One country, two systems - Phil Taylor


IBA Global Insight assesses Hong Kong’s proposed changes to corporate governance rules and how they fit with the approach in mainland China.

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Whether you view it as China’s most developed city, a former British colony, or an outpost of common law thinking, Hong Kong relies on mainland China for its success – and always has done. The People’s Republic of China (the ‘PRC’) is a vast trading zone, a ready-made source of lowcost labour, a wealth of business opportunities waiting to happen, and now the provider of a stream of companies wanting to float on Hong Kong’s stock exchange.

Like any listed companies, those originating in the PRC have to abide by the rules and guidance on corporate governance set by Hong Kong Exchanges and Clearing (the ‘HKEx’), the operator and regulator of the territory’s securities and derivatives markets. And in turn, HKEx has to bear in mind the characteristics of PRC-based listed companies, which form the foundation of the exchange (those companies being in the majority by market capitalisation), while also keeping its global players and local founder-owned companies happy.

Add to this the fact that Hong Kong is a common law jurisdiction that is being drawn into the ever-closer embrace of its civil law motherland and you have a classic example of Deng Xiaoping’s famous solution to the delicacies of the 1997 handover: ‘one country, two systems’.

HKEx faced no easy task, therefore, when it decided to review the Code on Corporate Governance Practices (introduced in 2005) and amendments to the Rules Governing the Listing of Securities. Its corporate governance subcommittee unusually carried out two rounds of so-called soft consultation before producing a 68-page public consultation paper in December 2010.

The paper is not groundbreaking at first glance, or even after a second read. One partner of a prominent firm reportedly ‘almost fell asleep reading it’. But with careful thought it is clear that HKEx had to approach its review very carefully to decide how to balance the needs of Hong Kong and the PRC.

Cooperation over harmonisation

The more pragmatic practitioner, for example, would see significant harmonisation of regulations between Hong Kong and the mainland as the way forward. DLA Piper Corporate Partner Jeffrey Mak points out that some of his typical clients – large PRC corporations that are dual-listed in Hong Kong and on the mainland – face a heavy compliance burden.

‘For such clients, you have to consider the implications of any amendments to the rules from a regional or Greater China perspective,’ Mak says. ‘I would like to have more consistent requirements. If you have a transaction in the region, any inconsistency is a headache to the managers of the deal.’

Mak says that a group company listing across the US would expect to encounter harmonised rules across the various exchanges, and the same should be true when listing in Hong Kong and Shanghai. The counter-argument is again rooted in ‘one country, two systems’. Hong Kong is undisputedly a part of China but is also widely advertised as operating an independent legal system until at least 2047. The territory is therefore keen to preserve a degree of independence to attract overseas business – after all, it has several neighbours whose stars are also rising.


‘Hong Kong must not be seen to be dropping its standards - it's always aware of, for example, Singapore pressing its case’
Alan Ewins
Allen & Overy


‘Hong Kong must not be seen to be dropping its standards – it’s always aware of, for example, Singapore pressing its case,’ says Alan Ewins, a partner at Allen & Overy. ‘Hong Kong is keen to be viewed as maintaining its standards internationally.’

As an illustration of how easy it is for Hong Kong’s reputation to be damaged, even by unfounded fears, look to December 2010 when HKEx decided to accept mainland accounting and auditing standards, and audits carried out by mainland audit firms, for Chinese companies listed in Hong Kong. Despite the fact that other exchanges, including London and New York, already had similar arrangements in place, some sections of the local and overseas media were thrown into an uproar. HKEx was forced to release a statement defending its decision amid accusations that the move was made to get more business from the mainland, and that some of Hong Kong’s regulatory power had been given up.

Although the political wisdom of a true harmonisation of rules could be argued ad infinitum, it is undeniable that such a merger would be impractical, as Lynn Yang, a partner at Norton Rose in Shanghai, highlights. ‘Although you can align the major concepts, they can’t exactly mirror each other,’ she says, adding that even the mainland’s Shanghai and Shenzhen exchanges have slightly different listing rules.

HKEx’s approach to finding a balance appears to be to ensure the corporate governance rules stay faithful to their common law background. For the regulator, tying in to the PRC’s rules on corporate governance was important but could only go so far.

‘Harmonisation as such is not a goal – I prefer to think of dovetailing,’ says Mark Dickens, Head of Listing at HKEx. ‘We shouldn’t have rules that pull in opposing directions – we’re trying to present an international standard of disclosure and we also have to accommodate non-state-owned, non-PRC companies.’

