An independent view
Many corporate governance systems around the world have put increasing reliance on the role of the independent director, but what is it like to perform this role? What makes a good independent director? What is the relationship between the company secretary and independent directors? This month’s In Profile candidate, Anthony Fan, President of the Hong Kong Independent Non-Executive Directors Association, gives us an introduction to the world of the professional independent non-executive director.
Thanks for giving us this interview. Could we start by discussing the Hong Kong Independent Non-Executive Directors Association (HKiNEDA) – when and why was it established?
‘In the second half of 2014, a number of independent non-executive directors (INEDs) in Hong Kong got together to address the increasing expectations of the INED role. From our viewpoint, achieving better corporate governance requires many different parties – including regulators, listed companies, investors, the management of public companies and the whole community – to work hand-in-hand together. A group of credible, high-reputation INEDs cannot single-handedly improve corporate governance. Even regulators putting out very strict rules cannot guarantee good corporate governance, it doesn’t work that way.
We felt therefore that there was a need for INEDs to have a window to communicate with other parties, including the regulators, the media and investors. We wanted to communicate the INED viewpoint on relevant issues, and particularly to address the high expectations of our role. So that was why we established HKiNEDA.
In March 2015, we formally registered the association with the Companies Registry, and last October we had the inauguration ceremony. I think we are approaching 400 members now. So it is really quite a well-established community and a good representative body for INEDs in Hong Kong.’
You mentioned that the expectations of INEDs can be too high and there has been an increasing reliance on independent directors, both globally and in Hong Kong. What do you think INEDs can achieve in terms of improving corporate governance?
‘Having independent directors is a good practice and this practice has been proven to work in developed capital markets. Hong Kong is probably one of the pioneers in this area in Asia, I would say. If I remember correctly, it brought in the practice in 1993, so it was one of the early adopters of this practice in Asia.
But this is an evolving issue. If the community is still developing and you suddenly set a very high standard for corporate governance, then you risk discouraging some very qualified INEDs from taking up the role. They may feel that the reward does not justify the responsibility. We want to encourage more professional directors to join our community and take up positions as professional INEDs; we don’t want the controlling shareholders to ask their primary school classmates to become INEDs on their board – that doesn’t help corporate governance.
So the reward and responsibility have to be better matched. Currently there are huge discrepancies in the compensation for INEDs – some companies are just paying them to be very passive independent directors. So the HKiNEDA is trying to build up a talent pool of professional independent directors and establish a channel for companies to source their independent directors in a professional manner, rather than through their personal connections.’
So HKiNEDA provides a channel to link businesses with potential INEDs?
‘That is one of the functions of HKiNEDA. Qualified INED candidates upload their CVs to our “talent pool” database, which has become a popular way for public companies to find independent directors. We don’t charge anything – this is purely a service for our members.’
Is HKiNEDA also involved in providing training to INEDs?
‘We are planning to introduce an induction course for INEDs. Currently there is no requirement for INEDs to have any professional qualifications. This is true of all directors – pretty much anybody can be a company director as long as he or she doesn’t have a criminal record. So many individuals who take up INED positions have professional experience in how to grow a company but very little knowledge about corporate governance. Our induction course will be designed to help these first-time independent directors, giving them a good orientation on how to perform their duties.
There aren’t any text books or courses to teach you how to become a good independent director and that knowledge belongs to a relatively small group of people. Business schools teach you about finance, marketing and human resources, but they don’t teach you how to become a good director. Our course would give new INEDs the chance to hear from very experienced INEDs about their practical experience of the INED role.’
Do you think there should be a formal professional qualification requirement for directors?
‘Our goal at this stage is to promote professional independent directors – that’s already a big step. If more and more public companies are willing to hire professionals to become their independent directors, rather than their school mates or relatives, that will already be a big step forward for corporate governance.’
In Taiwan and Mainland China it is relatively common to have both independent directors on the primary board and a supervisory board – do you think there is a danger of duplication in this arrangement?
‘Both Taiwan and China have this legacy in their company law structure. Taiwan is currently carrying out a major reform of its company law so we will have to see which way that goes, but the regulators there have been promoting independent directors quite aggressively. Recently, for example, they introduced a regulation that public companies need to have at least three independent directors on the board.
I do have experience of working for companies with a two-tier board and I think, where you have independent directors as well as a supervisory board, regulators tend to put more focus on the independent directors rather than the supervisory board. If you look at the functionality of the supervisory board, it acts very much like the audit committee of a single-tier board. But the terms of reference of the audit committee are very clear, whereas the functionality of the supervisory board is more ad hoc. If they spot something strange or of particular interest, they would raise the issue. The audit committee, on the other hand, has a set agenda which they need to fulfil throughout the year.’
