Rethinking the term limits for independent directors: Malaysia and Singapore
Written
07.12.2022
Author (Article 1)
Alvin Chiang
Author (Article 2)
Sulhi Khalid
Social
There is still a worldwide debate on whether setting mandatory term limits for independent directors should take place or not. Early this year, Bursa Malaysia announced that no one should serve as an independent director for more than a cumulative tenure of 12 years and those who served more should resign or be redesignated as non-independent directors by June 1, 2023. Currently in Singapore, the proposal made by the Singapore Exchange Regulation to impose a term limit of nine years to independent directors' independence is undergoing review.
1.
AS a corporate governance concept, director independence is as fundamental as it gets. To serve in the best interests of the company, the board has to be independent and free from conflicts of interest. Yet, many markets around the world have met with limited degrees of success while attempting to institutionalise this into their governance regimes.
In Singapore, the Code of Corporate Governance states that an independent director (ID) is “one who is independent in conduct, character and judgement, and has no relationship with the company, its related corporations, its shareholders or its officers that could interfere, or be reasonably perceived to interfere, with the exercise of the director’s independent business judgement in the best interests of the company”.
A controversial aspect of independence has been how the length of time the ID has been with the company affects his independence.
Term limits
The connection between director tenure and independence was introduced in the 2012 revision to the Code, which required the independence of a director who has served on the board beyond nine years to be subjected to “a particularly rigorous review”.
Implicitly, this meant that nine years, typically the equivalent of three three-year terms, was viewed as an adequate timeframe for members to meaningfully contribute to the board as IDs. But ceding to the argument that one’s independence should not be solely attributable to tenure, it was left to the discretion of the nominating committee (and, by extension, the board) to make this determination when IDs hit the nine-year mark.
Gaming the system
The unintended consequence of this concession was that it gave boards with long-serving IDs wriggle room. Rather than go through the hassle of replacing these directors, the easier alternative was instead to undertake a “review” to confirm their independence. Whatever went into such reviews was really anybody’s guess, as there was technically no guidance (nor requirement) to disclose anything beyond describing them as being “particularly rigorous”.
What then ensued was the proliferation of boilerplate statements in annual reports justifying the continued independence of long-tenured IDs.
If at first you don’t succeed
In 2018, the rule was further enhanced to a hybrid approach that stipulated a nine-year tenure restriction on director independence but left it to the shareholders to ultimately make the call via a two-tier voting mechanism when this limit was breached. A three- year transition period was factored into the implementation process.
In the three-year transition period, not only was there still a significant proportion of IDs serving past nine years through endorsement via the two-tier vote, it became abundantly clear that a large majority of affected boards had little intention of refreshing themselves.
The Singapore Board of Directors Survey 2022 provides a glimpse of this: 67 per cent of respondents with long-tenured IDs are looking to put them through the two-tier voting process. This suggest that what was intended as a last resort has instead become the default choice for this group.
A final landing?
In Singapore, the Code of Corporate Governance states that an independent director (ID) is “one who is independent in conduct, character and judgement, and has no relationship with the company, its related corporations, its shareholders or its officers that could interfere, or be reasonably perceived to interfere, with the exercise of the director’s independent business judgement in the best interests of the company”.
A controversial aspect of independence has been how the length of time the ID has been with the company affects his independence.
Term limits
The connection between director tenure and independence was introduced in the 2012 revision to the Code, which required the independence of a director who has served on the board beyond nine years to be subjected to “a particularly rigorous review”.
Implicitly, this meant that nine years, typically the equivalent of three three-year terms, was viewed as an adequate timeframe for members to meaningfully contribute to the board as IDs. But ceding to the argument that one’s independence should not be solely attributable to tenure, it was left to the discretion of the nominating committee (and, by extension, the board) to make this determination when IDs hit the nine-year mark.
Gaming the system
The unintended consequence of this concession was that it gave boards with long-serving IDs wriggle room. Rather than go through the hassle of replacing these directors, the easier alternative was instead to undertake a “review” to confirm their independence. Whatever went into such reviews was really anybody’s guess, as there was technically no guidance (nor requirement) to disclose anything beyond describing them as being “particularly rigorous”.
