A big bang for corporate governance in Hong Kong?

 

By Leanne Palmer

 

　 　

As a listed Hong Kong (HK) issuer, you will now have had the chance to experience first hand what it takes to comply with the HK Code on Corporate Governance Practices (the Code). Why? Because compliance was required for accounting periods beginning 1 January 2005, excluding compliance with Code Provision C2, which is effective for accounting periods beginning 1 July 2005. 

How difficult have your experiences been? Did you experience a sudden "big bang" change in compliance, or a gradual change? How much more work have you had to do to achieve full compliance with the Code and enhance your corporate governance reputation in the market?

With HK being new to the comply or explain approach demanded by the Code, many are eager to learn more about what the impact and response to the Code has been and how they compare to the market.

For those eager to learn more, one of the best places to start your research is from one of the following key reports (Figure 1 provides a summary of these reports):

Hong Kong 

The Hong Kong Stock Exchange (HKEx) released survey results in January 2006 from questionnaires sent to authorised representatives of the 1,117 listed issuers, comprising Main Board and GEM companies.
www.hkex.com.hk/publication/newsltr/2006-01-04-e.pdf 
  
The Hong Kong Institute of Certified Public Accountants (HKICPA) announced in November 2005 its "Best Corporate Governance Disclosure Awards 2005" resulting from its review of 150 annual reports from Hong Kong listed issuer entrants. www.hkicpa.org.hk/corporate_relations/media/pressrelease/2005/051129e.pdf

Figure 1

  HKEx FRC GTUK
Overall Impact of the Code Reviews had taken place in light of revised Code provisions Corporate governance standards were improving Significant drop in companies claiming full compliance since Code revised, expected due to new and additional Code provisions to follow
Increase in number choosing to follow majority of Code Provisions
Practical barriers and other problems with implementing the Code Most difficult areas were separate role of chairman and CEO, appointing non-executive directors for specific term, subjecting all directors to retirement in rotation and reviewing effectiveness of internal control systems No objective evidence found to support perceived difficulty of recruiting independent directors Struggle to achieve balance required in Board composition, having independent directors, separating roles of chairman and CEO
Broader concern about board time dominated by compliance rather than strategic issues
Quality of information in corporate governance reports A step had been taken to raise the overall standard of corporate governance Remains scope to be more informative, in particular giving a clearer impression of how the issuer has addressed corporate governance issues and be more company specific Improvement of informative explanations given for deviations from Code particularly in roles and responsibilities of various committees and how committees and individual director's performance are appraised annually
No desire to increase length of report and more use could be made of websites to provide information Significant shift towards greater transparency and accountability
Status of internal control review requirements Many have considered how to assess adequacy of internal controls and process for identifying material business risks Internal control statements in annual reports can often be uninformative Taken great strides with 99% of companies acknowledge responsibility to review effectiveness of internal controls
Many, have adopted a work plan, performed assessment and risk identification process New guidance has been issued which is to take effect for financial years beginning on or after 1 January 2006, changes are not major Need for improvement in explaining the process that was taken to perform this review
Role of audit committee is far more evident with greater disclosure of reviews undertaken
External professional advice External professional advice had been sought Not covered Need for specific statement on how auditor objectivity and independence has been considered has raised the bar for disclosure

United Kingdom

Looking to the UK for guidance is important as our HK Code was based on the UK's Combined Code 2003, and you could be looking at HK's future practice given the UK was already experienced 2 years of compliance. The Financial Reporting Council (FRC) in the UK released the results of its further review of the implementation of the UK Combined Code in January 2006. The results are derived from communications received from listed issuers, investors and other stakeholders in response to particular questions and to its observations and research.
www.frc.org.uk/documents/pagemanager/frc/Combined%20Code%20review%20main%20findings%2018%20January%202006.pdf
  
Grant Thornton United Kingdom conducted a detailed review of the impact of the UK Combined Code. It released its Fourth FTSE350 2005 Corporate Governance Review which consisted of a detailed page-by-page study of 319 annual reports of the FTSE 350 companies.
www.grant-thornton.co.uk/pages/publications_and_events-publications-corporate_governance_review_2005/$FILE/corporate+governance+review+2005.pdf

The main conclusions of the above reports contained both positives and negatives. On a positive note HK has officially taken a step towards raising the overall standard of governance. However given that the market is still learning, compliance measures have varied in terms of their nature and quality and there was some disappointment that companies took a very mediocre approach, not adopting the spirit of the Code. In particular, for GEM board companies, the HKICPA could not award all of its trophies and even requested that GEM issuers strengthen their transparency and accountability to shareholders and stakeholders.

Looking to the UK, the studies have shown that companies are truly embracing the principles enshrined in the UK Code and have concluded that any major changes to the Code would be unnecessary and inappropriate.

So are you and the HK market travelling on the right path to good corporate governance? When compared to the other largest capital market - the US, there is some debate. This is because there are considerable differences as to which practices should be adhered to, particularly in relation to the internal controls. The US requirements as defined in its Sarbanes Oxley Act are very strict in requiring issuers to make one single claim regarding the financial reporting controls and have this claim audited. However where the US focuses in detail on financial controls the UK/HK model maintains a focus on a much wider control environment without the requirement of an audit. At this stage there is no clear answer to whether the UK/HK or US model is best, although many HK issuers would probably be happier with our more flexible model.

leanne.palmer@gthk.com.hk

 

 

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