PRIMER: Changes to HKEX’s corporate governance rules
IFLR’s latest explainer looks at how proposed changes will have implications for diversity, board governance and ESG
The Hong Kong Stock Exchange (HKEX) is proposing changes to the Corporate Governance Code and Listing Rules to enhance standards in corporate culture, director independence, diversity and environmental, social and governance (ESG). Corporate governance experts said that the changes will help to enhance standards at listed companies but will require extensive planning, training and culture change for businesses.
What are the proposed new rules about?
Proposed changes to the Corporate Governance Code and the Listing Rules cover a wide range of areas. Board culture is a key concern and planned changes cover board independence, promoting board refreshment and succession planning, as well as gender diversity. New independent non-executive directors (INEDs) will need to be appointed for companies with long-serving INEDs. Additionally, ESG reports will need to be published at the same time as the publication of annual reports.
What motivated the HKEX to propose these changes?
According to the HKEX, the framework in the Corporate Governance Code and the Listing Rules is designed to help boards be effective, by providing benchmarks and best practice guidance for the delivery of good corporate governance. The proposed changes aim to improve the quality of governance and to maintain investors’ confidence in the Hong Kong SAR market.
What will be the biggest challenges for businesses?
One of the proposed changes is that listed companies currently with single gender boards will have to appoint at least one director of the absent gender on their boards within three years, and IPO applicants are not expected to have single gender boards.
“Companies in certain male-dominated industries may find it difficult to identify female candidates with appropriate skills, knowledge and experience,” said Peter Cheng, partner at Deacons.
Additionally with the proposed change requiring all listed issuers to set and disclose numerical targets and timelines for achieving gender diversity at both the board level as well as across the workforce, including senior management, Cheng said that it may pose challenges for certain male-dominated industries.
Listed companies will be given three years to comply with the gender diversity requirements. However, it is unclear how the gap will be filled.
According to Christopher Ma, partner at Simmons & Simmons, timing will be a challenge. “Although there will be a transition period of three years to allow issuers with single gender boards to appoint at least one director of the absent gender on their boards,” he said. “The transitional period may not be sufficient to appoint a person of the relevant background and suitable skills for the role from the absent gender.”
As of December 31 2020, around 32% of listed issuers in Hong Kong SAR do not have any female board directors, which demonstrates the possible magnitude of impact.
Belinda Wong, director at Leader Corporate Services, said: “Quality is of the utmost importance”.
“Being an employee is very different from sitting on the board. Knowledge, skills and experiences have to be learned and acquired,” she continued. “Whether companies which do not have female board members can find suitable board candidates remains to be seen. Some professional bodies have been providing directorship training but the question is: is that enough?”
Another proposed change is to elect a new INED if all INEDS are long-serving. As of December 2020, there were 153 companies with only long-serving INEDs on their boards. These companies will have to compete to get a new INED on board at annual general meetings.
For the proposal that re-election of long serving INEDs will be subject to independent shareholders’ approval, around 30% of existing listed issuers will be affected. If the re-election of any long serving INED is voted down, the issuer will have to get a new INED on board to fill up the place within three months in order to meet the HKEX’s Listing Rules requirements.
The INED requirements are proposed to be “comply or explain” requirements only, and HKEX is proposing a longer transition period for the financial year starting on or after January 1 2023 to implement the changes in relation to long serving INEDs. “Companies should however take note of HKEX’s remarks in the consultation paper that it may consider phasing out all long serving INEDs gradually in the long run,” said Cheng. “By then that will be a real challenge.”
The shortage of suitable and qualified INED candidates may be further exacerbated. According to Ma, in some cases, such shortage is caused by the inadequate level of remuneration. INED remuneration varies considerably, ranging from several tens of thousands to millions of dollars. The Hong Kong Monetary Authority issued guidance back in December 2016 that the recommended INED remuneration should have at least a basic fee of HK$400,000 ($51,507) per year, coupled with additional payments for membership or chairing of board committees, for banks in Hong Kong SAR.
Wong added: “Responsibilities and workload are getting much heavier so the risk to reward ratio is not well-balanced. People who are qualified enough may not be willing to accept the INED appointment.”
