Enhancing the Quality of Primary Market in Hong Kong Paul Chow Chief Executive, HKEx 20 November 2004 Conference on Asia's Financial Centre – Challenges & Opportunities Canadian Certified General Accountants Association of Hong Kong

2 1.Hong Kong Securities Market 2.Recent Initiatives in Enhancing Quality of Primary Market 3.Conclusions Agenda

3 Today’s focus Participants Issuers Intermediaries Investors Listed companies Sponsors & IFAs Exchange/Clearing participants Professionals Retail Institutional Enhance investor confidence Attract order flow Increase liquidity Market quality Key Drivers Global situation analysis: Fundamentals of a securities market Business culture & environment Director quality Management expertise Self regulation Licensing regime (SFC) Exchange & Clearing Rules Product & service Operational efficiency System reliability & efficiency Risk management Investor protection Disclosure & transparency Investor education Information dissemination Transaction costs Companies Ordinance (Companies Registry) Statutory Rules (SFC) Listing Rules Corporate Governance Supporting mechanisms Regulatory Framework Market Infrastructure

4 Set overall policy direction Initiate legislation Frontline regulator Public organisation Business entity Administer the listing rules Administer trading/clearing rules (for market operations) Statutory regulator Market watchdog Administer the Codes on Takeovers and Merger and Share Buybacks Regulate HKEx License sponsors and IFAs SFC Government HKEx RolesChecks & balances Executive Council Legislative Council Process Review Panel Securities and Futures Appeals Panel & Tribunal Independent committees & panels Judicial review Review by Independent Commission Against Corruption (ICAC) Oversight by SFC (via SFO & various MOUs) Balanced board structure Independent Listing Committee and Listing Appeals Committee Independent committees & panels Judicial review Review by ICAC Regulatory framework: Listed companies in HK are governed by a 3-tier regulatory system

5 HKEx’s Listing function: Safeguard measures ensure checks and balances SFO HKEx shall give precedence to the public interest over its own interests Appointment of HKEx Chairman (elected by HKEx Board) requires approval of CE of HK SAR Appointment of HKEx CE (appointed by HKEx Board) requires approval of SFC All HKEx’s fees and charges relating to listing activities and new and amendments to listing rules require approval of SFC SFC has power to give directions to HKEx if it deems appropriate (SFC needs to consult with FS in cases of issuing restriction notices and suspension notices ) SFC can introduce and make amendments to any listing rules after consulting FS and HKEx Dual filing Listing application materials submitted to SEHK are also filed with the SFC The SFC has the power to make comments on and object to a listing application Safeguard measures Description

6 SEHK has delegated all its listing decision making powers to the Listing Committee (“LC”) assisted by the Listing Division LC approves new listing applications, new and amendments to policies and the cancellation of any listing Independence of LC is secured by the Listing Nomination Committee, on which HKEx and SFC are equally represented Continuous oversight by SFC of HKEx’s performance of its listing responsibilities, including monthly reporting, monthly liaison meetings and periodic audits A Conflict Committee is established to review any situation where concerns are raised that HKEx may have a conflict of interest HKEx as a listed company is regulated by SFC, not by SEHK Safeguard measures Description MOU on Listing Matters MOU for the Listing of HKEx All board members (except HKEx CE) are INEDs (as confirmed by SFC) Government appoints 6 Public Interest Directors and shareholders elect 6 Directors Balanced Board HKEx’s Listing function: Safeguard measures ensure checks and balances (cont’d)

7 Hong Kong securities market has 2 distinct characteristics Highly concentrated corporate ownership Many non-Hong-Kong- based companies Implications Agency problem not a substantial issue Connected party transaction a potential issue INEDs may not be truly independent if appointed by major shareholders Difficult to deal with misdemeanours due to separate legal systems Difficult to undertake investigations if individuals and evidence are located outside home jurisdiction

8 Hong Kong’s solution is to adopt a primarily disclosure- based regulatory regime Elements of the disclosure-based regulatory regime in Hong Kong Companies allowed to list if comply with requirements stated in the Listing Rules ­ Quantitative requirements - profit track record ­ Qualitative requirements - appropriate management experience & suitability of business Listing criteria Continual obligations of listed issuers & directors Quality assurance Listed issuers obliged to maintain adequate procedures, systems and controls to enable them to comply with the Listing Rules Directors obliged to understand their responsibilities under the Listing Rules Timely & accurate information dissemination Disclosure-based regime – up to market to judge the quality of listed issuers Competence of preparers of financial information and auditors Sufficient powers available for regulators to pursue and invoke effective sanctions for wrongdoings post event

9 1.Hong Kong Securities Market 2.Recent Initiatives in Enhancing Quality of Primary Market 3.Conclusions Agenda

10 Hong Kong has undertaken a number of key CG initiatives recently 2. Revised Code on CG Practices & CG Report 1. Amendments to Listing Rules relating to CG issues 3. Enhancing the Regulation of Listing 5. Strengthening regulation of sponsors and IFAs 4. Enhancing regulation of the accounting profession HKEx issued amended rules on 31 Jan 2004 Effective on 31 Mar 2004 HKEx issued draft amended rules on 31 Jan 2004 Finalised rules published on 19 Nov 2004 To be effective on 1 Jan 2005 Government Consultation concluded on 26 Mar 2004 Implementation in progress by Government, SFC & HKEx HKEx & SFC published Consultation Conclusions on 19 October 2004 Phase 1 completed: ­ HKEx published rules amendments on 19 October 2004 ­ To be effective on 1 Jan 2005 Phase 2 to be completed by the SFC FSTB proposed the establishment of IIB and FRRP Government, SFC, HKICPA and HKEx agreed to fund IIB and FRRP 2004 Jan MarAprOct 2005

