The Corporate Governance Review: Hong Kong

Overview of governance regime

Over the years, with the growing pre-eminence of its stock exchange and the enhancement of its supporting market infrastructure and regulation, Hong Kong has moved on from being a regional market dominated by local tycoons and their traditional (often real estate-focused) businesses to become a truly international, and thoroughly modern, financial centre that facilitates efficient and friction-free access to international capital for all participants. The turning point arguably came in 1992, when the former Chinese Premier, Zhu Rongji, looked south for further impetus to his state-owned enterprise reform agenda. He believed that the listing of Chinese companies in Hong Kong would, over time, bring them (and therefore China more broadly) up to speed with international best practices and corporate governance standards. Since then, Chinese companies have flocked to the Hong Kong securities market, propelling Hong Kong to the position of a leading global financial centre.

The governance regime for Hong Kong listed companies derives from the common law, certain key statutes, and from a strong reliance on non-statutory rules, codes and best practices. In broad terms, laws and regulations operate to penalise companies and their directors for non-compliance and provide remedies for the aggrieved, while non-statutory rules and best practices serve to guide corporate behaviour.

i Securities and Futures Ordinance

The Securities and Futures Commission (SFC) is the principal regulator of the Hong Kong securities and futures markets. It derives its powers from the Securities and Futures Ordinance (SFO) – the key piece of legislation that in 2003 consolidated and modernised Hong Kong's diversified securities laws. All Hong Kong listed companies are subject to the SFO, regardless of their place of incorporation. This extraterritorial application is a particularly crucial feature of the SFO, as approximately 90 per cent of Hong Kong listed companies are incorporated in jurisdictions outside of Hong Kong.2

In the area of corporate governance, key functions of the SFO include:

  1. requiring directors to disclose their personal interests in the listed company and its affiliates;
  2. requiring timely disclosure of price sensitive information; and
  3. prohibiting insider dealing.

A breach of the SFO can lead to disciplinary proceedings and, at times, criminal sanctions. With the leave of the court, the SFC can also unwind transactions to remedy a breach. This is a power that the SFC has readily exercised in recent years, providing redress to victims of false corporate disclosures and insider dealing.

ii Listing rules

The Stock Exchange of Hong Kong Limited (SEHK) is one of only two entities approved by the SFC as a 'recognised exchange company' under the SFO.3 This arrangement grants the SEHK a statutory monopoly to operate the stock market in Hong Kong, and in turn, to act as the frontline regulator for the companies listed on its stock exchange. Under the SFO, ultimate powers of oversight are, however, reserved to the SFC.

The SEHK promulgates and administers the listing rules, which set out the principal regulatory mechanisms for companies listed, or who wish to seek a listing, in Hong Kong. As most Hong Kong listed companies are incorporated outside Hong Kong, the company law in Hong Kong has no direct application, save for a few exceptions. Against this background, a key function of the listing rules is to ensure that the governance standards of the People's Republic of China (PRC) and overseas companies align with what is expected under Hong Kong law. As a general requirement, all listing applicants must demonstrate a baseline level of shareholder protections that meet standards in Hong Kong. Failing that, the applicant will not be granted approval to list on the SEHK.

In addition to these gateway requirements, the listing rules also contain continuing compliance and corporate governance obligations for listed companies. These include rules on regular financial reporting, the appointment and retirement of directors (including independent directors), and shareholders' approval for certain important transactions. Although the listing rules do not carry the force of law, compliance is, in practice, mandatory as the SEHK ultimately has the power to cancel the listing of a non-compliant issuer. This power is exercised cautiously, as it can harm the shareholders and other stakeholders that the listing rules seek to protect. More often, the SEHK will rely on other options, including:

  1. public censure of delinquent issuers and the responsible directors;
  2. prohibiting a professional adviser from acting in a particular matter for a period of time; or
  3. referral of the matter to the SFC for further investigation and possible sanction.

iii Corporate governance code

A key underpinning of the corporate governance regime in Hong Kong is the Corporate Governance Code (the CG Code), appended to the listing rules. The CG Code sets out the mandatory requirements for disclosure in a listed company's corporate governance report, which is included in its annual report, and establishes a three-tier hierarchy comprising 'principles of good corporate governance', 'code provisions' and 'recommended best practices'. Recognising that there is no such thing as 'one size fits all' when it comes to corporate governance, compliance with the code provisions and recommended best practices is not mandatory. The code provisions operate on a comply or explain basis; listed companies are expected to comply with the code provisions but may deviate from them if they are otherwise able to satisfy the principles of good corporate governance and explain how good corporate governance was achieved by means other than strict compliance with the code provisions. Recommended best practices are for guidance only, although listed companies are encouraged to adopt them on a voluntary basis, to state whether they have complied with them and to give considered reasons for any deviation.

