China: Lifting Standards in Listed Companies: The Hong Kong Stock Exchange publishes its consultation conclusions on the Corporate Governance Code

Last Updated: 17 August 2012
Article by Jill Wong

The Hong Kong Stock Exchange ("HKEx") recently published its Consultation Conclusions on its review of the Corporate Governance Code ("Code") and associated Listing Rules (together, the "Conclusions"), ploughing ahead with its proposals to lift standards of governance in Hong Kong listed companies (each an "Issuer"). As was not totally unexpected, HKEx toned down some of its more controversial proposals, but it is clearly determined to improve corporate governance in listed companies by pushing ahead with the adoption of many of its original proposal.

The Conclusions followed a Consultation Paper released by HKEx in December 2010, which attracted a large number of submissions/comments from industry players.The Conclusions can be found here.

HKEx will introduce amendments to the Main Board and GEM Listing Rules, and also amend the existing Corporate Governance Code.1A complete copy of the amendments to Main Board Rules and the Code can be found here.

What are the significant changes?

The table at the end of this alert summarises the major changes and their implementation dates. Most of them will be implemented by January or April 2012.Our comments on some of these changes appear below.

Directors must take an active interest in an Issuer's affairs and to be provided with management updates

The current Rule 3.08 will be expanded to state that a director has a duty to take an active interest in the affairs of the Issuer, to obtain a general understanding of its business and is obliged to investigate anything untoward.The amendment to this Rule specifically notes that attendance at formal meetings alone does not satisfy directors' duties.

Directors should not be surprised; this reflects the current expectations of courts, regulators and investors, and is part of the trend towards greater accountability.The Australian case of Centro is a further demonstration of current expectations of competence and accountability, as directors there were found to have breached their duties of care and diligence for failing to read and understand financial reports. Please see our client alerts on Centro at 1 September 2011 and 30 June 2011, as well as our client alerts on Fortescue at 8 March 2011 and James Hardie at 13 May 2011, all of which comment on recent landmark pronouncements on directors' duties and liabilities that are likely to be referred to by Hong Kong regulators and stakeholders when determining the standards to which directors' duties in Issuers in Hong Kong should be judged.

A related change to the Code, which will assist directors to effectively perform their duties, will oblige an Issuer to provide monthly management updates to directors.These updates may not necessarily be in the form of management accounts, but must be sufficient to give directors a balanced and understandable assessment of the Issuer's performance, position and prospects.

As additional measures to be implemented by amendments to the Code, HKEx will now expect the board ("Board") of directors of an Issuer to review whether directors are spending sufficient time on the Issuer's affairs, and directors must inform the Board of any significant change to their time commitments to the Issuer.HKEx will not proceed with a proposal to oblige directors to obtain a minimum of 8 hours of training in a financial year but will instead expect the Issuer to disclose how directors complied with their training obligations.

Removal of the 5% exemption for voting by a director on a matter in which they have a personal interest

Previously, a director with 5% or less interest in a company's issued shares or voting rights would be allowed to vote on a transaction between the Issuer and that company, on the basis that 5% interest was de minimis. This threshold will now be removed.2 Going forward, directors will need to make a more considered assessment of whether a transaction is "material" (HKEx has declined to define "materiality"). 

Expanding the role of Independent Non-Executive Directors ("INEDs") and introducing further measures to ensure their independence

Rule 3.10A will be amended so that at least one-third of the Board need to be INEDs. This emphasises HKEx's intention to foster strong INED representation on the Board; according to HKEx, this will not impose an undue burden on Issuers as 80% of them need only to appoint one additional INED to meet the requirement. Alternatively, an Issuer could reduce the number of directors.The Rule, unlike the other changes, will become effective 31 December 2012 to allow Issuers time to comply.

Further changes demonstrate the growing importance of INEDs in good corporate governance - according to a new Code provision upgraded from existing Recommended Best Practices, an INED who has served for more than nine years will need shareholders' approval to continue to serve, and the Issuer will need to explain the reasons for the INED's re-election and his independence in any circular for the INED's re-election. Moreover, under the new Rule 3.25, the chairman of the Remuneration Committee of an Issuer will, in the future, need to be chaired by an INED.

Measures focusing on an Issuer's auditor and company secretary

Any appointment or removal of an auditor before the end of the auditor's term will require shareholders' approval at a general meeting. To increase transparency, and so shareholders understand why an auditor is being removed, an Issuer proposing to remove an auditor will need to send a circular to shareholders and the auditor will be allowed to make representations to shareholders.

For compliance with a new Code provision, an Issuer will also have to ensure that auditors attend the Annual General Meeting; this should not be an onerous obligation as most auditors do attend AGMs as a matter of practice.

