Hong Kong Exchanges and Clearing Ltd (HKEX) released a consultation paper in June in a move that could either be seen as a wake-up call or a “bewildering exercise”, as the bureaucratic jargon goes. The paper proposed revisions to the Corporate Governance Code (CG Code) and related listing rules, covering a wide range of topics — from board effectiveness to the independence and diversity of nonexecutive directors (or “independence and diversity of the independent nonexecutive directors (INEDs)”).
Proponents argue that enhancing corporate governance by boosting transparency and accountability is always the way to go — a crucial step toward boosting investor confidence and ensuring long-term stability of both Hong Kong’s financial market and its listed companies.
Yet with any attempt to reform, the devil always lies in the details. These reform measures must be carefully calibrated to avoid unleashing a regulatory whirlwind that not only imposes an undue burden on listed companies, especially, small and medium-sized enterprises (SMEs) with unnecessary compliance costs, but also further frustrates efforts to achieve effective governance. One misstep, all hell breaks loose; potential listings seeking to list in Hong Kong may start weighing their options elsewhere.
So while the intentions behind these proposals may be noble, it remains to be seen whether regulators are overregulating under the circumstances, in particular, noting that we only updated our CG codes not too long ago (2022). We should be extremely mindful at all times to strike a delicate balance between improving our governance framework and unrealistically overreaching in our financial regulations. Certainly, only time will tell if Hong Kong’s financial landscape will be transformed for the better or not. However, Hong Kong as an international financial center (IFC) is constantly racing against time! We cannot afford to lose any more time on certain “may be” or “may be not” nice-to-have corporate governance regulations.
Unintended consequences
In the proposed revisions, one focal point is the elevation of requirements for INEDs, including a restriction on their simultaneous tenure of up to six directorship positions, with a cap of nine years. HKEX’s intention is purportedly to ensure the independence of these directors and secure their sufficient dedication and commitment to a listed company’s affairs. Unfortunately, the execution of such measures poses challenges for listed companies and does little to improve corporate governance. The truth of the matter is that sourcing qualified independent directors, possessing relevant industry knowledge and requisite expertise, within the confines of Hong Kong’s limited talent pool has simply proved to be a herculean task.
Even more to the point, there is little to suggest that long-serving INEDs inherently harm company performance. Take Berkshire Hathaway Inc as a case in point — one of the most highly regarded listed companies in the world, with an exemplary record in both corporate governance and shareholder returns. It currently has eight INEDs, with length of service ranging from two years to an impressive 21 years. At present, four of the eight INEDs have served on the board for more than nine years with service of between 11 and 21 years, and back in 2021, six of the eight INEDs had passed the nine-year mark, including one who had been on the board for 23 years. Curiously, the long-serving INEDs do not seem to have done Berkshire Hathaway any harm. In fact, it continues to be one of the most admired and best-performing companies globally, suggesting that experience may not be as detrimental as some might fear.
Beyond term limits, another proposed amendment delves into the realm of board diversification, demanding that at least one director of a different gender to be included in the nomination committee. For certain specialized industries, where professionals tend to gravitate toward a particular gender, this push for diversity raises the bar, adding yet another layer of complexity for listed companies in finding suitable candidates. As a result, this further restricts the supply of qualified independent directors, driving up their remuneration, adding unnecessary burden to a listed company. Resource-strapped listed SMEs may be forced to seek second-tier talent to meet compliance requirements, thus inadvertently and unavoidably lowering the governance standards.
A sisyphean task for SMEs
The proposed amendments, if effective, will impose additional compliance costs on listed companies, including requirements on board performance review, mandatory director training, and disclosure of the board skills matrix. These measures pose an extra burden on SMEs with heavy operational expenses. Take for example, the suggestion of appointing a lead INED. Given the already limited supply of qualified independent directors, mandating one individual to take on such an onerous role becomes an almost impossible task for these smaller players in the financial market to comply with, perpetuating the existing conundrum. In reality, the choice of independent directors on the board still rests predominantly in the hands of the controlling shareholders. Creating the lead INED role does not enhance the independence of directors but will most likely diminish the motivation of other independent directors to fully discharge their duties. This suggestion seems only to serve as a cost-intensive cosmetic endeavor without addressing the crux of the matter.