11 1. Amendments to Listing Rules related to CG issues Increase number of INEDs from 2 to 3 Require at least 1 INED with appropriate professional qualifications/accounting/related financial management expertise Require to set up Audit Committee ­ Comprise NEDs only; majority INEDs ­ Minimum 3 members ­ At least 1 INED with relevant financial management expertise ­ Chaired by an INED Key elements Directors & senior management Disclosure Mandate disclosure of individual directors’ remuneration on a “named” basis Enhance Listing Rules provisions on notifiable transactions and connected transactions Quarterly Reporting for MB issuers NOT required

12 1. Amendments to Listing Rules related to CG issues (cont’d) Require subsequent refreshments of general mandate be subject to independent shareholders’ approval Extend voting by poll to connected transactions and transactions that require controlling shareholders to abstain from voting Key elements Continuing listing obligations Initial listing obligations Introduce alternate financial standards to the profit requirement: ­ Market capitalisation/revenue test ­ Market capitalisation/revenue/cash flow test Increase minimum number of shareholders required of MB issuers to 300 Increase required minimum number of shareholders to 1,000 for applicants under market capitalisation/revenue test

13 2. Revised Code on Corporate Governance Practices & Corporate Governance Report (cont’d) Key elements Structure Make reference to UK Combined Code & recommendations by SCCLR Consist of two tiers of compliance: ­ Code Provisions - require to comply or explain non- compliance in CG Report ­ Recommended Best Practices - compliance encouraged but disclosure of non-compliance voluntary Contain 5 sections covering: ­ Directors ­ Directors’ remuneration ­ Accountability and audit ­ Delegation by the Board ­ Communication with shareholders

14 2. Revised Code on Corporate Governance Practices & Corporate Governance Report (cont’d) Key elements Code provisions – examples Hold Board meeting on a quarterly basis Separate roles of chairman and chief executive officer Establish a remuneration committee; a majority of the members should be INEDs Conduct a review of the effectiveness of the system of internal control Explain the procedures for demanding and conducting a poll by the Chairman

15 2. Revised Code on Corporate Governance Practices & Corporate Governance Report (cont’d) Key elements Recommended best practices – examples Arrange appropriate insurance cover in respect of legal action against its directors Appoint INEDs representing at least one-third of the board Establish a nomination committee, a majority of the members of which are INEDs Directors should participate in a programme of continuous professional development Disclose details of any remuneration payable to senior management on an individual and named basis Disclose the division of responsibility between the board and management

16 3. Enhancing the Regulation of Listing Key elements Codification of certain Listing Rules in statue Proposed statutory-backed Listing Rules include: ­ Regular financial reporting obligations of listed companies ­ Disclosure obligations in relation to corporate transactions (particularly connected transactions) ­ Obligation to disclose price-sensitive information To be enforced by SFC Transparency/ accountability of Listing functions Publish SFC’s annual audits of HKEx’s performance of listing functions Implement measures to enhance transparency of listing decisions (e.g. Listing Committee Annual Report, issuance of decision letters) Invite ICAC to conduct independent study of the SFC’s Dual Filing Team and HKEx’s Listing Division/Listing Committee

17 4. Enhancing regulation of the accounting profession Consider complaints of alleged accounting, auditing and ethics irregularities committed by professional accountants involving listed entities Key elements Independent Investigation Board (IIB) Financial Reporting Review Panel (FRRP) Inquire into apparent departures from the law and accounting standards in the annual accounts of companies Seek remedial action

18 5. Strengthening regulation of sponsors and IFAs Specify appointment requirements Clarify definition of independence Clarify expectation on due diligence Emphasis on internal controls assessment by sponsor Key elements Phase 1: Appointment and role & responsibilities of compliance advisors, sponsors and IFAs Phase 1: Appointment and role & responsibilities of compliance advisors, sponsors and IFAs Phase 2: Enhancing SFC regulatory regime Phase 2: Enhancing SFC regulatory regime SFC to conduct an investor survey SFC to consult the market on: ­ Eligibility criteria ­ Ways to further enhance its licensing, inspection and enforcement functions

19 HKEx Listing Division is introducing a number of initiatives to enhance its operations * On-going initiative continues in 2005 Key elements 2004 achievements Tentative 2005 initiatives Streamline IPO vetting process* Refine compliance & monitoring practices* Streamline enforcement process* Implement case database for Listing Division* Enable e-Submission of IPO forms* Publish Listing Committee Annual Report Review role & structure of Listing Committee Introduce a more effective mechanism for delisting Facilitate simultaneous listing of A & H-shares Publish decision letters

20 Conclusions Hong Kong operates a disclosure-based regime Major reforms are underway in Hong Kong to further enhance quality of primary market Enhancing market quality is not solely a matter of rules and regulations – it is partly a matter of ethics, of culture and of people However, rules and regulations can influence corporate behaviour The regulators can help promote market quality by strengthening enforcement and raising public awareness through education and training Our ultimate goal is to establish a compliance culture where directors, market participants and professionals all want to behave well themselves Current status Purpose of rules and regulations Role of regulators

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