What then ensued was the proliferation of boilerplate statements in annual reports justifying the continued independence of long-tenured IDs.
If at first you don’t succeed
In 2018, the rule was further enhanced to a hybrid approach that stipulated a nine-year tenure restriction on director independence but left it to the shareholders to ultimately make the call via a two-tier voting mechanism when this limit was breached. A three- year transition period was factored into the implementation process.
In the three-year transition period, not only was there still a significant proportion of IDs serving past nine years through endorsement via the two-tier vote, it became abundantly clear that a large majority of affected boards had little intention of refreshing themselves.
The Singapore Board of Directors Survey 2022 provides a glimpse of this: 67 per cent of respondents with long-tenured IDs are looking to put them through the two-tier voting process. This suggest that what was intended as a last resort has instead become the default choice for this group.
A final landing?
The Singapore Exchange Regulation has proposed to do away with the two-tier voting system in a consultation paper in October 2022. The suggestion is to impose a hard stop to ID independence at the end of nine years. If this goes through, Singapore will join a group of markets that have implemented or are considering implementing similar restrictions on ID tenure. IDs in Malaysia, for example, will no longer be considered independent after their 12th year, come June 2023.
Many markets in the US and Europe do not have such restrictions on director term limits. Rather, the prevailing view is that independence needs to be considered holistically, accounting for a multitude of factors, of which tenure is but one of them. After all, a board can comprise directors who are independent in form but not in substance.
Are the rules and regulations in Singapore sufficient to ensure that boards comprise directors able to act in the company’s best interest and are willing to challenge management when required? The nine-year hard limit may go some way to nudge boards to renew and refresh themselves and, to an extent, address issues surrounding board diversity, but it can never truly guarantee the independence of directors.
Beyond drawing a line in the sandThe broader issue lies with the standards to which boards hold themselves. Nominating committees should be held to account. If the current state of disclosures and propensity for two-tier voting is anything to go by, it calls for an uplifting in the level of rigor and discipline in key activities like board effectiveness assessments and succession planning.
When all else fails, regulation becomes instrumental in driving desired behaviours. But it cannot exist nor operate in isolation. Apart from shareholders needing to be more assertive and vocal, the onus is also on the director community to further professionalise and take director independence more seriously.
2.
KUALA LUMPUR (Jan 19): A person can serve as an independent director for not more than a cumulative tenure of 12 years under enhanced listing requirements announced by Bursa Malaysia on Wednesday (Jan 19).
All long-serving independent directors impacted by this enhancement must resign or be redesignated as non-independent directors by June 1, 2023, said Bursa in a statement.
This new regulation comes as the stock exchange operator enhanced requirements in the Main and ACE Market Listing Requirements aimed at further strengthening board independence, quality and diversity.
"Additionally, the exchange introduces a new rule which requires public listed companies (PLCs) to have in place a fit and proper policy that addresses board quality and integrity for the appointment and re-election of directors across the PLC group, which must be published on the PLCs' websites, starting from July 1, 2022.
"PLCs are also required to disclose the application of the PLCs' fit and proper policy in the nomination and election of their directors in their annual reports.
"This seeks to improve the overall quality of directors and promote greater transparency on the criteria for board appointments," said Bursa.
Another key enhancement is the requirement for the PLCs with a market capitalisation of RM2 billion as at Dec 31, 2021 to appoint at least one woman director on their boards by Sept 1, 2022, as announced by the minister of finance in Budget 2022.
For the remaining PLCs, the requirement must be complied with by June 1, 2023.
Bursa Malaysia chief executive officer Datuk Muhamad Umar Swift said the amendments will serve as an impetus for Malaysian PLCs to refresh their board composition, with greater focus on board quality, diversity and independence, that will promote board dynamism ultimately.
"The bedrock of a well-functioning and well-governed PLC is an effective and quality board," he said in the statement.