Corporate Governance for Hong Kong Issuers

Sound corporate governance practices serve as the foundation for regulatory compliance, good business practices and long-term sustainability. There is increasing evidence that good corporate governance can have a positive impact on organizations in attracting and retaining talent, increasing customer loyalty and reputation, and creating long-term value for shareholders. As the most important decision-making body of any issuer, the board of directors is ultimately responsible for setting the corporate culture and driving the corporate governance agenda of the organization.

The CO provides a modern legal framework for the incorporation and operation of companies in Hong Kong, aiming to, among other things, enhance corporate governance and ensure better regulation. For instance, the CO has codified the directors’ duty of care, skill and diligence in discharging the directors’ functions. The SFO is the principal legislation for regulating the securities and futures industry in Hong Kong, containing regulations pertaining to financial products, the securities and futures market and industry, and protection of investors. The Listing Rules provide the requirements for listing applicants and continuing obligations for issuers listed in Hong Kong. The CG Code contained in the Listing Rules is the primary source of corporate governance principles and practices for listed issuers.

Corporate Governance Code

Hong Kong-listed issuers are guided by the principles of good corporate governance set forth in the CG Code. The CG Code also sets out provisions to help issuers apply good corporate governance principles. The code provisions operate on a “comply or explain” basis. Issuers must state whether they have complied with the code provisions in their annual and interim reports but may deviate from any code provisions provided that they explain how the principles are otherwise achieved. The CG Code also provides certain recommended best practices that issuers are encouraged to adopt on a voluntary basis.

The SEHK periodically reviews the corporate governance framework to ensure it remains fit for purpose, continues to promote governance quality and aligns stakeholder expectations with international best practice. The latest update to the CG Code (2022 update), effective on 1 January 2022, focused on aligning corporate culture with the company’s purpose, values and strategy, enhancing board independence and diversity, and elaborating the linkage between corporate governance and environmental, social and governance (ESG) measures.

Several main areas of the CG Code are discussed below:

Corporate culture. A healthy culture is crucial for good governance. Hence, the SEHK introduced a new code provision in the 2022 update requiring the board to establish the issuer’s purpose, values and strategy, and ensure their alignment with the issuer’s culture. In addition, all directors must act with integrity, lead by example and promote the desired culture. Such culture should instil and continually reinforce values of acting lawfully, ethically and responsibly across the organization.

To this end, the board should monitor and evaluate the issuer’s culture and pay attention to hints of potential cultural weaknesses. The board must ensure effective communication channels are in place to convey its message throughout the organization with management support. Furthermore, appropriate training, incentives and accountability mechanisms should be scrutinized to ensure optimal alignment with and promotion of the desired culture.

Since building the right culture is an iterative process, regular evaluations involving internal and external stakeholders are essential for providing the organization with positive reinforcement for things done right and directions for improvement.

Board effectiveness. The establishment and stewardship of a healthy corporate culture and governance framework is best achieved by an objective and independent board with access to diverse perspectives that can withstand mutual scrutiny. The following requirements under the CG Code and the Listing Rules concerning the independence and diversity of the board are of particular importance:

1. Board independence. An issuer should establish mechanisms to ensure independent views and input are available to the board, and the implementation and effectiveness of such mechanisms shall be reviewed by the board annually;
2. Board refreshment. Independent non-executive directors (INEDs) with long board tenures risk losing their independence and objectivity due to their growing familiarity with the issuer’s management. Consequently, the CG Code requires the reappointment of an INED who
   has served for more than nine years on the board, i.e. “long-serving” INEDs, to be approved by a separate resolution of shareholders, and requires disclosure of the factors
   considered, process, and the board
   or nomination committee’s discussion in arriving at the determination that the INED is still independent and should be re-elected. Furthermore, where all people on the board are long-serving INEDs, their individual tenures must be disclosed in the shareholders’ circular and a new INED must be appointed at the next annual general meeting;
3. Board diversity. A diverse board benefits from diverse perspectives and is less vulnerable to “group think”. The Listing Rules require an issuer to have a diversity policy. Pursuant to the CG Code, the board should annually review the implementation and effectiveness of the diversity policy. Furthermore, to promote gender diversity, the SEHK will not consider diversity to be achieved with a single gender board. Hence, issuers must have at least one director of a different gender by 31 December 2024 to comply with the Listing Rules.

Risk management. A robust risk management and internal control system (RM-IC system) is fundamental to the efficacy, legality and culture of a business in pursuit of its long-term goals. Hence, the CG Code requires the board to oversee the issuer’s RM-IC system on an ongoing basis and ensure that its effectiveness is reviewed at least annually. An issuer should have proper policies and procedures in place to assist the board in identifying, evaluating and managing all material risks.

As a crucial component, an issuer’s anti-corruption and whistleblowing systems work in tandem to detect and deter misconduct. The CG Code requires issuers to establish

1. 1. policies and systems that support anti-corruption laws and regulations, and
   2. a whistleblowing policy and system for employees and other stakeholders to raise concerns, in confidence and anonymously, with the audit committee (or any designated committee comprising a majority of INEDs) about possible improprieties related to the issuer.

An effective anti-corruption policy should establish clear guidelines for identifying, preventing and addressing corrupt practices, while outlining the company’s zero-tolerance stance, roles and responsibilities, and reporting mechanisms. Complementing this, a robust whistleblowing policy should outline confidential reporting channels, anonymity protocols, investigation procedures and measures for protection against retaliation.

ESG. Governance of ESG matters is integral to good corporate governance. Hence, as part of the 2022 update, the SEHK elaborated this link between corporate governance and ESG, and included ESG risks within the risk management framework.

To align with global baseline sustainability reporting standards of the International Sustainability Standards Board published in June 2023, the SEHK has proposed to mandate issuers to make climate-related disclosures (New Climate requirements) in their ESG reports, which will be implemented in phases subject to certain implementation relief. Under the phased approach,

1. all issuers will be required to disclose scope 1 and 2 greenhouse gas emissions on a mandatory basis for financial years commencing on or after 1 January 2025; and
2. all Main Board issuers are required to report in accordance with the New Climate requirements on a “comply or explain” regime for financial year 2025, while
3. Large Cap Issuers (i.e. issuers that are Hang Seng Composite Large Cap Index constituents) will be subject to mandatory climate reporting for financial years commencing on or after 1 January 2026.

As such, issuers are advised to enhance their ESG and climate-related governance and reporting mechanisms to ensure compliance with the New Climate requirements.

In view of the critical role of boards in overseeing and driving corporate sustainability, accountability, and long-term value creation, issuers should aim to go beyond mere compliance with minimum requirements to better align themselves with the spirit of the regulations. Only by doing so could issuers demonstrate their commitment to responsible business practices, build trust and safeguard the organization’s long-term prosperity.