Also, the requirement to disclose a board’s skill list in the CG report may seemingly offer the perception of greater transparency, i.e., allowing the public to better understand the directors. However, it oversimplifies the situation and overlooks the multifaceted crucial factors necessary to build an effective board, such as experience, individual character, values, and professional backgrounds. In order to achieve the skill matrix framework requirement, listed companies may appoint individuals for the sake of fulfilling the diversity skill set requirement instead of focusing on looking for and choosing high-caliber board members most suited to oversee the listed company’s affairs and development. In the long run, this approach is likely to be detrimental to the growth and sustainability of the businesses.
The suggested reforms, though proposed with good intentions, appear to grapple with the realities of Hong Kong’s financial market. Striking a balance between an appropriate regulatory framework and a healthy business environment is both an art and a science that remains a formidable challenge. As these proposed amendments place a huge compliance burden on SMEs, which form a substantial number in our financial market, it is imperative for regulators to be mindful and evaluate the practicality and effectiveness of these measures. Otherwise, Hong Kong risks losing its competitiveness and its status as an IFC.
While Hong Kong’s stock market has enjoyed a bout of optimism recently, let’s not crack a bottle of champagne just yet! Despite our rather sterling performance compared to other major markets, the Hang Seng Index’s price-to-earnings ratio remains stubbornly low at 12, a far cry from its historical high of 20. The intrinsic value of many companies, especially listed SMEs, has not yet been fully reflected by price discovery in the securities market. Meanwhile, the IPO market is still very much in a coma. In the first half of 2024, Hong Kong listed only 27 IPOs, raising a mere HK$11.6 billion — down 15 percent in volume and 35 percent in value compared to last year. Clearly, the market is still rubbing its eyes after a long slumber.
How can we boost our standing as an IFC? Radical reforms are definitely not the magical solution. Forcing sweeping changes on SMEs at a time when the market is still regaining its composure simply is not a wise move. HKEX should focus its efforts on smartly reenergizing our financial market with the primary objective of enhancing the value of listed companies; overregulation will only destroy Hong Kong’s competitiveness and our status as an IFC.
Although the HKEX’s proposed revisions are meant to shore up investor confidence, no man is an island. Hong Kong, as an IFC, must keep pace with, even if not leading, its global peers. Unfortunately, the HKEX’s proposed reforms demonstrate its overeagerness in trying to be the “teacher’s pet”. The proposed rules for INEDs, in particular, a cap on a rigid nine-year term and the maximum number of boards on which an INED can serve, are hardly the international standards in the global marketplace. On the one hand, listed companies on the New York Stock Exchange and Nasdaq are only encouraged to follow governance guidelines, which are not mandatory. On the other hand, Singapore, a frequently cited comparison in the consultation paper, has been actively abolishing its outdated financial regulations and slashing listing costs in a bid to breathe life into its listless securities market. Singapore’s goal is simple: more liquidity, fewer rules. Hong Kong, however, appears to be marching in a completely opposite direction, doubling down on corporate governance to such an extent that listed companies only wistfully look for a gentler and more reasonable regulatory regime.
For years, Hong Kong’s success has hinged on a delicate balance between regulation and growth. Prior to the last review of the Corporate Governance Code in 2022, Hong Kong has consistently been one of the world’s top IPO fundraising markets. In fact, from 2009 onwards, it was crowned the global IPO leader seven times, with few raising concerns about its governance practices. (N.B. 174 new listings (2017); 207 new listings (2018); 160 new listings (2019); 154 new listings (2020); less than 100 new listings a year since 2021) The real secret to keeping Hong Kong’s status as an IFC lies in its ability to embrace all who are interested in participating. Light-touch regulation, bustling markets and IPOs as far as the eye can see — these are the real goals.
During our crazy bull run recently, overseas investors came rushing in, not only because of the boundless opportunities they see lying ahead in this city but, also, for their high regard and huge confidence in Hong Kong as an international market practicing governance at its highest standards at all times as confirmed in the recent International Monetary Fund report. It is extremely critical that regulators have great confidence in our existing financial regulatory system, which has been faring very well all along and is not in need of further complications.
Hong Kong’s success as an IFC was not built in a day. Let’s hope our regulators understand and seize the moment to do the right thing by maintaining our international corporate governance standards, lowering compliance costs while allowing our market to thrive and prosper. Perhaps when things are truly back on track, we could revisit certain proposed changes advocated by the regulators.
The author is chairman of the Federation of Hong Kong Industries.
The views do not necessarily reflect those of China Daily.
