Key Insights and Observations from the HKEX’s 2024 Review of Annual Reports

On December 10, 2024, the Stock Exchange of Hong Kong Limited (HKEX) reported on the findings of its review of listed issuers’ annual reports, addressing various key topics including issuers’ compliance with disclosure requirements under the Listing Rules (Rules) and accounting standards in financial statements. The HKEX also made various recommendations on possible improvements. This year, accompanying HKEX’s Report of Review of Issuers’ Annual Reports for the financial year ended in 2023 (Report) is a new Guide on Preparation of Annual Report (Guide) to summarize the key disclosure rules and remind issuers of the level of detail and comprehensiveness expected by HKEX in the issuers’ annual reports.

HKEX’s observations

The HKEX noted that the rate of compliance by issuers with the disclosure requirements under the Rules and the relevant accounting standards remains high in 2023, notably with an impressive 98% of issuers achieving a compliance rate of 90% or above on the specific disclosure rules. The disclosure rules which were the least complied with by issuers primarily related to disclosures of share schemes, significant investments in funds and wealth management products, whether performance guarantees were met, and the intended use of and expected timeline for utilizing proceeds from fundraisings.

For the thematic review of areas in which HKEX has declared to be of regulatory interest, this year, HKEX’s picks include, again, (i) problematic cases and disclosures of material lending transactions, (ii) disclosures in the “management discussion and analysis section” (MD&A) by issuers (including newly-listed issuers), and (iii) reasons leading to modified audit opinions in issuers’ financial statements and disclosure concerning the modifications. HKEX’s recommendations for enhanced compliance in these areas are detailed in the Report and the Guide.

(i) Material lending transactions

It is not surprising that material lending transactions is featured in the Report as a major theme under HKEX’s review once again, as loans granted by issuers and their lending practices have increasingly been on not just HKEX’s but also other regulators’ radar in recent years. As we covered in our earlier client update on May 3, 2024, after a Joint Statement was issued by the Securities and Futures Commission (SFC) and the Accounting and Financial Reporting Council (AFRC) in July 2023 on issuers’ and auditors’ common failures in relation to the internal controls and scrutiny over the granting of loans, repayment monitoring, adequacy of related disclosures in financial statements and announcements, as well as the regulatory expectations for audits, HKEX further published the April 2024 edition of its Enforcement Bulletin, which was dedicated to the topic of issuers’ lending practices and highlighted some common red flags at the pre-loan, post-loan, and recovery stages of the lending process for loans granted by issuers.

Indeed, as we discussed in our client update on April 29, 2024, the regulators are also seen to be proactively combating issuers’ dubious lending arrangements, which had led to various enforcement actions, including the disciplinary action taken by HKEX against China Ecotourism Group Limited (China Ecotourism) and its serving and former directors on April 25, 2024. The main issues identified include, among others, disclosure failures, questionable flow of loan proceeds, lack of internal controls, failures to conduct due diligence and risk assessments prior to the granting of loans.

In the Report, HKEX observed that:

1. Issuers’ disclosure regarding material lending transactions have continued to improve, with most issuers subject to the review having followed “all or substantially all” of HKEX’s earlier disclosure recommendations. However, there remains room for improvement in, for example, disclosures of the rationale for lending (for those issuers who grant loans only incidental to their business operation, i.e., “non-money lenders”) and of the customer profile, risk of concentration, and the major commercial terms (for those issuers whose principal business activity is money lending, i.e., “money lenders”).
2. As to loan transactions, among the cases which HKEX reviewed, there are several isolated cases involving director misconduct and/or internal control breakdown, which are still under investigations by HKEX. These cases, similar to the case of China Ecotourism, typically involved an overall failure to adequately safeguard the issuers’ interest in the loans, which may have caused a material impairment shortly after the loans were granted, or alternatively, the issuer might have repeatedly agreed to renewals of loans for an unreasonably long period of time that was supported by no apparent commercial rationale and may be prejudicial to the issuer’s interest. On this, HKEX once again expressly declared that it “will not hesitate to take disciplinary actions” against director misconduct and major internal control deficiencies, and accordingly reminded issuers to ensure the adequacy of their controls over material lending transactions for safeguarding shareholders’ funds.

In the Guide (see section 2.4), HKEX went on to remind issuers of its expectations on the required disclosures in annual reports on lending transactions, which as a minimum should include disclosures of the following:

For a detailed overview of the common pitfalls relating to loans and lending arrangements, best practices and practical tips on governance and handling loans, and the general regulatory expectations and recent enforcement actions in connection with listed issuers’ loans, please refer to the Securities Law and Regulation Guidance Note (in two parts, respectively the Tenth and Eleventh issues), which we authored for the Hong Kong Chartered Governance Institute on “Governance and Best Practices for Listed Issuers in Handling Loans and Lending Arrangements”.

