In its recent circular, the Hong Kong Monetary Authority (HKMA) provided further guidance on the empowerment of independent non-executive directors (INEDs) in the banking industry in Hong Kong, following an industry consultation carried out in early 2016. The guidance examines, amongst other things:
he role of INEDs;
the expected practices of locally incorporated authorised institutions (HK-Incorporated AIs) with regard to INEDs; and
proposed measures to be taken by HK-Incorporated AIs to ensure that there are sufficient suitably qualified people willing to serve as INEDs on the boards of HK-Incorporated AIs.
HK-Incorporated AIs are expected to implement the new measures by 14 December 2017. The detailed guidance covers the following six areas:
- Constituting the board and its committees
- Roles, qualities and time commitment
- Independence and tenure
- Board practices
- Training and development requirements
The circular is intended to regulate practices of HK-Incorporated AIs in relation to INEDs only, but some of the guidelines set out therein will serve as a helpful reference guide to AIs incorporated outside of Hong Kong.
Below is a summary of the key requirements as set out in the circular.
In July 2015, the HKMA commissioned a small group comprising members with experience in the area of corporate governance, with particular reference to the banking sector, to undertake a study of the role of INEDs in the local banking sector and to provide their observations and recommendations to help empower INEDs. The group submitted its report to the HKMA in December 2015 and an industry consultation was carried out on the group's recommendations in early 2016.
Details of the new requirements
The guidance is set out in the annex to the circular, and it should be read in conjunction with the HKMA’s guidance on corporate governance in its Supervisory Policy Manual (SPM), in particular module CG-1 ("Corporate Governance of Locally Incorporated Authorised Institutions"). As noted in our briefing on new corporate governance standards for authorised insurers, CG-1 is currently under consultation.
(i) Constituting the board and its committees
The board of a HK-Incorporated AI should fulfil the following requirements:
- Have at least one INED from a background in accounting, banking or other relevant financial industry (the Required Background), and those of licensed banks or of any other AI designated as “systematically important” under the relevant rules should have at least two INEDs with the Required Background;
- Establish an audit committee made up of non-executive directors, the majority of whom should be INEDs and chaired by an INED with the Required Background; and
- For licensed banks and any other “systemically important” HK-Incorporated AIs, establish a risk committee, a nomination committee and a remuneration committee. Other requirements include, for example, that the risk committee should be distinct from the audit committee and it should be chaired by an INED with the Required Background. It is also good practice for other HK-Incorporated AIs to establish the aforesaid committees, depending on the size, scope and complexity of their businesses.
(ii) Roles, qualities and time commitment
INEDs of HK-Incorporated AIs do not only have a duty to protect the interests of shareholders, they also have to protect the interests of depositors and customers. They should therefore ensure that the AI conducts its business in a manner most conducive to ensure its continued stable operations in the wider public interest.
The circular contains the following guidance regarding INEDs:
- Generally expected to sit on or chair board committees;
- Should have experience and expertise enabling them to fulfil their roles effectively, having regard to the nature, scale and complexity of the AI's business;
- Must be persons of integrity with extensive professional or business experience;
- Should have skills and knowledge that are relevant to their role, including broad experience of identifying and managing operational, financial, reputational and other risks;
- Must have the necessary personal qualities and commitment to enable them to acquire a good understanding of the AI’s business and to consider objectively the management’s decisions and proposals;
- Should act towards the AI at all times with honesty, integrity and candour and use due care, skill and diligence in performing their functions;
- Should, in principle, be prepared to attend all meetings of the board in person and any committees on which he or she sits and should only miss meetings in exceptional circumstances with reasons being provided and documented; and
- Should be prepared to devote time to other meetings with management of the AI and to relevant training or briefings.
(iii) Independence and tenure
The HKMA sets out a non-exhaustive list of factors which may indicate that a director is not independent. A proposed or existing INED falling within one of the following categories may not be disqualified automatically (except for item (d) as explained below), but the nomination committee or the board should consider the appropriateness of the relevant INED and make a recommendation to the board accordingly.
The factors to be considered are as follows:
a. Holds more than 1% of the shares of the AI;
b. Has been an employee, executive or director (other than an INED) of the AI or any of its majority or minority shareholder controllers, group companies or subsidiaries (the Connected Entities) within three years before appointment to the board;
c. Receives any significant compensation (except for remuneration for service as an INED) from the AI or any of the Connected Entities;
d. Has any material business relationship with the AI or any of the Connected Entities (the HKMA expressly specifies that a person falling within this category will not normally be considered independent);
e. Has an immediate family member who:
- Is, or has been within three years before the appointment, employed in a senior management role by the AI or any of the Connected Entities, or
- Has a material business relationship with the AI or any of the Connected Entities;
f. Has close family ties, other than those described in (e), with the directors or senior employees of the AIs or the Connected Entities;
g. Holds cross directorships (or has significant links) with other directors through involvement in other companies or bodies that could give rise to conflicts of interest in the proposed role as INED;
h. Has served on the board for more than nine years;
i. Is, or has been an employee, director, partner or principal of a professional adviser which currently provides or provided professional services to the AI or any of the Connected Entities within one year (or three years if the person involved was the engagement partner of such service provider) immediately prior to the date of the proposed appointment as INED
Some of the aforesaid factors are similar to those applicable to the INEDs of listed AIs under rule 3.13 of the listing rules of The Stock Exchange of Hong Kong Limited.
(v) Board practices Set out below are some key good practices expected to be adopted by HK-Incorporated AIs:
- Arrange appropriate and review annually insurance cover regarding legal action against their directors;
- Facilitate attendance of board and other meetings by INEDs (eg, scheduling all meeting dates for a year before the year commences);
- If an INED of a non-listed HK-Incorporated AI has served for nine years, the remuneration committee or the board should consider whether the INED should continue to be regarded as independent and make a recommendation to the board and record the reasons for the re-appointment;
- Appointment of alternates for directors should be discouraged;
- INEDs should be briefed on complex matters prior to board/committee meetings;
- The chair of the board holds separate, regular meetings with INEDs;
- INEDs should meet separately without presence of other executive directors or management with the internal audit function, and where necessary, the compliance and the risk management functions at least once a year; and
- Evaluate the performance of the board and individual directors at least once a year.
(vi) Training and development requirements
INEDs should be offered appropriate and adequate induction and continuing training to be paid by the AIs. Regular presentations and briefings should be given to INEDs on
- the operation and risk management of individual business areas and departments of the AI; and
- development in the industry and regulatory requirements.
Although INEDs are not expected to have the same level of knowledge and expertise as executive directors regarding the AI’s business and day-to-day operations, they should equip themselves with knowledge of the AI’s business and the banking sector and undertake appropriate training.
The HKMA’s guidance on the role of INEDs, the proposed amendments to module CG-1 of the HKMA's SPM, together with the recent introduction of the “Manager in Charge” regime by the Securities and Futures Commission, highlight the increased focus of regulators on the role of the board of directors and more generally senior management in ensuring robust risk management.
Given the fact that all HK-Incorporated AIs are required to implement these measures relating to INEDs by midDecember of this year, senior management should ensure that a review of their existing governance frameworks, committee structures and membership takes place as soon as possible and make any necessary amendments to ensure due and timely compliance with the regulatory requirements.