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-less 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 practice and corporate governance standards. Since then, Chinese companies have flocked to the Hong Kong securities market, propelling Hong Kong to become one of the pre-eminent financial centres in the world.
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 behaviours.
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 extra-territorial application is a particularly crucial feature of the SFO, as almost 90 per cent of Hong Kong listed companies are incorporated abroad.
In the area of corporate governance, key functions of the SFO include:
- requiring directors to disclose their personal interests in the listed company and its affiliates;
- requiring timely disclosure of price sensitive information; and
- 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 the only entity approved by the SFC as a 'recognised exchange company' under the SFO. This arrangement grants the SEHK a statutory monopoly to operate the securities market in Hong Kong, and in turn, to act as 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 align the governance standards of PRC and overseas companies with what is expected under Hong Kong law. As a general requirement, PRC and other overseas incorporated listing applicants must demonstrate a level of shareholder protection that is at least on a par with standards in Hong Kong. Failing that, the applicant will not be granted approval to list on the SEHK.
On top of these gateway requirements, the listing rules also contain ongoing compliance and corporate governance obligations for listed companies. These include rules on regular financial reporting, 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:
- public censure of delinquent issuers and the responsible directors;
- 'cold shoulder orders' that prohibit dealers and financial advisers from acting for the issuers; or
- 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 (CG Code), which is appended to the listing rules. The CG Code has a three-tier structure. It sets out at a high-level the 'principles' of good corporate governance, followed by '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. A listed company may deviate from a code provision, provided it can find alternative ways to achieve the principles. The issuer must, however, explain in its annual report why good corporate governance is achieved by means other than strict compliance with the code provisions. For recommended best practices, these are for guidance only, and there is no reporting requirement for deviation.
iv SEHK – dual role as regulator and commercial company
One peculiar feature of the Hong Kong market is the SEHK's dual role of regulator and profit-making company. 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 ameliorated through various measures, including:
- delegation of HKEx's listing approval functions to an independent Listing Committee constituted by experienced market practitioners;
- a statutory requirement that all listing rules amendments have to be approved by the SFC; and
- HKEx being directly regulated by the SFC.
The debate as to the effectiveness of these arrangements will likely continue, although in this regard it is worth noting HKEx's own 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.
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 issuers must have 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 People's Republic of China (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 actively participate in the decision making process.
To promote checks and balances on the executives, the CG Code further requires the chairman to hold meetings solely with INEDs at least once a year and with 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 is a relatively new requirement that came into effect in 2019. Previously, the CG Code simply required the chairman and non-executive directors (including INEDs) to meet annually. The SEHK later surmises 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.3 It should be noted that the code provision, in its current form, may not fully accomplish what it set out to achieve. Where the same person acts both as the chief executive and the chairman, the management will remain present in this forum.
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 where the SEHK would cast doubt on a director's independence. Examples include where the director:
- holds more than a 1 per cent stake in the listed issuer;
- has received the listed issuers' securities as a gift from the listed issuer or its core connected persons;
- has a material interest in the listed issuer's principal business activity, or has material business dealings with the listed issuer's group;
- 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
- had a management role in the listed issuer's group during the two years prior to his appointment.
In addition, if an INED has served more than nine years in the company, that could undermine his or her independence. In this situation, the CG Code requires that the INED's further appointment be subject to a separate shareholders' resolution.
Independence might also be called into question if an INED holds cross-directorships4 or has significant business links with other directors. A new recommended best practice was introduced recently, such that the board should explain why the director remains independent despite having such ties.
Chairman and chief executive
It is an express principle under the CG Code that there be 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 chairman and chief executive, and have them performed by different people. The chief executive should focus on strategy and operations, while the chairman should lead the board and promote good corporate governance. If there is any financial, business, family or other material relationship between the chairman and the chief executive, that must be disclosed in the issuer's annual report.
As mentioned above, the CG Code operates on a 'comply or explain' basis, so it remains possible in Hong Kong to have the same person conduct both roles, so long as there is good reason justifying such an arrangement. In fact, among all code provisions, the requirement for separating the chairman and chief executive has consistently recorded the lowest compliance rates,5 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, where many listed companies remain family-controlled, dominated by a majority shareholder or both.