In 2012 the HKICS issued a research report which promoted the need for boards to look more widely in the talent pool to fill board vacancies in the interests of board diversity – do you think boards in Hong Kong and the region would benefit from greater diversity?
‘Board diversity right now is probably paying too much attention to female directors. Board diversity should cover many things, including gender, age, length of service, types of directors, professional qualifications and areas of expertise. Getting the right balance between executive, non-executive and independent directors is also a consideration. Some companies have a majority of non-executive and independent directors on their board. Other companies just meet the minimum requirement, that is, having one-third of the board comprising independent directors. So this should be a board diversity issue for discussion.
Qualifications is another area which not too many people have paid attention to. You need various kinds of expertise and talents to grow a company. You might need to have someone with a legal or an accounting background, you might need to have someone with a financial background on the board. Let’s say you are a mining company, you will probably want a director who knows about the safety issues in mining. If you are a food company, food safety is bound to be an issue. So there are many areas of knowledge which might be difficult to procure in the company. This goes back to your earlier question – how do you set the qualifications to become a director? Boards need various kinds of expertise and talents so just passing an examination won’t necessarily make you a good director. Let the market decide who are good directors.’
David Webb, the shareholder activist and market commentator, has suggested that independent directors should be elected by minority shareholders to strengthen their independence – what’s your view?
‘Working as an INED, 80% to 90% of my time is spent working with the whole board, including the executive, non-executive and independent directors, to grow the business together. Only 10% to 20% of my time, such as where connected-party transactions are involved, is spent working independently. On these occasions I need to use my professional knowledge to make sure that the transaction is fair, not only to the minority or the major shareholders, but to all shareholders and benefits the company. This is how independent directors should position themselves. So if you let the minority shareholders elect independent directors, would this independent director in the future work for the minority shareholders only and not for the major shareholder? I don’t think it should be that way.
Now, there are several relevant issues to discuss here. I know that in Taiwan minority shareholders can nominate independent directors, but you still need to go through a shareholders’ meeting for voting. That is one area for discussion, another is the question of how to vote for directors. Hong Kong has adopted straight voting, whereas in Taiwan they use cumulative voting (see ‘what is cumulative voting?’ below) to elect directors, including independent directors. In my view cumulative voting basically divides the vote. It means that all parties are not working in harmony to grow the business – that is one of the major disadvantages of cumulative voting.’
Do you think the role of the chairman and the chief executive should not be performed by the same person?
‘That’s the ideal situation, but currently over 50% of the listed companies in Hong Kong are family run and family owned. Moreover, the typical board size in Hong Kong is seven to nine people which is a relatively small board compared to mature markets. If you look at the HSBC board, for example, they have around 20 board members and a very sophisticated structure to make sure the board functions well. But in Asia, people want to save money, they want to make sure that the board of directors isn’t a major financial burden on the company, so the board size is typically seven to nine people.
Now, by requirement, three of those directors need to be independent. So you have four people who are executive or non-executive directors. In this context, in many cases, the major shareholder and the family owner will take both the chairman and CEO roles to save money. But my view is that the ideal situation is to separate these two roles – that helps corporate governance.’
And presumably it helps independent directors to have an independent chairman?
‘Well, in most cases in Hong Kong both the chairman and the CEO are executive, though I think the ideal situation is to have an independent chairman plus a full-time executive CEO.’
Can we talk about the relationship between INEDs the company secretary? Do you have a message for company secretaries in terms of their work with independent directors?
‘That relationship is very important. I work very closely with company secretaries and a capable company secretary really helps INEDs to perform their duties. A good company secretary is a bridge helping independent directors to communicate with the entire company. Hopefully in the future, independent directors will participate more actively in the hiring and compensation of the company secretary. I think INEDs could have a role nominating and appointing the company secretary just as they currently do with the auditor.’
Anthony Fan was interviewed by Kieran Colvert, Editor, CSj.
The HKICS research report ‘Diversity on the Boards of Hong Kong Main Board Listed Companies’ (2012) is available on the Institute’s website: www.hkics.org.hk.
SIDEBAR: What is cumulative voting?
Usually in director elections involving more than one opening on the board, shareholders cannot give more than one vote per share to any single nominee. For example, if the election is for four directors and you hold 500 shares you could give a maximum of 500 votes for each candidate. Under the cumulative voting system, you can cast your 2,000 votes (500 shares multiplied by the four board seats) for a single nominee, or in any other combination as you see fit. Cumulative voting is seen as strengthening the ability of minority shareholders to elect a director.