iv SEHK – dual role as regulator and commercial company

One peculiar feature of the Hong Kong market is the SEHK's dual role. On the one hand, the SEHK is the frontline regulator of companies listed on its stock exchange. On the other, SEHK listing fees are a significant stream of revenue for its parent company, Hong Kong Exchanges and Clearing Limited (HKEx), which is itself listed on the Main Board of the SEHK. This gives rise to a real and perceived tension between the SEHK's regulatory functions and the commercial interests of HKEx as a listed company. The tension is mitigated through various measures, including:

  1. delegation of HKEx's listing approval functions to an independent Listing Committee constituted by experienced market practitioners;
  2. a statutory requirement that all amendments to listing rules have to be approved by the SFC; and
  3. HKEx being directly regulated by the SFC.

As of July 2019, all decisions made by the Listing Committee are subject to review by an independent Listing Review Committee.

The debate as to the effectiveness of these arrangements is likely to continue, although in this regard HKEx exercises consistently high standards of transparency and disclosure. Through the years, HKEx has complied with virtually all code provisions and recommended best practices, setting itself up as a model of good corporate governance that other market participants can look up to.

Corporate leadership

i Board structure and practices

Hong Kong adopts a unitary board structure. Executive directors, non-executive directors and independent non-executive directors (INEDs) act collectively as one board. It is a mandatory requirement that an issuer has a minimum of three INEDs on its board, representing at least one-third of the entire board. In addition, at least one of the INEDs must have appropriate professional qualifications, or expertise in accounting or financial management.

The same board composition requirement applies to PRC issuers with a dual board structure. Minor adjustments are made so that most requirements that are applicable to directors are extended to cover supervisors of a PRC company.

The CG Code requires the board to meet at least four times a year, at approximately quarterly intervals, with a majority of eligible directors attending. Directors can meet in person or through electronic means of communication. However, the passing of written resolutions does not count as a meeting, as directors are expected to participate actively in the decision-making process.

To promote checks and balances on the executives, the CG Code further requires the chair to hold meetings solely with INEDs at least once a year and to the exclusion of any other directors. The purpose is to create a forum for open discussion without the presence of the company's management. This requirement came into effect in 2019. Previously, the CG Code simply required the chair and non-executive directors (including INEDs) to meet annually. In amending this requirement, the SEHK considered that the involvement of all non-executive directors may defeat the purpose of meeting without management, because in family-controlled companies, non-executive directors (who are not INEDs) are often family members appointed by the controlling shareholder.4 It should be noted that the code provision, in its current form, may not fully accomplish what it set out to achieve. If the same person acts as both chief executive and chair, the management will remain present in this forum.

In addition, a code provision was brought into effect in 2019 to address market concerns of INEDs sitting on too many boards, which could hinder INEDs from performing their roles effectively. For instance, with most issuers having a December financial year end, an INED with multiple directorships in listed companies may encounter time conflicts that prevent him or her from sufficiently preparing for and attending meetings.5 To this end, if a proposed INED will be holding his or her seventh (or more) listed company directorship (an overboarding INED), the issuer should explain why the board believes that the individual would still be able to devote sufficient time to the board. The SEHK has stressed the need for INEDs to be 'fully engaged with the issuer's affairs', both within and outside the boardroom.6

Independence of directors

The listing rules do not expressly define 'independence' with regard to INEDs. Instead, the rules set out a non-exhaustive list of situations in which the SEHK would cast doubt on a director's independence. Examples include where the director:

  1. holds a stake of more than 1 per cent in the listed issuer;
  2. has received the listed issuer's securities as a gift from the listed issuer or its core connected persons;
  3. has a material interest in the listed issuer's principal business activity, or has material business dealings with the listed issuer's group;
  4. is or was a director, partner or principal of a professional adviser to the listed issuer during the two years prior to his or her appointment; or
  5. has or had a management role in the listed issuer's group during the two years prior to his or her appointment.

In addition, the CG Code recognises that an INED's independence may be affected by having served for a long period. A code provision requires that the further appointment of an INED who has served for more than nine years be subject to a separate shareholders' resolution. Beginning from an issuer's first financial year commencing on or after 1 January 2023, a code provision will require a new INED to be appointed at its next annual general meeting if all of its INED's have served on its board for more than nine years.

