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Hong Kong issues clear rules of corporate governance and leadership

Thanks to its strategic location and easy access to the Chinese and other Asian Pacific markets, Hong Kong continues to be the preferred center of operations for many foreign companies, which must follow strict local corporate governance and leadership rules and regulations.

In 2022, Hong Kong ranked 5th most competitive out of 63 economies by the International Institute for Management Development. Private companies in Hong Kong get to operate in a favorable and efficient business environment.


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However, the law clearly states the way companies must structure and run their boards. Hong Kong has a unitary board structure, which includes executive directors, non-executive directors, and independent non-executive directors (INEDs) who act collectively as one board. Board structure A company’s board must have a minimum of three INEDs, 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 Chinese companies with a dual board structure. A board shall meet a minimum of four times a year, at approximately quarterly intervals, with a majority of eligible directors attending, according to the Corporate Governance (CG) Code. 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. The CG Code states that the chair must meet solely with INEDs at least once a year. Prior to this requirement being introduced in 2019, the CG Code simply required the chair and non-executive directors (including INEDs) to meet annually. 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. A code provision was introduced 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. If a proposed INED holds seven or more listed company directorships (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. An INEDs should be able to 'fully engage with the issuer's affairs', both within and outside the boardroom. Director’s Independence The Listing Rules do not expressly define 'independence' regarding INEDs, but list factors that may cast doubt on a director's independence. Some of these factors are:

  • A director holds a stake of more than 1 per cent in the issuer;

  • A director has received the issuer's securities as a gift from the issuer or its core connected persons;

  • A director has a material interest in the issuer's principal business activity or has material business dealings with the issuer's group;

  • A director is or was a director, partner, or principal of a professional adviser to the issuer during the two years prior to his or her appointment; or

  • has or had a management role in the issuer's group during the two years prior to his or her appointment.

An INED's independence may be affected by the length of time served on a board. 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.

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Beginning from an issuer's first financial year commencing on or after 1 January 2023, a code provision requires a new INED to be appointed at its next annual general meeting if all of its INEDs have served on its board for more than nine years. Independence might be questioned if an INED holds cross-directorships or has significant business links with other directors. It is recommended that the board explain why the director remains independent despite having such ties. Chair and chief executive A division of responsibilities for the management of the board and the management of the company's day-to-day business must be clear, under the CG Code. The goal of this rule is to avoid the concentration of power in one person. Companies should separate 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, it 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, as long as there is a good reason justifying the arrangement. Corporate governance responsibilities A company’s board may delegate responsibilities to board committees, such as the audit, nomination, and remuneration committees. Each committee is required to have INEDs play significant roles. 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 in charge of monitoring the integrity of 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 A nomination committee must have 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 main objective is board recruitment, and it should ensure that there is a board in place that possesses a balance of skills, experience, and diversity of perspectives. Another important function is to consider and make recommendations to the board on succession planning. Remuneration committee This committee must comprise a majority of INEDs and be chaired by an INED. Its goal is to ensure that the remuneration levels of directors and management are sufficient to attract and retain those who are crucial to the company's success, without paying more than necessary. In formulating remuneration packages, the committee should evaluate 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 disclose its reasons in the next corporate governance report. Director and executive pay The company’s financial statements must disclose details of directors' basic salary, discretionary bonuses, contributions to pension schemes and other forms of remuneration. It is recommended 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 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. Directors' duties Regardless of a company’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 goal of fiduciary law is to police the exercise of discretion. A fiduciary must not profit from his or her position or have conflicting interests or duties unless the beneficiary has given informed consent. 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 conflicts of interest; and

  • not to profit from his or her position at the expense of the company.

According to the Listing Rules, a director is prohibited 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. 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. Dealing in securities Directors' dealings in the issuer's securities are 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 companies adopt the Model Code, sometimes with minor adaptations. A breach of the Model Code is regarded as a breach of the Listing Rules.

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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, other than in exceptional circumstances. Term of service and re-election All directors are 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 is required. Board diversity It is 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 2022, Hong Kong launched a repository, 'Board Diversity & Inclusion in Focus', with the aim of improving access to information on, and transparency around, board diversity. Data on each issuer's board of directors by age, gender and years of tenure is made available on the platform. Despite of the phasing out of single gender boards and other gender diversity requirements to improve female representation on boards, there is still a lot to be done to ensure that companies fully embrace the advantages of gender diversity on boards and implement their own diversity measures.




 

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