Delegation of corporate governance responsibilities
While 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 chairman of the board and the chair of each committee are expected to attend general meetings and to answer questions from shareholders.
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.
It is a CG Code requirement to establish a nomination committee. The committee should have a majority of INEDs, and be chaired by either the chairman of the board or an INED. 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.
As a listing rule requirement, issuers must establish a remuneration committee. The committee must have a majority of INEDs, and be chaired by an INED. The committee should ensure that remuneration levels of the 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 own remuneration. If the board decides to approve any remuneration arrangements with which the remuneration committee disagrees, the board should explain their decision in the next corporate governance report, which usually comes as a chapter of the annual report.
The listing rules require that details of directors' basic salary, discretionary bonuses, contributions to pension schemes, and other forms of remuneration be disclosed in the company's financial statements on an individual and named basis. Furthermore, it is a recommended best practice that a significant portion of the executive directors' remuneration be 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 of the five are directors, in which case their remuneration would have been disclosed as discussed anyway. 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.
Regardless of an issuer's place of incorporation, the listing rules specifically require that all directors fulfill fiduciary duties and duties of care, skill and diligence to a standard commensurate with Hong Kong law requirements. In Hong Kong, 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'.6 It follows that a fiduciary must, therefore, 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:
- to act in good faith in the interests of the company as a whole;
- to exercise powers for proper purposes;
- to avoid conflict of interest; and
- not to profit from his 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 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 the company's informed consent by virtue of an independent shareholders' approval.
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:
- 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
- the general knowledge, skill and experience that the director actually has.
Requirement (a) sets out the minimum objective standards expected of all directors. A director who did his or her incompetent best could still fall short of this objective standard of care. In cases where the 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 in order 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 only be made 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 (Model Code). The listing rules require all issuers to adopt the Model Code, or alternatively, 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 lays down certain 'blackout periods' prior to the release of annual and interim financial results, during which directors are prohibited from dealing, save in very exceptional circumstances. During the windows where directors are not prohibited from trading, the Model Code sets out the procedures for obtaining dealing clearances.
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 an employment contract for a duration that may exceed three years, with a termination notice period of more than one year, this will require prior shareholder's approval at a general meeting. In this situation, the remuneration 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.
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 starting in 2019. It is now a mandatory requirement to have in place a policy for board diversity, and to disclose it in the issuer's corporate governance report.
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 13.4 per cent in 2019.7 Whilst such increase in numbers may look encouraging at first sight, Hong Kong still lags behind other international financial centres such as Singapore (15.7 per cent), the United States (27.0 per cent) and the United Kingdom (32.0 per cent).8 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 play 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. Whether the recent upgrade of the code provision to a Listing Rule will give further impetus to board diversity remains to be seen. For now, suffice to say there is still a long way for the Hong Kong market to go on board diversity.
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.
Annual reports containing audited accounts must be published within four months of the financial year-end. Issuers also need to publish interim reports within three months of 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 due to uncertainties around certain figures, it must issue a holding announcement, suspend trading, and explain to the market the reasons behind the delay.
The CG Code expects directors to acknowledge 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 make disclosure 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. Since the regime's inception in 2013, the SFC has commenced eight proceedings, with four concluded to date. Fines for non-compliant directors range from around HK$1 million, together with an additional order covering the SFC's investigation costs.
iii Notifiable transactions and connected transactions
The listing rules contain announcement requirements when an issuer enters into connected transactions, or significant transactions that are out of 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 their interests and short positions in the relevant issuer and its associated corporations, regardless of the size of their stake.
