(i) HKEX’s latest Listed Issuer Regulation Newsletter covers various themes relevant to listed issuers, e.g. guidance on lending transactions (summarized below).

As regards “notifiable transaction” announcements, HKEX previously reminded issuers to disclose significant relationships between counterparties to the transactions (and ultimate beneficial owners) and the issuer’s connected persons. E.g. a connected person may provide loans to the counterparty funding the transaction. This is relevant in assessing if the counterparty should be deemed a “connected person”.

The newsletter explains that HKEX may require issuers to provide a confirmation on any material loan arrangements between the counterparty and connected persons.

HKEX also observed that despite Covid 19, issuers demonstrated a high level of compliance with their financial reporting obligations. Highlights of listed issuers’ spin-off activities are also addressed.

What you should know/do:

Guidance on loan transactions

• Lending transactions which raise concerns
  — Lack of business rationale/ commercial substance
  — Excessive lending in size compared to scale of issuer’s business operation
  — Defaults in repayment or full impairments shortly after grant of the loans

• Example: gaming operator lent money to six independent parties
  — Mostly interest-free or at a rate substantially lower than its cost of capital
  — Raises question of commercial merit
  — 70% of loans unrecoverable shortly after being made

• Financial reporting
  — Appropriate and supportable estimates to assess loans recoverability to support “impairment” assessment
  — Disclosure on material lending transactions in annual report (“MD+A” section)
  (i) major terms (total outstanding loan receivables, maturity profile, interest rates, collateral/ guarantee)
  (ii) discussion on provisions and impairments, bases of impairment assessment, valuations / other supporting evidence
  (iii) (outside ordinary course of business) reasons for granting such loans and how they meet business strategies

• Proper and adequate internal controls
  — Assess and manage credit exposure
  — Monitor recoverability of loans
  — Monitor adequacy of collaterals

• Improper discharge of directors’ fiduciary duties
  — Should critically assess commercial rationale
  — Terms are fair and reasonable
  — Use of issuers’ fund in the ordinary and usual course of business and in best interest of company

(ii)  3 HKEX Listing Decisions on directors’ duties

The cases reflect directors’ duties in different context: loans, acquisitions, and joint ventures (“JVs”)

Listing Rules requirements

Rule 3.08: the board of directors is collectively responsible for its management and operations, and the directors are collectively and individually responsible for ensuring Listing Rule compliance.

Every director must apply such degree of skill, care and diligence as may reasonably be expected of a person of his knowledge and experience and holding his office; act honestly and in good faith in the interests of the issuer.

(A) [Loans] decision on Dongyue Limited and named directors (executive, non-executive, independent) (Press release; Statement of Disciplinary Action)

This involves misappropriations by the company’s financial controller, who was responsible for the wealth management business. Transactions involving loans/deposits around RMB 1.5b were entered into over 1.5 years. The amount remains unrepaid or has been forfeited. Significant internal control deficiencies in the wealth management business was found.

The directors had failed to implement effective risk management and internal control procedures to supervise the financial controller or safeguard the company’s assets. Placing trust in senior members of staff is not a substitute for a proper internal control framework.

What you should know/do:

Internal controls deficiencies + failure in directors’ duties include

• No specific internal control procedures re: wealth management business

• Financial controller given a freehand re: treasury function enabling him to conduct the problematic loans

• Monthly management reports
  — No separate item for wealth management business
  — No evidence that any relevant director made meaningful enquiries
  — No attempt by any director to change the level of details

• Wealth management reports supplied to CFO only, and on an ad hoc basis

• No requirement for CFO/directors to review the above reports in detail

• Despite auditor’s red flags, directors did not review the relevant processes/ procedures or follow through

Audit Committee

• Never met with internal audit team to discuss issues raised by them/ wealth management business

(B) [Acquisitions] case on named former directors (executive, non-executive, independent) of Huiyin Holdings Group Limited (Press release; Statement of Disciplinary Action)

In 2016, the company sought to acquire 2 companies. However, issues arose and directors failed to establish adequate internal controls to ensure that relevant documentation re: the acquisition was obtained/ retained (e.g. personal guarantee by vendor). Auditor issued disclaimer. There was a subsequent impairment (over $100 m), and significant loss for the company.

The directors failed to establish adequate internal controls in the company to obtain / retain the relevant documentation in respect of the acquisitions.

What you should know/do:

Internal controls deficiencies + failure in directors’ duties include

• Disclaimer was due to unavailability of relevant books/records, or appropriate evidence to verify the ownership of the subsidiaries

• Company could not explain various issues which reflect its internal controls inadequacies

• No formal procedures to take control over the newly acquired subsidiaries

(C) [JV] Decision on Tech Pro Technology Development Limited and named former directors (executive, independent) (Press release; Statement of Disciplinary Action)

The company acquired a 50% interest in a JV, whose principal business was to lease a property from a lessor and sub-lease it to tenants. It appointed 2 directors as representatives on the JV board.

Directors failed to take adequate steps or implement effective risk management and internal controls to monitor the operations of the JV or safeguard its assets. There was an over-reliance on JV partner.

This created an environment for irregularities. E.g. JV partner continued to collect a substantial part of rent on behalf of JV. The outstanding amount due from JV partner was very substantial. JV was unaware of a major lawsuit by the lessor resulting in the loss of its sub-leasing right, a substantial asset.

What you should know/do:

Internal controls deficiencies + failure in directors’ duties include

Executive directors

• E.g. no protective measures in place for monitoring JV’s business and operations
  — JV partner was able to continue the historical rental collection arrangement

• E.g. very substantial outstanding amount from JV partner; no risk management measures

• E.g. inadequate checks and balances re: JV’s operations and cash flows

 Representatives on JV board

• E.g. lack of involvement in JV’s management and operations

• E.g. lack of action to address the JV partner’s dominance for a prolonged period

Audit Committee members

• E.g. neither the company’s management nor audit committee members adequately addressed the company’s obvious lack of control over the cashflows of the JV

(iii) HKEX published new FAQs relating to notifiable/connected transactions.

• FAQ 073-2021
  — Calculation of “5 tests”: proposed loan to substantial shareholder; percentage ratio based on stand-alone loan amount OR after setting off loan owed by company
• FAQ 074-2021
  — “Aggregation” principle —acquisition of wealth management products from bank