Corporate Governance Code Amendments and Guidance for Boards and Directors

Introduction

On 27 July 2018, the Stock Exchange of Hong Kong Limited (the Stock Exchange) published its Consultation Conclusions on the Review of the Corporate Governance Code and Related Listing Rules (the Consultation Conclusions), pursuant to which various amendments to the Listing Rules will take place on 1 January 2019 so as to enhance the corporate governance standards of listed issuers in Hong Kong. This follows the Stock Exchange’s November 2017 Consultation Paper on Review of the Corporate Governance Code and Related Listing Rules (the Consultation Paper).

In conjunction with the Listing Rules’ amendments, the Hong Kong Stock Exchange has published a “Guidance for Boards and Directors” (the Guidance), which provides practical advice to the board and directors to facilitate their performance of their roles and responsibilities, including a recommendation to listing applicants to appoint independent non-executive directors (INEDs) at least two months before listing. The Guidance is not part of the Listing Rules and does not amend the Listing Rules’ requirements.

The amendments set out in the Consultation Conclusions include:

• a new disclosure requirement requiring issuers to explain to why an INED would be able to devote sufficient time to the board where he/she will be holding his/her seventh (or more) listed company directorship (amended Code Provision (CP) A.5.5 of Appendix 14 to the Listing Rules);

• CP A.5.6 requiring issuers to have a policy concerning diversity of board members and to disclose the policy or a summary of the policy in their corporate governance reports will be upgraded to a Listing Rule (new Listing Rule 13.92);

• amended disclosure requirements in respect of the election of an INED, including new requirements to disclose the process used for identifying the nominee; the perspectives, skills and experience that the nominee can bring to the board; and how the nominee would contribute to diversity of the board (amended CP A.5.5);

• extended cooling off periods:

  • for a director, partner or principal or employee of a former professional adviser, s/he would only be considered independent from the issuer following a two year cooling off period, rather than one year under the existing rules (Listing Rule 3.13(3));

  • for a former partner of an issuer’s existing audit firm, the cooling off period for qualifying to become a member of the issuer’s audit committee has been extended from one year to two years (amended CP C.3.2);

  • for persons with material interests in the issuer’s principal business activities, a cooling off period of one year has been introduced before such persons may become an INED (amended Listing Rule 3.13(4));

• a new disclosure requirement requiring issuers to provide reasons as to why proposed directors are considered independent even where they hold cross-directorships or have significant links with other directors through involvements in other companies or bodies (new Recommended Best Practice (RBP) A.3.3 of Appendix 14);

• when determining the independence of a director under Listing Rule 3.13, the same factors also apply to the director’s immediate family members (new Note 2 to Listing Rule 3.13);

• a new requirement to disclose issuer’s nomination policy in its corporate governance report (amended Mandatory Disclosure Requirement L. (d)(ii) of Appendix 14);

• amended requirement for INEDs to meet with the chairman at least annually (rather than all NEDs as currently required) (amended CP A.2.7);

• a new requirement for issuers to have a policy on payment of dividends to be disclosed in annual reports (new CP E.1.5); and

• the Stock Exchange will not allow shareholders’ consent to be implied for electronic dissemination of corporate communications by issuers.

Corporate Governance Code and Corporate Governance Report

Appendix 14 Corporate Governance Code and Corporate Governance Report (the Corporate Governance Code) contains two levels of recommendations: the code provisions and recommended best practices.

Issuers are expected to comply with, but may choose to deviate from, the code provisions. However, the code provisions are subject to “comply or explain” requirements; namely, issuers must disclose whether the code provisions have been complied with, and give considered reasons for any deviations from them, in their interim reports (and summary interim reports, if any) and in their corporate governance reports required to be included in their annual reports (and summary financial reports, if any).

On the other hand, recommended best practices are subject to voluntary disclosure and are for guidance only. Issuers are encouraged, but not required, to state whether they have complied with the recommended best practices and provide considered reasons for any deviation.

In addition, issuers must contain all information that falls within the scope of mandatory disclosure requirements under paragraphs G to P of the Corporate Governance Code in their CG report (“Mandatory Disclosure Requirements“).

Amendments to the Corporate Governance Code

Independent Non-executive Directors

Overboarding and INED’s time commitment

CP A.5.5 will be amended to require the board to state in the circular to shareholders accompanying the notice of the resolution to elect an INED, and where the proposed INED will be holding his/her seventh (or more) listed company directorship, why the INED would be able to devote sufficient time to the board.

This will apply to the INED’s election to a new board and any re-elections to other boards. The Hong Kong Stock Exchange in the Consultation Conclusions disagreed with comments by some respondents that the same individual being an INED across companies within one listed issuer’s group should only represent one directorship.