Independence might also be called into question if an INED holds cross-directorships7 or has significant business links with other directors. It is a recommended best practice that the board explain why the director remains independent despite having such ties.

Chair and chief executive

It is an express principle under the CG Code that there is a clear division of responsibilities for the management of the board and the management of the company's day-to-day business. The purpose is to encourage a balance of power and authority, and avoid power being concentrated in one individual. Flowing from this principle, issuers should split the roles of chair and chief executive, and have different people perform them. The chair should lead the board and promote good corporate governance, whereas the chief executive should oversee the company's operations. If there is any financial, business, family or other material relationship between the chair and the chief executive, that must be disclosed in the issuer's annual report.

The CG Code operates on a comply or explain basis, so it remains possible in Hong Kong to have the same person performing both roles, so long as there is a good reason justifying the arrangement. In fact, of all code provisions, the requirement for separating the chair and chief executive has consistently recorded the lowest rates of compliance,8 with issuers citing as reasons for this the need for 'strong and consistent leadership' and 'more effective formulation and implementation of long-term business strategies'. This is, perhaps, no surprise given the make-up of the Hong Kong market, in which many listed companies remain family-controlled or dominated by a majority shareholder, or both.

Delegation of corporate governance responsibilities

Although the board is ultimately responsible for ensuring compliance with corporate governance standards, it may delegate responsibilities for implementation to board committees. The key board committees for a Hong Kong listed company are the audit, nomination and remuneration committees. Common to them is the requirement for significant involvement of INEDs in each committee. The chair of the board and the chair of each committee are expected to attend general meetings and to answer questions from shareholders.

Audit committee

The listing rules require issuers to set up an audit committee. Its key functions include monitoring the integrity of the issuer's financial statements, risk management and internal control, and reviewing the independence of external auditors. Members should be proactive in understanding the issuer's affairs and watch out for potential red flags.

Only non-executive directors are eligible for membership. The committee should have at least three members, with a majority being INEDs. At least one of the INEDs must possess professional qualifications or expertise in accounting or financial management. The committee must be chaired by an INED.

Nomination committee

Issuers are required to establish a nomination committee, which must comprise a majority of INEDs and be chaired by either the chair of the board or an INED. Prior to being given listing rule status on 1 January 2022, this requirement was a code provision.

The committee's core function is board recruitment. Members should work towards a board that possesses a balance of skills, experience and diversity of perspectives appropriate to the issuer's business. The committee should do so through a fair and transparent selection process. It is also the committee's duty to consider succession planning and promote the long-term success of the company.

Remuneration committee

As a listing rule requirement, issuers must establish a remuneration committee. The committee must comprise a majority of INEDs and be chaired by an INED. The committee should ensure that remuneration levels of management are sufficient to attract and retain those who are crucial to the company's success, but without paying more than necessary. In formulating remuneration packages, the committee should have regard to salaries paid by comparable issuers. No director should decide his or her own remuneration. If the board decides to approve any remuneration arrangements with which the remuneration committee disagrees, the board should explain its decision in the next corporate governance report.

Director and executive pay

The listing rules require that details of directors' basic salary, discretionary bonuses, contributions to pension schemes, and other forms of remuneration be disclosed by name in the company's financial statements. Furthermore, it is a recommended best practice that a significant portion of the executive directors' remuneration is linked to corporate and individual performance.

Issuers must also disclose on a no-name aggregate basis the information relating to the five highest paid individuals for the financial year, unless all five are directors, in which case their remuneration would already have been subject to disclosure. The CG Code expects issuers to disclose pay ranges for senior management in bands. It is also a recommended best practice to disclose the remuneration of senior management in annual reports, on an individual and named basis.

ii Directors

Directors' duties

Regardless of an issuer's place of incorporation, the listing rules specifically require that all directors fulfil fiduciary duties and duties of care, skill and diligence to a standard commensurate with the standard established by Hong Kong law. Only the duty of care of directors has been codified in the Companies Ordinance. Fiduciary duties remain a matter of common law.

Directors are fiduciaries of the company, and as such are entrusted to manage the company's assets and affairs. The ultimate goal of fiduciary law is to police the exercise of discretion. It does so by removing temptation and unconscious bias that may lead a fiduciary to exercise powers for an extraneous purpose. In the words of Lord Herschell, fiduciary law is 'based on the consideration that, human nature being what it is, there is danger, in such circumstances, of the person holding a fiduciary position being swayed by interest rather than by duty, and thus prejudicing those whom he was bound to protect'.9 It follows, therefore, that a fiduciary must not profit from his or her position, or have conflicting interests or duties, unless the beneficiary has given informed consent.

