How is Corporate Governance Changing? Good morning. You may be wondering why someone from the Hong Kong Government Efficiency Unit is giving the opening address at this conference. The very idea of government efficiency may seem incongruous, and what has it to do with corporate governance? Aren‟t we the people who do the time and motion studies and value for money audits – the kind of activities that good corporate governance makes sure take place, not the people concerned with corporate governance itself. Let me take just a moment to establish my credentials by giving you a brief introduction to my team and our role. The Efficiency Unit was set up seventeen years ago. The mission it was given was this: “to pursue Government’s commitment to improve services to the community and to achieve openness and accountability by.…securing support.…for a programme of public sector reform”. Not a word about efficiency. But, the thinking behind the creation of the unit is that there is a direct relationship between accountability and efficiency. One public statement made shortly after the creation of the unit put it thus : “Accountable government … is a P. 1 of 17 fundamental safeguard for every section of the community, the most effective guarantee of the integrity and efficiency of an executive led administration”. The counter-point to that statement might be the observation made by the historian Alistair Horne in „The Price of Glory‟, that the old War Office used to keep three sets of figures, “The first was to mislead the public, another to mislead the Cabinet, and the third was to mislead itself.” That nicely makes the point that accountability is not just an external matter, it is also about internal clarity and honesty. Without that, inefficiency spreads and creates fertile ground for deception and corruption. Accountability is the responsibility of every branch of the public service. standards. Audit aims to check compliance with established The role of the Efficiency Unit is more forward looking, to identify and encourage the adoption of good practice. My understanding is that you have all come here today because you share the view that there is a link between accountability, integrity and efficiency and that it is as important to the private sector as it is in public organizations. The organizers of this event advance the idea that attention to corporate ethics and compliance can be turned into a competitive advantage for companies in Asia. What I would like to do this P. 2 of 17 morning, to help start your deliberations, is to outline two areas of involvement that Government has in corporate governance and then to leave you with a proposition to think about. The first area of involvement for Government is in setting and overseeing the observance of regulations for the governance of privately funded corporations. This is not my unit‟s particular area of expertise. I will not go much into the detail of regulation and enforcement here but will focus on why such regulation is important and how the Government seeks to encourage best practice here in Hong Kong. The second area of involvement is in the governance of public agencies and other bodies that receive public funds. The Efficiency Unit has recently been commissioned to help develop guidance and processes to improve the quality of corporate governance in this area. I will share with you some of what we are doing that may be relevant for you. The proposition I will leave you with is that good corporate governance has a vital part to play in helping our societies face up to and deal with the effects of our current patterns of uneconomic, inefficient use of the world‟s resources. Simple compliance with regulations and guidelines is insufficient. The old adage “Much compliance, much craft” makes the point. P. 3 of 17 An understanding that private corporations and public bodies alike are both the creations and the servants of our common, human society, and must be directed with at least some understanding of their ethical duty to that society is important today and will be of no small importance in the years ahead. Corporate governance in privately funded organizations In recent years most discussion of corporate governance in the private sector has revolved around the provisions of the U.S. Sarbanes-Oxley Act. Enacted in the wake of the Enron and Worldcom scandals, this legislation has been criticized for having been an over-reaction, disproportionately burdening smaller companies with compliance costs. The complaint that such legislative reactions to failure are excessive is not new. Indeed, the late J.K. Galbraith – in his study „The Great Crash 1929‟advanced the idea that : “As a protection against financial illusion and insanity, memory is far better than law”. While, as an amateur historian, I have some sympathy for this idea, we cannot rely on history being well taught or well remembered. And even when it is, unaided memory is rarely a sufficient safeguard against cupidity. Law stands to remind people of their duty. The events of the last year or so in financial markets may not be fully explained by the repeal of the Glass-Steagall Act, but, by letting slip the civil bonds of regulation, there is no doubt that a warning P. 4 of 17 marker and an obstacle to self-deception had been taken away. That is a lesson to keep firmly in mind in any debate about the value of Sarbanes-Oxley, or discussion of the merit of adopting similar measures targeting standards of corporate governance here in this region. If you expend great effort to find a firm theoretical base for the „right‟ regulation on corporate governance, you are likely to be disappointed. The two main theories – agency theory with its view that directors are utility maximizers who, therefore, cannot be trusted to act in the best interests of their principals, and stewardship theory, rooted in the belief that directors accept a fiduciary duty and can be trusted – are obviously in tension. Both can be shown to be false in specific circumstances. It is not surprising, therefore, that the impetus for legislative interventions has been provided by corporate corruption and collapse, rather than by intent to optimize the operation of companies. The pragmatic view that has developed in the absence of any agreed general theory, is that corporate governance covers the processes by which organizations are directed, controlled and held to account, encompassing authority, accountability, stewardship, leadership, direction and control exercised in the organization. In other words, it covers the principles and the practices adopted by a Board that give assurance internally and externally that the P. 5 of 17 organization is being managed effectively, with integrity and with transparency. For Hong Kong, one of the world‟s key financial centres, good