Hong Kong Institute of Directors Speaker Dinner Meeting The Directors’ Role in the Hong Kong Securities Market Andrew Sheng Chairman Securities and Futures Commission 22 March 2005
Profound changes in the Securities Landscape since 1996 � Number of listed companies increased 30% from 680 to 1096 � Market cap increased 1.5 times from HK$2.7 trillion to HK$6.7 trillion � Daily turnover doubled from HK$6.9 bn to HK$15.9 bn, higher than 1997 peak � Funds raised in SEHK was HK$281.4 bn, 13.7% higher than 1997 peak � Derivative markets considerably more developed 2
Market has become much broader and deeper � Since 1996, Hong Kong stock market has a more diversified structure from properties and banking due to:- � Diversification of Hong Kong companies towards international markets � Entry of large Mainland companies, especially those in the energy, telecom and heavy industrial sectors 3
Market Capitalisation by Sector (%) (Main Board) End 1996 End 2004 (Total market cap: HK$3,476.0 bn) (Total market cap: HK6,629.2 bn) Consolidated Properties Consolidated Utilities Utilities Miscellaneous enterprises 12.1% enterprises Properties 6.3% 10.3% 26.0% 0.2% 30.0% 31.0% Finance Industrials Miscellaneous 23.2% 15.6% Hotels Industrials 0.3% Hotels Finance 0.9% 7.3% 2.0% 34.9% 4 Source : HKEx
Listed Companies by Market cap: end 2004 � Institutional-led : 1985 – 12% Others Institutional- 23% led � State-led (Mainland 25% SOEs + MTRC) : 1985 – 0% � Family-led HSI : Family-led Mainland + 1985 – 37% HSI MTRC 23% 29% � Others : 1985 – 51% 5
Corporate Governance Successes � Improved Transparency – better disclosure and higher scrutiny by investors and analysts � Focus on Ethics – adopting a principles-based system that emphasizes core ethical values � Self-Regulation – onus is on companies to devise own corporate governance regimes – standards must be visible for benchmarking � Improved Accountability - shareholders expect directors to bear more responsibility and accountability for the performance and conformance of companies HKICS Conference 2004 Highlights 6
Corporate Governance Challenges � Compliance Costs – HSBC annual compliance costs US$400 mn, more than half of S&P500 companies’ net income � Financial Reporting – need to make financial reports more understandable and restore credibility � Board Independence – need for INEDs to challenge Executives on performance and conformance � Auditor Responsibility - stricter standards with public oversight of the audit profession � Shareholder Responsibility - need greater involvement of shareholders (including institutional investors) to exercise discipline HKICS Conference 2004 Highlights 7
Does good Governance pay? - YES � McKinsey study shows premium ranging from 11-14% for US/UK companies to up to 40% for Emerging Market companies � Gompers study of 1,500 US companies show that if fund managers “long” good companies (according to governance ratings) and “short” bad companies, funds outperform by 8.5% throughout the 1990s 8
What do the directors think? Korn-Ferry Survey: Asia-Pacific companies’ directors believe part of their fiduciary responsibilities is to continually improve the quality of governance: � 89% of Asian boards (ex Japan) believe the top factor in determining good governance is having a board committee develop and review governance guidelines. � 81% of Asian boards (ex Japan) developed formalised corporate governance guidelines (up from 61% in 2003). Source: Korn/Ferry International 31 st Annual Board of Directors Study 2004 9
What do the investors think? Overall quality of financial or corporate information disclosed by listed companies Below Excellent Good Average Poor Average Australia (50 responses) 0% 64% 28% 8% 0% Mainland China (190 responses) 2% 23% 51% 22% 2% Hong Kong (139 responses) 2% 32% 53% 11% 3% Japan (85 responses) 1% 41% 48% 9% 0% Korea (62 responses) 3% 56% 34% 6% 0% Malaysia (48 responses) 4% 23% 58% 15% 0% Singapore (109 responses) 2% 36% 56% 6% 0% Total Region 2% 35% 49% 13% 1% (683 responses) Source : CFA 2004 Asia Pacific Corporate and Financial Disclosure Survey 10
Investors want performance + conformance � Performance relates to profitability, robustness of earnings, financial strength and growth. � Conformance relates to being a good corporate citizen. Traditionally, HK companies good at delivering value and performance but need to pay more attention to conformance with corporate governance standards. 11
