The Hong Kong Institute of Chartered Secretaries Louisa

The Hong Kong Institute of Chartered Secretaries Louisa Lau General Manager 特許秘書. 潛能. 超越所見 Chartered Secretaries. More than meets the eye. Professional Seminar The Hong Kong Shue Yan University 22 October 2008

Today’s Sharing • What is Corporate Governance? • Stakeholders’ needs • Shortcomings of Corporate Governance • Internal Controls • Company secretary’s role • Introduction of HKICS 潛能. 超越所見 More than meets the eye. 2

Current News … 潛能. 超越所見 More than meets the eye. 3

潛能. 超越所見 More than meets the eye. 4

潛能. 超越所見 More than meets the eye. 5

Collapse of Barings 潛能. 超越所見 More than meets the eye. 6

Definitions of Corporate Governance • Promoting corporate fairness, transparency and accountability - directors and auditors handle their responsibilities towards shareholders - a firm’s relationship to society, corporate social responsibility 潛能. 超越所見 More than meets the eye. 7

Definitions of Corporate Governance • System by which business corporations are directed and controlled 潛能. 超越所見 - distribution of rights and responsibilities among different stakeholders in the corporation - the rules and procedures for making decisions on corporate affairs - the structure through which the company objectives are set, and the 8 More than meets the eye.

Definitions of Corporate Governance • A mindset of compliance • Fair, Equitable, Transparent • A good internal control system 潛能. 超越所見 More than meets the eye. 9

Main ingredients of Corporate Governance 1. Aim - Reduce conflict of interests Protect the minority 2. Enforcement 潛能. 超越所見 More than meets the eye. Disclosure Minority’s rights 3. The machine - Company Secretary Directors/INED’s Board Committees Internal Control System 4. Handling non-compliance 10

A typical Corporate Governance Structure of a listed company Typical Corporate Governance Structure Core Typical Corporate Governance Structure Duties Core Duties Board of Directors Executive committee Accounts and finance Audit Committee … Remunerat ion Committee Company Secretary Risks Mgt Com. Nomination Committee Functional Bo. D and its Committees u Decide and direct the company’s strategic directions u Close supervision ; Bo. D must possess professional knowledge and business experience u Effectively monitor the Management u Ensure the Management is responsible to the shareholders Subsidiar Productio Business Investors ies and n and operation Relation Branches Services units Business Other considerations Operations Department Level u Execute the strategic direction of the Board u Operate day-to-day business structure includes u Investors are concern of the structure of the Board u Compare with other listed companies Operations Department Level u CEO or Chairman of the Board as the spokesman of the company u Except A typical corporate governance the Board. Investors of Relation u Achieve business Directors, its Committees of the Board , Management and Operations department, other targets operations departments / units departments’ 潛能. 超越所見 More than meets the eye. transparency is 11 low.

Stakeholders Staff Directors Shareholders LISTED COMPANY Suppliers Regulators 潛能. 超越所見 More than meets the eye. SOCIETY Ratings Agencies Government Communication Media 12

Stakeholder’s needs Shareholders • Minority - Voting power - Relying on rules & regulations • Shareholders in general - Investment returns - Value of company/ stock price 潛能. 超越所見 More than meets the eye. 13

Value VS Price VALUE > PRICE Buy/Hold VALUE < PRICES Is. Sell a main duty of a Director to it increase the value of the company OR to increase the return to shareholders? 潛能. 超越所見 More than meets the eye. 14

Cases for discussion (1)A listed company is sitting on huge cash. When asked by reporters, the Board of Directors have made it clear that the Board have no immediate investment or acquisition targets. 潛能. 超越所見 More than meets the eye. There is a strong desire of shareholders for the company to pay 15 big cash dividends.

Cases for discussion (2)In recent years, the average earning of the company is above HK$100 million, and every year the Board of Directors have donated about HK$3 million to Universities/charity. A shareholder disagreed with such donation at the AGM. 潛能. 超越所見 More than meets the eye. 16

Cases for discussion (3) A consortium of listed companies have acquired three vacant/never occupied residential buildings. The Directors planned to demolish, rebuild and sell the properties for an estimated profit of about HK$1 billion. If, however, to renovate and sell, the profit is estimated to be HK$3 million. So, they decided the former one. 潛能. 超越所見 More than meets the eye. 17

Stakeholder’s Needs Directors • Don’t want complicated rules & regulations • Don’t want heavy penalties • Cost of corporate governance 潛能. 超越所見 More than meets the eye. 18