standards of corporate governance are considered essential to sustain public and investor trust. For companies, good standards of corporate governance are an essential element in attracting investment. As a leading financial centre and capital formation hub supporting China‟s development and integration into the world economy, Hong Kong assists mainland companies not simply to raise funding, but to raise their corporate governance standards as well, so as to establish and sustain trust and credibility among international investors. The Hong Kong Government‟s objective is to maintain a strong and effective corporate governance regime so as to ensure that market participants meet recognized international standards, including those related to risk management and disclosure of information. In 2005, this city became the first jurisdiction in the Asia-Pacific region to achieve full convergence with the International Financial Reporting Standards and full convergence with best international practice in the areas of ethics for professional accountants. The Code on Corporate Governance P. 6 of 17 Practices for Listed Companies which became effective that year includes two levels of recommendations - code provisions and recommended best practices. Issuers must disclose in their interim and annual reports whether they have complied with each code provision. If there is any deviation from a code provision, the issuer must give explanation. Since the Code became effective, the HKEx has conducted three reviews of listed issuers‟ corporate governance practices, as disclosed in their annual reports. The latest review found that all 1,213 issuers met the requirement either to comply with Code provisions or to explain deviations. About 98 per cent of the issuers complied with at least 41 of the 45 code provisions (up from 96 per cent in the second review). The Financial Reporting Council, a new statutory body empowered to investigate accounting and auditing irregularities of listed companies, became operational in July 2007. Formation of this Council was a direct regulatory response to Enron and Worldcom to strengthen the oversight of the accounting profession and the quality of financial reporting. In mid-2006 a major exercise to rewrite the Companies Ordinance was launched to provide Hong Kong with a legal infrastructure attuned to its long term needs as a major P. 7 of 17 international business and financial centre. A significant part of that exercise is to review and further strengthen Hong Kong‟s existing corporate governance framework. Together, Government and regulators work to sustain Hong Kong‟s reputation through action at three levels. At the general level, the objective is to maintain a fair, transparent and orderly market. At the company level, emphasis is on providing a sound institutional framework that encourages good corporate governance. Underpinning these two is the enforcement level, ensuring that there are appropriate penalties, together with effective investigation and prosecution of fraud and dishonest acts. The primary concern of Government and regulators is naturally with standards of corporate governance in listed companies, given the high degree of public interest, involvement and investment in such companies. But listed companies do not exist in isolation. The wider environment in which they operate - the ethics and practice in private companies and in the publicly financed sector - affects them. These areas need attention as well if the underlying goal of sustaining decent conditions for economic activity and social development is to be met. Indeed, the quality of corporate governance in the publicly funded sector has become a subject of particular interest in Hong Kong over the P. 8 of 17 last couple of years and to this I now turn. I will outline reasons for the renewed attention and the direction that action is taking in this field. Corporate governance in the public sector As with private companies, the objective for standards on corporate governance in publicly funded bodies is to ensure that the organization achieves its purposes in ways that enhance confidence and trust in the organization. The agency that provides funding, the staff the organization employs, the Government and the community all seek assurance that they can rely on the organization to do its work well and with integrity. In Hong Kong, a large number of non-departmental public bodies have been set up, many of which are supported in whole or in part by public money. The Government also makes use of many Non-governmental Organizations (NGOs) to deliver services to the public. In the current financial year the amount of funding provided to these various organizations comes to HK$89 billion, about 40% of public sector recurrent expenditure. Around 170,000 staff are employed by these groups, which is about the same as the number of permanent civil servants. P. 9 of 17 The nature of these bodies varies greatly. Some are major statutory organizations like the Hospital Authority or Trade Development Council, bound by their legislation to specific standards of corporate governance. Most NGOs are simply incorporated under the Companies Ordinance as limited companies, but their Boards may find themselves responsible for extensive public assets and large amounts of public funding. Creating a framework to stimulate improvement in the quality of corporate governance for such a diverse group has its challenges. For example : 1. The amount of subsidy given to them varies from a few hundred thousand dollars to hundreds of millions of dollars; 2. Public subvention as a share of their total income ranges from just a few percent to 100%; 3. The activities and services provided range from education, healthcare, social welfare, arts, sports, and consumer protection, to trade and industry bodies and government oversight agencies. P. 10 of 17 But what is clear is that these complexities cannot be taken as reason for inaction. In the past few years the Director of Audit has found varying degrees of inadequacy in corporate governance systems, processes and practices in all cases where formal investigation has been made. Among statutory bodies, while no major questions over the use of public funds were raised by audits, inadequacies were found in board structures and composition, board operation and effectiveness, strategic planning and monitoring, transparency and disclosure, risk management, compliance and corporate citizenship. In his most recent report the Director of Audit turned his attention to NGOs in the sports field. Here, in addition to concern about organization structure and management, even basic accounting was found to be inadequate. Many NGOs in Hong Kong depend heavily on public subventions, grants and reimbursement arrangements to support their activities. In