Following is the full text of the speech (English only) delivered by the Registrar of Companies, Mr Gordon Jones, at the MAICSA International Conference on Corporate Governance in Kuala Lumpur today (April 24):
Corporate Governance Reform:
Hong Kong's Experience
En Khairil Annuar, Ladies and Gentlemen,
First of all, I would like to say how delighted I am to be back in Malaysia just over four years after the very successful international conference on corporate governance which MAICSA organized in 1996. The title of this session is: 'Applied Corporate Governance : A Global Perspective of the Geo-political & Economic Evolution' which gives me an excellent opportunity to outline what is happening regarding Hong Kong's Corporate Governance Review which commenced in early 2000. But first of all, I would like to make some general remarks.
Three years ago, when the Asian economic downturn was very severe, there was a clear need for corporate governance reform and a collective will to take action. Poor or inadequate disclosure, although not a cause of the downturn, certainly exacerbated underlying economic problems. At the very least, it can be said that better disclosure would have allowed both governments and companies to react to underlying economic problems in a more timely manner. Today, with the apparent recovery of many Asian economies, the need for corporate governance reform is no less clear, and it is very important that the collective will to take action does not weaken, particularly as this recovery could be more illusory than real and be profoundly affected by developments in the US economy. Ironically, it is always easier to make the case and obtain support for reform when there is a crisis. However, when the situation improves, there is always a temptation to let things slip and put reform aside for another day because it involves too much trouble and is, perhaps, unnecessary. Nothing could be further from the truth.
In Hong Kong, we are very conscious of the need to continually enhance corporate governance standards if we are to maintain our position as one of the pre-eminent international financial and business centres in Asia. In fact, last year has been, if any thing, the year of corporate governance. In February 2000, the Financial Services Bureau (FSB) of the Hong Kong Government asked the Standing Committee on Company Law Reform (SCCLR) to undertake an overall review of corporate governance in Hong Kong. This review was announced publicly by the Financial Secretary (FS) in his budget speech in March 2000. Then, from 31 May to 2 June, the Special Administrative Region played host to the OECD's Second Asian Roundtable on Corporate Governance which focussed on the role of disclosure in governance. Finally, in November, the Hong Kong Institute of Company Secretaries (HKICS) held the Institute's second international corporate governance conference. One of the messages which emerged loud and clear from the OECD Roundtable was that there had been enough talk of principles and it was now time to translate these into practice.
Structure, Scope and Direction of the Review
In order to take the review forward, the SCCLR agreed that three sub-committees should be established namely -
* Directors Sub-Committee (DSC)
* Shareholders Sub-Committee (SSC)
* Corporate Reporting Sub-Committee (CRSC)
As far as the scope of the review is concerned, it is a roots and branch examination of the existing corporate governance regime in Hong Kong. However, in order to do this properly and thoroughly, it is necessary to establish external and internal benchmarks as a framework for reference. Consequently, one of the first tasks of the Review was to commission two major surveys. The first will be a survey and analysis of the attitudes of international institutional investors towards corporate governance standards in Hong Kong. The views of such investors will be of particular importance and value given Hong Kong's importance as a capital-raising centre, with particular reference to China listings, and the need to access international capital at the most advantageous rates. The second will be a comparative survey and analysis of the development of corporate governance standards in both competitor jurisdictions in South East Asia and jurisdictions elsewhere in the world. These are Australia, Malaysia, Singapore, Taiwan, the United Kingdom and the United States of America.
The review will also cover unlisted as well as listed companies. To date, the corporate governance debate has tended to proceed as if listed companies were the only companies worth considering and, in this respect, I would make two points. First, the law does not require a company issuing shares to the public to list on any exchange. However, investors in a publicity-held but not listed company need as much protection as investors in a listed company. Indeed they need more because they do not have the protection of the Securities and Futures Commission (SFC) and the Stock Exchange (SEHK). Secondly, private companies comprise the overwhelming majority of the half a million companies registered in Hong Kong. Together with unincorporated businesses, these companies represent about 99% of all entities both incorporated and unincorporated. They play a very important economic role as they sell a significant proportion of the Special Administrative Region's exports, contribute roughly 40% to GDP and employ about 60% of the work force. However, in the final analysis, if the shareholders in a public company have a grievance which either cannot or will not be remedied, they have an exit as there is usually a market for their shares. By contrast, no such remedy is available to the shareholders in private companies. It is, therefore, very important that the governance issues affecting unlisted companies, both public and private, are addressed fully in any review.
