Introduction

On 26 January 2024, the Stock Exchange of Hong Kong Limited (“Stock Exchange”) published a report on the findings and recommendations of its annual review of issuers’ annual reports for the 2022 financial year end. The Stock Exchange indicated that issuers continued to achieve a high rate of compliance with the annual report disclosure requirements under the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited (the “Listing Rules”)

The Stock Exchange selected several areas for thematic review including financial reporting and controls, material asset impairments (including loan impairments) and compliance with annual report disclosure requirement. This article will mainly focus on the issues identified by the Stock Exchange in its review in the above three areas.

Financial reporting and control

Auditors’ modified opinions

120 issuers (compared to 125 in the 2021 financial year) received modified audit opinions on their published financial statements. Going concern qualifications continued to be the most common audit modifications. Other audit modifications were similar to last year’s and mainly related to valuation of assets and limited access to accounting records.

Valuation of assets - These audit modifications were mainly caused by issuers’ inability to satisfy their auditors as to the fairness of the reported asset value by sufficient audit evidence. This was mainly attributable to the lack of proper control procedures in different aspects, including (i) some issuers failed to have proper internal guidelines to collate up-to-date financial information of investees or debtors to assess deterioration in the financial performance of investees or debtors; (ii) some issuers lacked policies and control procedures to perform adequate credit risk assessment or background search on the counterparties before granting loans or prepayments, causing doubt on their recoverability.

Limited access to accounting records – This modification often stemmed from the lack of policies and control procedures to secure unrestricted access to books and records of investees at the time of and after making the investment. For instance, some issuers failed to secure access to books and records by inserting appropriate terms in the investors’ agreement when investing in minority interests in companies or private funds. Even in case of acquiring controlling interests in an investee, some issuers failed to change the legal representatives or maintain control over the company chops of the investees, giving rise to auditors’ doubt over whether the issuers indeed had control over the purported subsidiaries and whether it was appropriate to consolidate them in the issuers’ financial statements. In some disposal transactions, the issuers did not arrange for their auditors to audit the disposal targets before completion. Subsequently, the purchasers refused to provide any information.

Delay in publication of results

73 issuers (compared to 85 at last review) failed to publish their annual results within the 3-month reporting deadline. Inadequate audit planning and oversight was a factor contributing to the delay, including (i) late audit fee negotiation causing 85 issuers to change auditors within four months before reporting deadline due to disagreement on audit fee, (ii) engagement of valuers at a late stage of the audit process, causing parties inability to  agree on a work schedule that aligned with the overall audit timetable and delay to completion of audit and (iii) lack of escalation policy causing delay in management’s reporting the identified audit issues to the audit committees.

Material asset impairments

As part of the Stock Exchange’s thematic review of material asset impairments in the last two years, the Stock Exchange looked at issuers’ material lending transactions and, where applicable, material impairments on loan receivables and other issues associated with the lending activities.

About two-thirds of the selected issuers reported money lending as a principal activity in their 2022 annual reports. About 9% of these money lenders reported material impairments on loan receivables. A few cases exhibited characteristics that raised questions about directors’ conduct and adequacy of the issuers’ risk management and internal control over lending business such as impairment of a majority part of the loan shortly after granting; questionable commercial merits of loan terms (e.g. interest rate lower than the issuer’s own financing costs); lack of safeguarding measures (e.g. failure in obtaining securities for loans with high credit risks and taking adequate actions to recover overdue loans).

Separately, the Stock Exchange’s review also found isolated cases of breaches of the notifiable/connected transaction Rules while the issuers conducted lending transactions.

The Stock Exchange also highlighted a few areas that issuers should pay attention to for more informative disclosure, including (i) some issuers only provided very limited profile information about their customers such as only stating whether they were individual or corporate customers, the issuers should present particulars to enable investors to understand background and quality of the borrowers such as their size, industry, credit rating, listed or private companies, etc., (ii) the disclosure about concentration risks was insufficient, the issuers should disclose, for example, the number and loans receivables from the five largest borrowers as the Stock Exchange recommended, (iii) issuers should disclose all major aspects of (but not only part of) its lending operations and procedures to allow investors to have a holistic understanding and evaluation of adequacy of the control.

In respect of the remaining issuers who did not carry out money lending as a principal business, the Stock Exchange noted that a significant number of issuers failed to disclose the reasons for providing the loans. Since money lending is not a part of their principal businesses, the relevant issuers should provide more transparency on the business rationale for lending the corporate funds.

Compliance with annual report disclosure requirements

The Stock Exchange conducted review on issuers’ disclosure in annual report and announcements and highlighted the following areas for attention:

1.    Share schemes: Effective from 1 January 2023, Chapter 17 of the Listing Rules was amended so that the disclosure obligation extends to share award schemes. The amended Listing Rules also impose additional disclosure requirement relating to information to facilitate shareholders’ assessment of the dilution impact of share scheme (e.g. options and awards available for grant). The Stock Exchange found that some issuers did not disclose the aforesaid additional information.

2.    Significant investments: the Stock Exchange identified cases where issuers failed to comply with the notifiable transaction Rules when acquiring investment products, which are transactions subject to announcement and/or shareholders’ approval requirements.

Conclusion

The annual review exercise shows the Stock Exchange’s commitment to promoting good standards of governance and transparency of the issuers. Issuers are reminded to consult legal or compliance advisers in order to comply with the Listing Rules as well as proper accounting standards from time to time.