HKEX review of issuers’ annual reports for the year ended 2020
The Hong Kong Exchanges and Clearing Limited (“HKEX”) published on 28 January 2022 a report1 on its annual review of the annual reports of listed issuers for the financial year ending between January and December 2020 (the “Report”).
The report covers thematic reviews on selected areas and related disclosures, certain types of listed issuers, disclosures of issuers’ financial statements in accordance with accounting standards, and compliance with annual report disclosure requirements.
This article summarizes the findings of the report, focusing on the four identified areas deemed to pose higher risks, namely (i) modified auditor opinions, (ii) material impairments of assets, (iii) transactions and (iv) reviews in the Management Discussion and Analysis (“MD&A”) section, as well as items commonly omitted from annual reports.
Modified auditor opinions
Each issuer is required to present financial statements that give a true and fair view of its situation, its results of operations and its cash flows. The role of the Audit Committee is to oversee the integrity of its financial statements and annual reports and to ensure that management implements its plans to resolve issues related to audit changes in a timely manner.
The HKEX found that for fiscal 2020, 136 issuers received modified audit opinions on their published financial statements, up from 133 the previous year, including 51 issuers with modified opinions for the first time. The main audit changes related, as last year, to the accuracy of the declared value of issuers’ assets. For example, with respect to recoverability of loans/receivables, some issuers did not support the assessment of expected credit losses on loans and receivables with appropriate documentation due to a lack of internal control and oversight. of the management of the companies which generated the loans and receivables concerned.
The HKEX recommends that issuers develop estimates to support the valuation of their key assets and consider engaging experts to perform asset valuations if necessary, and agree as soon as possible with auditors on the approach to evaluating estimates. In addition, the HKEX emphasizes the responsibility of audit committees to assess and challenge the reasonableness of management’s assumptions and valuation methods adopted.
Significant impairment of assets
Under the Listing Rules, issuers are required to include in their annual reports a discussion and analysis of the material factors underlying their results and financial condition and of significant events that occurred during the year. When a significant impairment of assets is recorded, the issuer must indicate the circumstances that led to the impairment. If the impairment is supported by a valuation, the HKEX recommends that details of the valuation (including the valuation method and reason for using that method, details of the value of inputs used with the basis and assumptions, explanations of any changes, etc.) be disclosed.
Regarding the impairment of acquired assets, the HKEX found that issuers were mostly compliant. Issuers generally outline the circumstances that led to the material impairments, with a large majority attributing the impairments to the significant deterioration in business or project delays caused by COVID-19, and most issuers support their impairment amounts with assessments . However, information such as the basis and assumptions of the data have been omitted. Nevertheless, the number of issuers having declared significant impairments on assets other than acquired assets fell by more than half compared to the previous year.
Significant lending transactions
Of the 211 issuers that reported large loans, prepayments, deposits and other receivables in their 2020 financial statements, the HKEX identified a number of instances where loans were made outside of the normal and customary course. Business. There have also been a few cases involving loans not duly authorized by the board, or which were supposed to be upfront payments to suppliers and/or service providers and which subsequently became uncollectible. Other cases currently under investigation by the HKEX or referred to the Securities and Futures Commission included questionable cases as to whether there were material deficiencies in the issuers’ internal control systems and whether due diligence reasonable appropriate on the borrowers had been made by the administrators. Although the above cases are isolated cases, they raise concerns about the potential dissipation of assets through lending transactions. This further underscores the importance of establishing appropriate internal controls to monitor these lending operations and maintain good corporate governance.
The HKEX noted that pawnshops generally provided very limited information in annual reports about their loan portfolios, customer base and risk measures and controls over their business, and management’s discussions were also generic. In order to improve information about the operation of the money lending business, the HKEX recommended including the following information in future annual reports:
- business model and issuer credit risk assessment policy;
- the main terms of the loans granted (including details of the guarantees), the size and diversity of the customers and the concentration of the loans on the main customers;
- management’s discussion of movements in loan impairments (and write-offs) and the underlying reasons; and
- other key internal controls in terms of, for example, credit approval, ongoing loan recovery monitoring and loan collection.
Review of activity in the MD&A section
In last year’s report, the HKEX provided some recommendations to help issuers improve disclosures on key risks arising from COVID-19, and was generally pleased with the review conducted this year.
Of the 50 issuers selected for review regarding disclosures about the impact of COVID-19, all provided assessments of the effect of the pandemic on their operations and relevant risks or uncertainties that could affect future performance, as well as only quantitative information to illustrate the impacts of the pandemic on their financial performance and position, for example, percentage reduction in flight passenger capacity, hotel room occupancy rate and revenue per room. In addition, a large majority of them disclosed their liquidity position and the adequacy of their working capital, as well as the measures taken to manage the impact of the pandemic, for example, the diversification of activities and the application technology to expand offerings.
Annual report disclosure requirements
Overall, despite a few isolated instances of potentially misleading disclosures or material non-compliance with listing rules that are under investigation, the HKEX was satisfied with disclosures by issuers.
Some commonly omitted disclosures include the following:
- Ongoing Related Transactions (“CCTs”) – Approximately 90% of issuers reviewed fully complied with the requirements for CCTs. However, certain information relating to the terms of the SCCs, the conclusions of the examination of the auditors and/or the independent non-executive directors have been omitted. The most common being whether related party transactions are CCTs. For example, related party transactions were in some cases subject to the relevant CTC rules, but issuers did not make announcements and/or seek independent shareholder approval.
- Stock and pension plans – A large majority of issuers reviewed fully disclosed the information required under the Listing Rules regarding stock option and stock award plans. However, certain information regarding stock option plans and stock option movements, such as securities available
- Other Disclosures – Over 99% of disclosure documents were compliant, but some common general omissions include certain details on the emoluments of the top five earners, details of subsidiaries, and percentages of revenue/purchases attributable to the top five customers and suppliers .
Take away food
The review by the HKEX found that the rate of compliance with disclosure requirements under the Listing Rules is high. With the aim of improving integrity in the financial market, the report provides a comprehensive guide to issues that issuers should pay attention to when preparing their disclosures, and highlights commonly omitted disclosures that issuers should be aware of. Do not miss. Issuers must also put in place appropriate and sufficient internal control mechanisms to ensure that they comply with the disclosure requirements under the Listing Rules as amended from time to time, for example taking into account new obligations introduced by the updated corporate governance code which came into effect on January 1, 2022.
The author would like to thank Ms. Nicole Chan (trainee lawyer) for her contribution to this article.