According to Dickens, there was also a balance to be struck between hard-and-fast rules and general guidance.

‘100 per cent PRC companies love bright-line rules, as most emerging market companies do,’ he says. ‘The problem is that doesn’t create a culture which fills the gaps the regulator hadn’t thought of.’

To that end, the HKEx committee evidently made some reference to PRC rules when researching the consultation paper, but concentrated more on the common law world, in particular the codes in the UK and Australia.


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Who's doing the chasing?

It is common to encounter a presumption that the PRC lags behind Hong Kong in many areas, and, while in some respects this may be true, many specialists say there has in fact been a great improvement in quality.

‘There’s a clear acknowledgment that PRC standards have moved up in recent times – the proof of that particular pudding is in the significant increase in listings of PRC companies in Hong Kong,’ says Ewins. And in terms of rules on corporate governance, some even claim that mainland China leads the region.

‘The PRC is quite advanced, and it seems Hong Kong is catching up,’ says Mak. ‘There was a time when [mainland] China was regarded as less modernised and sophisticated in terms of corporate governance matters, but now the PRC rules are more advanced in some aspects.’ This progress has come out of China’s new and deeper engagement in the international process and the fact that, as something of a late adopter, China has had the opportunity to build on what has worked best elsewhere. Even proponents of China’s leadership in this area admit, though, that the practical implementation of some rules may not be so clear cut.

‘In terms of what’s on paper, that’s all very well, but the crucial thing is how it’s supervised and enforced,’ Ewins says. ‘You can have fantastic rules, but if they are not overseen properly, that can be a problem. The two aspects need to work in tandem.’

The regulator responsible for doing this is the China Securities Regulatory Commission (the ‘CSRC’), which is relatively sophisticated when it comes to making rules, but is not yet able to be as proactive as its peers overseas.  It does have a team to look into compliance issues, but it prioritises its work for major problems, not minor ones… it can only focus on the key issues first,’ says Yang.

The CSRC recently issued a report comparing China’s national governance practices with the OECD’s principles of corporate governance, and concluded that the PRC is generally in line with international standards. In terms of implementation, however, it is of course the issuer’s management team who bear much of the responsibility, and Herbert Smith partner Tom Chau says that mainland Chinese companies are increasingly seeing the value of corporate governance, too.

‘PRC companies now believe good corporate governance could help improve investor relations and is accordingly good for pushing up the share price,’ he says.

Meanwhile, Yang points out that compliance can depend on the type of company concerned. ‘Companies such as CNOOC, Sinopec and China Life have a large compliance team,’ she says. ‘But for medium or small non-state-owned listed companies, we need some time for them to pick up the learning curve on this.’


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The independents

The use of independent non-executive directors (‘INEDs’) makes an interesting study. Their use is, as Mak puts it, ‘one of the fundamental principles of good corporate governance for listed companies’. Understandably, then, the HKEx consultation paper dedicates a significant amount of space to dealing with the role of INEDs. It also focuses on regulating so-called professional non-execs who take on a large number of positions, and are directors in the loosest sense of the word. The consultation paper cites ‘market concerns’ that some individuals may have taken on too many directorships, resulting in a reduced ability to devote sufficient time and energy to their duties, and reports disciplinary cases in which ‘an obvious lack of attention given by INEDs to their duties was a contributing factor to the non-compliance with the [listing rules] by the issuer’.

The solution on the mainland (in the CSRC’s 2001 ‘Guidelines for Establishing Independent Directors System in Listed Companies’) has been to impose a limit of five INED positions on an individual, as well as a rule that independent non-execs ‘shall have enough time and energy to perform the duties of the independent directors effectively’. Admittedly, this rule is vague and probably unenforceable, and the Guidelines do not make any reference to a penalty for INEDs’ non-performance. ‘It is somehow difficult to assess whether a particular INED has enough time and energy,’ says Chau, who points out that the fiveposition limit can itself act as an assurance of an independent director’s commitment to his or her duties. According to him, the mainland regulator also relies heavily on INEDs’ personal declarations of any current positions that they hold, although it has the power to reprimand both the individual and the listed company if a false declaration is later discovered. The reprimand will have an effect on other listed companies in which the errant director holds a position, as they too must announce the reprimand. It is in an INED’s own interest to make honest declarations if he or she wants to get other positions later.

