Long-Term Growth Through Enhanced Corporate Governance for HK Issuers

January 3, 2025

Corporate governance refers to the system of rules, practices, and processes by which a firm is directed and controlled. It fundamentally involves balancing the interests of a company’s many stakeholders, such as shareholders, management, customers, suppliers, financiers, government, and the community. An essential factor in long-term growth, good corporate governance impacts an organization’s ability to attract and retain talent, enhance customer loyalty, build a solid reputation, and create enduring shareholder value. The board of directors plays a pivotal role in establishing corporate culture and advancing the governance agenda within the organization.

Regulatory Framework

The corporate governance regulatory framework for Hong Kong-listed issuers is primarily constituted by the Companies Ordinance (Cap.622) (CO), the Securities and Futures Ordinance (Cap.571) (SFO), and the Rules Governing the Listing of Securities (Listing Rules) on the Stock Exchange of Hong Kong (SEHK). Central to these regulations is the Corporate Governance Code (CG Code) embedded within the Listing Rules, serving as the primary source of corporate governance principles and practices for listed issuers.

The CO offers a contemporary legal structure for the incorporation and operation of companies in Hong Kong. It aims to enhance corporate governance and ensure improved regulation, including codified duties of directors concerning care, skill, and diligence. The SFO is the main legislation regulating the securities and futures industry in Hong Kong, covering financial products, markets, and investor protection. The Listing Rules stipulate requirements for listing applicants and ongoing obligations for listed issuers, with the CG Code specifically providing guidelines on corporate governance principles and practices.

Core Tenets of the CG Code

Hong Kong-listed issuers adhere to the good corporate governance principles delineated in the CG Code, which operates on a “comply or explain” basis. This means issuers must indicate their compliance with the code provisions in their annual and interim reports, and any deviations must be explicated in terms of how the principles are otherwise met. Additionally, the CG Code offers recommended best practices that issuers are encouraged to adopt voluntarily.

SEHK periodically revises the corporate governance framework to ensure its relevance, efficiency, and alignment with international best practices. The latest CG Code update, effective from 1 January 2022, emphasizes aligning corporate culture with company purposes, values, and strategies; enhancing board independence and diversity; and linking corporate governance with Environmental, Social, and Governance (ESG) measures.

Corporate Culture

A healthy corporate culture is essential for effective governance. The 2022 update of the CG Code introduced a new provision requiring the board to establish the issuer’s purpose, values, and strategy, ensuring their alignment with corporate culture. Directors are expected to act with integrity, lead by example, and promote a culture of lawful, ethical, and responsible behavior across the organization.

The board must monitor and assess the organization’s culture, taking into account potential weaknesses. Effective communication channels should be implemented to convey the desired culture throughout the organization, with management’s support. Ensuring congruity between organizational processes, training, incentives, and accountability mechanisms is critical for fostering the desired culture. Building a positive culture is a continuous process. Regular evaluations involving internal and external stakeholders are necessary, providing positive reinforcement for successful practices and directions for improvement.

Board Effectiveness

The effectiveness of the board in establishing and maintaining a robust corporate culture and governance framework is maximized through objectivity, independence, and diversity. Specific CG Code and Listing Rules requirements emphasize the importance of independence and diversity in the board composition. Mechanisms should be in place to guarantee that independent views and input are accessible to the board, with annual reviews by the board to assess the efficacy of these mechanisms.

Independent Non-Executive Directors (INEDs) serving for more than nine years, deemed “long-serving,” must be reappointed through a separate shareholder resolution, accompanied by a disclosure of factors, processes, and discussions affirming their continued independence and eligibility for re-election. If all INEDs on the board are long-serving, each director’s tenure must be disclosed, and a new INED must be appointed at the next annual general meeting. Diversity of perspectives within the board mitigates risks of “group think”. Issuers are mandated to have a diversity policy, with an annual review of its implementation and effectiveness by the board. To promote gender diversity, the SEHK stipulates that boards must not be of a single gender, requiring issuers to have at least one director of a different gender by 31 December 2024.

Risk Management

A robust risk management and internal control system (RM-IC system) is fundamental for achieving business efficacy, legality, and cultural integrity. The board is mandated to oversee the issuer’s RM-IC system continuously, with annual effectiveness reviews. Proper policies and procedures assist the board in identifying, evaluating, and managing significant risks. Integral to risk management is an issuer’s anti-corruption and whistleblowing systems. According to the CG Code, these should include anti-corruption policy and systems supporting anti-corruption laws and regulations.

Effective anti-corruption policies should clearly outline the company’s zero-tolerance stance, roles and responsibilities, and reporting mechanisms. Complementarily, robust whistleblowing policies should incorporate confidential reporting channels, anonymity protocols, investigation procedures, and measures against retaliation.

ESG (Environmental, Social, and Governance)

Governance of ESG matters is inherently linked to good corporate governance. The 2022 CG Code update elaborated on this linkage, integrating ESG considerations into the overall risk management framework. To align with the new International Sustainability Standards Board’s global baseline sustainability reporting standards introduced in June 2023, SEHK proposed mandatory climate-related disclosures (New Climate Requirements) in issuer ESG reports, phased implementation as follows:

  • Mandatory scope 1 and 2 greenhouse gas emissions disclosures from 1 January 2025;
  • All Main Board issuers must comply with new climate reporting standards on a “comply or explain” basis for financial year 2025;
  • Large Cap issuers must mandatorily comply with climate reporting for financial years starting on or after 1 January 2026.

Issuers are encouraged to enhance their ESG and climate-related governance and reporting mechanisms to meet these new requirements. Effective governance of ESG areas fosters corporate sustainability, accountability, and long-term value creation, going beyond basic compliance to align with the spirit of regulations.

Conclusion

Corporate governance encompasses the framework of rules, practices, and procedures through which a company is managed and steered. At its core, it involves balancing the interests of various stakeholders, including shareholders, executives, customers, suppliers, financiers, government bodies, and the broader community. Effective corporate governance is crucial for long-term success as it has a significant impact on a company’s capacity to attract and keep talent, boost customer loyalty, develop a robust reputation, and generate sustainable shareholder value.

The board of directors is instrumental in setting the tone for corporate culture and pushing forward the governance agenda within the organization. Their leadership and oversight ensure that ethical standards are maintained, and strategic objectives are met. By fostering transparency and accountability, good corporate governance practices help mitigate risks and promote operational integrity. Ultimately, a firm with strong corporate governance is better positioned to thrive in a competitive market, responding adeptly to challenges and opportunities alike. The commitment to ethical principles and effective governance practices benefits all stakeholders, paving the way for enduring success and stability.

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