The SFC’s Principles of Responsible Ownership: a review
CSj reviews the finalised draft of Hong Kong’s new investor code which seeks to provide guidance on how investors should fulfil their ownership responsibilities in relation to investments in Hong Kong listed companies.
There is currently no guidance in Hong Kong on how investors should engage with investee companies, vote or even to disclose how they exercise their voting rights. The Securities and Futures Commission (SFC) regards this as a gap in Hong Kong’s corporate governance regime which it intends to remedy. Last month the SFC announced that it will implement its proposed voluntary code on responsible ownership, though no date has yet been fixed for its implementation. The SFC launched its draft code – entitled Principles of Responsible Ownership – for a three-month public consultation in March 2015. Last month the SFC published the consultation conclusions and the finalised draft of the code.
‘The Principles of Responsible Ownership describe what we perceive as best practices for share ownership and we encourage investors to adopt them,’ said Ashley Alder, the SFC’s Chief Executive Officer. ‘This can encourage an investment culture where engagement with investee companies is seen as paramount and fundamental and which in turn strengthens corporate governance.’
Key features of the code
During the consultation on its draft principles last year, the SFC received written submissions from 56 respondents, including one from the HKICS. The SFC has modified the principles in view of the responses and comments received and the revised principles are included in Appendix A of the consultation conclusions (available in the ‘Consultations and conclusions’ section of the SFC website: www.sfc.hk).
There has been no change to the seven basic principles included in the code. These are that investors should:
- establish and report to their stakeholders their policies for discharging their ownership responsibilities
- monitor and engage with their investee companies
- consider and establish clear policies on when they will escalate their
- engagement activities have clear policies on voting guidance
- be willing to act collectively with other investors where appropriate
- report to their stakeholders on how they have discharged their ownership responsibilities, and
- have policies on managing conflicts of interests when investing on behalf of clients.
The changes made as a result of the consultation relate to the scope and application of these principles.
To whom does the code apply?
The draft principles launched for consultation last year were unusual in that they were intended to target all investors rather than just institutional investors. Most overseas investor codes exclusively apply to institutional investors. The SFC argued that the benefits of responsible ownership 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 SFC’s March 2015 consultation states.
In the finalised draft of the principles, however, references to individual and retail investors have been deleted. The principles do not define the scope or meaning of the term ‘investors’, as the SFC intends to leave it to investors to determine whether the principles are applicable to them, but the SFC has narrowed the focus of the code to investors who invest money, or hold shares, on behalf of clients and other stakeholders and are accountable to such clients and other stakeholders.
The SFC still hopes that individual and retail investors will use the principles as valuable guidance on share ownership engagement. ‘Although individual and retail investors are in a different position (in terms of accountability) from other investors like institutional investors, they still play an important role in terms of corporate governance in listed companies. They should recognise the ownership rights that are available to them, including the right to exercise their votes at annual general meetings,’ the SFC’s consultation conclusions state.
The conclusions add that individual and retail investors can also exercise their market power by choosing asset managers who have adopted the principles.
Is the code voluntary?
The original text of the principles stated that – ‘The principles are non-binding and are voluntary in that they operate on a “comply-or-explain” basis’. This was somewhat confusing. Within the context of Hong Kong’s Corporate Governance Code there is a very clear distinction between the ‘Recommended Best Practices’ which are entirely voluntary, and the ‘Code Provisions’ which are subject to “comply-or-explain”. The “comply-or-explain” expectation therefore sits mid-way between voluntary ‘Recommended Best Practices’ and the mandatory listing rules.
In the finalised text, this confusion has been cleared up with the deletion of the reference to comply-or-explain. The SFC makes it clear that the principles are voluntary although it seeks to encourage investors to adopt the principles. In particular:
- investors who hold or receive funds from the public that are invested in shares of Hong Kong listed companies are encouraged to adopt the principles and disclose to their stakeholders in accordance with the principles, and
- investors who do not think that the principles are relevant or suitable for them are encouraged to provide their stakeholders with disclosure which clearly explains why the principles have not been adopted at the outset and, if applicable, explain what alternative measures they have in place.
