China: calling time on supervisory boards?

The latest rewrite of PRC company law is expected to be deliberated at the national legislature by the end of 2023. ACGA Head of Research Jane Moir, and Research Managers Stephanie Lin and Lake Wang, look at the direction of policy.

One of the key takeaways from China’s most recent company law draft is that supervisory boards may be phased out in favour of audit committees. At the same time, the role of the employee—and the Party—will be fortified.

The overhaul would enable issuers to swap the supervisory board in favour of an audit committee. Listed companies who take this route will be required to have an employee representative on the board, and the audit committee must comprise at least three members, half of whom cannot have any position in the company except that of director.

Beyond that, the law redraft is silent on specific qualifications of audit committee members: while the second draft released in 2022 required at least one member to be an accounting professional, this was dropped in the third version released in August 2023. Still, as we outline below, recent reforms to the independent director regime encourage these candidates to be equipped with more relevant skills.

China has a ‘two-tier’ board system: a board of directors and a supervisory board, or board of supervisors. Unlike other ‘two-tier’ regimes however, in practice supervisory boards have limited authority over directors and management. Their oversight function is formalistic and adds little value to companies or assurance to shareholders. Members typically lack relevant business credentials and are appointed (and fired) by controlling shareholders.

In ACGA’s 2018 report on China, “Awakening Governance,’’ as a governance-enhancing measure we encouraged a move to either see supervisory boards have their powers strengthened or delineated, or that they be phased out entirely.

It is worth noting that it is only in the third draft that this proposal has been on the table for larger companies (the first draft limited the scope to smaller firms). The current draft also comes against the backdrop of a set of reforms aimed at enhancing role of independent directors in China. In September this year the China Securities Regulatory Commission (CSRC) brought into effect Measures for the Management of Independent Directors of Listed Companies, which seek to provide clarity over the credentials of independents, and how they should interact with other board members.

In particular, independent directors are expected to have at least five years’ experience in law, accounting, economics or other relevant professions, while issuers are to give them adequate remuneration, resources, right to information and other support to fulfil their functions.

Taken with a requirement in the independent director reforms that at least half of the audit committee be comprised of independent directors (as well as the nomination and remuneration committees), an improved governance structure is at least on paper, a possibility.

An enhanced role for employees—a board seat if there is no supervisory entity

Another theme of the company law revision is to give workers more influence in companies. As mentioned above, any company of scale opting to abolish the supervisory board in favour of an audit committee must then have an employee representative on the board.

A key prong of the law redraft is to emphasise the “democratic management’’ of a company, in particular an enhanced role for employees in the decision-making process. Corporate decisions on restructuring ‘or any important issues related to business operations,’ should be subject to the opinions and advice of employee unions. And where employee representatives do still sit on a board of supervisors, they shall account for at least one third of the members.

A chapter on ‘state-funded’ enterprises: reinforcing the role of the Party

A notable feature of the third draft is that it keeps intact a brand-new chapter on the regulation of ‘state-funded’ companies (the current law only mandates special provisions for wholly state-owned enterprises) and in particular a requirement that Party organisations play a leadership role in these firms.

The chapter states that organisations of the Party “shall play a leadership role according to the Constitution…deliberate and discuss major business management matters of the company and support the company in exercising its powers in accordance with the law,’’ it says.

‘State-funded’ is defined as including firms where the state has a ‘controlling stake.’ In company law terms this equates to at least 50% in shareholding terms, or where voting rights can enable majority control.

This provision appears to provide an umbrella term and broaden the scope of the 2017 version of the Constitution which refers to Party organisations playing a leadership role of ‘state-owned’ enterprises.

For more information, please contact:
Jane Moir, Head of Research, ACGA: jane@acga-asia.org
Stephanie Lin, Research Manager, China & Korea, ACGA: stephanie@acga-asia.org
Lake Wang, Research Manager, ACGA: lake@acga-asia.org