Independence or Interdependence? The Way Forward for Long-Serving INEDs

The Stock Exchange of Hong Kong Limited published a consultation paper in April 2021 (the “Consultation”) containing proposals to enhance the corporate governance provisions of the Listing Rules. While we applaud the Stock Exchange’s initiative in staying at the forefront of global trends and standards, we have reservations about some of the proposals.

One of the stated goals of the Consultation is to enhance the independence of independent non-executive directors (“INEDs”). The Stock Exchange highlighted the prevalence of “Long Serving INEDs”, being INEDs who have served continuously for more than nine years. The concern is that a board whose INEDs comprise of, or mainly of, Long Serving INEDs would suffer from entrenchment and a groupthink; it may promote an erosion of independence from management. To this end, several proposals in connection with board refreshment and succession planning were recommended.

Currently, the Listing Rules require issuers to make separate shareholders’ resolution for the re-election of a Long Serving INED and attach papers thereto explaining the INED’s independence and fitness for re-election. In the Consultation, the Stock Exchange proposes requiring the re-election of a Long Serving INED to be subject to (a) independent shareholders’ approval, and (b) additional disclosure be made on (i) the factors considered, (ii) the process and (iii) the board or nomination committee’s discussion in the determination on why such an INED is still independent and should be re-elected. In circumstances where all the INEDs on the board are Long Serving INEDs, the Stock Exchange proposes requiring the appointment of a new INED. It is also contemplated that, in the long-term, Long Serving INEDs will be phased out completely.

We are in full agreement with the objective of promoting effective boards in Hong Kong issuers, and the ability for INEDs to contribute fresh perspectives and independent judgment. The board of issuers should not be a proverbial private club of university friends. However, we have reservations about some of the mooted proposals.

While we understand the concerns raised by the Exchange, it may not be accurate to question the objectivity and independence of INEDs solely on account of their years of service. In practice, seasoned INEDs may be more at ease in speaking their mind and offering their insights, even if it might contradict executive management’s viewpoint. They also have the benefit of a thorough knowledge of the issuer’s history and operations. By the same token, new INEDs may feel uneasy to oppose the rest of the board, as they may feel unfamiliar with the issuer’s affairs. This is particularly the case where only one new INED is appointed and the remaining board members are executive directors and Long Serving INEDs. Appointing a new INED solely for the sake of compliance may not achieve the desired outcome of bringing a fresh and independent view to the board. We believe the current Listing Rules and Corporate Governance Code retain enough flexibility to accommodate the needs of different issuers in constituting their boards.

The proposals also leave open certain questions that may affect their effectiveness. For instance, the proposals do not consider whether a Long Serving INED who has not been re-elected at a general meeting may be elected as a new INED in the immediately subsequent general meeting. If he or she is not debarred from offering himself or herself for election at a subsequent general meeting, the effectiveness of the proposal may be reduced. If however the mandated “cooling off period” is too long, it may be unfairly restrictive to the issuer and the INED. Secondly, as secondary listed companies are automatically waived from compliance with the Corporate Governance Code, they would appear to benefit from preferential treatment as their Long Serving INEDs would not be subject to such requirements.

Without prejudice to the foregoing response, if the new proposed Corporate Governance Code concerning Long Serving INEDs are introduced, it may be helpful to also introduce a unified system to assist issuers who are seeking to appoint new INEDs. As stated in the response to the Consultation by the Hong Kong General Chamber of Commerce dated 17 June 2021, the proposals may impose a disproportionate burden on small and medium-cap issuers, which may not have access to the same talent pool of potential INEDs as large-cap issuers. It would therefore be of assistance if the Stock Exchange, perhaps in cooperation with an industry body such as the Hong Kong Institute of Directors, maintains a platform or directory on which currently serving INEDs and other interested persons can publish their profiles and set out their experience, qualifications, competences, and the types of issuer on whose boards they wish to serve. This would promote greater transparency in the market for appointing INEDs. An issuer looking to replace an existing INED or appoint a new one would be able to browse the platform or directory to find candidates who match their criteria. This could promote competition among, and increase the standards of, INEDs generally and expose new and possibly younger INEDs to more opportunities.

Such a platform would also be aligned with and promote the spirit behind the Consultation’s proposal to require issuers to disclose the channels used in searching for INED candidates and the contribution such candidates could bring to the board. With that said, we think such a new disclosure requirement to be superfluous and irrelevant. The manner through which the issuer comes to be acquainted with the INED has no bearing on the competence and perspective of an INED, and it would be unfair if this results in pressure on smaller issuers to unnecessarily expend capital to retain search firms or publicize advertisements.

We generally applaud the initiative taken by the Stock Exchange to improve Hong Kong as a premier listing destination. Ensuring high corporate governance standards that are consonant with the current social, cultural and economic climate is key. Nevertheless, the right balance must be struck between this objective and the need to avoid overreaching interference in the operations of listed issuers. We think, in the case of Long Serving INEDs, the scales tilt in favor of the status quo.


Partner, Corporate Team, Withers

Mike is a partner in the corporate team. He has over twenty years’ experience in corporate finance and specialises principally in initial public offerings on the Main and Growth Enterprise Market Boards of the Hong Kong Stock Exchange, including the listing of real estate investment trusts.

He also has extensive experience in mergers and acquisitions, corporate reorganisations, compliance pertaining to Hong Kong listing rules and local securities regulatory compliance.

Associate, Corporate Team, Withers. 

Ryan is an associate in the corporate team. He is involved in a broad range of corporate and commercial matters. He has assisted clients in connection with mergers and acquisitions, banking and finance, corporate reorganisations as well as licensing and regulation of private equity/ venture capital funds. He also has corporate finance and capital markets experience, having advised on initial public offerings and on general compliance pertaining to listed companies and addressing enquiries and investigations from regulators.