Enhancing the Quality of Primary Market in Hong Kong

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

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

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

5. HKEx’s Listing function: Safeguard measures ensure checks and balances Safeguard measures Description • 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 SFO • 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 Dual filing

6. HKEx’s Listing function: Safeguard measures ensure checks and balances (cont’d) Safeguard measures Description • 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 MOU on Listing Matters • 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 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

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

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 • 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 Continual obligations of listed issuers & directors • 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 Quality assurance

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

10. Hong Kong has undertaken a number of key CG initiatives recently 2004 2005 Mar Apr Oct Jan 1. Amendments to Listing Rules relating to CG issues 3. Enhancing the Regulation of Listing 4. Enhancing regulation of the accounting profession 5. Strengthening regulation of sponsors and IFAs • HKEx issued amended rules on 31 Jan 2004 • Effective on 31 Mar 2004 • 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 2. Revised Code on CG Practices & CG Report • HKEx issued draft amended rules on 31 Jan 2004 • Finalised rules published on 19 Nov 2004 • To be effective on 1 Jan 2005

11. 1. Amendments to Listing Rules related to CG issues Key elements Directors & senior management • 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 • 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 Disclosure

12. 1. Amendments to Listing Rules related to CG issues (cont’d) Key elements Continuing listing obligations • 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 • 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 Initial listing obligations

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 • 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 Transparency/ accountability of Listing functions

17. 4. Enhancing regulation of the accounting profession Key elements Independent Investigation Board (IIB) • Consider complaints of alleged accounting, auditing and ethics irregularities committed by professional accountants involving listed entities 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 Key elements Phase 1: Appointment and role & responsibilities of compliance advisors, sponsors and IFAs • Specify appointment requirements • Clarify definition of independence • Clarify expectation on due diligence • Emphasis on internal controls assessment by sponsor 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 Key elements 2004 achievements • 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 Tentative 2005 initiatives • Review role & structure of Listing Committee • Introduce a more effective mechanism for delisting • Facilitate simultaneous listing of A & H-shares • Publish decision letters * On-going initiative continues in 2005

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

21. Thank you Copy of this presentation is available @ www.hkex.com.hk