Flowing from these principles, and unless the company has consented otherwise through shareholders' approval, a director is under a duty:

  1. to act in good faith in the interests of the company as a whole;
  2. to exercise powers for proper purposes;
  3. to avoid conflicts of interest; and
  4. not to profit from his or her position at the expense of the company.

The listing rules contain various provisions that spell out directors' fiduciary duties. For instance, subject to certain narrow exceptions, the listing rules prohibit a director from voting on any board resolution that approves a contract, arrangement or proposal in which that director (or any of his or her associates) has a material interest. A proposed transaction between the issuer and a director or his or her associates will, in most circumstances, constitute a connected transaction, which will trigger the requirement for independent shareholder approval, save in limited circumstances when this approval is exempted because of the size or nature of the proposed transaction.

As for a director's duty of care, the Companies Ordinance requires a director to exercise a standard of care, skill and diligence that would be exercised by a reasonably diligent person with:

  1. the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company; and
  2. the general knowledge, skill and experience that the director actually has.

Requirement (a) sets out the minimum objective standard expected of all directors. A director who did his or her incompetent best could still fall short of this objective standard of care. If a director possesses special knowledge, skills and experience, requirement (b) holds him or her accountable to that higher standard.

Directors may delegate responsibilities to members of the company's management, but to properly discharge their duty of care, directors must establish reporting mechanisms and controls that facilitate meaningful oversight. Under the CG Code, issuers should set out a schedule of reserved matters, such that management can know with clarity which decisions can be made only by the board.

Dealing in securities

Directors' dealings in the issuer's securities are primarily governed by the Model Code for Securities Transactions by Directors of Listed Issuers (the Model Code). The listing rules require all issuers to adopt the Model Code, or a securities dealing code that is at least as strict. In practice, most issuers adopt the Model Code, sometimes with minor adaptations. A breach of the Model Code is regarded as a breach of the listing rules.

The key function of the Model Code is to prohibit dealings in securities when a director is in possession of unpublished price-sensitive information. It also establishes blackout periods prior to the release of annual and interim financial results, during which directors are prohibited from dealing, save in very exceptional circumstances. The Model Code also sets out the procedures for directors to obtain clearances to deal during periods when directors are not prohibited from trading.

Term of service and re-election

The CG Code requires that all directors be subject to retirement by rotation at least once every three years. Under the listing rules, if an issuer proposes to enter into a service contract for a duration that may exceed three years or with a termination notice period of more than one year, the prior approval of shareholders at a general meeting will be required. In this situation, the remuneration committee or an independent board committee must advise shareholders as to whether the terms are fair and reasonable, and whether such a contract is in the interests of the issuer and its shareholders as a whole.

Board diversity

Promoting board diversity has been one of the SEHK's key initiatives in recent years. The SEHK introduced a code provision in 2013 requiring issuers to adopt a policy for achieving board diversity, with measurable objectives to assess its implementation. As a code provision, issuers could choose to deviate and explain why a diversity of perspectives in the board could be achieved despite not having a formal diversity policy in place. After further consultation, and with much support from market participants, the code provision has been upgraded to a listing rule as of 2019. It is now a mandatory requirement to have in place a policy for board diversity, and for the issuer to disclose it in its corporate governance report.

In April 2021, the SEHK launched a consultation on proposed changes to the CG Code (the 2021 CG Code Consultation).10 The consultation resulted in a number of significant changes being introduced on 1 January 2022, including those summarised below,11 with the aim of further promoting gender diversity on boards:

  1. The SEHK has initiated the phasing out of single gender boards by confirming that the SEHK will not consider that a single gender board achieves diversity; single gender boards will be required to appoint a director of a different gender by no later than 31 December 2024 and, commencing on 1 July 2022, listing applications filed by applicants with single gender boards will not be accepted.
  2. It is mandatory for an issuer to disclose and explain the numerical targets and timelines it has set for achieving gender diversity on its board, and the gender ratio in its workforce (including its senior management), and any plans or measurable objectives the issuer has set for achieving gender diversity in its workforce.
  3. A code provision requires a board to review annually the implementation and effectiveness of its policy on board diversity.
  4. Relevant SEHK forms have been varied to capture directors' gender details upon their appointment.