Whether or not an INED would be able to devote sufficient time commitment to an issuer would depend on a number of factors, including:

• the level of involvement expected of the INED due to the level of activity of the issuer – for example, an INED may be expected to spend more time in respect of an issuer undergoing a period of particularly increased activity, for example during an acquisition or a takeover;

• whether the INED would be chairing any board and/or board committees of a listed issuer;

• the INED’s membership of board committees;

• whether the INED is a chief executive officer (CEO) or full time executive director of another listed issuer; and

• whether the INED already sits on multiple boards and/or has a number of significant commitments in government or non-profit making organisations.

According to the Consultation Conclusions, when assessing an INED’s time commitments, other significant commitments should be taken into account. Here, the Stock Exchange made reference to CP A.6.6 pursuant to which each director should disclose to the issuer at appointment, and subsequently in a timely manner in respect of any change, the number and nature of offices held in public companies or organisations and other significant commitments.

Election of INEDs

The Corporate Governance code will be amended so that the board must state in the circular to shareholders accompanying the notice of the resolution to elect an INED:

1. the process used for identifying the nominee;

2. the perspectives, skills and experience that the nominee can bring to the board; and

3. how the nominee would contribute to diversity of the board.

Factors affecting INED’s independence

Cooling off periods for former professional advisers

Listing Rule 3.13(3) will be amended to extend the cooling-off period for a director, partner or principal or employee of a former professional adviser to an additional second year before they could be considered independent.

Currently Listing Rule 3.13(3) provides that independence is likely to be questioned where a director, partner or principal or employee of a professional adviser has provided services within one year immediately prior to the proposed appointment. This Listing Rule will also be subject to minor amendments in response to a comment that a strict reading of the current drafting only captures current but not former directors, partners or principals or employees.

It was proposed in the Consultation Paper to revise Listing Rule 3.13(3) so that there is a three year cooling-off period for professional advisers before being considered independent. Only a slight majority supported the proposal, and there was a broad range of views supporting between one and five year cooling-off periods. In response to the opposition to the proposal on the basis that it is overly restrictive, the Stock Exchange stated that the pool of professional candidates is reduced by a very small number of persons who may have had professional affiliations with the issuer, and that issuers should look for a wider range of experienced professionals and persuade them of the advantages of becoming members of their boards. After considering international best practice and balancing the various views, the Stock Exchange determined that it is most appropriate to extend the cooling-off period to two years.

Cooling off periods for former audit partners

As to the cooling off periods for former audit partners, the corporate governance code will be amended in such a way that the cooling off period will be extended from one year to two years for a former partner of an issuer’s existing audit firm before he/she can be a member of the issuer’s audit committee.

It was proposed in the Consultation Paper to extend the cooling off period to three years. However, the cooling off period for former audit partners should be aligned to that of professional advisers (i.e. two years).

Cooling off periods in respect of material interests in business activities

Listing Rule 3.13(4) will be amended so that the cooling off period for persons with material interests in the issuer’s principal business activities will be extended from no cooling off period to a one year period before he/she can be an INED.

The Hong Kong Stock Exchange noted that even where a person does not have any actual interests, there is still a perception issue.

Cross-directorships or significant links with other directors

Recommended Best Practice A.3.3 will be introduced pursuant to which the board should disclose reasons if it considers a proposed director as independent even where the individual holds cross-directorships or has significant links with other directors through involvement in other companies or bodies. According to the Note to Recommended Best Practice A.3.3, cross directorship exists when two (or more) directors sit on each other’s boards.

The Stock Exchange considers it appropriate to introduce this disclosure as a Recommended Best Practice, rather than a Code Provision or Rule. It may, however, in the future consider enhancing this recommendation where appropriate and following market consultation.

Family ties

Note 2 will be introduced under Listing Rule 3.13 so that when determining the independence of a director under the rule, the same factors should also apply to the director’s immediate family members. The same definition for “immediate family member” as under Rule 14A.12(1)(a) will be adopted, that is “his spouse, his (or his spouse’s) child or step-child, natural or adopted, under the age of 18 years”.

Board diversity

Diversity policy

The existing CP A.5.6 requirement that issuers must have a policy concerning diversity of board members and to disclose the policy or a summary of the policy in the issuers’ corporate governance report, will be upgraded to a Listing Rule requirement (namely, new Listing Rule 13.92). This is a more stringent position than that in Australia (where reporting of listed issuers’ diversity policy is only subject to “comply or explain”) and in the UK (where only certain large listed companies must include a description of their diversity policies in their corporate governance code).

