A new definition for independent directors – Part 2

Improving the Corporate Governance Code will provide much-needed reform for boards of listed companies, while also updating responsibilities for independent directors

This is the second part of a two-part series about independent director reform. To read the first part, click here

By Ricky Lai

In the first part of this series we talked about a consultation paper published by the Hong Kong Stock Exchange (0388.HK) in June 2024 on improving the Corporate Governance Code. We paid particular focus to tightening independence requirements for independent non-executive directors of listed companies in Hong Kong and a proposal to set up a position for each company board to have a lead independent director.

The paper proposes various new restrictions for independent directors, including not serving on the boards of over six listed companies at one time. This proposal is based on the concern that acting as director for too many companies makes it difficult for an individual to fully understand each’s operational activities and risks, and may even cause conflicts of interest among different companies, undermining these directors’ independence.

I support the proposal in theory. Many independent directors in Hong Kong are high-profile influential figures serving important positions in different professional organizations, public institutions and philanthropic groups. Being appointed as independent directors to listed companies on top of carrying out those other mandates might leave them with very little time to participate sufficiently in the affairs of each company.

But someone dedicated full-time to being an independent director without many other civic duties might have enough time to participate in all the companies in his or her portfolio, even if the person serves on multiple boards. So, whether limiting the number of companies a person can work with really depends on a person’s actual individual circumstances.

Moreover, the fact is that many executive directors in Hong Kong juggle multiple positions and are paid much more than independent directors even when their performance is subpar. Thus, the new restrictions targeting only independent directors, but not executive directors, might be unfair to independent directors, investors and minority shareholders.

Setting term limits

Independent directors in Mainland China and Singapore are currently subject to a maximum tenure of six and nine years, respectively. The consultation paper proposes setting a nine-year term limit for independent directors in Hong Kong as well. They would also have to go through a two-year “cooling-off period” before being reappointed to the same positions.

The idea is that after engaging with a company for nine years, independent directors might establish close connections with management, making it difficult for them to maintain the necessary distance and critical view of the company as well as a neutral position in their decision-making.

The longer they have served in a company, the more likely an independent director will develop a sort of attachment and become overly familiar with the internal operations and culture of the company, making them reluctant to criticize or offer different views. Similar to the proposal limiting independent directors from serving on no more than six boards at once, this term limit proposal also provides a transition period of three years before becoming effective on Jan. 1, 2028.

However, I personally have reservations about this proposal because the length of an independent director’s term has no direct bearing on his or her independence. For example, if an independent director has some personal connections with a company’s other directors, then even if he or she only serves a short tenure, there is no guarantee of his or her complete independence.

To the contrary, sometimes a longer tenure allows for greater contribution to the board and greater understanding of the company’s strategy, governance and culture. Such accumulated experience is also conductive to better discharge of his or her duties as an independent director.

Another concern is the possibility of a brain drain. After the new rules go into effect, many independent directors will have to leave their current positions. Will listed companies losing these people be able to secure their replacements with the same level of experience? Or will they face persistent vacancies?

Last but not least, the paper does not mention how the cooling-off period applies to different affiliated companies within a group. Will an independent director who has hit his or her term limit at one company immediately be able to go on to serve on the board of its affiliated company under the same group with the new rules?

In general, I recognize the merits of most proposals in the consultations paper, which envision improving the Corporate Governance Code in Hong Kong, while taking slight issues with only some. Improving the code will provide much-needed opportunity for boards of listed companies to undergo necessary reforms, while updating responsibilities for independent directors will help enhance Hong Kong’s status as an international financial center.

Ricky Lai is secretary for a Hong Kong Stock Exchange-listed company and lectures part-time at various Hong Kong tertiary institutions

This commentary is the view of the writer and does not necessarily reflect the views of Bamboo Works

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