Since the inception of the code provision in 2013, female representation on the boards of Hang Seng Index constituent companies has increased from 9.4 per cent in 2013 to 14.3 per cent in 2021.12 Although this increase in numbers may look encouraging at first sight, Hong Kong still lags behind other international financial centres, such as Singapore (17.6 per cent), the United States (28 per cent) and the United Kingdom (36.2 per cent).13 The picture is even less encouraging if we look behind the figures. It is not uncommon for founders of family-controlled issuers to appoint their spouses or daughters as non-executive directors. These female directors often perform a less substantive role in management, meaning that statistics on female board representation tend to overstate the actual level of gender diversity in Hong Kong listed companies.

While the phasing out of single gender boards and other recent gender diversity requirements introduced by the SEHK are important steps that should improve female representation on boards, there remains some way to go before listed companies fully embrace the advantages of gender diversity on boards and implement their own diversity measures over and above what is prescribed by regulation.

Disclosure

i Financial reporting

Timely disclosure of financial information is one of the most critical requirements under the listing rules. Non-compliance will normally lead to suspension of trading in the issuer's securities until the requisite financial information is published.

Companies listed on the Main Board of the SEHK must publish their annual report containing audited accounts within four months after the financial year-end and their interim report within three months after the end of the half-year period. In the run-up to the publication of annual reports and interim reports, there will inevitably be a time gap between the financial statements being approved by the board and their actual publication. Since information in the financial statements is usually highly price sensitive, and with a view to maintaining a fair and orderly market, the listing rules require the publication of preliminary announcements of financial results, which must be published no later than the day following the board's approval of the issuer's financial statements. If an issuer fails to publish preliminary announcements in time, for example if there are uncertainties about certain figures, it must issue a holding announcement, suspend trading and explain to the market the reasons for the delay.

The CG Code expects directors to acknowledge in the corporate governance report their responsibilities for preparing financial accounts. It also requires directors to include a statement in the annual report, setting out their discussion and analysis of the issuer's performance, an explanation of the business model and their strategy for delivering the issuer's objectives. The CG Code stresses that long-term financial performance, rather than short-term rewards, should be a corporate governance objective.

ii Disclosure of price-sensitive information

Another key disclosure obligation for Hong Kong issuers is the timely disclosure of price-sensitive information – a critical measure to eliminate asymmetry of information and possible abuse by corporate insiders. This obligation was previously a listing rule requirement, but it received statutory backing in the SFO in 2013 with a view to imposing stricter penalties on offenders. Currently, the SFC enforces the statutory disclosure regime under the SFO.

The obligation to disclose is triggered once the issuer is in possession of price-sensitive information. Knowledge of the issuer's management is imputed to the issuer. It follows that issuers must establish and maintain an effective internal control system, such that material information known to its management is promptly escalated to board level for assessment. Directors should take reasonable steps to ensure that proper safeguards for timely disclosures are in place, failing which directors can be personally liable.

It is acknowledged that premature disclosure of price-sensitive information may at times be prejudicial to a company's legitimate interests. To strike a balance, the statutory disclosure regime carves out several safe harbours. For instance, issuers are exempted from disclosing proposals or negotiations when they are at a formulative stage, so long as the discussions are kept confidential. If confidentiality is lost, issuers must suspend trading until an announcement is made to eliminate any asymmetry of information.

Late disclosure may lead to civil sanctions. The SFC can take enforcement proceedings at the Market Misconduct Tribunal. Sanctions available to the tribunal include fines, disqualification orders for officers and cold shoulder orders.

iii Notifiable transactions and connected transactions

The listing rules contain announcement requirements when an issuer enters into connected transactions, or significant transactions that are not in the ordinary course of the issuer's business (known as notifiable transactions). Depending on the size and nature of the transactions, there may be further requirements for shareholders' approval.

iv Disclosure of interests

The SFO also contains a separate regime that aims to provide the investing public with transparency on the ownership of listed issuers. Shareholders who are directly or indirectly interested in 5 per cent or more of a listed company's voting share capital must report their interests and short positions through an online filing system. Further reporting is required if their shareholding percentage changes and crosses, whether up or down, a whole number percentage level (e.g., an increase from 6.8 per cent to 7.2 per cent, or vice versa). Directors and chief executives of listed issuers must disclose all of their interests and short positions in the relevant issuer and its associated corporations, regardless of the size of their holding.

