views on whether Hong Kong should impose stricter compliance requirements for institutional investors and particularly those institutions which are authorised to manage assets for others. In general, the proposal is to make the principles non-binding and voluntary. Investors will be encouraged to ‘sign up’ to the principles and either disclose how they comply with them or explain why some or all of the principles do not apply.
The consultation seeks views on whether relevant entities, particularly those authorised, licensed and/or regulated by the Hong Kong Monetary Authority, the Mandatory Provident Fund Schemes Authority, the Office of the Commissioner of Insurance and the SFC, should be obliged to, rather than encouraged to, apply the principles on a ‘comply-or-explain’ basis.
The SFC envisages that eventually institutional investors will be subject to a stewardship code on a ‘comply-or-explain’ basis and points out that such codes are already in force in some overseas jurisdictions. ‘We believe a code setting out good practices of shareholder engagement for institutional investors will assist in encouraging such shareholders to act responsibly, not only towards their investee companies, but to support the health and stability of the Hong Kong financial market as a whole,’ the consultation states.
Imposing such a code in Hong Kong will require a number of issues to be considered. For example, which institutions would be deemed to be institutional investors? Moreover, how should compliance with the code be monitored and which regulator should be responsible for doing so? The obvious answer would be the SFC, but the consultation seeks views on whether the primary regulator in each respective industry should take on this task.
What is the relevance for intermediaries?
One obstacle to shareholder engagement, both in Hong Kong and globally, has been the increasing trend for investors to own their shares via intermediaries. These investors therefore exercise their shareholder rights – such as the right
to participate and vote in general meetings – via intermediaries such as institutional investors, brokers, banks
and proxy advisers.
The SFC proposes to establish the principle that owners of company equity should not blindly delegate their ownership responsibilities. ‘Even when they employ agents, directly or indirectly, to act on their behalf, owners should ensure that their ownership responsibilities are appropriately discharged by those agents,’ the consultation states.
The SFC believes that there should be guidance:
- to assist investors in determining how best to meet their ownership responsibilities whether these are exercised directly or through intermediaries, and
- for intermediaries on whom investors are depending to exercise ownership responsibilities.
The consultation asks whether intermediaries should be encouraged to commit to the principles and, if so, how this should be facilitated.
The initiative to introduce a paperless securities regime in Hong Kong is relevant here. Currently in Hong Kong, investors trading their shares via the Central Clearing and Settlement System (CCASS) do not always receive corporate communications and proxy voting materials since as they are not the registered holders of the shares. Legal ownership of the shares remains with the operator of CCASS – the Hong Kong Securities Clearing Company Nominees Ltd (HKSCC). One of the main drivers of the dematerialisation reform has been to facilitate direct ownership. The reform will allow investors holding electronic shares in CCASS to be able, for the first time, to register their securities in their own names and enjoy the full benefits of legal ownership.
The scripless share proposals are currently under scrutiny by LegCo. The SFC is also working on subsidiary legislation which it will be consulting the market on, though no dates have yet been fixed.
What difference will it make?
Looking at global trends, it would seem that the prospects for shareholder engagement in Hong Kong over the long term are good. Globally there has been an increasing trend for investors to exercise their votes on issues such as excessive director remuneration, dilution of shares, pre-emption rights, etc. Technological advances have also made activism much easier. As Lucy Newcombe, Corporate Communications Director at Computershare, pointed out in her article in this journal ‘preparing for your AGM’ (CSj, March 2013), social media platforms such as Twitter, Weibo, Facebook and Youtube, have provided ideal platforms for shareholders to escalate issues they feel strongly about.
Nevertheless, other global trends have been going in the opposite direction. The trend for shareholders to increasingly own their shares via intermediaries, and the trend towards short-term investing and high speed electronic trading, for example, have tended to reduce investor engagement.
Meanwhile, the level of shareholder engagement in Hong Kong has remained stubbornly low. In her ‘AGM Season Review 2014’ (CSj, November 2014), Lucy Newcombe notes the falling voting figures at AGMs here. While attendance at AGMs has been going up, the number of attendees who participate in the votes has been declining for four consecutive years.
In the context of these trends, will the SFC’s proposed Principles of Responsible Ownership have much impact? As mentioned at the beginning of this article, the philosophy underpinning Hong Kong’s regulatory regime requires that investors play their part in maintaining corporate governance standards. Whether or not they succeed in improving shareholder engagement in Hong Kong, what the SFC principles are attempting is highly significant for the HKSAR. Both its disclosure-based regime and the ‘comply or explain’ enforcement mechanism used by the Corporate Governance Code, only make sense if there is a real possibility that shareholders will take action where companies fall below expected standards.
Kieran Colvert, Editor, CSj
The SFC consultation will run until 2 June 2015. The full consultation paper is available on the SFC website (www.sfc.hk).