Background
On 10 December 2024, The Stock Exchange of Hong Kong Limited (Exchange) published a report on the findings of its annual review of issuers' compliance with the annual report disclosure requirements and specific accounting standards for the financial year ended in 2023 (Report). Assisted by artificial intelligence, the review covered approximately 400,000 disclosure records and over 155 disclosure rules. The Report not only highlighted a commendable compliance rate among issuers but also identified major areas for improvement. The Exchange also prepared a guide on preparation of annual report (Guide), summarising its recommendations to facilitate issuers in preparing their upcoming annual reports.
The Exchange's Observation
A standout revelation from the review is that 98% of issuers have achieved a compliance rate of at least 90% on the specific disclosure rules under review. This high compliance rate underscores issuers' dedication to transparency and regulatory adherence. However, the Report also spotlighted areas that need improvement, particularly in disclosure rules related to share schemes, significant investments, performance guarantees, and the use of proceeds from fundraisings, signalling a pathway for issuers to further refine their reporting practices.
The Exchange selected three areas for thematic review, namely disclosure related to financial statements with auditors' modified opinions, material lending transactions and management discussion and analysis, and reviewed the financial disclosure under applicable accounting standards.
Auditors' Opinions and Modifications
The Exchange recognised that 95% of issuers published financial statements with an unmodified audit opinion. For the 139 issuers that received a modified audit opinion, it was observed that the most common modifications were attributable to going concern uncertainties, asset valuation issues and restricted access to accounting records. While the Exchange urged issuers that receive modified audit opinions to resolve the going concern issue as soon as practicable, it identified the major cause of asset valuation issues and limited access to accounting records as being the issuers' lack of adequate risk identification policies and mitigating measures, resulting in the issuers' failure to supply satisfactory evidence to auditors to substantiate the reported balance. Issuers were therefore reminded in the Report to put in place adequate risk management and internal control systems to avoid such deficiencies.
The Exchange further reminded issuers in the Guide that when an issuer receives a modified audit opinion, it should disclose in the annual report the underlying issues of the modifications, their impact, the reasons for insufficient information leading to auditor concerns, management's stance on significant judgmental areas and how the management's view differs from that of the auditors, and the audit committee's view on these modifications. If the audit committee disagrees with the management's position, the specific areas and reasons for such disagreement should be disclosed. Issuers should also outline plans to address the modifications and disclose actions taken for repeated issues. If there are any material deviations from previously proposed plans during the current financial year, they should also be explained. Issuers and their audit committees should discuss these plans with the auditors to effectively address and resolve audit concerns.
Material Lending Transactions
The Exchange observed improvements in the quality of disclosure of material lending transactions, with most issuers following all or substantially all of the Exchange's disclosure recommendations. The Exchange also reported that fewer cases of potential non-compliance with notifiable/connect transaction rules and problematic lending cases were identified compared to the previous review. Despite this, the Exchange emphasised that it takes director misconduct and material internal control deficiencies seriously, and it will not hesitate to take necessary disciplinary actions if non-compliances are observed.
Issuers involved in significant lending transactions are encouraged to improve their annual report disclosure on lending activities for greater transparency and accountability regarding the use of shareholders' funds. For issuers with money lending as a principal activity, disclosure should include details about their business models, customer profiles, risk management policies, and loan impairment policies, as well as a comprehensive breakdown of their loan portfolios and discussion on loan impairments or write-offs. Non-money lending issuers engaging in lending outside their regular business should disclose details of loan receivables, discuss any significant impairments or write-offs, and explain how these lending activities align with their business strategies.
Management Discussion and Analysis (MD&A)
The review of MD&A sections in issuers' annual reports, including those of newly listed issuers, found compliance with the relevant disclosure rules generally. However, the Exchange also identified room for improvement in the quality of disclosure, especially in explaining year-on-year performance variances, and significant events and risks. In particular, the Exchange noted that some issuers failed to disclose the impacts of significant events and risks identified, as well as the issuers' countermeasures against them. The Exchange also observed that newly listed issuers often provided less detailed MD&A disclosure compared to their prospectuses and sometimes omitted updates on significant issues highlighted in their prospectuses.
The Exchange emphasised that the MD&A section of financial statements is crucial for elaborating on business trends and year-on-year variances, helping investors grasp the key factors influencing an issuer's financial performance, including risks and mitigating measures. Issuers should provide detailed commentary on both external and internal factors affecting their performance, such as market changes, significant events, and strategic shifts. They should also explain the impact of these factors on financial results and discuss any adopted performance indicators or specific ratios relevant to their industry. Additionally, issuers should clarify material line items in their financial statements to enhance investor understanding of the nature of such items and the reasons for changes during the year.
The discussion should extend to the issuers' principal risks and uncertainties, detailing how these might impact their operations and financial position, and the strategies for mitigation. Liquidity and financial resources assessment are also essential, particularly regarding capital expenditure plans and debt management.
Issuers are encouraged to ensure their MD&A disclosure is fair, balanced, and understandable, to avoid using boilerplate statements, and to strive to have the MD&A disclosure comparable to that of a listing document.
Financial Disclosure and Accounting Standards
The Exchange acknowledged that no significant accounting non-compliances were identified. However, in the Report, issuers are encouraged to enrich qualitative disclosure, including how the accounting requirements were applied to material accounting policies, key judgments, and estimates. The nuanced handling of non-GAAP measures, including better labelling and reconciliation, was also highlighted as an area for improvement.
Conclusion
In summary, the Report showcased a high compliance rate among issuers with the annual report disclosure requirements and specific accounting standards. Despite this commendable adherence, the Report and Guide underscore the Exchange's commitment to continuous improvement in the quality of financial disclosure. Issuers are strongly encouraged to adhere to the recommendations provided, not only to fulfil regulatory requirements but also to bolster investor confidence. This concerted effort will contribute to a more robust, transparent, and trustworthy financial ecosystem in Hong Kong, reinforcing the market's integrity and appeal to investors.