Corporate social responsibility / ESG

i Risk management

The incurrence of risk is an inevitable element in the conduct of a company's business, and it is the board's responsibility to identify and seek to control such risks. The board should assess its risk appetite in light of the company's objectives and set the right tone at the top. The CG Code requires the board to review and test its risk management and internal control systems annually, with a view to assessing their effectiveness and responding to changes of circumstances. After the annual review, the board should report its findings in its corporate governance report. Since 1 January 2022, the principles of good corporate governance established by the CG Code expressly refer to material risks relating to environmental, social and governance (ESG) matters as being risks that the board is responsible for evaluating and addressing through its risk management and internal control systems.

ii Reporting environmental, social and governance risks

The SEHK's ESG reporting framework for Hong Kong listed companies comprises both mandatory disclosure requirements and 'comply or explain' requirements, each of which is set out in an ESG reporting guide within the listing rules. Issuers are required to disclose ESG matters in ESG reports prepared in accordance with the ESG reporting guide. In respect of financial years commencing on or after 1 January 2022, the listing rules require issuers to publish their ESG report concurrently with their annual report (if the ESG report does not form part of the annual report); it is thought that improving the timeliness of ESG information will facilitate the development of more coherent strategies and execution plans.

The SEHK's ESG reporting guide lists areas for issuers to address, including emissions, use of resources, employment, labour standards, supply chain management and anti-corruption. If these areas raise material concerns in an issuer's business operations, the issuer should evaluate the associated risks and disclose its policies surrounding these ESG issues. Issuers are also required to make use of key performance indicators in their ESG reports, so that investors can evaluate the implementation of their policies and management systems.

The SEHK recognises that every business is different. Certain areas in the ESG reporting guide may not be material to a particular issuer. In these circumstances, the SEHK has stressed the importance of substance over form. Issuers should explain in the ESG report any aspects that are not relevant and focus their disclosures on material and relevant ESG issues.14

The SEHK is committed to broadening and deepening ESG reporting obligations.15 With effect from July 2020, the ESG reporting guide was amended to incorporate certain recommendations of the Financial Stability Board's Task Force on Climate-Related Financial Disclosures. As a result, issuers are now required to comply with mandatory disclosure requirements on the board's oversight of ESG issues, the board's ESG management approach and strategy, how the board reviews progress made against ESG-related goals and targets, and the application of certain reporting principles in preparing the ESG report. In addition, issuers should make disclosures on climate-related issues on a comply or explain basis. Issuers are further encouraged to include independent third-party assurances to enhance the credibility and quality of their ESG reporting. All of these moves are indicative of the SEHK's view that ESG is more than a reputational issue; rather, it is closely allied to the governance and financial performance of a company.

iii Corporate culture

The CG Code requires the board to establish the issuer's purpose, values and strategy, and to satisfy itself that these and the issuer's culture are aligned. All directors are required to act with integrity, to lead by example and to promote the desired culture that should instil and continually reinforce across the organisation the values of acting lawfully, ethically and responsibly.

iv Whistle-blowing

Hong Kong does not have in place specific legislation on whistle-blowing, although certain protections are available under employment and discrimination laws. Following the 2021 CG Code Consultation, the status of the CG Code recommended best practice to establish a whistle-blowing policy, so that employees and those dealing with the issuer are able to report improprieties confidentially, was upgraded to a code provision, signifying a recognition by the SEHK that whistle-blowing is core to maintaining high ethical standards and good corporate governance.

Shareholders

i Shareholder rights and powers

Shareholders in a Hong Kong incorporated company enjoy powers set out in the Companies Ordinance. For instance, members holding 5 per cent of the company's voting rights can requisition a general meeting and put forward matters to be voted on. Certain important decisions, such as change of name, amendments to articles of association and voluntary winding-up, can only be made with a 75 per cent supermajority approval.

Prior to 1 January 2022, the SEHK could refuse to list the securities of a non-Hong Kong applicant if it was not satisfied that the applicant's place of incorporation offered shareholder protection standards that were at least equivalent to those provided in Hong Kong; in these circumstances, listing approval could be granted by the SEHK subject to any shortfalls being addressed by amendments to the issuer's constitutional documents. The SEHK had also adopted different approaches to evaluating compliance with the 'equivalence requirement', depending on the jurisdiction of incorporation of the applicant.