(ii) MD&A and disclosures by newly-listed issuers

On disclosures by the management of listed issuers in their MD&A, HKEX was of the view that issuers “generally complied with the Rules”, but there was room for improvement as to the quality of the disclosure. While the exact disclosures required would depend on the circumstances on an issuer-by-issuer basis, HKEX provided guidance to issuers in the Guide through an inexhaustive list of matters (see Section 2.2) relating to the issuer’s business review, the principal risks and uncertainties faced by the issuer, and assessment of the issuer’s liquidity and financial resources, which issuers are recommended to consider covering and elaborating in their MD&A.

HKEX also stressed that directors of issuers should (a) ensure that the matters presented in the MD&A are “fair, balanced and understandable” with both positive and negative factors and without omission of material facts, and (b) avoid using generic or boilerplate statements in the MD&A that are not tailored to the issuer’s situation (say, (i) without elaborating on the underlying causes or business factors leading to the financial results, (ii) without explaining how the estimated capital expenditure might match the business plans, (iii) without disclosing the impact of foreign exchange and interest rate risks from substantial borrowings, and (iv) without elaborating on a major change in business model and its future impact on the issuer’s financials). HKEX indicated that it is a guiding principle that an issuer’s MD&A disclosure should be “on par with the disclosure standard of a listing document”.

As to disclosures made by newly-listed issuers in their MD&A, in addition to reminding them of the requirement to consult their compliance advisers before publishing the annual report, HKEX also reminded them that they should review their IPO prospectuses in determining the appropriate level of information to be included in the MD&A section. Issuers are required to provide updates on the key major matters which they previously discussed in their prospectuses, so as to enable investors to evaluate whether the issuers’ post-listing performance is in line with their pre-listing track record, business plan, and prospects as previously outlined in their prospectuses.

This is in line with the scrutiny we have seen HKEX exercise over newly-listed issuers’ post-listing business and affairs in terms of their post-listing (mis)use of IPO proceeds (as seen in the disciplinary actions taken by HKEX against Optima Automobile Group Holdings Limited and its directors on June 27, 2023, against C-Link Squared Limited and its former directors on October 5, 2023, and against Global Uin Intelligence Holdings Limited and its former directors on March 5, 2024, all cases discussed in our earlier client update dated March 15, 2024). This reinforces the regulatory objective that investors must be kept updated of issuers’ affairs throughout for them to make informed investment decisions.

(iii) Modified audit opinions in financial statements

Upon a brief analysis of the reasons for the auditors’ modified opinions given by the issuers reviewed by HKEX, HKEX has provided recommendations in the Guide (see Section 2.1) to issuers for making additional disclosures following the receipt of a modified audit opinion so as to fulfill the duty to provide the investing public with a true and fair view of its financial and operational state of affairs in financial statements. Such disclosures should include details of the modifications, their impact on the issuer’s financial position, the position of the issuer’s management and audit committee compared with that of the auditors, and the issuer’s proposal to address the modifications.

Key Takeaways

1. The Guide and Report serve as a firm reminder in relation to HKEX’s expectations on the minimum disclosure standards expected of issuers in their annual reports. This update does not provide an exhaustive summary of all regulatory areas reviewed by HKEX in the Report and all regulatory guidance encompassed in the Guide, but aims to offer a snapshot of HKEX’s key observations and recommendations to issuers in preparing their annual reports.
2. Issuers, their directors, and management should be mindful that the annual report is a critical corporate communication tool for issuers to present material and relevant information, including the issuers’ financial results, operational performance, and future outlook, to the investing public, which in turn is critical for investors in their decision-making on investments. Issuers should therefore strive to maintain the highest standard of disclosures in annual reports to achieve this objective, which is not only in the interest of investors but also avoids triggering any adverse regulatory implications on the part of the issuer.
3. When drafting annual reports, issuers and their directors should be mindful of the overall disclosure obligations under the Rules and the relevant guidance provided by HKEX from time to time, and communicate effectively with their advisers to ensure that tailored, adequate, and appropriate disclosures are made to investors. They should also avoid adopting boilerplate statements which do not provide investors with a comprehensive picture of the issuer’s latest business, operational, and financial affairs.
4. It is evident that loans and lending arrangements have remained one of the major areas under the regulators’ close scrutiny and will continue to be a major enforcement priority in the coming years. There is now frequent joint collaboration between SFC, HKEX and AFRC in investigating and taking enforcement actions against issuers, directors and auditors, including on matters involving questionable lending arrangements. Any non-compliance may result in parallel investigations followed by multiple disciplinary actions and sanctions in the prevailing regulatory environment.
5. Therefore, all stakeholders are reminded to take steps to fully discharge their regulatory duties and responsibilities, and to keep proper records so that they are in a position to demonstrate compliance to the regulators, if and when called upon to do so.