The direction of the review is also 'open' in so much as we do not have any pre-determined theoretical balance to be struck between external statutory regulation on the one hand and internal best practice on the other. Any recommendations on this 'mix' can evolve only after the review has begun to consider the existing corporate governance regime against external and internal benchmarks, having regard to the results of detailed research projects, and decided where it would be appropriate and reasonable to make adjustments in order to enhance corporate governance standards. Having said this, I would stress that, if good corporate governance practice is to take root, it must come from within rather than being imposed from without. Consequently, it is as much, if not more so, a matter of corporate culture, education and best practice as well as legislation and regulation. However, it would be foolish and naive to leave everything to best practice, and one point which has emerged strongly from the review to date is that there must be adequate policing and enforcement of corporate governance standards. Consequently, while regulators like me should talk softly, it is also essential that we carry big sticks and are not afraid to use them!
Programme of the Review
Essentially, the Corporate Governance Review is proceeding on two major fronts as follows:-
(a) A number of universities will be commissioned to undertake two surveys and three research projects which have been identified by the SCCLR and the three Sub-Committees;
(b) The Sub-Committees are considering papers on specific subjects having regard to their terms of reference.
Surveys and Research Projects
The surveys and research projects will provide available data regarding 'benchmarking' Hong Kong as regards corporate governance standards and major 'broadbrush' issues where it is very important to assess empirically-derived data before making policy decisions. I have already mentioned the survey on international institutional investors' attitudes towards corporate governance standards in Hong Kong and the survey on the corporate governance standards in other jurisdictions. In addition, three other studies will be commissioned as follows:-
(a) The roles and functions of audit, nomination and remuneration committees;
(b) Company information flow and shareholders' rights of access to such information;
(c) An economic analysis correlating the performance of listed companies with their shareholders' profile.
Consultancy briefs regarding these projects were issued on 18 January 2001 to five universities in Hong Kong which had responded positively to earlier letters inviting expressions of interest. They were given until 28 February 2001 to submit detailed proposals. In the event, three universities submitted detailed proposals which were considered by a Selection Panel in March. It is hoped that contracts will be signed with the selected university(ies) some time in April and the results of the surveys and research projects will be available by the end of the year.
The Work of the Sub-Committees
In the meantime, the three Sub-Committees are continuing with their work on specific issues which can be tackled in advance of the results of the surveys and research projects being known. However, it is possible that we may need to revisit some of these issues in the light of the results of the research work.
First of all, the work of the DSC. To date, the most salient recommendations emerging from this sub-committee can be summarized as follows:-
(a) The different types of director e.g. executive, non-executive, and independent non-executive director should not be specifically categorized in statute law as this could hamper the development of case law which had proved quite adequate to accommodate different standards without undermining the principle of collective responsibility;
(b) There should be a non-statutory rather than a statutory code of directors' duties as a statutory code would inevitably be regarded as exclusive; would inhibit the development of case law in an ever changing situation; and would, in any case, have to be supplemented by detailed and definitive non-statutory guidelines. Action is now being taken to draft this code;
(c) There should be statutory requirement that directors should not vote on transactions in which they have a material interest subject to certain statutorily specified exceptions. Furthermore, shareholders should be permitted to ratify or approve transactions where directors or controlling shareholders have an interest, provided that these do not fall within the categories of unratifiable acts on omissions;
(d) The right of shareholders to elect directors should be clearly set out in legislation so that it cannot be excluded by a company's articles of association; the existing statutory period during which shareholders can lodge a proposal for a candidate should be amended so that they have a realistic time frame within which to effectively lodge their nominations; and there should be a statutory provision that each nominee for the post of director should have an equal opportunity to be voted as a director even if the number of nominees exceeds the number of vacancies.
In addition, the DSC has been examining at its most recent meetings the particularly problematic issues of connected party transactions and arrangements between private joint venture companies in which a public company is a shareholder and a director or connected person where the joint venture company is not a subsidiary of the public company.