A potential issue that may arise is the integration of a new INED into a board with long-serving INEDs. Wong said: “If the existing INEDs have served the company for a long time, they would know one another quite well and have good knowledge of the company’s operation. Group think might come into play, but the new INED may not be able to break through this.”
As to the proposal to align the publication timeframe of ESG reports and annual reports, Ma said that the requirement to publish ESG reports at the same time as annual reports may add pressure on smaller listed issuers.
A further challenge for smaller companies is the need for enhanced two-way communication with shareholders as currently only large listed companies have investor relations officers.
“Communication with shareholders requires specific skill sets to prevent companies from breaching rules on insider information,” said Wong. “Under current economic circumstances, smaller-sized listed companies may find it too burdensome. HKEX has to convince them that transparency and enhanced communication could have positive impact on share price and turnover.”
What areas still lack clarity?
Mary Leung, head of advocacy, Asia-Pacific at the CFA Institute, said that the proposals around culture may be challenging. “It is absolutely the right thing to focus on but it is very “squishy” – there are no bright line tests as to whether an issuer has a good culture,” she said. “The guidance from HKEX is helpful but it remains to be seen if and how the proposals will lead to a change in mindset and behaviour.”
For the proposed requirement for disclosure in gender diversity in the workforce, the consultation does not specify the granularity of the disclosure. “It’s unclear whether disclosures should be made separately for each level or cumulatively,” said Ma. “In addition, organisational structures may vary across industries, which would require different approaches in disclosure.”
The HKEX proposed that independent shareholders’ approval is required for re-election of long serving INEDs. However, the consultation paper does not elaborate on the meaning of “independent shareholders’ approval”, said Cheng.
Cheng believes that the HKEX contemplates that “independent shareholders” would bear the same meaning as set out in the note to Listing Rule 13.39. It indicates that an independent shareholder is one other than controlling shareholders of the issuer and their associates or, where there are no controlling shareholders, any shareholders other than directors, excluding INEDs, and the chief executive of the issuer and their respective associates. However, in this context the long serving INED in question would not be considered as an independent shareholder.
How can the proposed changes go further?
CFA Institute’s Leung said that the proposed changes on INEDs do not go far enough. As indicated in the consultation paper, 18% of INEDs have a tenure of nine years or more and they sit across 30% of all issuers in Hong Kong SAR. “This is too high, there should be a hard stop on tenure after which an INED either has to step down or be re-designated as non-independent,” she said. “Some companies have INEDs that have served on the board for over 10 or 20 years and it is hard to fathom that one’s independence is not affected.”
According to OECD data, institutional investor ownership is only around 12% for Hong Kong SAR listed companies, with the rest being family or corporation owned (23%), public sector (38%), and retail (27%). Additionally, there are no requirements to separate the role of chair and CEO or requirements to make the chair independent.
“These features make the role of INEDs particularly important because the independent shareholder voice is not as strong as say the US, UK or Australia where there much higher institutional investor ownership,” said Leung. “INEDs are important gatekeepers and are essential in scrutinising any related party transactions, recruiting new board members and approving remuneration.”
How should companies be preparing?
While proposed changes to corporate governance are laudable, for some companies it will be a difficult journey to embark on.
Companies should set realistic, achievable targets according to their own circumstances, suggested Cheng. In the planning, formulation and implementation of policies for achieving proposed targets, such as those related to gender diversity, companies should also be mindful not to create any perception of positive discrimination which could have a detrimental impact on morale in their organisations.
According to Wong, Mindset is difficult to change. “If the current corporate culture of a listed company does not meet the required standards of transparency and visibility, the directors, senior management and general staff will have to undergo training which may not achieve results within a short time frame,” she said.
Time, resources and talent are going to be key challenges going forward. HKEX has proposed to commence changes in the financial year commencing on or January 1 2022, with proposals on long serving INED taking effect one year thereafter.
“Listed companies may face substantial mileage in shaping their corporate culture in these areas, the development of which would require continuous measurement and feedback,” said Ma.
He continued: “There would also be the need for the drafting and review of new policies, as well as new hires or internal organic development in order to implement and comply with the proposed changes.”
“Listed issuers would face competition in attracting and retaining talent, particularly as diversity targets would have to be met, not just on the board level, but generally in the workforce,” he concluded.