Hong Kong: Corporate Law: Independent Directors in Hong Kong and the Code of Corporate Governance Practices

Last Updated: 11 April 2006

Introduction

The number of Hong Kong listed mainland companies reached 307 accounting for 28% of the listed companies in Hong Kong and taking up 31% (about 2.109 trillion RMB) of the aggregate market value as at February 2005. Following major corporate scandals in China and elsewhere, Hong Kong Stock Exchange has been setting new rules to improve corporate governance. One of the crucial safeguards for ensuring good corporate governance with listed companies in Hong Kong is the revised requirements regarding independent non-executive directors ("INEDs") under the Rules Governing the Listing of Securities on the Stock Exchange of Hong Kong Limited ("Listing Rules").

The Code of Best Practices in Appendix 14 of the Listing Rules has been replaced by the Code of Corporate Governance Practices ("Code") which Code is effective for accounting periods commencing on or after 1 January 2005. Most listed companies which have not already complied with the Code would now have to do so in 2006. The Code cover 5 main areas :-

Directors, Remuneration of Directors and Senior Management, Accountability and Audit, Delegation by the Board and Communication with Shareholders.

Under the new Listing Rules, listed companies are inter alia required to disclose in their annual repots, independent directors’ remuneration on a named basis. Listed companies are also required to present a Corporate Governance Report for inclusive in annual reports.

General Requirements under the Listing Rules

Pursuant to the Listing Rules, every board of directors of a listed company must include at least 3 INEDs at least 1 of whom must have appropriate professional qualifications or accounting or related financial management expertise. In addition, pursuant to the Code (which a listed company is generally expected to follow and is required to give reasons for non-compliance with), INEDs should represent at least one-third of the board of directors.

Further, every listed company is required under the Listing Rules to establish an audit committee comprising only of non-executive directors with at least 1 INED and such committee must be chaired by an INED.

The objective of the audit committee is to review and supervise the financial reporting process and internal controls. With the involvement of INEDs it helps to reduce the possibility of fraud and improves the level of disclosure in financial reporting.

Pursuant to the Code, a listed company is also required to establish a remuneration committee to review and make recommendation on the remuneration of executive directors and senior management. The majority of members of such remuneration committee should be INEDs.

The Criteria of "Independence"

The purpose of enhancing corporate governance will only be served if INEDs are indeed independent. Although independence is a subjective state of mind, Rule 13.13 of the Listing Rules sets out tests to be applied in assessing whether a director is independent.

Generally speaking, the issue of independence is likely to be questioned where the director :-

  1. holds more than 1% of the total issued share capital of the listed company;
  2. has received an interest in any securities or the listed company as a gift, or by means of other financial assistance from a connected person or the listed company;
  3. is a director, partner or principal of a professional adviser which currently provides or has within 1 year prior to his proposed appointment provided services to the listed company, its holding company or their respective subsidiaries or connected persons or a controlling shareholder;
  4. has a material interest in any principal business activity of or is involved in any material business dealings with the listed company, its holding company or their respective subsidiaries or with any connected persons of the listed company;
  5. is on the board specifically to protect the interests of an entity whose interests are not the same as those of the shareholders as a whole;
  6. is or was connected with a director, the chief executive or a substantial shareholder of the listed company within 2 years immediately prior to the date of his proposed appointment;
  7. is, or has at any time during the 2 years immediately prior to the date of his proposed appointment been, an executive or director (other than an INED) of the listed company, of its holding company or of any of their respective subsidiaries or of any connected persons of the listed company; and
  8. is financially dependent on the listed company, its holding company or any of their respective subsidiaries or connected persons of the listed company.

Conclusion

The challenges faced by INEDs in Hong Kong today are to comply with and operate within a regulated environment whilst at the same time providing value to listed companies. In meeting such challenges, both the INEDs and the listed companies should be familiar with the legal and regulatory issues relating to them.

Our Corporate Department provides INED and corporate compliance services and regularly advise various INEDs and listed companies on a wide range of legal issues relating to as well as regulatory compliance with the Listing Rules. Please contact us if you have any queries.

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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