Under a new Code provision, a company secretary's selection, appointment or dismissal must be discussed at a physical Board meeting, again to ensure these events receive appropriate Board attention. There will also be new rules setting out qualifications and experience for company secretaries, as well as a new section in the Code describing their roles and responsibilities.  In particular, a company secretary will need to complete 15 hours of professional training service each financial year to comply with a new Rule.

Emphasising the roles of Board committees

HKEx will also introduce new measures so that Board committees are more effective. For example, an Issuer must establish a remuneration committee with a majority of INEDs, the chairman must be an INED, and there must be written terms of reference for the committee. A nomination committee is also expected to be established, with a majority of INEDs and written terms of reference, although HKEx will allow the chairman to be either the Board chairman or an INED. HKEx will leave it up to Issuers whether to establish a corporate governance committee or the Board can elect to retain these responsibilities themselves.

Key dates

The changes come into effect on the following dates:

  • 31 January 2012 - most of the Rule amendments.
  • 1 April 2012 - the Code and the new Rules.
  • 31 December 2012 - Rule regarding independent non-executive directors.

What do Issuers need to do?

  • By January 2011
    • Review and, if necessary, update training for Directors so that they properly understand the scope of their duties, that is, to take an active interest in, and understand the business of, the Issuer.  For example, they could be provided with a management overview of the business, operations, and informed of internal procedures to escalate issues or problems;
    • Review the qualifications of the company secretary;
    • Take internal steps to ensure Directors understand, and voting at board meetings reflect, the removal of the 5% threshold; and
    • Put in place compliance procedures for timely notification of change of directors and their information.
  • By April 2012
    • Establish procedures to keep track of Directors' activities : attendance at board meetings, training, and time of service of INEDs i.e. time spent on corporate governance;
    • Establish remuneration and nomination committees; or where you already have them, review their terms of reference (as well as those of the audit committee);
    • Establish an internal system to provide monthly management updates to Directors; and
    • Establish policies and procedures around communication with shareholders.
  • By December 2012
    • Ensure at least one-third of the Board consists of INEDs.

What do Directors of Issuers need to do?

