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Analysis of Corporate Governance Practice Disclosure

Written by: Mr. Samson Choy (Risk Assistant Manager), Mr. Stanley Chan (Senior Risk Consultant)

In May 2016, the Stock Exchange of Hong Kong Limited (“The Exchange”) published a review (“March Review”) on the issuers’ compliance with the corporate governance practice disclosure in their 2015 annual reports with a financial year-end date of 31 March 2015. The review analyzed 318 issuers’ compliance with the Corporate Governance Code (“CG Code”) of the Listing Rules. In November 2015, the Exchange also published its review (“December Review”) of 1,237 issuers’ compliance with the CG Code in their 2014 annual reports.

Comparing the results of the two reviews, generally speaking, 25% of the issuers with the financial year-end date of March (“March FYE issuers”) reported that they had full compliance with all Code Provisions, lower than 35% , which was reported by  the issuers with December as their financial year end (“December FYE issuers”). 99% of the March FYE issuers complied with 70 or more Code Provisions, out of 75, which was slightly better than the figures of the December Review. The percentage of compliance with two Code Provisions, however, has significant differences: (i) the percentage of March FYE issuers (21%) disclosing that they had an internal audit function was lower than that of the December FYE issuers (47%); (ii) more March FYE issuers (28%) omitted disclosures of board diversity policies than the December FYE issuers (12%).

 

Internal Audit Function

As of 31 March 2015, it was still a recommended best practice that issuers without an internal audit function should review the need for one on an annual basis (RBP C.2.6). The figure for March FYE issuers (21%) who disclosed that they had an internal audit function was significantly lower than that of December FYE issuers (47%). Such difference may be due to the smaller market capitalization of the majority of March FYE issuers who lack resources to establish an internal audit function.

This RBP has been upgraded to Code Provision C.2.5, which states that issuers should have an internal audit function, effective on 1 January 2016. Institute of Internal Auditors' International Professional Practices Framework defines "internal auditing" as "an independent, objective assurance and consulting activity designed to add value and improve an organization's operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes". Large-scale enterprises may have sufficient resources to set up an internal audit department while small-scale enterprises can also consider engaging external service providers to perform regular internal control review and risk assessment. The Exchange once pointed out that it was common for issuers to engage external service providers to perform the internal audit function. Outsourcing the internal audit function to competent parties would not be considered as a deviation from Code Provision C.2.5, as long as they had fulfilled their responsibilities properly.

 

Board Diversity

Effective on 1 September 2013, the nomination committee (or the board) should have policies concerning diversity of board members, and should disclose the policies or a summary of the policies in the corporate governance report (CP A.5.6).

In the March Review, all 318 issuers reported that they had complied with this Code Provision. Nevertheless, it was found that there were omissions in 28% of the reports when the Exchange randomly selected 10% of the issuers and examined their actual disclosure in their corporate governance reports. The level of omissions of March Review was higher than that of the December Review.

To avoid omissions, the issuers should carefully review their corporate governance reports in order to determine whether there is a need to provide reasons of the non-compliance with the code provisions after careful considerations. Board diversity can be achieved by taking various factors into account, including (but not limited to) gender, age, culture, and education background or professional experience. Each issuer should consider their own business nature and if their board members possess appropriate skills, experience and diversified perspectives to achieve maximum benefits. Issuers should also discuss in the board meetings and develop a policy according to the board's business strategy and existing board’s composition in terms of skills, experience and diversity of perspectives.

The percentage of small and medium enterprises in March Review is higher than December Review. Except the above mentioned points, however, the level of compliance with the CG Code of March FYE issuers is similar to the December FYE issuers.

 

Source:
Analysis of Corporate Governance - Practice Disclosure in March Year-End 2015 Annual Reports

FAQs – Main Board Listing Rules – Appendix 14

 

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Senior Risk Manager - Ms. Gloria So
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