Stakeholder’s Needs Government • To make it an international financial centre Regulators • To reduce disclosures • To enforce with “Teeth” • Rules on penalities 潛能. 超越所見 More than meets the eye. 19

Statutory Backing • Punishment: Civil/ Criminal • Post-vetting • Burden on intermediaries • Increase supervisory power of minority and other stakeholders 潛能. 超越所見 More than meets the eye. 20

Stakeholder’s Needs Staff l Career prospect l Staff pensions l Stock options Media l Adequate & timely report l Exclusive report Suppliers l Credit risk l Business risk 潛能. 超越所見 More than meets the eye. 21

Cases for discussion (1)A listed company requested for suspension of trading on 27/10/2008 (Friday) after the noon time. A reporter approached a Director of the Company, and requested for releasing an exclusive report of what’s going on the next day (Saturday). 潛能. 超越所見 More than meets the eye. It was expected that an official 22

Cases for discussion (2) 潛能. 超越所見 More than meets the eye. IF AWSJ approached you (a Director) and requested for exclusive reporting on the Monday press (with an assurance of the Chief Editor that no news would be leaked out before Monday). Do you agree to help? 23

Cases for discussion (3)Shall a Director avoid meeting reporters/media? (4)How to handle media? How to avoid mis-quoting? 潛能. 超越所見 More than meets the eye. 24

Incentives to corporate governance • • • Investor support Media Support Relevance to stakeholders Influence to vested interests Role of government 潛能. 超越所見 More than meets the eye. 25

Investor Support § In its Consultation Paper in July 2003, the Standing Committee on Company Law Reform (SCCLR) reviewed attitudes of international institutional investor towards corporate governance standards in Hong Kong § The level of corporate governance was last of a list of 21 “information needs” of such investors § Corporate governance was described as “somewhat important” and placed 17 th in a 潛能. 超越所見 More than meets the eye. ranking of 22 company specific factors 26

Investor Support Why would investors push for better corporate governance? § They can sell § No reason to do other shareholders’ work for them (and for free) “The review found evidence of a general reluctance to tackle corporate governance in investee companies” - Myners Review 2001 潛能. 超越所見 More than meets the eye. 27

Investor Support § Absence of shareholder organisations § Quality of their own governance § The reasons for investment § Value counts, not governance “If poor governance is being introduced as a result of the transaction, the company must demonstrate that the economic benefits clearly outweigh any reduction in shareholder rights” 潛能. 超越所見 ISS HK Corporate Governance Policy, w. e. f. 1 More than meets the eye. January 2008 28

Media Support Why wouldn’t the media support good corporate governance? § § § Complicated Not interesting to readers Advertising revenue Self-censorship Defamation “The media also have a part to play in drawing attention to governance issues of public or 29 潛能. 超越所見 shareholder concern” - Cadbury More than meets the eye.

Relevance to Stakeholders What evidence is there that other stakeholders support good corporate governance? § Employees § Lenders § Insurers § NGO’s (environmentalists, community groups) etc. 潛能. 超越所見 More than meets the eye. 30

The influence of vested interests Does corporate governance threaten vested interests? § § § 潛能. 超越所見 More than meets the eye. Accountants IPO companies Sponsors Listed companies Controlling shareholders “The State” 31

The Role of the HKSAR Government Is the HKSAR Government an unequivocal promoter of good corporate? § Its own governance § HKSARG’s role on listed companies, statutory corporations § Exercise of patronage and nomination powers § Political appointments 潛能. 超越所見 § Hong Kong as financial services centre 32 – quantity or quality of listings More than meets the eye.

The influence of regulation 潛能. 超越所見 More than meets the eye. 33

“One size fits all” Listed companies differ by But §Size §Corporate Governance Code may dictate there is only one model of governance for all §Maturity §Type and nature of business §Location §Listing rules; and §Culture [Companies] believe that the codes “Too often have to be treated as sets of prescriptive rules” 34 - Hampel More than meets the eye. 潛能. 超越所見

Box-ticking § Regulation can promote “boxticking” § “Box-ticking” does not equal good governance § Focus on processes not “Box ticking takes no account of the diversity of outcomes circumstances and experience among companies, and within the same company over time” § Complexity (affects “It can be seized on as an easier objective than the accessibility and governance objectives” diligent pursuit of corporate instinct) “It might even be possible for the next disaster to emerge in a company with, on paper, a 100% record of More than meets the eye. compliance” – Hampel 潛能. 超越所見 35

Box-ticking (Cont’d) § In 2005, 89% of 621 HK issuers complied with 41 or more of the 44 Code provisions (HKEx Analysis, 2007) § 49% of Hong Kong listed companies “achieved full compliance with the Hong Kong Code of Corporate Governance” – (Grant Thornton Study 2007) § But - is this true? - what is the substance behind the tick? “Raising standards cannot be achieved by structures and - is alone … they provide a framework … but what rules uniformity a quality? counts is the way in which they are put to use” 36 潛能. 超越所見 Cadbury More than meets the eye.

