HKEX Annual Review Reiterates Concerns over Issuers' Deficiencies in Internal Controls

The annual Hong Kong Stock Exchange (HKEX) review of Issuers’ Annual Reports (Review) for 2022 found that deficiencies in internal controls remained a common underlying reason for modification of audit opinion by auditors and delay in financial reporting.

For the 2022 financial year, 120 issuers (compared to 125 for year 2021) received modified audit opinions on their published financial statements – including 86 receiving modified opinions for two or more consecutive years. 

‘Going concern’ qualifications continued to be the most common audit modifications.

Others mainly related to valuation of assets – mainly caused by issuers’ inability to satisfy auditors over fairness of their reported asset value – and limited access to accounting records, mainly due to issuers’ inability to secure access to books and records of investees when making investments. 

HKEX said in many cases the audit modifications stemmed from lack of policies and internal control procedures.

For instance, issuers’ lack of policies and control procedures in granting loans or making prepayments raised auditor doubt about the recoverability of such loans or prepayments; in some extreme cases including the existence, commercial substance and business rationale of the transactions. 

To facilitate timely and accurate financial reporting, the HKEX therefore recommends that issuers’ management should establish a policy to identify emerging risks, develop risk-mitigating controls and review control effectiveness on a continuous basis under the oversight of audit committees. 

Other HKEX findings and recommendations in the Review include: 

• In relation to newly listed issuers – two cases were identified involving arrangements conducted shortly after listing and changes in use of IPO proceeds that were inconsistent with the issuers’ business plan stated in the prospectus. HKEX said appropriate action will be taken against these issuers. 
  
  Directors are reminded to ensure the issuers have effective infrastructure and controls enabling them to timely identify material corporate developments – such as material changes in financial performance and position, business plans and directions, and use of IPO proceeds, as well as material corporate transactions or incidents – and make disclosure promptly. 
• In conducting material lending transactions, issuers should be mindful of the Listing Rule requirements (lending transactions being a form of “financial assistance”) and ensure compliance. 
• When performing expected credit losses assessment, fair value measurement and impairment testing, issuers’ directors must exercise their own judgement to assess the reasonableness of assumptions and inputs – and should not overly rely on valuers.