corporategovernance hongkong

Corporate Governance in Hong Kong

1. Background

Hong Kong’s position as an international economic and financial center is attributed

to its exemplary corporate governance. With Hong Kong’s various authorities and

regulatory bodies emphasizing on transparency and accountability for listed

companies, Hong Kong was ranked first for corporate governance among 11 Asian

countries in 2007. (Refer to Appendix 1)

The Stock Exchange of Hong Kong (SEHK) describes corporate governance as the

“duties, functions and power of the board of directors as a whole and executives and

non-executive directors individually”. These binding responsibilities include the

fulfillment of their legal obligations towards the company and its shareholders, the

proper conduct of their functions in relation to the company’s business assets,

abiding by standards of best practice and ethics as well as accepting responsibility

for their actions.

2. Alternative Labels

The common label applied by most Hong Kong companies is Corporate Governance.

However, some companies prefer alternative descriptors such as Corporate Risk

Management or Enterprise Governance.

3. Introduction of Corporate Governance in Hong Kong

3.1 History of Corporate Governance

The history of corporate governance in Hong Kong dates back to the 1700s and the

South Sea Bubble episode, where there were fundamental changes in business laws

and practices in England. The need to access financial resources and seek economic

and social progress has brought corporate governance into greater prominence.

As a former British dependent territory, Hong Kong has its regulatory system based

on English common law, but its business practices and corporate governance carry

both Asian and UK influences. The family ownership structure that prevails in Hong

Kong signifies the strong influence of dominant shareholders and a limited voice for

minority shareholders. SEHK published its own Code of Best Practice in 1993 to

enshrine good corporate governance practice. In addition, many improvements have

been made at a macro level since the Asian Financial Crisis in 1997. Corporate

governance is increasingly emphasized by government authorities, regulators and

NGOs; there is a clear intent to adopt governance standards at the highest level.

The following illustrates the typical family business in Hong Kong. The first priority in

the family business will be given to the immediate family members, then related

parties in business and finally, other shareholders.

Figure 1: Priority (“Concentric rings”) in the family business in Hong Kong

Source: Ferdinand A.Gul and Judy S.L.Tsui , The Governance of East Asian

Corporations-post Asian Financial Crisis

3.2 Nature of Corporate Governance

3.2 Corporate Governance Index in Hong Kong

Corporate Governance Index is an objective benchmark for regulators to distinguish

varying corporate governance standards of different companies. The criteria are

based on internationally accepted principles of fairness, transparency, accountability,

and responsibility in corporate governance. Its qualitative measurement is

differentiated from quantitative data and provides investors with better consolidated

and more comprehensive analysis of the companies’ profile. Regulators currently

recommend that the score should be reviewed regularly and Hong Kong CGI should

be charged by HKEx or any independent commercial entity.

Source: Hon. Laura M. Cha, member of Exective Council, HKSAR Government, The

case for a Corporate Governance Index for Hong Kong. Retrieved from

http://www.hkbu.edu.hk/~apcgc/ms-laura.php

4. Influences on Corporate Governance

Quoting from the Manager of CLP Holdings Limited, Mrs. Chan, “Corporate

governance is a process of continuous improvement”. In shaping the corporate

governance efforts, Hong Kong has taken into account its unique blend of Western

and Asian cultures.

4.1 Western Influence

Until 1997, Hong Kong was colonized by the British and thus, the Western Culture

predominantly exists in Hong Kong. As a former British dependent territory, Hong

Kong has its regulatory system based on English common law.

Hong Kong complies with The Companies Ordinance (Cap 32), originally derived

from the United Kingdom Companies Act 1948. This provides the basic regulatory

infrastructure, addressing corporate governance issues for all companies.

The Committee on the Financial Aspects of Corporate Governance was set up in

May 1991 by the Financial Reporting Council and London Stock Exchange to

address the financial aspects of corporate governance in the United Kingdom. It

produced the Code of Best Practice in UK, which was adopted by SEHK in 1993.

The Committee also came up with the Cadbury Report in 1992, which provided a

basis for Hong Kong to adopt certain recommendations regarding the Board of

Directors. For instance: A mixture of executive and non-executive directors on board;

seeking of separate professional advice by independent directors; and regular board

meetings.

However, some recommendations of the Committee have not been adopted by Hong

Kong. For instance, large companies in Hong Kong are not required to separate the

roles of CEO and Chairman. This is hard to practise due to the family-dominated

business characteristic.

