The Stock Exchange of Hong Kong Limited (the “Exchange”) published on 29 January 2016 the fourth report on the findings and recommendations from its review of issuers’ annual reports.  This review covers annual reports for the financial year ended in December 2014 (the “Dec 2014 Review”) and focuses on issuers’ compliance with the Listing Rules, corporate conduct and disclosure of material events and developments.

The Exchange noted that while a vast majority of issuers continue to comply with the Listing Rules in the areas reviewed last year, there are areas where some issuers did not fully follow the relevant guidance on best practices. The Exchange specifically draws issuers' attention to some of those areas where they should improve their practices.

Areas covered in the Dec 2014 Review

The Dec 2014 Review covered the following areas:

  • Fundraising through issue of equity / convertible securities and subscription rights
  • Updates on material changes and results of performance guarantees after acquisitions
  • Continuing connected transactions*
  • Share option / award schemes*
  • Disclosure of significant changes to issuers’ financial performance and reliance on key customers in the MD&A section
  • Contractual arrangements adopted by issuers*
  • ƒƒIssuers listed in 2013 and 2014

*New areas of review not covered last year

Specific areas where issuers should improve their practices

The Exchange specifically draws issuers' attention to the following areas where they should improve their practices:

Continuing connected transactions

During the Exchange’s review, it has obtained copies of the minutes of audit committee (or appropriate committee) of selected issuers to consider whether independent directors were given sufficient information to discharge their duties in monitoring issuers' continuing connected transactions. These minutes were normally attached with reports prepared by the issuers’ management and/ or external auditors. The Exchange noted that such reports did not cover the work done by the management to ascertain, and so it is unclear how the independent directors had assessed, (a) whether the transactions have been conducted in accordance with the pricing policies or mechanisms under the framework agreement (including the pricing range, the process for estimating the selling prices for the goods or services, and the procedures for obtaining quotations or tenders, as appropriate); and (b) whether the issuer’s internal control procedures are adequate and effective to ensure that transactions are so conducted.

Reminders:

  • Independent directors are reminded of their important roles in monitoring issuers' continuing connected transactions. They should properly assess (a) whether the transactions were indeed conducted in accordance with the terms of the framework agreements and on normal commercial terms; and (b) the adequacy and effectiveness of the issuer’s internal control procedures, and, where appropriate, make enquiries with the management to ensure that they have sufficient information to properly review the transactions and the internal control procedures.
  • With the new Code Provision C.2.5 of Appendix 14 to the Main Board Listing Rules / Appendix 15 to the GEM Listing Rules requiring internal audit review of risk management and internal control systems, issuers should ensure that their internal audits review continuing connected transactions and the relevant internal control procedures, and provide the findings to independent directors to assist them in performing their annual review.

Contractual arrangements adopted by issuers

A vast majority of issuers adopting contractual arrangements did not follow the Exchange’s Guidance Letter (GL77-14) to make disclosures in their annual reports in respect of their material business operations through these arrangements.

Reminder:

  • Issuers should take note of the guidance in the Exchange’s Guidance Letter (GL77-14) and make the following disclosures in their future annual reports in relation to their business operations through contractual arrangements:
    • particulars of the operating entity and its registered owners, and a summary of the major terms of the structured contracts;
    • a description of the operating entity’s business activities and their significance to the issuer (e.g. the respective revenue and assets value);
    • the extent to which structured contracts relate to requirements other than the foreign ownership restriction;
    • reasons for using contractual arrangements, the associated risks and actions taken by the issuer to mitigate the risks;
    • any material change in the contractual arrangements and/or the circumstances under which they were adopted, and its impact on the issuer group; and
    • any unwinding of structured contracts or failure to unwind when the restrictions that led to the adopted of structured contracts are removed.

Disclosure of significant changes to issuers' financial performance and reliance on key customers in the MD&A section

The Exchange noted that there is general improvement in the MD&A disclosures in the areas reviewed. However, many issuers have not disclosed:

  • their compliance with the relevant laws and regulations that have a significant impact on their businesses;
  • updates on material changes to their operations (such as product mix and business model), management’s objectives and corporate strategies, and how these changes have contributed to their business performance during the financial year;
  • an analysis of their performance using financial key performance indicators, and comparison of their results with industry peers;
  • their capital requirements and their financing plan for such capital requirements; and
  • their relationships with key customers.

Reminders:

  • Issuers are reminded to make the above disclosures in their future annual reports.
  • Issuers should note that the following items which were recommended commentaries are now disclosure requirements for business reviews under the Listing Rules, which apply to annual reports of financial periods ended on or after 31 December 2015: 
    • a discussion on business risks (including known events, uncertainties and other factors which may substantially affect future performance) and risks management policy;
    • a discussion on the issuer’s environmental policies and performance, including compliance with the relevant laws and regulations; and
    • an account of the issuer’s key relationships with employees, customers, suppliers and others, on which its success depends.
  • For further guidance on the preparation of a business review, issuers may refer to the Hong Kong Institute of Certified Public Accountants’ Accounting Bulletin 5 “Guidance for the Preparation and Presentation of a Business Review under the Hong Kong Companies Ordinance Cap. 622” and the Hong Kong Institute of Directors’ “Clear and Concise: A Director’s Guide to Writing the Business Review of an Annual Report”.

Equity fundraising

The Exchange recommended in its previous reports that issuers should provide meaningful updates in their annual reports on the actual use of proceeds from equity fundraising, including details of the application and a breakdown of how the funds were allocated among different uses. Only approximately half of the issuers disclosed specific details of the use of proceeds in annual reports.

Reminders:

  • Issuers are reminded to provide meaningful updates in their annual reports on the actual use of proceeds from equity fundraising, including details of the application and a breakdown of how the funds were allocated among different uses.
  • In relation to the issue of convertible securities, issuers are reminded to take note of the Exchange’s Guidance Letter (GL80- 15) and have appropriate procedures in place to keep track of the number of conversion shares issued and issuable under the terms of the convertible securities, and to take this into account before taking any corporate actions that would trigger the adjustment provisions.

Share option schemes

The Exchange noted that issuers generally complied with the specific disclosure requirements for their share option scheme. However, there is a common omission in relation to the total number of securities available for issue under the schemes together with the percentage of issued shares that it represents as at the date of annual report.

Reminder:

  • Issuers are reminded to make all the necessary disclosures in relation to their share option scheme as required under the Listing Rules, including but not limited to the total number of securities available for issue under the schemes together with the percentage of issued shares that it represents as at the date of annual report.

Exchange’s next review

The Exchange’s next review will cover annual reports for the financial year ended between January and December 2015, and the Exchange intends to cover most of the areas covered in the Dec 2014 Review, in particular continuing connected transactions will continue to be an area of focus.

Issuers are reminded to note the observations and recommendations discussed in the Exchange's report and follow the relevant guidance to avoid the need to issue clarification or supplemental announcements subsequent to the publication of their annual reports to make further disclosures at the request of the Exchange.