Following a consultation process,16 the SEHK has introduced a revised listing regime for overseas issuers that has removed the 'equivalence requirement' and established a baseline level of shareholder protections that apply to all issuers (including Hong Kong issuers and PRC issuers).17 Broadly, the baseline shareholder protections include the following:

  1. the right to receive notice of general meetings;
  2. members' rights to remove directors, requisition general meetings, speak and vote (except where the listing rules require that a member abstains from voting) at meetings, and to appoint proxies or corporate representatives;
  3. reserving approval of the appointment, removal and remuneration of auditors to an independent board committee or a majority of the shareholders;
  4. reserving certain material matters to a supermajority voting approval by shareholders;
  5. restrictions on the term of a director appointed to fill a casual vacancy;
  6. the availability of the shareholders' register for inspection; and
  7. restrictions on shareholder voting on certain matters required by the listing rules.

ii Notifiable and connected transactions

A core shareholder right under the listing rules is the right to vote on certain notifiable transactions and most related-party or connected transactions.

For notifiable transactions, shareholders' approval is required if the transaction exceeds a certain size relative to the issuer. Shareholders' involvement is considered necessary in this situation, as the issuer is committing itself to a transaction not routine to its business, but with substantial potential impact on its resources and prospects.

As for connected transactions, the complexity of the relevant rules is a unique feature of the Hong Kong regulatory regime. This is largely due to the prevalence of family or state-controlled issuers and cross-holdings in the Hong Kong market. To limit the risks that come with this structure, the listing rules cast a wide net on what constitutes a connected transaction, and subject to certain limited de minimis and other exceptions, renders these transactions conditional on approval by independent shareholders. To help independent shareholders make a well-informed decision, issuers are further required to form an independent board committee (IBC), constituted by INEDs only, and commission an independent financial adviser (IFA). The IBC and IFA will then tender their advice in a circular to shareholders, providing comments on the fairness of the transaction terms.

iii Takeovers

In the context of a takeover, the interests of directors and shareholders can conflict. The Hong Kong Code on Takeovers and Mergers (the Takeovers Code) builds in safeguards, such that directors may not deny shareholders the opportunity to consider an offer, unless shareholders' approval at a general meeting has been obtained.18

Another important shareholder right under the Takeovers Code is the right to exit the company in the event of a consolidation or change in control. For the purpose of the Takeovers Code, holding 30 per cent or more of the company's voting rights is regarded as having control of the company. Whenever a person (or a group of persons acting in concert) acquires 30 per cent control of a company, or when a controller holding at least 30 per cent, but not more than 50 per cent, acquires a further 2 per cent of the voting rights in the company in any 12-month period, the Takeovers Code requires that a general offer be made to all other shareholders.

iv Shareholder remedies

Although local legislation generally does not apply to overseas incorporated issuers, shareholders of all Hong Kong listed issuers can bring unfair prejudice petitions and derivative actions under the Companies Ordinance, regardless of the issuer's jurisdiction of incorporation. When the company's affairs have been conducted in a manner unfairly prejudicial to certain members, a shareholder can petition for relief. The court has flexibility in the relief it may grant, including buy-out orders. If directors act in breach of their fiduciary duties or duty of care to the company, shareholders can, with the leave of the court, bring statutory derivative actions against the wrongdoers in the name of the company.

v Shareholder activism

In 2016, the SFC published the Principles of Responsible Ownership, providing non-binding and voluntary guidance to investors on how to fulfil their ownership responsibilities. The purpose of the Principles is to promote an investment culture in which investors actively communicate with management and speak and vote at general meetings. When appropriate, shareholders may even consider taking collective action or making public statements through the media.

The level of shareholder activism in Hong Kong has traditionally been low, mostly as a result of the concentrated shareholding structures in Hong Kong listed companies. Behind-the-scenes private settlements are more common, reflecting the cultural aversion to confrontations in this part of the world. Typical arrangements between issuers and activists include trade-offs on board composition, in return for dropping demands or the signing of non-disparagement agreements.

Yet the landscape is changing. As the younger generation succeeds the founders, shareholdings in family-controlled issuers are beginning to diversify. Couple this with a regulatory atmosphere that encourages dialogue between investors and management, one could well expect that activism in Hong Kong will gradually become more prevalent in the years ahead.

vi Weighted voting rights

After much debate, the listing rules were amended in April 2018 to permit the listing of companies with a weighted voting rights (WVR) structure. However, this option is available only to companies that the SEHK considers to be innovative, and only an individual who is a director of the issuer and has contributed materially to the growth of its business is permitted to be a WVR beneficiary (save in the case of certain grandfathered issuers with a close connection to Greater China and with a primary listing on a qualifying exchange).