4.2 Asian Influence

As prevalent in East Asian countries, most listed companies in Hong Kong are family-

controlled, resulting in minority shareholders being placed at a disadvantage.

To protect the interests of minority shareholders, SEHK implemented the Listing

Rules to strengthen the practice of corporate governance in listed companies.

According to the rules, at least three nonexecutive directors must sit on the board of

a company to ensure its independence. This minimizes the influence of majority

shareholders in family-dominated companies.

In addition, family-dominated banks face the problem of reckless lending to

connected parties. To minimize such lending, the power to regulate bank ownership

structure was strengthened and restrictions on connected lending were implemented

under the Banking Ordinance in 19863.

In its efforts to develop the “Code on Corporate Governance Practices”, SEHK takes

into account the culture and history of a market. Since there is no single set of

universal code that fits all economies, it is imperative that the code is market-oriented

and adapts to the culture of Hong Kong.

5. Company Law

In Hong Kong, the duties and obligations on Directors and Officers are covered

primarily by three sets of ordinances and rules:

1) Hong Kong Listing Rules

2) Securities and Futures Ordinance (“SFO”)

3) Companies Ordinance

5.1 Hong Kong Listing Rules

On March 31 2004, significant changes were made to the Hong Kong Listing Rules.

This includes the updating of entry requirements for listing applicants and listed

companies, as well as increasing guidance and requirements on directors and their

independence. For instance, a listed company must have at least three independent

directors. Disclosure of accounting matters must be qualitative and quantitative.

5.2 Securities and Future Ordinance (“SFO”)

The Securities and Futures Ordinance (SFO) was introduced on 1 April 2003 for

listed companies in Hong Kong. It enforced a new licensing regime which makes

insider dealing a criminal offence. Besides, it introduced detailed provisions on

securities misconduct and more extensive disclosure requirements. Under the SFO,

dual filing of listing documents and various types of corporate communications with

both HKEx and SFC is also required. This enables the SFC to investigate and

prosecute deliberate or reckless misstatements.

5.3 Companies Ordinance

The Companies Ordinance came up with various changes dealing with issues such

as the regulation of foreign companies, prospectus liability and enhancement of

shareholders’ remedies.

5.3.1 Shareholders’ rights

5.3.1.1 Right to call meetings and propose resolutions

Members of a Hong Kong company holding more than 5% of its issued share capital

may request that meetings be convened. In relation to foreign companies, the

position is governed by domestic law.

5.3.1.2 Voting requirements

While most matters only require a simple majority vote, certain matters must be

approved by independent shareholders. This occurs in situations where interests of

shareholders differ.

5.3.1.3 Nomination and election of directors

Directors of listed companies must rotate every three years. Shareholders may

nominate anyone to be a company director by informing the company, after which

personal information of candidates would be circulated.

5.3.1.4 Enforcement powers

The constitution of a Hong Kong company is a statutory contract between the

members and the company. The Companies Ordinance has been amended to allow

a shareholder directly to enforce provisions contained in the constitution.

6. Main Corporate Governance Initiative

Committee

of

The Stock Exchange of Hong Kong Limited

Refer to table 6.7

Holding Company of

Holding Company of

f

Standing Committee on Company Law Reform

Refer to table 6.6

Figure 2: Overview of Organizations with Corporate Governance initiatives

Source: Corporate Governance (An Asia-Pacific Critique) by Low Chee Keong

Table: 6.1

Country Bodies | Role | CG Initiatives |

Securities and Futures Commission (SFC) | Administer the laws governing the

securities and futures markets in Hong Kong | Year 2004

- Introduced the concept of dual filingYear 2006

- Developed regime governing public offering of shares and debentures in the

Companies OrdinanceYear 2008

- Submitted a report to the Financial Secretary on “Issues raised by the Lehmans

Minibond crisis” to enhance investor protection|

Table 6.2


Hong Kong Monetary Authority | Maintain monetary and banking stability |

Year 1998

- Published Best Practice Guide on Financial Disclosure |

Table 6.3


Hong Kong Society of Accountants | Review the regulation of accounts and

accountancy profession | Year 2000

- Organized Best Corporate Governance Disclosure AwardsYear 1997

- Published guidelines on disclosure in annual reports and directors’ business review

|

Table 6.4


Independent Commission Against Corruption (ICAC)| Serves as Hong Kong’s Anti-

Corruption Agency | Year 1996

- ICAC and the Guangdong Provincial People's Procuratorate collaborated to publish

