Various changes to the Listing Rules and the Corporate Governance Code will come into effect on 1 January 2019. The changes are contained in the Exchange's consultation conclusions regarding the Corporate Governance Code that were published on 27 July 2018. On the same day, the Exchange also published the Guidance for Boards and Directors, which contains practical advice to boards and directors on their roles and responsibilities.
The upcoming changes mainly relate to the nomination of independent non-executive directors and board diversity. This means greater demands will be imposed on the board and/or the nomination committee in future, as its work will be subject to further scrutiny.
We summarise the key changes and new guidance below.
Overboarding and INED's time commitment
Code Provision ("CP", subject to "comply and explain") A.5.5 of the Corporate Governance Code and Corporate Governance Report (the "Code") will be amended so that if a proposed independent non-executive director ("INED") will be holding his/her seventh (or more) listed company directorship, the board will need to explain why it believes the proposed INED would still be able to devote sufficient time to the board. The explanation should be contained in the circular to shareholders accompanying the resolution to elect the INED. This change would provide greater accountability in the nomination process.
During the consultation process, certain market participants raised the suggestion that if the same individual acted as an INED in multiple listed companies within one listed issuer group, it should be counted as one directorship. The Exchange expressly disagreed with this suggestion in its consultation conclusions.
Factors affecting an INED's independence
A number of changes will be introduced to strengthen the criteria for assessing the independence of potential INEDs and to align standards in Hong Kong with international practice.
Cooling off periods
Professional advisers: Listing Rule 3.13(3) will be amended to require a two year cooling off period (instead of the current one year period) for professional advisers to the issuer or its related entities before they can be considered independent. The Exchange initially suggested that the cooling off period be extended to three years in its consultation paper, but it has been shortened to two years in its consultation conclusions after taking into account market feedback.
Former audit partners: CP C.3.2 will be amended to require a two year cooling off period (instead of the current one year period) for a former partner of the issuer's existing audit firm before that person can be a member of the issuer's audit committee. This change was made to align it with the new cooling off period for professional advisers.
Material interests in business activities: Listing Rule 3.13 will be amended to introduce a new one year cooling off period for a proposed INED who has had material interests in the issuer's principal business activities in the past year.
Cross directorships or significant links with other directors
A new Recommended Best Practice A.3.3 (i.e. subject to voluntary disclosure) will be introduced to the Code to recommend disclosure in the issuer's corporate governance report to explain why a proposed INED is still considered independent even though the individual may hold cross-directorships (which exists when two (or more) directors sit on each other's boards) or has significant links with other directors through involvement in other companies or bodies.
A new Note will be included under Listing Rule 3.13 to include an INED's immediate family members in the assessment of the director's independence. "Immediate family members" will be defined as the proposed INED's spouse and the INED's (or his/her spouse's) child or step-child, natural or adopted, under 18 years old (i.e. same definition used in Listing Rule 14A.12(1)(a)).
Board diversity and election of INEDs
In order to promote board diversity, existing CP A.5.6 will be upgraded to new Listing Rule 13.92, requiring the issuer's nomination committee (or the board) to have a diversity policy and to disclose the policy or a summary of it in the issuer's corporate governance report.
In addition, CP A.5.5 will be amended, requiring the board to state, in the circular to shareholders accompanying the resolution to appoint an INED, its diversity considerations, including:
(i) the process used for identifying the proposed INED;
(ii) the perspectives, skills and experience the proposed INED is expected to bring on board; and
(iii) how the proposed INED would contribute to the diversity of the board.
The Exchange's new Guidance for Boards and Directors ("Guidance") includes a specific section on board diversity (including gender diversity). The Guidance sets out various factors for issuers to consider when formulating their diversity policies. The diversity policy should include measurable objectives that the issuer has set for implementing its diversity policy and progress on achieving those objectives.
Although diversity encompasses much more than simply gender diversity, the Guidance notes that statistics on gender diversity can be obtained with more certainty compared to other factors (such as cultural background and professional experience). Given that a substantial proportion of Hong Kong listed companies do not have any women on their boards, objectives relating to gender diversity should be included in the diversity policy, and there should also be more transparency on the consideration of gender diversity (among other diversity factors) during the nomination process of directors.
The Guidance also recommends the use of a "board skills matrix" and disclosure of the matrix to investors. A "board skills matrix" is a table that sets out the background of board members in relation to certain skills, experience and diversity of perspectives. The matrix assists the board to assess the mix of competencies and diversity on the board and to identify any gaps. As the strategy and objectives of each board are different, the Guidance does not set out a "one size fits all" list of criteria, however, the Guidance suggests that a typical matrix should include industry or professional knowledge and experience, gender, technical skills and management experience.
Mandatory Disclosure Requirement L.(d)(ii) of the Code will be amended to require disclosure of an issuer's nomination policy (including the diversity policy or a summary of it) adopted during the year.
Directors' attendance at general meetings: CP A.6.7 is amended to clarify that generally, INEDs and non-executive directors ("NEDs") should attend general meetings to gain and develop a balanced understanding of the views of shareholders.
Chairman's annual meeting with INEDs: CP A.2.7 is revised to state that INEDs should meet at least annually with the chairman without the presence of other directors.
Dividend policy: a new CP E.1.5 will be introduced requiring the issuer to disclose its dividend policy in its annual report.
Practical advice under the Guidance
The new Guidance contains practical advice to boards and directors on their roles and responsibilities. It
covers the topics set out below.
Directors' duties and board effectiveness: The Guidance reiterates the basic concept that all directors, whether they are executive directors ("EDs"), NEDs, or INEDs, are all subject to the same duty to exercise reasonable care, skill and diligence set out in the Listing Rules and general Hong Kong company law.
However, EDs, NEDs and INEDs perform different roles and functions, which is further elaborated in the
Board committees' roles and functions: The Guidance describes the functions of the nomination, audit and remuneration committees, and also provides further information for issuers to consider when formulating their nomination policies.
Board diversity and policy: Please refer to the "Board diversity and election of INEDs" section above for further information.
Risk management and internal control: The Guidance describes the board's role and management's role relating to risk management and suggestions on steps to take to manage and identify risks.
Company secretary: The Guidance describes the role and function of company secretaries, and provides guidance on when the role is outsourced to an external service provider.
Corporate governance for weighted voting rights ("WVR") issuers: The Guidance summarises the additional regulatory requirements WVR issuers are expected to follow.
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