The Hong Kong consultation paper recommends that a listed company’s nomination committee should ‘regularly review the time required by a director to perform his responsibilities to the issuer and whether he is spending sufficient time as required’. ‘In theory, this is a reasonable check and balance,’ comments Ewins. ‘It’s important that the activities of the committee are sufficiently and robustly pursued (ie vetted by the board as a whole or by internal auditing) to ensure that the reviews are indeed reasonably frequently and robustly carried out.’

HKEx also takes the view that putting a strict limit on the number of INED positions an individual may hold is akin to an unfair penalty. As Ewins explains it, ‘if there’s a particularly energetic and insightful individual able to cope with the stresses of multiple directorships, then surely that shouldn’t be snookered?’ Consequently, HKEx simply recommends that independent non-execs ‘must take an active interest in the issuer’s affairs, obtain a general understanding of its business and follow up anything untoward that comes to their attention’.

‘We thought the emphasis should be on time, energies and commitments – taking a qualitative approach rather than a numerical one,’ says Dickens. ‘If you have the right skillset and manage your time and energy well, then being on a number of boards is an advantage not a handicap. The minute you start using more prescriptive language, you take the INEDs away from what they’re meant to do,’ he explains.

Dickens adds that the solution proposed by HKEx is a composite of the equivalent UK and Australian codes as well as information drawn from publications issued by the Hong Kong’s Companies Registry and Institute of Directors. He also points out that the proposed language is stronger than in the UK. The regulator also believes that increasing the number of INEDs will promote better corporate governance and proposes to introduce a rule that INEDs should constitute one-third of an issuer’s board.

It is clear also that HKEx intends to increase the burden on listed companies themselves. The consultation paper proposes that companies set up a mandatory remuneration committee (staffed mostly by INEDs), suggests the strengthening of guidance on the nomination and audit committees, and recommends an optional new corporate governance committee. The regulator also wants to increase the emphasis on a chairman’s role and responsibility in leading issuers’ corporate governance efforts. Practitioners do not see this increased load as unreasonable, however.

‘It’s formalising international developments in many respects,’ says Ewins. ‘[The proposals] do create a burden, but they also formalise a set of best practice type issues and requirements. They are putting a structure in place to ensure as far as possible that companies do things that they should in fact be doing in the first place.’ In the end, perhaps this is what is most important. Striving for the goal of harmonisation may have to wait until 2047.

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Summary of the 2010 consultation paper

HKEx published its consultation paper on review of the Code on Corporate Governance Practices on 17 December 2010, with a deadline for replies of 18 March 2011.

The paper proposes upgrades of some existing, non-binding ‘provisions’ to mandatory rules, which issuers must follow. Certain ‘best practices’ have been upgraded to provisions. It also includes measures to:

  • improve transparency by bolstering requirements for disclosure and communication with stakeholders;
  • enhance the quality of directors and company secretaries by requiring training;
  • require greater involvement in issuers’ board committees by INEDs;
  • recognise company secretaries’ contribution to corporate governance and define their role and function; and
  • place emphasis on the leadership role of the chairman of the board in corporate governance matters.

Source: Hong Kong Exchanges and Clearing news release


HKEx: History and vital statistics
HKEx operates a securities and a derivatives market in Hong Kong as well as the clearing houses for those markets. It is now one of the world’s largest exchange owners based on market capitalisation.
1891 Association of Stockbrokers, Hong Kong’s first formal securities market, established
1914 Association renamed Hong Kong Stock Exchange
1947 Stock market re-established after World War II
1969 Far East Exchange set up
1971 Kam Ngan Stock Exchange set up
1972 Kowloon Stock Exchange set up
1976 Hong Kong Commodity Exchange established, mainly trading cotton, sugar, soybean and gold futures
1980 Stock Exchange of Hong Kong Limited (SEHK) incorporated
1985 Hong Kong Commodity Exchange changes name to Hong Kong Futures Exchange (HKFE)
1986 Four stock exchanges cease trading and computer-assisted trading begins on SEHK; HKFE launches HIS Futures product
1989 Hong Kong Securities Clearing Company Limited incorporated
1992 Central clearing and settlement system begins operation
March 2000 HKEx created as holding company by merger of the SEHK, HKFE and Hong Kong Securities Clearing Company
June 2000 HKEx listed on the stock exchange
Source: Hong Kong Exchanges and Clearing website


Phil Taylor is a freelance writer and editor. He can be contacted at

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