Hong Kong Stock Exchange eyes further enhancements to CG Code: are issuers ready?

In a bid to further enhance corporate governance standards among listed companies in Hong Kong, the Stock Exchange of Hong Kong (SEHK) issued on 16 April 2021 a consultation paper on proposed enhancements to the Corporate Governance Code and Corporate Governance Report (the CG Code), as well as related amendments to the Listing Rules. From a policy perspective, improving the governance standards of companies, which would in turn improve the quality of the Hong Kong market, is a welcome step. The particular focus areas of this consultation paper, namely corporate culture, director independence, diversity, and ESG reporting, have also been (and will remain) high on the global regulatory agenda, so sustained interest of the SEHK in these areas is helpful and should help to strengthen Hong Kong’s position as an international financial centre. The continued drive to encourage listed companies to become TCFD-compliant (alongside other sectors such as banking and asset management) is particularly encouraging.

However, for listed issuers and listing applicants, the devil is in the detail. Many proposals in the consultation paper, if implemented, would require changes to companies’ policies (or the formulation of new ones), as well as recalibration of the way in which boards organise themselves and engage with shareholders and other stakeholders. Companies would be well advised to start considering the potential impact of the proposals at the earliest opportunity and seek professional advice, given the additional time and resources that companies will likely require in order to comply with the revised rules.

We highlight below some of the key proposals that warrant companies’ attention. This is not an exhaustive list, so please do reach out to your usual Freshfields contacts should you wish to discuss the proposals in greater detail.

Corporate culture, aligned with vision and strategy, is the recipe for long-term sustainable performance

It is helpful that the SEHK has elaborated in the consultation paper on the board’s role in setting and embedding a company’s culture, what a “sound culture” looks like, and how companies can facilitate stakeholders’ understanding of their culture. It is also helpful that the SEHK has acknowledged that there is no one-size-fits-all when it comes to culture.

In order to meet the updated regulatory expectations, a company would need policies and processes to ensure its board is focused on promoting, monitoring and assessing the company’s culture, and that such culture is well understood by and embedded at every level of the organisation. This is an ongoing process that will require periodic reviews and recalibration – as a company is an organic being with evolving strategies and business models, its culture statement and initiatives will need to evolve in parallel in order to remain relevant and aligned with the company’s values and strategies.

The SEHK has proposed that the requirement to have in place an anti-corruption policy and a whistleblowing policy should become CG Code Provisions. Further guidance will follow in relation to the elements that a company should consider when formulating such policies, but companies might want to start deliberating issues such as who should be tasked with drafting and implementing these policies (the SEHK has suggested that sometimes it would be more appropriate for the board as a whole to handle such tasks, rather than just leaving it to the audit committee), and how to ensure reporting channels would function effectively.

Board independence and Long Serving INEDs

The proposal to require companies to establish and disclose policies to ensure that independent views and input are available to the board should not in itself create too many difficulties. What companies are likely to find challenging is the proposed requirement for a company to appoint a new INED where all the INEDs on its board are Long Serving (i.e. 9+ years) INEDs. Given the proportion of Long Serving INEDs in the Hong Kong market (17.8% of all INEDs, as at December 2020), and the spread of Long Serving INEDs across Hong Kong-listed companies (around one-third of all issuers), a sizeable number of issuers would need to identify and appoint new INEDs with the right skills and experience (and who also fit the company’s values and culture). This will undoubtedly add to a company’s operational burden, a reality that appears to be recognised by the SEHK, as it has proposed a longer lead-in time for the implementation of the Long Serving INED proposals (i.e. to be implemented for FY commencing on or after 1 January 2023, one year later than the timeframe envisaged for the other proposals).

It is also worth noting that the SEHK is minded to phase out all Long Serving INEDs “in the long run”, although it has not divulged any details of such plans.

Doing away with single gender boards

The SEHK’s proposals on gender diversity might present equal (if not greater) challenges for companies. It proposes to clarify in the Listing Rules that single gender boards fall short of what is required to achieve diversity. Further, a company would be required to set and disclose numerical targets and timelines for achieving gender diversity, both at the board level and across its workforce. While issuers with all-male boards would be given a three-year transitional period to appoint at least one female director, IPO applicants are not expected to have single gender boards at all. Contrast these expectations with the reality that, in 2020, only 12.7% of Hong Kong-listed company directors were female, and over 70% of issuers had zero or only one female director. The need to play catch-up (and to play it quick) is all too clear to see.

Simultaneous publication of ESG reports and annual reports

Another proposal that calls for plenty of pre-planning is the requirement for companies to publish their ESG reports at the same time as their annual reports. Currently, companies are given up to five months to publish their ESG reports following the end of their financial year. The SEHK has taken the view that since ESG information is becoming increasingly important, and that investors would benefit from ESG data that is current, it would be best to align the publication timeframes of ESG reports and annual reports. While this would enable a company’s board to assess the ESG-related risks and financial risks that the company is faced with in a more holistic way (hopefully leading to more comprehensive and meaningful disclosure for investors), companies should be mindful of the additional time and resource pressure that this proposal might generate, and should plan accordingly.

While seeking to enhance the timeliness and relevance of ESG reports, the SEHK has also reiterated the importance for issuers to consider adopting the TCFD Recommendations when disclosing climate change-related information. This is an encouraging move, following the incorporation in 2020 of certain key elements of the TCFD Recommendations in the HKEx’s ESG Reporting Guide, and the declared aim of the Hong Kong Green and Sustainable Finance Cross-Agency Steering Group to implement mandatory TCFD-aligned climate-related disclosures by 2025. We would be happy to help you navigate this constantly evolving area as the various implementation deadlines are fast approaching.