  • Ask the Issuer what it is doing to comply with the new rules; and
  • Refresh your knowledge of directors' duties.
Subject and Relevant Rules/Code Summary of the Proposals Adopted? Implementation Date
Directors' duties
Main Board Rule (MB R) 3.08,
GEM Rule (GEM R) 5.01
Directors to take an active interest in the issuer's affairs and obtain a general understanding of its business and follow up on anything untoward. 1 January 2012
Disclosure of chief executive's remuneration
MB R 13.51, GEM R 17.50
Issuer to disclose the remuneration of a chief executive who is not a director. 1 January 2012
Company secretary's qualifications, experience and training
MB Rs 3.28, 3.29, and 19A.16, GEM Rs 5.14, 5.15 and 25.11
Specifying the academic or professional qualifications that the Exchange would consider acceptable.
The requirement for a company secretary to be ordinarily resident in Hong Kong will be removed.
Company secretaries will require 15 hours' professional training in a financial year (there will be a transitional period for implementation.
1 January 2012
Removing 5% threshold for voting on a resolution in which a director has an interest
MB R 13.44, GEM R 17.48A
The 5% exemption for voting by a director on a board resolution in which he has an interest, will be removed. 1 January 2012
Notifying directorship change and disclosure of directors' information (including the chief executive)
MB R 13.51, GEM R 17.50, new CP A.3.2
Issuer to:
  1. disclose information on the retirement or removal of a director or supervisor;
  2. disclose information on the appointment, resignation, re-designation, retirement or removal of a chief executive;
  3. disclose a director's information on all civil judgments of fraud, breach of duty, or other misconduct involving dishonesty; and
  4. clarify that the sanctions referred to in Rule 13.51B(3)(c) are those made against the issuer.
1 January 2012
Shareholders' approval to appoint and remove an auditor
MB R 13.88, GEM R 17.100
Shareholders' approval to be required at a general meeting of any proposal to appoint or remove an auditor before the term of his office. The Rule requires the issuer to send a circular containing any written representation from the auditor to shareholders and the auditor to be allowed to make written and/or verbal representations at the general meeting. 1 January 2012
Directors' time commitments Code3: A.1 Principle, new CP A.6.6 The board to regularly review the contribution by a director in the performance of his responsibilities to the issuer, and whether he is spending sufficient time. Directors should inform the issuer of any change to their significant commitments in a timely manner. 1 April 2012
Directors' training
New CP A.6.5, and new mandatory disclosure requirement under Paragraph I(i) of the Code
Issuer to disclose in its Corporate Governance Report how directors complied with training. 1 April 2012
An INED who has served nine years
New CP A.4.3
Shareholders should vote to retain an INED who has served on the board for more than nine years. Also, an issuer should include the reasons why the board considers the INED independent in the circular nominating him for election. 1 April 2012
A. Remuneration committee
MB Rs 3.25 to 3.27, GEM Rs 5.34 to 5.36, new CPs B.1.1 to B.1.4 and RBPs B.1.6 to B.1.8, new mandatory disclosure requirement under Paragraph L(d)(i) of the Code
Issuer to establish a remuneration committee with a majority of INED members; an INED as chairman of remuneration committee and written terms of reference for the remuneration committee. 1 April 2012
B. Nomination committee New CPs A.5.1 to A.5.5, new mandatory disclosure requirement under Paragraph L(d)(ii) of the Code Issuer to establish a nomination committee with a majority of INEDs; chaired by an INED or the board chairman; establish a nomination committee with written terms of reference and include, as one of the nomination committee's duties, a review of the structure, size and composition of the board at least annually to complement the issuer's corporate strategy. 1 April 2012
C. Corporate governance functions New CPs D.3.1 and D.3.2, new mandatory disclosure requirement under Paragraph L(d)(iii) of the Code The board to be responsible for corporate governance, and to disclose the corporate governance policy and duties performed in the Corporate Governance Report. 1 April 2012
D. Audit committee New CPs C.3.7 and C.3.3(e)(i), and RBP C.3.8. New mandatory disclosure requirement under Paragraph L(d)(iv) of the Code
An audit committee's terms of reference should include arrangements for employees to raise concerns about financial reporting improprieties.
An audit committee should meet the external auditor at least twice a year.
1 April 2012
Disclosure of senior management remuneration by band New CP B.1.5 Senior management remuneration should be disclosed by band. 1 April 2012
Directors' attendance at board meetings New CP A.1.7, new mandatory disclosure requirement under Paragraph I(c) of the Code An issuer may count attendance by electronic means (including telephonic or video-conferencing) as attendance at a physical board meeting (subject to other applicable law). 1 April 2012
Providing monthly information to board members to enable them to discharge their duties New CP C.1.2 Management should provide monthly updates to board members giving a balanced and understandable assessment of the issuer's performance, position and prospects in sufficient detail. 1 April 2012
Directors' attendance at meetings
New CPs A.6.7 and A.6.8, new mandatory disclosure requirement under Paragraph (I)(c) of the Code
New CP E.1.2
Non-executive directors, including INEDs, should attend board, committee and general meetings and contribute to the issuer's strategy and policies.
Issuer to disclose details of the attendance at general meetings of each director by name in its Corporate Governance Report.
1 April 2012
Auditor's attendance at AGMs
New CP E.1.2
Issuer to ensure that the external auditors attend the AGM to answer questions about the conduct of the audit, the preparation and content of the auditors' report, accounting policies and auditor independence. 1 April 2012
Shareholders' rights
New mandatory disclosure requirements under Paragraph O of the Code
An issuer must disclose the following "shareholder rights" information in its Corporate Governance Report:
  1. the way in which shareholders can convene an extraordinary general meeting;
  2. the procedures for sending enquiries to the board; and
  3. the procedures for making proposals at shareholders' meetings.
1 April 2012
Establishing a communication policy
New CP E.1.4
Issuer to establish a shareholder communication policy. 1 April 2012
Publishing constitutional documents on website
MB R 13.90, GEM R 17.101
Issuer to publish an updated and consolidated version of its constitutional documents on its own website and the HKEx website. 1 April 2012
Publishing procedures for election of directors
MB R 13.51D, GEM R 17.50C
Issuer to publish on its website the procedures shareholders can use to propose a person for election as a director. 1 April 2012
New section in Code on Company Secretary
New Section F of the Code
  1. The company secretary should be an employee of the issuer;
  2. the selection, appointment, or dismissal of the company secretary should be a board decision;
  3. the company secretary should report to the board chairman and/or the chief executive; and
  4. all directors should have access to the advice and services of the company secretary.
1 April 2012
INEDs to form one-third of board
MB Rs 3.10A and 3.11, GEM Rs 5.05A and 5.06
At least one-third of an issuer's board should be independent non-executive directors (INEDs). In addition, an issuer will have a three-month period to appoint a sufficient number of INEDs to comply with the one-third Rule after failing to meet the requirement. By 31 December 2012


1 Compliance with Listing Rules is mandatory for all issuers; whereas compliance with the Code is not. However, the "comply or explain" principle continues to apply to the Code provisions, so when an issuer does not comply with the Code provisions, they must explain why with considered reasons.

2 By an amendment to Rule 13.44.

3 Although the wording of the Main Board Code (Appendix 14) and the GEM Code (Appendix 15) are not identical, the paragraph numberings in both Codes are the same.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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