the ‘A Legal Guide for Investors’ in Guangdong and Hong Kong

Year 2002

- Published Ethics in Practice for businesses in Shanghai and Hong Kong

Year 2004

- Organized the Ethical Management seminar to deepen cross-border businesses

understanding of the anti-corruption and bribery legislation |

Table 6.5


Companies Registry | Advise the Government on policy and legislative issues

regarding company law, corporate governance| Year 1997

- Ensure that the Companies Ordinance remains responsive to the everyday needs

of the business and society |

Table 6.6


Standing Committee on Company Law Reform (Committee of

Companies Registry) | Regulator of listed companies in Hong Kong | Year 1990

- Proposed establishing a Financial Reporting Review Panel in line with the UK Panel

Year 2003

- Issued its Phase II consultation paper, proposing actions to enhance Hong Kong’s

corporate governance |

Table 6.7


The Stock Exchange of Hong Kong Limited (SEHK) | Serves as front line regulator

of listed issuers | Year 1993

- Developed the “Code on Corporate Governance Practices” (Refer to Appendix

2)Year 1998

- Issued its “Market Consultation Policy Paper on Financial Disclosure”Year 2002

- Issued a consultation paper on proposed amendments to the Listing Rules

- Produced policy papers that outline roles and responsibilities of corporate boards

|

Table 6.8


Hong Kong Exchanges and Clearing Limited (HKEx) | Holding Company for SEHK

| Year 1999

- Implemented comprehensive market reform of the stock and futures markets |

7. Efforts in Encouraging Corporate Governance

7.1 Punishment Effort (Cases and Measures taken for Corporate Governance)

7.1.1 Peregrine Investments Case

One of the main contributory factors leading to the liquidation

Peregrine Investments Holdings Ltd

Dealt with Indonesian taxi company, Steady Safe

Bought US$265 million worth of US dollar-denominated promissory notes

Rupiah’s precipitous fall led to major loss and investor’s loss of confidence

Executive management did not monitor and supervise the investment

Managing director and cofounder were not aware of this new investment

Lack of internal control

Asia’s largest home-grown investment house besides Japan

Figure 3: Peregrine Investments lack of internal control leading to liquidation.

Measures taken:

The government of Hong Kong placed great emphasis on this case and required

financial institutions to disclose more investment information to SEHK and

shareholders, particularly on potential markets’ risk procedures.

7.1.2 The CA Pacific Securities Case

CA Pacific Finance

Transferred shareholdings

of cash accounts to

margin accounts

Without investor’s acknowledgement

Used investors’ share as collateral to secure bank loans

Company ran into liquidation

problems due to the drop in

share market

Shares used as collateral was sold by the bank

Public lost confidence in small and medium-size brokerage houses

Investors lost their shares in both cash and margin accounts

Figure 4: CA Pacific Finance utilizes unauthorized funds

Occurred just after CA Pacific Incident

7.1.3 Forluxe Securities Case

Figure 5: Forluxe Securities obtains margin financing without authorization

Forluxe Securities

Misused investor's shares to obtain margin financing without seeking approval

Owner disappeared with HK$20 million worth of investor’s shares

Conducted lending business through finance arm

Further undermined public Confidence in brokerages

Measures:

SEHK and SFC started visiting selected brokerage houses regularly and their

associated financial companies. The aim is to ensure financial accuracy and

adequacy of risk management procedures.

Financial Services Bureau, SEHK and SFC set up a special task force to ensure a

proper monitor system for brokerage houses.

7.2 Awards / Efforts in encouraging Corporate Governance

Hong Kong has designed various awards and support in encouraging Corporate

Governance (CG). Corporations with exemplary CG are recognized publicly. These

recognitions not only benefit individual companies’ profiles, but also maintain

credibility and competitiveness in the financial market.

Figure 6: Main form of rewards for Corporate Governance

7.2.1 Hong Kong Corporate Governance Excellence Awards

These awards were launched in 2007 by Chamber of Hong Kong Listed Companies

and the Center for Corporate Governance and Financial Policy, Hong Kong Baptist

University. They were designed to encourage improvements in corporate governance

of listed companies in Hong Kong. The awards are conferred annually and the

judging criteria include:

* Corporate governance culture

* Protection of shareholders interests

* Transparency in governance, standard of the board, internal control and risk

management

* Corporate social responsibility

Winners of Hong Kong Corporate Governance Excellence Awards in Hong Kong,

December 3, 2008 will be tabulated in the following in order of stock code:

Category for Hang Seng Index Companies | Category for Hang Seng Composite

Index Companies | Category for Other Main Board and GEM Board Companies

|

* China Construction Bank Corporation (939) * The China Shenhua Energy

Company Limited (1088) * The Industrial and Commercial Bank of China Limited

(1398) * Ping An Group of China Limited (2388) | * China Railways Group

Limited (390)| * Giordano International Limited (408) * Yip’s Chemical Holdings

Limited (709) * Shui On Construction and Materials Limited (983) |

Figure 7: Companies received Hong Kong Corporate Governance Excellence

Awards in 3 different categories.

