Introduction

On 29 January 2021, The Stock Exchange of Hong Kong Limited (the “Stock Exchange”) published a report (the “Report”) on its on-going review (the “Review”) over the listed issuers’ annual reports. In the Report, the Stock Exchange highlighted specific areas for enhanced disclosure and presented its recommendations and observations as guidance to the listed issuers when preparing their own annual reports. 

Disclosure in the management discussion and analysis section

The management discussion and analysis section of an annual report serves to provide meaningful information for appraisal of a listed issuer’s financial performance and prospects. The Review highlighted that sufficient disclosure should be made for the risks arising from the Covid-19 pandemic (the “Pandemic”), its impact on the listed issuers and the measures taken to manage the risks. From the Review, the Stock Exchange found that the disclosure was relatively generic in many annual reports under review and expected that the listed issuers would be in a better position to make informed assessment and disclosure in the next annual report. In particular, it recommended the listed issuers to make more specific and adequate disclosure along the following areas:

1.          qualitative discussion about the Pandemic’s effect on the operations of the listed issuer, as well as the relevant risks or uncertainties that will have material impact on its future performance. For example, whether there will be any suspension of operations, disruptions to supply chains or distribution channels and change in customers’ demands;

2.          quantitative measures of the Pandemic’s financial or operational impact with reference to, for example, percentage of revenue or profit, operating capacity, and impairments to assets, loans and receivables;

3.          assessments of liquidity positions, working capital sufficiency of the listed issuer and its ability to fulfil financial obligations or meet debt covenants; and

4.          measures taken or to be taken by the listed issuer to manage the impact of the Pandemic, such as cost control, funding and adjustment to its business plans.

Financial statements with auditors’ modified opinions

The Stock Exchange identified that the major issues giving rise to audit modifications include the existence of material uncertainty on the listed issuers’ ability to continue as a going concern, valuation of assets, recoverability of loans and receivables and issues arising from limited access to accounting books and records. When the auditors put up audit modifications in the financial statements, the following recommended disclosure should be made in the annual reports:

1.            where the auditors highlighted the existence of material uncertainty on the listed issuers’ ability to continue as a going concern, the listed issuers should formulate action plans to address the funding needs in a timely manner, and take concrete actions to implement those plans;

2.            where there are material changes in the financial reporting items, the listed issuers should develop appropriate and supportable estimates, document the key judgments and consider retaining experts where necessary. It is also recommended to engage in early discussions and reach agreement with the auditors in relation to the timing, form and approach of assessment of these estimates as soon as practicable; and

3.            the listed issuers should put in place effective internal controls to ensure the adequate arrangements for fulfilling their financial reporting obligations, as well as sufficient division of responsibilities instead of undue reliance on a few employees.

Continuing connected transactions

In addition to the obligations of the listed issuers to report their continuing connected transactions (the “CCTs”) in the annual reports, independent non-executive directors (the “INEDs”) and auditors are required to review and confirm, among others, whether the transactions were made on terms that are fair and reasonable and had exceeded the annual cap which limit the aggregate size of the transactions in each financial year. In the Review, the Stock Exchange noted that in a few cases of non-compliance with the CCTs requirements, the listed issuers announced that their CCTs exceeded the annual caps or they failed to comply with the disclosure requirements on CCTs, despite the confirmations made by the INEDs and auditors that the relevant requirements have been compiled with.

The Stock Exchange reminded that INEDs play an important role in providing checks and balance over the corporate and business affairs of listed issuers, in particular in overseeing the connected transactions. Listed issuers should have appropriate internal controls and mechanisms to monitor and should provide sufficient assistance to INEDs in overseeing their CCTs. The Stock Exchange recommended listed issuers and their INEDs to review the appropriateness of their internal control procedures to ensure full compliance of the CCTs requirements.

Other findings and recommendations

The Stock Exchange’s other recommendations include:

4.       where material assets impairments are recorded in the annual reports, disclosure should be made on the basis of the valuation including (i) details of the value of inputs together with the bases and assumptions; (ii) reasons for any significant changes in the value of inputs and assumptions; (iii) the valuation method and the reason for using that method; and (iv) an explanation of any subsequent changes to the adopted valuation method;

5.       where performance guarantees were given to the listed issuers in previous acquisitions and the guarantee period ended in the financial year under review, the required disclosure should be made in their annual reports and to publish announcements if such guarantees were not met;

6.       where share options are granted to non-employees, disclosure should be made as to the identities of the grantees, terms of the share options granted and the rationale for making the grants;

7.       the major terms of listed issuers’ share award schemes should be disclosed (if any);

8.       meaningful, accurate and complete disclosure on material other expense and income should be made in order to facilitate investors’ understanding and assessment of cost structure;

9.       appropriate disclosure of the expected use of proceeds from fund raisings should be provided to support their future business developments, the expected time frame and change in use of proceeds; and

10.    for biotech issuers, additional disclosure on major business developments should be continuously made, such as market information on post-commercialisation core products and development of newly in-licensed or non-core products.

Conclusion

The Stock Exchange’s Report provided helpful guidance to the listed issuers in preparation of annual reports in compliance with the disclosure requirements. Listed issuers are recommended not only to comply with the minimum requirements set out in the Listing Rules, but also to take note of the Stock Exchange’s guidance summarised after the Review. Otherwise, the listed issuers that fail to comply with the required disclosure standards may be requested to disclose the omitted information by supplemental announcement.