most cases, once an NGO has been selected to provide a service, it will continue to be given funding for a lengthy, often indeterminate period, in the absence of any competitive or benchmarking process. In such an environment it is crucial that their Boards understand that they are publicly P. 11 of 17 accountable bodies and understand how to conduct themselves accordingly. They are responsible for the effective use of public funds, donations and services entrusted to them and they are responsible for the effective performance of staff in their employment. It is particularly important that individual Board members realize that an invitation to join the Board of an NGO or statutory body is not merely an honour. Such a role carries real responsibilities and should be treated seriously. The honour lies in discharging the responsibility well so that the public benefits that the organization is tasked to bring about are achieved and public moneys are clearly used for the intended purpose. The Director of Audit has not just highlighted concern about the internal governance of the publicly funded bodies. He has also drawn attention to a need to improve civil servants‟ understanding of good practice in corporate governance in the public sector so that they act appropriately and consistently. Civil Servants in many parts of the public service have oversight responsibilities for statutory boards or for funding that is directed to NGOs. We have to play an effective role in evaluating and monitoring the performance of these bodies. Officers may be in charge of developing and formulating policies P. 12 of 17 on public subventions and grants. They may be processing applications for subventions, grants or “benefits in kind” - such as concessionary grants or nominal rentals. They may be required to oversee the policy, resource and budgetary control of subvented organizations, to monitor the delivery of services or results, or they may represent the Government as members of a Board. In performing any of these roles, we must have a good understanding of the part we need to play to ensure that good corporate governance practices are being followed in organizations for which we have responsibilities, and we need to act on that understanding. To help address the concerns raised in the audit reports, the Efficiency Unit has been asked by the Financial Services and the Treasury Bureau to produce a practical guide to corporate governance applicable to subvented bodies. The Guide is intended as a tool for both subvented organizations and for civil servants holding oversight responsibility for the organizations or for allocation of public funds. It will provide reference for the design and implementation of good corporate governance arrangements, as well as for monitoring and evaluation of performance. P. 13 of 17 The practices to be promulgated in the Guide will : 1. Draw on best practice based on the understanding from both private and public sectors of measures that support good corporate governance; 2. Be applicable in the context of Hong Kong‟s legislation; and 3. Be clear and practical to help civil servants to discharge their oversight responsibilities effectively. Good corporate governance is not a “one size fits all” proposition. Given the diverse nature of individual subvented organizations, while the Guide will make clear essential principles, it will be written as far as possible in a non-prescriptive style to avoid organizations blindly following practices that might not be suitable and conducive to their work, or civil servants insisting on inappropriate measures. before they apply. Users will be encouraged to think The Guide will offer a collection of good and bad practices, practical advice and a variety of tools such as templates, questionnaires and checklists to help users work through different aspects of corporate governance. Users of the Guide will be able to select suitable tools and applications to fit their particular circumstances. P. 14 of 17 We are conscious that for the private sector, the cost of compliance with corporate governance requirements has been significant. Cost of compliance is likely to be an even more sensitive issue for subvented bodies, particularly smaller NGOs that are often heavily reliant on unpaid volunteers. We will be giving careful thought to how the fundamental principles of achieving clarity of purpose and accountability for actions can be achieved most efficiently within such environments. Drafting of the Guide is now underway. The first edition is expected to be launched by April or May next year. That will be the easy part. The follow-up will be more painstaking but more important. Many bodies are likely to need external assistance from professional practitioners with relevant skills to help them design and carry through reforms. Within the public service, care will be needed to ensure that it is kept clearly in mind that the objective is better provision of public services and better value in return for public funding, not compliance with the new guideline for compliance‟ sake. Looking Forward For both private sector and public sector, good governance - measures that provide clarity about objectives, accountability for actions and honest information that enables others to form a P. 15 of 17 reasonable judgement of the performance of an organization - is of great significance. It helps to build an environment of trust and security in which individuals and businesses can go about their lives and activities with assurance. But there is more to it. Putting trustworthy information into the public domain opens up opportunity for learning and innovative thinking, for assessing whether individual and corporate activities contribute to or detract from the needs and purposes of our human society. changing our ways. It opens up possibilities for The current effect of our uneconomic behaviour on the limited resources of this earth gives us all some cause to think that we are perhaps not over-burdened with learning and understanding, and could benefit from more. And there is more. An approach to corporate governance that is attentive to building ethical conduct, rather than compliance with regulation alone, increases the possibility of trust and learning between individuals and organizations, and so may help to build an environment of civic conduct in which the competitive advantage of companies, the comparative advantages of cities, and human society itself, may still be possible. P. 16 of 17 None of us, I think, would see the enforcement of ethical conduct, as opposed to breach of regulation, as a proper or effective duty for government. All, I hope, would see upholding personal standards rooted in honesty, integrity and concern for others, as a proper and essential duty in the boardroom. Thank you. P. 17 of 17