If investors choose to adopt the principles, they do so by first disclosing to their stakeholders that they have done so, and then proceed to apply the principles in their entirety or explain any deviations. At this stage, the SFC does not intend to keep or publish a list of investors who have chosen to adopt the principles.
The issue of whether certain types of investors, such as statutory asset owners and public institutions managing funds collected from the general public, should be obliged to apply the principles on a comply-or-explain basis has not been resolved. ‘The SFC will monitor the Principles’ reception and development to determine whether any amendments or the introduction of obligations or requirements may be necessary at a future stage,’ the SFC states. In particular, the SFC will review the issues set out below:
- Should there be requirements for specified institutions to disclose whether they have adopted the principles and, if not, explain why?
- Should the disclosure of a fund manager’s engagement policy be mandated, whether by adoption of the principles or an equivalent overseas stewardship code and, if so, how it should be disclosed?
- If intermediaries hold investments on behalf of individual investors, should intermediaries explain, if appropriate, in writing whether ownership responsibilities rest with the intermediaries or individuals and, if the latter, whether the individuals should be advised on how they can exercise their ownership responsibilities?
What difference will it make?
What will be the impact of Hong Kong’s new investor code? In the short term, it is unlikely to have much impact on the level of investor engagement with companies in Hong Kong. While there has been a rising trend for institutional investors to engage with investee companies in Hong Kong, the average voting rate at AGMs in Hong Kong and Mainland China has been declining for five consecutive years (see Lucy Newcombe’s article ‘2015 AGM season review’ in the November 2015 edition of CSj).
The publication of this best practice code should, however, promote greater understanding among investors of their share ownership responsibilities. Its emphasis on the need for investors to report to stakeholders on their policies for discharging their ownership responsibilities (this is the first principle in the new code, coming before the principle on the need for investors to monitor and engage with investee companies), should also promote greater transparency between investors and their stakeholders.
The SFC hopes that the impact of the code will go beyond that, however. It hopes that the code will put investors back into the corporate governance picture. Hong Kong’s corporate governance regime is based on the notion that investors provide ‘market discipline’ by making informed choices about where to invest. This mechanism only works, of course, if investors are well informed and sufficiently ‘active’ to take action where companies fall below expected standards. The consultation conclusions released last month point out that ‘strong corporate governance requires listed companies and their directors to be proactive, as well as shareholders to be both reactive and proactive. Without shareholders’ involvement, the efforts of listed companies and their directors cannot be measured or appreciated’.
The SFC sees the new investor code as complementary to the existing legal framework for promoting corporate governance, which has historically been focused on corporate and directors’ obligations. ‘Investors who take the initiative to review their investee companies’ disclosures and monitor their investee companies (including the companies’ performance, decisions and corporate actions) tend to have a better understanding of their investments. Well-informed investors are able to react effectively to their investee companies’ disclosures and, in exercising their rights, are thereby able to engage effectively with investee companies. Effective engagement by investors generally leads to better-run companies,’ the SFC’s consultation conclusions state.
The SFC’s ‘Consultation Conclusions on Responsible Ownership’ are available on the ‘Consultations and conclusions’ section of the SFC website: www.sfc.hk.
SIDEBAR: INSIDE INFORMATION
Some respondents to the SFC’s March 2015 consultation on the Principles of Responsible Ownership expressed concerns that listed companies engaging with shareholders may result in accidental dissemination of inside information, especially where companies are pressed by aggressive fund managers or analysts. The SFC emphasises that the principles do not give investors the right to information beyond that available in compliance with legislation or regulation. An amendment has been made to the notes to Principle 2 to this end. The amended notes make it clear that investors should not seek inside information under the guise of engagement, and investee companies answering requests for meetings or information have a duty to ensure that confidential inside information is not leaked and to ensure that investors are treated equally.