Regulation is Reactive § - Regulation is reactive to events, such as Enron World. Com Parmalat § - Meaning that its development is unstructured unpredictable politically driven catches the innocent and the guilty; and operates by punishment, not reward 潛能. 超越所見 More than meets the eye. 37

Emphasis on Financial Reporting § Regulation has focused on financial reporting but value drivers can be varied and wide-ranging - customer service - employee development - innovation - reputation management - supply chain management - environmental performance - ethnical behaviour and values - relationships with governments and regulators § These are non-financial disclosures which often fall outside “corporate governance” as commonly understood and regulated 潛能. 超越所見 More than meets the eye. 38

Promotion of Risk-aversion § Corporate Governance does not create value § May help manage downside risk § Encourages compliance with set procedures for its own sake § Inhibits - flexibility - rapidity - creativity in the decision-making process § Sarbanes-Oxley “It is equally important to have structures and principles which allow businesses to flourish and 39 潛能. 超越所見 grow” - Hampel More than meets the eye.

The impact of reality 潛能. 超越所見 More than meets the eye. 40

An Outdated Corporate Model? § Is corporate governance being implanted into a corporate model which is outdated? § The joint stock company is a 19 th century structure § It reflects an era when - business was simpler - businesses were smaller - geographical coverage was smaller - businesses were often single asset or single activity - information flow was lower and slower - any single individual (or group of “Someindividuals) couldthe increasing complexity have argued that “understand the business” of business life … is such that the whole 41 潛能. 超越所見 structure of the board needs to be reconsidered” More than meets the eye.

Governing the Family How effective can corporate governance processes be in reconciling the reality of Family control with the potential negatives of: § misalignment of Family’s interests with those of other shareholders § blurring of the roles of owners and management (where Family has quasi-executive role) § inability to attract and retain quality management § misdealings between the Family’s private 潛能. 超越所見 interests and its listed vehicle More than meets the eye. 42

Governing the Outsiders § How can Corporate Governance be applied to businesses which - are incorporated outside Hong Kong - have no business in Hong Kong - have no management in Hong Kong and whose only Hong Kong connections is their listing? 潛能. 超越所見 More than meets the eye. 43

Governing the Outsiders (Cont’d) § Is it possible for Hong Kong’s corporate governance standards to be applied to red-chips which - are state-owned - operate under a different legal regime and regulatory structure - have a different corporate model (e. g. supervisory boards, no audit committees etc. ) and will efforts taken if pushed? “Despite thelist elsewhere so far by the authorities to emphasise minority shareholders’ rights, significant or observable changes have yet 潛能. 超越所見 to take effect in the listed Chinese companies” - 44 More than meets the eye. CFA China Corporate Governance Survey 2007

Over-emphasing the Role of INEDs Are corporate governance developments putting an unrealistic burden on INEDs? § INEDs have no executive role – no daily involvement § Businesses are too complex to be overseen by INEDs § Threatens the principle of the unitary board § Risks of office outweigh the benefits (especially if things go wrong) § Difficulty in sourcing INEDs “Care needs to be taken in imposing additional duties § Procedures for beyond those with and workload on INEDs appointing INEDs which they can § Can they be truly independent? 潛能. 超越所見 realistically cope” - HKICS Report 2006 More than meets the eye. 45

Solutions …… 潛能. 超越所見 More than meets the eye. 46

Some thoughts on the way forward § Investors to be proactive on corporate governance (as in the UK) § Government to set an example § Regulatory breather § Broader disclosure and verification of nonfinancial data § Limitation of liability for INEDs § Eliminate connected transactions § Recognise and accept the limitations of corporate governance regulation 47 潛能. 超越所見 § The best corporate governance should be measured More than meets the eye. by results – sustained delivery of value to all

Ideas of Internal Control • INTERNAL CONTROL is a risk management process and system with the aims to achieve: - Operations efficiency - Reliability and accuracy of operations/ financial data - Compliance of rules/regulations 潛能. 超越所見 More than meets the eye. 48