7.2.2 Best First-time Annual Report Award

Hong Kong has constantly sought to better its corporate governance. It not only

focuses on the existing companies in the capital market, but also encourages new

companies to practise good corporate governance. The new award entitled “Best

First-time Annual Report Award” was introduced in 2008 to encourage good

corporate governance in new companies.

The awards are presented in five different categories:

* Hang Seng Index (HSI)-constituent companies

* Non-HSI main board-listed companies

* GEM-listed companies

* H-share companies

* Public sector/not-for-profit organizations

7.2.3 Best Corporate Governance Disclosure Awards

These awards, introduced in 2000 and pioneered by the Hong Kong Institute of

CPAs, advocate accountability and transparency to stakeholders. In addition, much

emphasis was placed on voluntary disclosures of relevant information in annual

reports that exceed legal and regulatory requirements. The government, regulators

and business communities provide great support for the implementation of awards.

In 2008, 3 more categories were introduced — the Diamond, Platinum and Gold

Award. These new additions highlighted the importance of risk management and

internal controls.

7.2.4 Directors of the Year Awards

This award was first launched in Asian countries in 2001. Its main aims are to

publicize the significance of good corporate governance, and recognize directors for

their outstanding corporate governance practices. This helps to encourage their

continuous efforts to promote good corporate governance and directorship in Hong

Kong. The Directors of the Year Award is classified into different categories:

* Listed Companies (SEHK—Hang Seng Index Constituents)

* Listed Companies (SEHK—Non-Hang Seng Index Constituents)

* Private Companies

* Statutory/Non-profit-distributing Organizations

8. Case Studies of Country’s Top Corporations

Company | Overview | Reasons for exemplary CG |

NWS Holdings Limited | Operates businesses in infrastructure, facilities rental,

construction-related contracting and public transport.

Awarded Hong Kong Corporate

Governance Excellence on 4 December 2007.

(Refer to Appendix 3) |

Outstanding

management team and effective policies:

1. Balanced composition of executive and

non-executive directors. Established the Corporate Governance Steering Committee

to foster Corporate Governance

2. Issued Guidelines on Internal Control System and

Corporate Governance Manual to ensure related rules and regulations are fully

complied.

Distributed handbook for Corporate Policy on Staff Responsibility. |

Hong Kong and Shanghai Banking Corporation Limited | Largest banking and

financial services organizations in the world.Combined Code on Corporate

Governance (UK) and the Code on Corporate Governance Practice (HK).| 1. Balance

of executive and non-executive directors. Establish the Corporate Sustainability

Committee.2. Key procedures established by the Directors help provide effective

internal control. 3. Communication with shareholders is highly prioritized.

Shareholders are well-informed about HSBC’s activities. |


Bank Of China | Bank of China is a leading listed commercial banking group in

Hong Kong in terms of assets and customer deposit, offering a comprehensive range

of financial products and services to customers.(Refer to Appendix 4) | 1.

Reviews its Corporate Governance system constantly to ensure conformity to

international and local best practices.2. Clear division of responsibilities between the

Board and the Management.3. Roles of Chairman and CEO are clearly established

and stipulated in the Board's Mandate.4. Publishes quarterly financial and business

reviews to update shareholders on the performance, financial position and prospects

of the Company. |

Li & Fung Group | A global trading group supplying high-volume, time-sensitive

consumer goods. E.g. Garments and hard goods.(Refer to Appendix 5) | 1. Takes

responsibility in maintaining a sound and effective system of internal controls.2. The

Board, the four committees, Group Chairman and Group Managing Director all have

clearly defined roles and responsibilities to perform.3. Follows the principles of

transparency, accountability and independence |


CLP Holdings Limited | Operates a vertically integrated electricity generation,

transmission and distribution business. | 1. Combined Code on Corporate

Governance Practices, and company’s existing principles and practices2. Adopted a

policy of open communication and fair disclosure.3. A sound board of directors and a

dynamic management team. |

Figure 8: Case Studies for exemplary in Hong Kong.