Dealing with Bad Behaviour “People in Hong Kong recognise that you cannot eliminate bad behaviour – that’s human nature. The important thing is to have enough checks and balances to make corporate activities transparent. [Hong Kong] also has a very effective enforcement system which pursues and prosecutes the culprits of bad corporate behaviour. At the end of the day though, it is up to investors to steer away from companies they are not comfortable with, which is a better remedy than over-regulation.” Herbert Hui Korn/Ferry 31 st Annual Board of Directors Study 2004 12
Role of Board Members � Directors (EDs, NEDs and INEDs) � Companies Ordinance fundamental principle is that all directors are responsible for a company’s affairs � Individually and collectively responsible for the company’s compliance with the laws and regulations � Accordingly, Directors must conduct proper due diligence on affairs and accounts of company because they have more liabilities and risks under current environment � Directors have to be more professional – continuous professional education is now a must 13
Division of Labour between regulators � Division of labour between SFC and Stock Exchange is along statutory/non-statutory lines � Voluntary code and non-statutory corporate governance rules – SEHK � Statutory disclosure requirements – SFC, where false or misleading disclosure of information carry statutory penalties 14
Moving into a Statutory Regime for Disclosure � SEHK responsible for Code on Corporate Governance Practices as well as Listing Rules that are non-statutory � Under the Dual Filing Regime, SFC is the statutory regulator of listed company disclosure � Building on the Dual Filing regime, the Government proposes to codify the more important listing rules requirements into subsidiary legislation under the SFO 15
Proposed statutory backing to listing requirements � The proposed amendments to the Securities and Futures (Stock Market Listing) Rules is to codify the disclosure requirements in the Listing Rules: � Disclosure of price sensitive information and specific events � Disclosure of financial reports � Disclosure and shareholders’ approval for transactions � The proposed amendments does not cover: � Corporate governance related matters e.g. authorisation for general mandate, approval of share option schemes because corporate governance issue � Disclosure requirements for listed debt and structured products 16
Strengthening Checks and Balances � Improve the integrity of information disclosure: fast, reliable information is the fundamental principle of investor-based capitalism � Focus on the roles of intermediaries (eg auditors, investment banks, analysts and directors) to improve information flow and the integrity of information 17
Residue Risk Problem � In the 1990s, issuers, intermediaries and professional advisers have shifted risks to the investor � Losses by investors create political pressure for regulatory change: More rules, laws, tougher sanctions and greater legal responsibilities and liabilities e.g. Sarbanes-Oxley . � The only way to restore balance is to have greater corporate self-regulation: delicate balance between benefits of self-regulation and statutory regulation 18
Regulation is Trade-off between Gains versus Risks or Costs � Cost of Regulation � Resources spent to apply it + Burden Imposed on Firms + Law of Unintended Consequences � Benefits of Regulation � Reducing market failure and externalities � Preventing bad behaviour � Zingales: “necessary to do an overall calculation of the overall benefits of regulation versus its overall costs”* � Uncertainties:- Information not always available and market response uncertain and subject to lags 19
To Reform or Not Reform High incidence of market misconduct and fraud. Need to No market enforce to punish misconduct or perpetrators and fraud. Little or no deter future regulation required. misconduct. Market and issuers exercise self- discipline. Benefit of regulation Benefit of regulation < costs of regulation > costs of regulation � Don’t reform � Reform 20
Concluding Remarks � Ultimately the deliverers of value are the corporate captains. � Hong Kong seeks important balance – need to deliver better performance and better conformance � SFC will work with the HKIoD and other professional bodies to help uplift professional standards and quality of market 21
22 Thank you very much
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