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SCCLR issues final recommendations from Corporate Governance Review Phase II

20 January 2004

The Standing Committee on Company Law Reform (SCCLR) today (January 20) issued its Final Recommendations arising from the Corporate Governance Review Phase II.

On June 11, 2003, the SCCLR published the Consultation Paper for the Phase II review. The proposals relate to different aspects of directorship (including directors' roles, duties, qualifications, training and remuneration, as well as connected transactions, board procedures and board committees etc.); shareholders' rights and conflicts of interest; corporate reporting with focus mainly on external auditors; and corporate regulation.

A total of 25 submissions have been received, 17 from market regulators and operators/professional organisations and trade bodies, and eight from individuals or firms.

Mr Justice Rogers, the Chairman of the SCCLR, said, "Most proposals have the strong support of the respondents. They have been included in the SCCLR's Final Recommendations to the Government subject to some refinements. Together with recommendations made in Phase I, this concludes the four years' work by the SCCLR on Corporate Governance Review."

On proposals relating to directors:

SCCLR had drawn up a set of "Non-statutory Guidelines on Directors' Duties" which were published today (January 20) to help company directors to better understand their roles. It also confirmed its proposals in the Consultation Paper to improve the general legal position on self-dealing by directors, as well as proposals on shareholders' approval for significant transactions involving directors.

For transactions between directors or connected parties with an associated company, SCCLR recommended that, in relation to the definition of "associated company", the test of control through the exercise of dominant influence to determine whether the company was associated with another company should be adopted. The approval of disinterested shareholders would be required in relation to such transactions.

The SCCLR also included in its Final Recommendations extensive proposals on board procedures, the structure of the board and the role of non-executive directors in the Consultation Paper. The Listing Rules should make audit committees mandatory, with at least one independent non-executive director on the committee having financial expertise. The establishment of nomination and remuneration committees should remain as a best practice.

To address the increasing public concern over the directors' remuneration, SCCLR recommended that listed companies should disclose individual director's remuneration packages by name in their annual financial statements. The Code of Best Practice (of the Listing Rules) should contain a requirement that a listed company should disclose the arrangements made to train its directors in view of the importance of directors' qualifications and training.

On proposals relating to Shareholders:

SCCLR adopted in its Final Recommendations the proposals on self-dealing by controlling shareholders in the Consultation Paper and that "controlling shareholders" should be defined for the purpose of connected transactions using the same criterion as that under the Listing Rules for "substantial shareholder", ie, a person controlling 10% or more of the voting power at any general meeting of the company. SCCLR also adopted the proposals in the Consultation Paper to enhance the effectiveness and transparency of company general meetings.

On proposals relating to Corporate Reporting:

SCCLR included in its Final Recommendations a number of proposals in the Consultation Paper to enhance and strengthen the functioning and quality of external auditors. These include imposing a duty on employees (in addition to directors) to provide information to auditors.

A number of other proposals relating to auditing have been referred to either the Hong Kong Society of Accountants or the Law Reform Commission for further consideration and follow-up action. These include: improving the supervision of audit firms; provision of material information by an outgoing auditor to his successor; mandatory rotation of lead and concurring audit partners every 5 years with a "time-out" period of 5 years; and the introduction of proportionate liability for civil torts.

On proposals relating to Corporate Regulation:

SCCLR recommended that statutory backing should be given to the relevant Listing Rules together with tougher statutory sanctions including fines for non-compliance. In addition, the regulation of unlisted companies should be improved by enhancing the Companies Registry's capability as a corporate regulator on an incremental basis.

A list of major items in the SCCLR's Final Recommendations arising from the Phase II Review is at Annex.

"Hong Kong's corporate governance has been of a high standard, but like everything else it needs to be looked at and improved as time goes by. The proposals are part of this process, which to a greater or lesser extent has to be continuous," Mr Justice Rogers added.

In view of the limited support expressed by the respondents, the SCCLR had dropped the proposals to prohibit absolutely a retired partner of the company's auditing firm from acting as a member of an audit committee; provide for a deposit system to deal with members' resolutions; and require directors of a company and directors or auditors of the company's subsidiaries to volunteer material information to the auditor of the company.

Welcoming the SCCLR's recommendations, a government spokesman said the Recommendations will help to bring Hong Kong's corporate governance regime in line with best international standards. "We will consider how best they should be taken forward in consultation with the relevant parties such as the Hong Kong Society of Accountants and the Stock Exchange of Hong Kong Limited, etc. Those recommendations which involve statutory amendments would be taken forward as part of a Companies Amendment Bill."

"As a first step, the Companies Registry has published Non-statutory Guidelines on Directors' Duties, as drawn up by the SCCLR. The Guidelines will help directors to better understand their duties of care and skill and fiduciary duties," said Mr Gordon Jones, the Registrar of Companies.

Copies of the Guidelines will be available at the offices of the Companies Registry, the Financial Services and the Treasury Bureau, the Official Receiver, the Securities and Futures Commission, the Hong Kong Monetary Authority and the Stock Exchange of Hong Kong Limited, as well as on their websites.

The SCCLR, tasked with undertaking the Corporate Governance Review in 2000, published its Phase I Consultation Paper in July 2001. The 2001 Consultation Paper contained a total of 21 proposals regarding directors, shareholders and corporate reporting. Some of these proposals relating to shareholder remedies have been included in the Companies (Amendment) Bill 2003 which is being scrutinised by the Legislative Council.