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 on an annual basis, with a view to assessing their effectiveness and responding to changes of circumstances. After the annual review, the board should report their findings in its corporate governance report.
ii ESG reporting
Since 2016, Hong Kong listed companies have a 'comply or explain' obligation to assess and disclose environmental, social and governance (ESG) risks. The SEHK's ESG reporting guide sets out a list of areas for issuers to attend to, including emissions, use of resources, employment, labour standards, 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 indexes (KPIs) 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 well be immaterial to a particular issuer. In such 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 its disclosures on material and relevant ESG issues.9
The SEHK is committed to broadening and deepening ESG reporting obligations.10 Starting in July 2020, the ESG reporting guide will be revised to require disclosures on climate-related issues. Certain KPIs will be amended to provide more particularity on issuers' ESG performance. Issuers are further encouraged to include independent third-party assurances to enhance the credibility and quality of their ESG reporting. All these moves are indicative of the SEHK's firm belief that ESG is more than a reputational issue but is closely allied to the governance and financial performance of a company.
Hong Kong does not have in place specific legislation on whistle-blowing, although certain protections are available under employment and discrimination laws. It is a recommended best practice for audit committees to establish whistle-blowing policies, so that employees and those dealing with the issuer are able to report improprieties on a confidential basis.
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 super-majority approval.
The listing rules expect no less from PRC and overseas issuers. Before a PRC or overseas applicant is approved for listing, it must demonstrate that its place of incorporation offers shareholder protection standards that are at least equivalent to those in Hong Kong. If there is any shortfall, the issuer must address the gap through amendments to its constitutional documents. The specific requirements are further set out in a joint policy statement issued by the SFC and HKEx.11
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 substantive 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 the high level of cross-holding 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 such transactions conditional upon independent shareholders' approval. 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.
In the context of a takeover, the interests of directors and shareholders can conflict. The Hong Kong Takeovers Code builds in safeguards, such that directors may not deny shareholders the opportunity to consider an offer, unless shareholders' approval at general meeting has been obtained.12
Another important shareholder right under the Takeovers Code is the right to exit the company's shares 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 30 per cent-controller further acquires a 2 per cent stake in the company in any 12-month period, the Takeovers Code requires that a general offer be made to all other shareholders. The spirit behind this is to ensure that shareholders are given the opportunity to exit after a change or consolidation of control occurs.
iv Shareholders' remedies
Though 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. In the event that 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 fulfill their ownership responsibilities. The principles seek to promote an investment culture where 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 shareholders activism in Hong Kong has traditionally been low, mostly as a result of the concentrated shareholding structures in Hong Kong listed companies. Behind-the-scene private settlements are more common, reflecting the cultural aversion against 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, and 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. This option is, however, only available to companies that the SEHK considers to be 'innovative'. 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 built in certain safeguards. These protections include:
- 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;
- 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;
- 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
- 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.13
The dominance of family and closely controlled companies will continue to be a feature of the Hong Kong market for some time to come. While significant steps have been taken to address the challenges such 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 to play. 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.
1 Robert Ashworth is a partner and the global co-head of M&A and Chris Mo is a trainee solicitor at Freshfields Bruckhaus Deringer.
2 HKEx. HKEx Factbook 2018, p. 32.
3 HKEx, (2017). Consultation Paper – Review of the Corporate Governance Code and Related Listing Rules, paragraph 106.
4 A cross-directorship arises when two directors sit on each other's board.
5 This code provision A.2.1 recorded a 64 per cent compliance rate in the 2017/2018 review and a 63 per cent compliance rate in the 2016 review. See HKEx, (2018). Analysis of Corporate Governance Practice Disclosure in June and December Year-End 2017 and March Year-End 2018 Annual Reports, p. 14.
6 Bray v Ford  AC 44 (HL) 51.
7 Community Business, (2018). Women on Boards – Hong Kong 2018; and Community Business, (2019). Women on Boards – Hong Kong 2019.
9 HKEx (2019). Analysis of Environmental, Social and Governance Practice Disclosure in 2018, paragraph 46.
10 HKEx (2019). Consultation Conclusions on Review of the Environmental, Social and Governance Reporting Guide and related listing rules (December 2019).
11 SFC and HKEx, (2013). Joint Policy Statement Regarding the Listing of Overseas Companies.
12 Takeovers Code, General Principle 9.
13 HKEx, (2019). Research Report – Weighted Voting Rights: Angel or Evil To Investors?, Section 2.4 and Appendix.