To address the risks inherent in a WVR structure, where managers are able to maintain majority control with a relatively small stake, the listing rules include certain safeguards, such as:

  1. requiring resolutions on the amendment of articles, variation of class rights, appointment and removal of INEDs and auditors, and voluntary winding up to be approved on a one share, one vote basis;
  2. allowing shareholders with at least a 10 per cent stake calculated on a one share, one vote basis to convene general meetings and put resolutions on the agenda;
  3. requiring the establishment of a corporate governance committee, constituted by INEDs only, to review the management's compliance with listing rules and monitor any conflicts of interests; and
  4. imposing a sunset arrangement, such that the WVR structure will cease when the beneficiary ceases to be a director of the issuer.

Whether these arrangements will prove sufficient to protect investors' interests will remain a subject of debate. However, investor safeguards for Hong Kong listed WVR companies are already more comprehensive than those available in New York, London, Tokyo and Singapore.19

In January 2020, the SEHK launched a consultation for a proposed expansion of the existing WVR regime to allow corporate entities (and not just individuals) to benefit from WVR.20 The proposal was floated to raise the competitiveness of Hong Kong as a listing venue for participants in some of the fastest-growing sectors, such as the technology sector. Although the proposal garnered strong support, the SEHK recognised at the time that there were very diverse views and expectations as to how the proposed regime would operate in practice and decided that more time was required for the market to better understand Hong Kong's regulatory approach, and for regulators to observe the operation of the current regime.21 As discussed above, concessions have been granted to certain grandfathered issuers with a close connection to Greater China and with a primary listing on a qualifying exchange.

Outlook

The dominance of family and closely controlled companies will continue to be a feature of the Hong Kong market for some time. Although significant steps have been taken to address the challenges these structures present, corporate governance standards must continue to evolve if Hong Kong is to keep pace with international best practices. Going forward, institutional investors have an important role. By taking greater stewardship of the company's management, as often happens in developed markets, this will significantly enhance the quality of corporate governance in Hong Kong listed companies.

Footnotes

1 Robert Ashworth is global co-head of M&A and a senior partner, and James Parkin is a senior associate, at Freshfields Bruckhaus Deringer.

2 Hong Kong Exchanges and Clearing Limited (HKEx) (2021), HKEx Factbook 2020, p. 36.

3 The other being Hong Kong Futures Exchange Limited, which operates a futures market in Hong Kong.

4 HKEx (November 2017), 'Consultation Paper: Review of the Corporate Governance Code and Related Listing Rules', para. 106.

5 ibid., paras. 37 and 38.

6 See HKEx (December 2020), 'Analysis of 2019 Corporate Governance Practice Disclosure', para. 38.

7 A cross-directorship arises when two or more directors sit on each other's boards.

8 This code provision (now C.2.1) recorded a 64 per cent compliance rate in both the 2019 and 2017/2018 reviews and a 63 per cent compliance rate in the 2016 review. See HKEx (December 2020), 'Analysis of 2019 Corporate Governance Practice Disclosure', para. 61.

9 Bray v. Ford [1896] AC 44 (HL) 51.

10 HKEx (April 2021), 'Consultation Paper: Review of Corporate Governance Code and Related Listing Rules'.

11 HKEx (December 2021), 'Consultation Conclusions: Review of Corporate Governance Code & Related Listing Rules, and Housekeeping Rule Amendments'.

12 Community Business, 'Women on Boards: Hong Kong 2018' and 'Women on Boards: Hong Kong 2021'.

13 ibid.

14 HKEx (2019), 'Analysis of Environmental, Social and Governance Practice Disclosure in 2018', para. 46.

15 HKEx (December 2019), 'Consultation Conclusions: Review of the Environmental, Social and Governance Reporting Guide and Related Listing Rules'.

16 HKEx (March 2021), 'Consultation Paper: Listing Regime for Overseas Issuers'.

17 HKEx (November 2021), 'Consultation Conclusions: Listing Regime for Overseas Issuers'.

18 Takeovers Code, General Principle 9.

19 HKEx (2019), 'Research Report: Weighted Voting Rights: Angel or Evil to Investors?', Section 2.4 and Appendix.

20 HKEx (January 2020), 'Consultation Paper: Corporate WVR Beneficiaries'.

21 HKEx (October 2020), 'Consultation Conclusions: Corporate WVR Beneficiaries', paras. 103 and 104.

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