Annex
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Following is a list of major items in the SCCLR's Final Recommendations arising from the Phase II of the Corporate Governance Review:

  1. Proposals relating to Different Aspects of Directorship

    • A director should be required to abstain from voting at a board meeting on a transaction in which he has an interest, with exceptions for immaterial transactions.

    • For transactions or arrangements above a threshold value involving directors or persons connected with directors, the approval of disinterested shareholders voting on a poll should be obtained.

    • Requirements for disinterested shareholders' approval for connected party transactions should be extended to transactions between a company and an "associated company" and not limited to transactions between the company and "subsidiaries". The test of control through the exercise of dominant influence should be adopted for the purpose of defining "associated companies".

    • These proposals should apply to all listed and unlisted public companies in Hong Kong including companies registered under Part XI of the Companies Ordinance save for oversea public companies not listed in Hong Kong or those with a secondary listing in Hong Kong.

    • In relation to directors' duties, SCCLR recommends the adoption of non-statutory guidelines stating the principles of law.

    • Board Procedures including the frequency of full board meetings and the delivery of agenda and board papers to all directors should be improved and included in the Code of Best Practice.

    • The Listing Rules should be amended to make it mandatory that all listed companies should establish an audit committee. At least one independent non-executive director (INED) on a listed company's audit committee should have some "financial expertise".

    • The Code of Best Practice should be amended to make the establishment of nomination and remuneration committees in listed companies a recommended best practice.

    • The boards of listed companies should have a minimum of three INEDs, and where nomination committees exist, they should take a more systematic approach to identifying suitable NEDs. The Code of Best Practice should provide that listed companies should disclose the system for deciding the remuneration of their NEDs in their annual reports. The Code should also provide that directors of listed companies should disclose the number of other directorships which they hold in their companies' annual reports.

    • On directors' qualification and training, the Code of Best Practice should contain a requirement that a listed company has to disclose the arrangements made to train its directors, and in particular new NEDs, on both an initial and continuous basis.

    • The Listing Rules and the Companies Ordinance should be amended to require listed companies to disclose full details of all elements of individual director's remuneration package. The Companies Ordinance should be amended to require unlisted public companies or private companies, if directed to do so by holders of not less than 5% of all the nominal issued share capital of the company, to disclose full details of all elements of individual director's remuneration package. SCCLR also recommends that there should be specific disclosures on key aspects of a company's remuneration policy.

  2. Proposals relating to Shareholders' Rights and Conflicts of Interests

    • SCCLR recommends that -

      1. Subject to certain exceptions (e.g., transactions entered into by liquidators) connected transactions must be disclosed and subject to a disinterested shareholders' vote made by poll.

      2. The definition of connected person in relation to controlling shareholder should include the controlling shareholder's children or step-children, his spouse; trustee of any trusts in which the controlling shareholder, his spouse, children or step children are beneficiaries under the trust, and any corporation associated with the controlling shareholder.

      3. The court's power to determine whether or not a transaction constitutes a waste of corporate assets should be preserved.

      4. Failure to comply with the rule should render the transaction voidable at the instance of the company or any shareholder.

      5. These proposals should apply to all listed and unlisted public companies in Hong Kong including companies registered under Part XI of the Companies Ordinance save for oversea public companies not listed in Hong Kong or those with a secondary listing in Hong Kong.

    • SCCLR recommends that controlling shareholder should be defined for the purpose of connected transactions using the same criterion as that under the Listing Rules for "substantial shareholder" i.e. a person controlling 10% or more of the voting power at any general meeting of the company.

    • To enhance the effectiveness and transparency of company general meetings, the SCCLR recommends the following -

      1. A Hong Kong company should be permitted to hold a general meeting at more than one location. The meeting should take place at the venue specified by the notice of the meeting which would be regarded as the principal venue, but subsidiary or satellite venues should be allowed. Both visual and audio real time communications should be permitted by legislation.

      2. The timing of the Annual General Meeting (AGM) should be changed to within a certain period after the end of each financial year of the company. For private companies with a share capital and companies limited by guarantee, the period should be nine months and for other public companies, the period should be six months.

      3. Notices should be given personally or sent by post to shareholders unless the shareholders agree to adopt electronic means of communication including the use of personal identification numbers.

      4. There should be a requirement of minimum information to be given in the meeting notices regarding the proposed resolutions.

      5. Absentee voting should be permitted. Electronic voting should be permitted and there should be rules and guidance for such voting procedures.

      6. the empowerment of proxies should be reformed.

  3. Proposals relating to Corporate Reporting with focus mainly on external auditors

    • The Companies Ordinance should be amended to remove the requirements for the shareholders to fix the auditors' remuneration or determine the manner of how it is to be fixed.

    • To improve auditors' access to information, the present requirement for directors and officers of the company to provide such information and explanations as the auditors think necessary should be extended to include employees.

    • The Government and the Hong Kong Society of Accountants (HKSA) should undertake work to identify the types of non-audit services which are incompatible with the principles underlying auditor independence and enhance the disclosures of the nature and value of all services provided by auditors to audit clients, defining what falls into the categories of audit, audit-related and non-audit.

    • A retired partner of the firm auditing the company's accounts should be prohibited absolutely from acting as the chairman of an audit committee but such a partner should be allowed to act as a member of an audit committee subject to a cooling off period of 3 years;

  4. Proposals relating to Corporate Regulation

    • The SCCLR recommends that statutory backing should be given to the relevant Listing Rules together with tougher statutory sanctions including fines against non-compliance. In addition, the regulation of unlisted companies should be improved by enhancing the Companies Registry's capability as a corporate regulator on an incremental basis.

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