The Note to the new Listing Rule provides that board diversity will differ according to the circumstances of each issuer. Diversity may be attained through a number of factors, including (without limitation) gender, age, cultural and educational background, or professional experience. Issuers should take into account their own business model and specific needs, and disclose the rationale for the factors relied on for this purpose.

According to the Diversity Policy section of the Guidance, diversity policies should be formulated according to issuers’ own circumstances, and the following guidance should be considered:

• stating the advantages of diversity (including gender diversity), as well as the importance of being able to attract, retain and motivate employees from the broadest possible pool of available talent;

• stating the issuer’s commitment to diversity at all levels, including gender, age, cultural and educational background or professional experience;

• an annual assessment of an issuer’s diversity profile including gender balance of the senior management and their direct reports, as well as its progress in reaching its diversity objectives;

• making sure that recruitment and selection practices at all levels are structured in a way that ensures that a wide range of candidates are considered; and

• a statement as to whether the issuer has identified and implemented programs that will facilitate the development of a more diverse group of skilled and experienced employees and that, in due course, their skills will prepare them for senior management and board directorship positions.

The Guidance further recommends a board skills matrix, which is a table that shows board members’ skills, experience and perspectives. A board skills matrix facilitates the board’s assessment of the current mix of attributes and competencies on the board, its understanding of how directors’ attributes and competencies contribute to the issuer’s strategic direction and succession planning and diversity, as well as its identification of any gaps that may exist.

It was considered that disclosure of a board skills matrix is good practice and investors appreciate the transparency of the board’s selection and appointment of directors. Although a universal set of criteria for all issuers is not appropriate, criteria would normally include industry or professional knowledge and experience, gender, technical skills and management experience.

Nomination policy

Paragraph L(d)(ii) of the Mandatory Disclosure Requirement of Appendix 14 will be amended so that an issuer must disclose its policy for the nomination of directors adopted during the year in the issuer’s corporate governance report.

The Hong Kong Stock Exchange noted that amendments to the Listing Rules and the Code pursuant to the consultation will mean that the board and/or nomination committee will be subject to greater scrutiny and the nomination committee’s work will be subject to increased scrutiny. Where the nomination committee performs its role and function properly, this will result in enhanced board effectiveness and diversity.

The Guidance includes recommendations on the scope of the nomination committee’s work and nomination policy. Issuers should consider the following guidance when devising their nomination policy:

1. the policy should state its objectives, which should include making sure that the board has a balance of skills, experience and diversity of perspectives which are appropriate to the requirements of the issuer’s business;

2. the policy should emphasise that it is the entire board who has the ultimate responsibility for selecting and appointing directors;

3. the policy should set out the procedure for the selection, appointment and reappointment of directors comprising the selection criteria, including (without limitation) considering a candidate’s potential contributions to the board in terms of qualifications, skills, experience, independence and gender diversity;

4. the policy should have board succession planning considerations with periodical reviews of such plan;

5. it should deal with how disclosure of the nomination policy and the progress towards achieving the objectives set out in the policy will be made available for shareholders and potential investors of the issuer, for example in the corporate governance report; and

6. it should contemplate a formal process for the review and monitoring of the nomination policy so as to ensure that it continues to be relevant to the needs of the issuer and reflects current regulatory requirements and good governance practice.

Directors’ attendance at meetings

Directors’ attendance at general meetings

It was proposed in the Consultation Paper to remove the last sentence of Code Provision 6.7 (“[Independent non-executive directors and other non-executive directors] should also attend general meetings and develop a balanced understanding of the views of shareholders.”) in order to remove inconsistencies in the market’s interpretation of the provision as issuers have different understanding as to whether compliance with the provision requires full attendance. In response to comments during the consultation that this may discourage directors from attending general meetings, the sentence was revised to read: “Generally they should also attend general meetings to gain and develop a balanced understanding of the view of shareholders.”

Chairman’s annual meetings with INEDs

Code Provision 2.7 will be amended to require that INEDs only (rather than the current provision requiring NEDs including INEDs) meet with the chairman at least annually without the presence of the other directors.

Dividend policy

Code Provision E.1.5 will be introduced to require issuers to have a policy on payment of dividends which should be disclosed in their annual reports.

Electronic dissemination of corporate communications – implied consent

In the Consultation Paper, the Hong Kong Stock Exchange sought market views on whether the Listing Rules should be amended to permit shareholders’ consent to be implied for electronic dissemination of corporate communications by issuers. Although a significant majority of respondents supported the suggested amendment, the Stock Exchange will not adopt such regime until Hong Kong’s company law is amended to allow implied consent for corporate communications.