Finally, before I leave the subject of directors, the Companies (Amendment) (No. 2) Bill 2001, which is currently being drafted, contains a number of major proposals regarding directors which have arisen in the context of the SCCLR's separate overall review of the Companies Ordinance. These are as follows:-
* Abolishing corporate directors;
* Removing directors by ordinary (as opposed to special) resolution notwithstanding any provision in the company's constitution;
* Making a director vicariously liable for the acts and omissions of his alternates;
* Providing a statutory definition of shadow directors.
All these measures will assist with the overall objective of improving the accountability of directors.
I turn now to the work of the Shareholders Sub-Committee. We consider that shareholders play a critically important role in enhanced good corporate governance for the following reasons :-
(a) Shareholders, rather than the Government and regulators, should be the primary guardians of their interests in a company. As such, they should have the ability and powers to protect these interests. If not, they should be adequately empowered to protect these interests;
(b) Shareholder activism, by its nature, should promote good corporate governance within companies thereby reducing the need for intervention by the Government and regulators.
At present, quite apart from any prosecution of companies by the Government and the regulators, shareholders can also seek civil remedies. However, the cost and time required to initiate shareholders' actions is regarded by many as being prohibitive. There are also structural impediments in bringing a case to court as evidenced by the difficulty of commencing derivative actions. Furthermore, there have been doubts regarding their effectiveness as the company would almost inevitably be financing the litigation out of its assets which may work to the shareholders' disadvantage. In the final analysis, the shareholders of companies whose shares are publicly traded can vote with their feet and opt for selling their shares instead of litigating, and it is believed that this takes place in many instances.
As regards the empowerment of shareholders, the SSC has, to date, been focussing on two major issues. First, the re-enfranchisement of the beneficial holders of shares whose legal title is, in most cases, held by the nominee of the Hong Kong Securities Clearing Corporation (HKSCC) which operates the Central Clearing and Settlement System (CCASS). As a result, the nominee company rather than the beneficial owners will, for example, receive notices of meetings and corporate actions. This makes it impossible for the beneficial owners to exercise their rights as shareholders unless they enter into specific contractual agreements with the HKSCC but this option is not taken up in most cases. The SFC is currently drawing up proposals to resolve this problem so that the electronic book entries under CCASS will effect the transfer of the legal ownership of the shares as opposed to the beneficial ownership which is currently the case.
Secondly, the SSC is considering the question of shareholders remedies and removing structural impediments to shareholders taking action through the courts. It is therefore proposed that there should be a statutory derivative action under which, if there is a cause of action which is not ratifiable i.e. dishonesty, fraud or expropriation of corporate assets is involved, the plaintiff should be allowed to proceed to trial on the merits of his case. There will be no need for the plaintiff to have a preliminary hearing before the court to determine whether or not he should be allowed to sue on behalf of the company. In parallel, it is also proposed that the SFC should be able to conduct civil proceedings on behalf of any company or individual in certain statutorily specified circumstances. Other recommendations to enhance shareholders' remedies include the inclusion of a statutory procedure whereby shareholders can obtain access to company records upon application to the court, and giving the court the power to restrain potential breaches of the Companies Ordinance or directors' fiduciary duties.
However, in the final analysis, the law can only empower shareholders to take action, and whether or not they actually take action is up to the shareholders themselves which brings us to the critically important subject of shareholder activism. Logically, if the adoption of good corporate governance practice makes a company more attractive to investors, the pressure for corporate governance reform should come from the shareholders. However, that is the theory and the practice can be somewhat different. To date, attempts to promote greater activism by institutional shareholders in Hong Kong have proved disappointing. It is possible that the growth of institutional investments under the recently established Mandatory Provident Fund (MPF) may see a change in this area but, if so, it may be more of a long term than short term improvement.
A related recent initiative, aimed at minority shareholders, concerns the establishment of a Hong Kong Association of Minority Shareholders (HAMS) which would be funded by a new market transaction levy. If constituted, HAMS would comprise a policy division to lobby for and promote improvements in the legislation and regulatory framework; a ratings division to establish and publish a system of corporate governance ratings; and an enforcement division to sue companies which abuse minority shareholders achieving quasi-class actions on behalf of members without need to reform the legal system.
