Introduction

In January 2023, the Stock Exchange of Hong Kong Limited (the “Stock Exchange”) published a report (the “Report”) on the findings and recommendations of its annual review of issuers’ annual reports for the 2021 financial year end. The Stock Exchange selected a number of specific areas for review, such as disclosures on financial reporting and internal controls, material asset valuations and impairments. The review also assessed issuers’ compliance with annual report disclosure requirements under the Rules Governing the Listing of Securities on the Stock Exchange (the “Listing Rules”) and specific accounting standards in financial statements.

Financial reporting and related controls

Upon review of issuers’ published unaudited financial results, audited financial statements and announcements, the Stock Exchange identified the matters below that require issuers’ attention:

1.    Material differences between audited and unaudited financial statements

In 2022, approximately one-fifth (1/5) of issuers which published unaudited financial statements before the reporting deadlines subsequently published audited financial statements that reported material adjustments. As observed by the Stock Exchange, changes to the initial impairment assessments and valuations of assets are due to (i) failure by issuers to make impairment assessments on their assets in their unaudited financial statements, (ii) failure by management to collect or consider sufficient information to substantiate the assumptions for the preparation of valuations; and (iii) failure to conduct the valuation processes as the valuers were unable to perform site visits.

2.    Auditors’ modified opinions

The major area of concern raised by auditors was the fairness of the reported values of issuers’ assets. These modifications were mainly due to the (i) management’s inability to provide objective evidence to substantiate the values of acquired assets, recoverability of loans granted and prepayments made due to insufficient due diligence or business justifications before relevant transactions were entered into, (ii) failure by management to maintain proper controls on documentation, record keeping and segregation of duties and (iii) failure by management to apply appropriate assumptions in assessing the valuations of assets.

3.    Delays in publication of results

For the 2021 financial year, a small number of issuers failed to publish their annual results before the 3-month reporting deadline and consequently, were required to suspend their securities trading.

In view of the above, the Stock Exchange suggested, among others, the following room for improvement for directors and audit committee of issuers: 

1.       Directors should ensure the financial statements are prepared in accordance with relevant accounting standards with sufficient and objective information being provided;

2.       Directors should deploy adequate resources to staffing and maintaining appropriate financial reporting system;

3.       To avoid the modified opinions and delays in publication of financial results, issuers should maintain proper risk management and internal controls, and to perform proper due diligence at the time when the issuer initially entered into the arrangements (such as granting of loans or asset acquisitions); and

4.       The audit committee should ensure compliance with accounting standards and to review significant financial reporting judgments, critically assess and challenge the reasonableness of the assumptions adopted by the management in the valuations of material assets reported in the issuer’s financial statements, monitor the effectiveness of the audit process and play an active role in overseeing the issuer’s financial reporting system, risk management and internal controls.

Material lending transactions

The Stock Exchange reviewed issuers’ financial statements and management discussion and analysis (“MD&A”) section regarding disclosure about material asset impairments and have, amongst others, the following findings:

1.    Material asset impairments (other than loans)

A large majority of the issuers reviewed have discussed the circumstances that led to the material impairments in the annual reports, and supported the reported impairment amount by valuations or other evidence. In a small number of cases, however, the issuers disclosed generic reasons for the impairments and were required by the Stock Exchange to make further explanation in supplemental announcements.

The Stock Exchange also reviewed whether issuers have timely informed the market about material asset impairments by way of announcements under Rule 13.09 of the Listing Rules (Rule 17.10 of the Rules Governing the Listing of Securities on the GEM of The Stock Exchange of Hong Kong Limited (“GEM Listing Rules”)). Except in two cases, it is observed that issuers generally announced changes to their financial position arising from asset impairments on a timely basis.

2.    Material lending transactions by money lenders

The Stock Exchange highlighted some common omissions in disclosure of money lending business in annual reports as follows:

1.       Details of business model and credit assessment policy – some issuers simply provided a generic description of their internal control systems without details of the key procedures (e.g. credit risk assessments, ongoing monitoring of loan recoverability and loan collection);

2.       Breakdowns of material loan receivables and major terms of the loans – some issuers disclosed a range of interest rates for their loan portfolios without further categorisation of the types of loans and other terms that reflected different credit risks;

3.       Breakdowns of concentration of loans with major customers (e.g. loans receivables from the top five customers); and

4.       Management discussion on the impairment assessments of individual loan receivables, and the basis for the general loan impairment provision.

Thematic review on newly listed issuers

The Stock Exchange recorded 87 non-compliances with the Listing Rules by newly listed issuers. Non-compliances with the notifiable or connected transaction Rules included (i) failure to announce subscriptions of wealth management products issued by banks or investments in investment funds, which constituted acquisitions under the relevant Listing Rules on notifiable transactions and (ii) failure to comply with the relevant Listing Rules on connected transactions when making advances to connected persons, or (iii) exceeding the agreed annual caps on connected transactions.

The Stock Exchange reminds newly listed issuers to consult their compliance advisers on matters required under Chapter 3A of the Listing Rules (Chapter 6A of the GEM Listing Rules). Directors of the issuers should also ensure that their financial reporting and internal controls provide adequate safeguards to ensure compliance with the Listing Rules.

Compliance with annual report disclosure requirements

The Stock Exchange conducted a general review on issuers’ compliance with specific disclosure under the relevant Listing Rules requirements and highlighted, among others, the following key areas at which special attention is needed:

1.       Continuing connected transactions (“CCT”) – whether the related party transactions are CCT, terms of the CCT, auditors’ and/or independent non-executive directors’ review findings and whether the amount of CCT exceeded the annual cap;

2.       Share schemes – the relevant disclosures on share option schemes required under Rules 17.07, 17.08 and17.09 of the Listing Rules (Rules 23.07, 23.08 and 23.09 of the GEM Listing Rules) and certain recommended disclosures on share award schemes;

3.       Proceeds on fundraising – the relevant disclosures under Paragraphs 11(8) and 11A of Appendix 16 of the Listing Rules (Rules 18.32(8) and 18.32A of the GEM Listing Rules);

4.       Significant investment – the relevant disclosures on significant investment under Paragraph 32(4A) of Appendix 16 of the Listing Rules (Rule 18.41(4A) of the GEM Listing Rules); and

5.       Results of performance guarantee after acquisition – status and details of compliance of the performance guarantee under Chapter 14 of the Listing Rules (Chapter 20 of the GEM Listing Rules.

Conclusion

The Stock Exchange’s annual review serves the purpose of monitoring the actions taken by the issuers and their directors to safeguard company’s assets, and whether material information was disclosed to allow shareholders to properly assess the relevant matters reported on. 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.

 

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Published by ONC Lawyers © 2023