Source: Media Information,

http://www.nws.com.hk/html/eng/pdf/PR2007120501E.pdf

The

similarities among these five companies with exemplary Corporate Governance are

as follows:

*

Implement their own Corporate Governance policies, beyond the minimal Code of

Best Practice

*

Focus strongly on internal control and communication with their shareholders

*

Ensure that their boards and committees have distinct roles and responsibilities to

prevent conflicts of interest which might undermine the credibility of companies.

9. Promote Good Corporate Governance Culture

9.1 Shareholder Activism

Figure 9: Hong Kong’s level of Shareholder Activism

Shareholder activists have risen over the years and challenged companies to

improve returns or restructure. However, shareholder activism is uncommon in Hong

Kong due to three main reasons. Firstly, many companies in Hong Kong are family-

based, resulting in minority shareholders having less capacity to express their

opinions during general meetings. Secondly, shareholders cannot afford the fees

required to sue the companies even if they want to. Lastly, shareholders seldom

voice out during meetings since they are usually out-voted by controlling

shareholders.

9.1.1 Promoting Shareholder Activism

Even though Hong Kong’s shareholder activism is not prevalent, some organizations

are being established to promote active shareholder activism. For instance, Asian

Corporate Governance Association (ACGA) created an investor discussion group,

providing shareholders a common platform to discuss pertinent issues.

9.2 Appointment Service

Companies must ensure that their boards consist of credible directors before seeking

financial assistance from institutional investors. The Hong Kong Institute of Directors

offers services such as matching companies with candidates on the Institute’s

register of qualified members for director appointment.

9.3 CEO’s Compensation

Directors’ compensation will be disclosed on an anonymous individual basis, of a

general description of the remuneration policy and long-term incentive schemes. In

addition, the Code of Best Practice has included that the Remuneration Committee

should consist of mainly independent non-executive directors (INEDs).

9.4 Corporate Reporting

Companies in Hong Kong need to maintain and disclose their financial information in

compliance with Hong Kong accounting and auditing standards, which are based on

the International Accounting Standards and International Standards on Auditing.

9.5 Audit Committee and Internal Controls

The Audit Committee must comprise of at least three non-executive directors, a

majority of INEDs, one of whom is qualified in financial reporting, and chaired by an

INED. The Code of Best Practice also recommends an evaluation by each company

of the effectiveness of internal control, covering financial, operational and compliance

controls and risk management.

9.6 Transparency and Disclosure

Any director or chief executive is required by law to inform the listed company of

relevant interests. A listed company is required by law to make a register of this

information available for public scrutiny.

9.7 Private Companies

Government, professional bodies and chambers of commerce are working on

enlightening and empowering private companies, particularly the Small and Medium

Enterprises (SMEs), in the field of corporate governance.

Source: Carlye W L Tsui, An Overview of Corporate Governance in Hong Kong.The

Hong Kong Institute of Directors. June 2003. Retrieved from

http://www.hkiod.com/publication/overview_eng.pdf

Conclusion

Corporate governance in Hong Kong has come a long way, with more companies

embracing good governance practices to attract investment and gain

competitiveness in the global market. Initiatives undertaken by regulatory bodies,

such as the development of Code of Best Practice, serve as a stepping stone to bring

Hong Kong’s corporate governance to greater heights. However, areas that call for

attention still exist:

* Highly concentrated share ownership by families leading to disadvantaged

minority shareholders

* Uncommon shareholder activism and lack of initiatives by institutional investors to

ameliorate the situation

* Lack of truly independent INEDs

* Only Company Ordinance (CO) and Securities and Futures Ordinance (SFO) hold

legal power; the Listing Rules and Code of Best Practice on corporate governance do

not

Despite the problems mentioned above, corporate governance is becoming

increasingly prevalent in Hong Kong society. In light of the ongoing governmental

initiatives to ameliorate the situation, Hong Kong is envisaged to maintain its status

as one of the countries with topmost corporate governance in Asia.

Source: Ferdinand A.Gul and Judy S.L.Tsui , The Governance of East Asian

Corporations-post Asian Financial Crisis

Appendix 1

Source: Corporate Governance Watch 2007

http://www.ethicalcorp.com/content.asp?ContentID=5483&ContTypeID=67

Appendix 2

Appendix 3

Case study of NWS Holdings

Appendix 4

Bank of China (Hong Kong)

Appendix 5

Li & Fund Group

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