In addition to these measures, the Companies (Amendment) (No. 2) Bill 2001, which I mentioned earlier, also contains a number of proposals regarding shareholders. These are as follows :-
* Reducing the threshold for circulating shareholders' proposals to 2.5% of the voting rights or 50 shareholders;
* Giving every shareholder a personal right to sue to enforce the terms of a company's Memorandum and Articles of Association.
Once again, these measures should assist with making it easier for minority shareholders to take action in the context of a corporate scene where many listed companies are dominated by majority shareholders.
Corporate Reporting Sub-Committee
Finally, I come to the work of the Corporate Reporting Sub-Committee. In many ways, disclosure is the most basic corporate governance principle. Adequate and timely disclosure ensures the transparency of a company's operations without which potential investors and shareholders cannot make informed investment decisions, quite irrespective of whether they are majority or minority shareholders. The work of the CRSC is proceeding on a number of fronts and involves, to a very considerable extent, the Hong Kong Society of Accountants (HKSA) which is the public body charged with responsibility for 'the registration and control of the accountancy profession' under the Professional Accountants Ordinance (Cap. 50).
As far as the work on improving the statutory disclosure requirements in the Companies Ordinance and accounting standards are concerned, the present position is as follows:-
* The harmonization of Hong Kong Statements of Standard Accounting Practice (SSAPs) with International Accounting Standards (IASs), has been making generally good progress. It is intended that HKSSAPs will be fully compatible with all the IASs endorsed by IOSCO by the end of 2001;
* The CRSC and the HKSA's Financial Accounting Standards Committee (FASC) will be reviewing the statutory disclosure requirements in the 10th Schedule to the Companies Ordinance;
* A HKSA Working Group is drawing up proposals regarding the introduction of Generally Agreed Accounting Practices (GAAP) for small companies and reviewing the provisions in the Companies Ordinance regarding accounts for small private companies, namely section 141D and the 11th Schedule.
* The proposed introduction of Summary Financial Statements (SFS) for listed companies which can be sent to shareholders, only at the shareholders' request, as an alternative to the full annual report and accounts. Legislative proposals to implement this proposal are contained in the Companies (Amendment) (No. 1) Bill 2001 which it is hoped will be introduced into the Legislative Council in June 2001;
Other major initiatives taken by the CSRC to date include:-
* A review of the financial reporting structure for Hong Kong companies;
* The proposed mandatory filing of audited accounts by private companies with the Companies Registry;
* A review of the current system for preparing and monitoring accounting and auditing standards.
Hong Kong's corporate governance review has now been in progress for one year. While much has been done, much also requires to be done and there is no room for complacency. As corporate governance reform is a continuous not a finite process, the SCCLR's corporate governance review will be proceeding in phases. In this respect, the three sub-committee's recommendations to date will be summarized in a report which will be launched in the middle of this year for a period of public consultation, lasting, say, six months. At the end of this period, the recommendations will be reconsidered, in the light of the comments received, and firm proposals formulated for legislative and administrative action. In the meantime, the three sub-committees will continue these work with a view to repeating the process in, say, a year's time.
Ladies and Gentlemen, some might argue that there is a surfeit of corporate governance conferences and I have to say that this is the second such conference which I have attended this month! However, given the fact that the performance of a country's economy lies, in no small part, with the state of corporate governance in that country, this may not be a bad thing. I also have to say that, in my experience, these conferences tend to be cases of the converted preaching to the converted as they are dominated by government officials, regulators and practitioners. However, businessmen, in particular the directors of companies, who should be the main driving force behind good corporate governance tend to be rather thin on the ground. In this respect, it is essential that we get the message outside these four walls that good corporate governance practice is also good business practice. It is an integral element in driving a country's economic development, not an optional extra. All of us are here to day because we recognize this key fact. We must not be defensive about our perceived weaknesses in corporate governance but be prepared to acknowledge them and, if appropriate, learn from each other in order to address them. I would therefore like to congratulate MAICSA and MICG for organizing this conference with its strong practical emphasis and hope that conformance will undoubtedly lead to performance. Thank you.
End/Tuesday, April 24, 2001