Effective corporate governance mechanism, professional and ethical board of directors and senior management, proper internal control system and sound legal system and regulatory framework are the conditions leading to a successful capital market. After the global financial crisis, there has been increased awareness of improving corporate governance promoted by the international standard setters. Hong Kong being a major international financial centre adopts the same trend. The paper discusses how increased focus of corporate governance affects the Hong Kong listed banks.
Why good corporate governance is important to a listed bank in Hong Kong?
Effective corporate governance is of significant importance due to two distinct features of the Hong Kong banking industry.
First, the business of the banking sector is complex and globalised involving transactions across different jurisdictions. The operation tends to be opaque and not transparent. Leverage is one of the factors of production in banks. Shareholders and the board tend to undertake excessive risks for short term benefits. The banks can easily hide problems by transferring the extra debt to its customers. This is in conflict with the interests of other stakeholders.
Second, there are numerous stakeholders in the banking sector. Stakeholders include “shareholders, directors, managers, employees, customers, creditors, suppliers, market intermediaries, auditors, regulators, and the government, as well as members of the community” . Majority of the stakeholders are holders of debt such as depositors and subordinated debtholders. The increasing risk taking practice of the banks without good corporate governance in place affects its liquidity and solvency. There are adverse consequences on the financial market and the public if large banks become insolvent.
Effective corporate governance is of significant importance not only to individual banks but to the economy as a whole.
Revised Basel Committee on Banking Supervision (“BCBS”): Corporate Governance Principles for Banks (‘CG Principles’) issued in 2015
BCBS published a consultation paper in 2014 revising and developing the corporate governance principles issued in 2010. The revised guidance was issued on 8 July 2015 .
The revisions of the BCBS CG Principles issued in 2015 are summarized as follows:-
‘ the revised principles focus on the role of the board of directors in overseeing the risk management system and competence of the board;
‘ clarify expectations in relation to group structures;
‘ strengthen guidance concerning risk governance;
‘ define the role of supervisors; and
‘ Update principles concerning compensation, transparency and disclosure.
Implementation of the international principles in local laws, rules, regulations and guidelines of Hong Kong
The international corporate governance principles have been adopted and implemented through Hong Kong laws and regulations such as the Companies Ordinance (“CO”), the Securities and Futures Ordinance (“SFO”), the Listing Rules and Code on Corporate Governance (“CG Code”) issued by Hong Kong Stock Exchange (“SEHK”), the rules, codes, guidelines and circulars issued by the regulators such as the Hong Kong Monetary Authority (“HKMA”) and the Securities and Futures Commission (‘SFC’). Localization of the international corporate governance standards has influential impact on the banking industry and the financial market in Hong Kong. The increased focus on corporate governance is reflected in the recent revisions of the said laws, rules and regulations.
The new CO was passed in 2012. One of the guiding principles of the reform concerning rewrite of the entire CO was to enhance corporate governance.
The corporate governance reform includes :-
‘ codification of directors’ duty of care, skill and diligence and improving their accountability;
‘ shareholders have more engagement in decision making process;
‘ disclosure of business information: business review has to be conducted and included in the directors’ report containing fair review of business, description of principle risks, particulars of important events and future development ;
‘ raising shareholders’ protection such as measures introduced to avoid directors’ conflict of interest; and
‘ expansion of auditors’ power in acquiring corporate information
Most of the provisions in the new CO and its subsidiary legislation have commenced operation on 3 March 2014.
Securities and Futures Ordinance
SFO gives statutory backing to the Listing Rules on financial disclosure, disclosure of inside information and shareholders’ approval on connected transactions.
The statutory regime on inside information disclosure came into effect in January 2013. A listed company and its officers will commit civil offence if they fail to make disclosure of the inside information. SFC has power to investigate the breaches and impose civil sanctions.
SFO establishes the civil and criminal regimes for market misconduct offences . This gives the Market Misconduct Tribunal power to impose wide range of civil sanctions. Serious market misconduct cases will be taken to criminal proceedings where criminal sanctions can be imposed by the courts.
The provisions in SFO aim to build up a good corporate governance structure not only for the good of individual companies but also for the benefits of the stakeholders including the public, ensuring fairness, stability and transparency of the financial market.
The Listing Rules
The Listing Rules published by SEHK govern the requirements of initial listing and continuous compliance of all listed companies of the Main and Growth Enterprise Market (‘GEM’). It contains a number of corporate governance requirements such as financial disclosure, establishment of audit and remuneration committees, provisions concerning the independent non-executive directors (‘INED’).
Code on Corporate Governance
CG code was modeled on UK Corporate Governance Code. It contains in Appendix 14 of the Listing Rules. It operates on a ‘comply or explain’ approach setting out the corporate governance principles in 2 levels, the code provisions and recommended best practices. The main areas covered by the CG Code are the roles and functions of INED, establishment of board committees with written terms of reference, the procedure and policy of board meetings, shareholders’ communications, the qualification and duties of company secretary.
The listed company has to provide explanation for not complying with the code provisions. Individual characteristics shall be considered such as the size, nature of business, business strategy, complexity of operation, the nature of risks in formulating its own corporate governance practices .
SEHK published a consultation paper in June 2014 on improving the risk management and internal control elements of the listed companies.
Supervisory Policy Manual: Corporate Governance of Locally Authorized Institutions (‘CG Manual’) issued by HKMA
The CG Manual was revised in August 2012 setting out the minimum standard that HKMA expects banks in Hong Kong to adopt for their corporate governance practices. Failure to comply with the CG Manual casts doubts as to whether the bank continues to satisfy the minimum criteria for authorization of the Banking Ordinance (‘BO’) and on fitness and propriety of the directors and shareholders of the bank.
The CG Manual covers :-
‘ the composition, structure, responsibilities and qualification of the board;
‘ governance in group structure;
‘ control over structure established for the customers and
‘ supervisory and review process on governance evaluation
Examples of the increased corporate governance impact on Hong Kong banks
HSBC Holdings (‘HSBC’) and Bank of East Asia (‘BEA’) are good examples illustrating that Hong Kong banks have enhanced their corporate governance standards over the years:-
1. HSBC stated in its corporate governance report in 2013 that:-
‘ the board promoted long-term success of the bank and delivered sustainable value to its shareholders.
‘ There were regular meetings for the group audit, group risk committee and remuneration committee to give non-executive oversight on various matters.
‘ The Corporate Sustainability Committee was responsible during 2013 for advising the board, the board committees and executive management on corporate sustainability policies including, social, ethical and environmental issues.
‘ The Conduct & Values Committee established in January 2014 focused on ensuring customers were fairly treated in the course of business.
2. BEA stated in its corporate governance report in 2014 that:-
‘ The current Board was composed of 7 non-executive directors and 8 INED. Over one-third of the Directors are INED.
‘ All directors attended training on regulatory updates.
‘ The work done by the board committees are clearly stated. The terms of reference were available in the bank’s website.