Risk Management AVOID RISK REDUCE CHOICE OF INTERNAL CONTROLS TRANSFER ACCEPT 潛能. 超越所見 More than meets the eye. 49

Main Focus of Internal Control • Segregation of duties/ check-andbalance • Reduce frauds • Protect company assets 潛能. 超越所見 More than meets the eye. 50

Independent Non-Executive Directors (INED) • Listing Rules >Minimum of THREE >At least one with accounting experience • RBP > One-third of the Board of Director is INED’s 潛能. 超越所見 More than meets the eye. 51

Board Committees • LR – Audit Committee >majority is INED’s • CE – Remuneration Committee >majority is INED’s • RBP – Nomination Committee >majority is INED’s • LR – Independent Board Committee (“IBC”) >Connected Transactions: IBC are all INED’s 潛能. 超越所見 >Takeovers & Mergers: IBC report More than meets the eye. 52

Internal Control • The duty of a company’s standard up the Listing a Director is to bring internal control to the requirement of Rules. • Focus on major risky areas. • Focus on effectiveness of control. 潛能. 超越所見 • Avoid areas of non-compliance: Directors’ Undertaking More than meets the eye. 53

Internal Control (Cont’d) A. FINANCIAL REPORTS: • • 潛能. 超越所見 • More than meets the eye. Timely and adequate information Financial data-storing system Efficient and timely retrieval of data for financial reporting Ensure systematic maintenance of data of subsidiaries (even when the subsidiaries were sold) Ensure auditors can obtain data 54 from the company and its

Internal Control (Cont’d) • • • 潛能. 超越所見 More than meets the eye. Ensure sufficient data are obtained during the due diligence process on any acquisition, and ensure efficient data retrieval when needed All internal control process shall include the subsidiaries Ensure subsidiaries/associated companies/JV companies could provide 55 relevant information on timely

Internal Control (Cont’d) B. Discloseable/ Connected Transactions: • Ensure that there is system/guidelines to identify Discloseable/Connected Transactions - Identify connected persons - Internal approval process • Ensure executives have adequate knowledge and/or external consultants available • Ensure rules/regulations are updated at all times 56 潛能. 超越所見 More than meets the eye.

Internal Control (Cont’d) • Internal control shall also covers - Identify connected transactions - Report to regulators and seek clearance - Comply with the rules and regulations • In the course of merger and acquisition, ensure there is due diligence process to identify connected persons involved • Ensure all group companies (including overseas companies) have control system over utilization of company funds, and avoid financial transactions with 57 潛能. 超越所見 More than meets the eye. connected persons

3 Lines of Defence Board of Directors Risk Management Committee Audit Committee Risk Management CEO/CFO/CO. SEC Internal Audit Operating Departments 1 st Line of Defence 3 rd Line of Defence 潛能. 超越所見 More than meets the eye. 2 nd Line of Defence 58

The Company Secretary’s role • CS = Company’s con. Science • Effective working Chairman and CEO relationship with the • Smooth running of the board’s activities • Close review all legislative, regulatory and corporate governance developments • Ensure the concept of stakeholders (particularly employees) is in the board’s mind • Advice and Directors guidance for non executive • Ensure the standards and/or disclosures 59 More than meets the eye. required by Listing Rules are observed 潛能. 超越所見

Purposes of Board Meetings • Opinions Sharing • Discuss and review • To reach a consensus • To agree or disagree 潛能. 超越所見 More than meets the eye. 60

Written Board Resolutions • Try to avoid • Reasons: – Lack of discussion – Insufficient information/data attached – Seems time-saving, but actually, time-consuming on administration aspects 潛能. 超越所見 More than meets the eye. 61

Minutes Paper Meetings • Prohibit Back-dating • Prohibit 潛能. 超越所見 More than meets the eye. 62

Conclusions 1 Corporate Governance - A mindset of compliance - Fair, Equitable, Transparent - A good internal control system 2 Company Secretaries 潛能. 超越所見 More than meets the eye. - Company’s conscience - Advisor to the Board - A senior executive/officer of the company 63

Conclusions (Cont’d) 3 Directors - Enhance company value - Ensure good internal control 4 Paper Meetings and Back-dating shall be PROHIBITED 潛能. 超越所見 More than meets the eye. 64

Rules cannot substitute for character "But corporate scandals of recent years have clearly shown that the plethora of laws of the past century have not eliminated the less savory side of human behavior, " he said. "Rules cannot substitute for character. " Alan Greenspan Federal Reserve Chairman 《Chicago Tribune》, 17 April 2004 潛能. 超越所見 More than meets the eye. 65