A number of points merit special attention in the current discussion internationally on strengthening corporate governance.
I am sure in the next few months there will be intense discussion, particularly in the United States, about what needs to be done to strengthen corporate governance and accounting standards to address weaknesses revealed in recent high profile corporate failures. We in Hong Kong are following this discussion closely, notwithstanding the fact that we have not been hit by the same spate of large corporate failures. As an international financial centre with financial markets frequented by international investors, we have to ensure that the integrity of our markets is beyond doubt. This means, among other things, that those who provide and raise funds through financial markets, as well as the intermediaries, should observe and keep up with the highest international business standards.
The Financial Services Bureau has already initiated discussions with the Securities and Futures Commission, the Hong Kong Exchanges and Clearing Limited, the Hong Kong Society of Accountants and the Standing Committee on Company Law Reform on how corporate governance in Hong Kong could be strengthened. We will therefore be able to contribute to the current international dialogue as well as address possible weaknesses specific to the circumstances in Hong Kong.
I think there are three areas that merit special attention in these deliberations. The first is the role of the Board members. In the Enron case the company had a number of independent directors and a Board structure that, on the face of it, one would have expected to deliver good corporate governance. But somehow things did not work this way. Whether this was due to Board members failing to understand the importance of their responsibilities and therefore carry them out appropriately remains to be seen. But the point is that what looked like a good structure in principle did not work well in practice. In Hong Kong, on the other hand, a number of companies, including some banks, have management and Board structures that mean that individuals, or a family, which are significant, if not majority, shareholders, play a key role in directing the company. While we should not over-generalise, perhaps this is not necessarily such a bad thing after all. Amid all the talk of having independent Board members and management teams perhaps we have lost sight of the fact that management and Board members who have a close association with and financial interest in a company have a very strong vested interest in ensuring that the company does not go astray. Clearly, however, questions regarding the optimal structure remain to be answered - independent Board members and management are perhaps not the panacea they seemed.
The second concerns accounting standards. These have probably become inadequate in dealing with the ever-increasing sophistication of financial operations. If so, they open up scope for aggressive interpretations that could well amount to circumvention, particularly in jurisdictions with rule-based accounting standards. The consequence is that accounts may not necessarily reflect a true and fair view of the state of a company, and in the worst case deliberately so. The discussion in international forums on accounting standards is, encouragingly, suggesting a consensus that accounting standards based on principles are preferred to rule-based ones, opening up the possibility of convergence into a set of common standards to be observed globally. Specifically, the consolidation of special purpose vehicles with risks and rewards borne by the company should be looked at. So should the accounting treatment of derivatives in respect of, for example, the measurement of their fair value in illiquid markets.
The third concerns auditing. There is a combination of inter-related issues here. There is the question of independence and accountability of the audit profession, and arrangements for its oversight. There is the question of possible conflicts of interest in the provision by the same firm of consulting as well as auditing services. There is the question of how incentives of the auditor could be more aligned with those of the investor rather than with those of the management. There is also the questionable suggestion of compulsory rotation of auditors (questionable given the higher incidence of corporate failures in the couple of first years in the appointment of new auditors).
I am sure there will be interesting ideas and useful recommendations emanating from this discussion. We in the HKMA look forward to playing our part actively in this important process.
Joseph Yam
18 April 2002
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