Submission to SEHK on Financial Disclosure consultation
17 January 1999

What follows was our submission to the Stock Exchange of Hong Kong in response to its paper "Market Consultation Policy Paper on Financial Disclosure" dated December 1998. The numbering follows that of the questions in paragraph 5 of that paper, to which you will need to refer in order to understand the answers.

A. Interim Financial Reporting

  1. Yes
  2. Yes. Note: interest expense and depreciation/amortisation should be disclosed in 2 separate items, not aggregated as might be inferred from the proposal in Appendix 2.
  3. No. There is no need for transitional arrangements, since issuers should have sufficient accounting records to be able to produce the comparative statement.
  4. No.
  5. No. Valuations can be expensive and time consuming - no doubt Mr. C.Y. Leung, an Executive Councilor whose firm of the same name now has the lion's share of the valuation work in Hong Kong, would be delighted by the proposal. However, I think on balance that interim professional valuations are an unnecessary step. Instead, directors should be required to make any adjustments that they consider appropriate to the last year-end valuation in order to reflect market conditions (including transacted prices in similar properties) at the interim date. In other words, a directors' valuation. Similarly, the notes in the interim report should also show the market value of listed investments (as well as book value) at the interim date, as they do in the full-year accounts.
  6. Yes, two months for interims is more than adequate. This is proven by the fact that highly complicated groups such as HSBC are able to report their interim results within 2 months. However, companies would probably have difficulty complying if you want auditors to review the interim reports, since this would take perhaps 1-2 weeks depending on the depth of work that the auditors are expected to do. They would not be given the statements to review until the directors had finished preparing them, and therefor hundreds of companies would need the major accounting firms to work in a very tight period, basically in August (when holiday season is high) and November. The accounting firms may not have sufficient resources to handle such a surge of work.

    Yes, 3 months for final results is also adequate, and will still allow the audit work to be spread within the 2nd and 3rd months, so the accounting firms should be able to cope. I presume that you will require the announcement of results to include a balance sheet and notes, so that we don't have to wait until the annual report is printed.

    It is not clear whether the proposal refers to the timing of the preliminary announcement of interim results, or of the interim report itself. Currently, there is a 3-month limit for the announcement (para 11(1)(a) of the Listing Agreement), but it only says "as soon as practicable" for the interim report (para 11(1)(c)). It is time to remove the distinction, by making sure that the announcement contains the full content of the interim report (including the shareholding data which is currently the only difference between them). Then the interim report, which can be sent to shareholders when it is ready, will contain nothing new.

    Conversely, the 5-month deadline for sending annual reports is set out in para 8(1) but there is no specific deadline for the preliminary announcement of results. Presumably you are suggesting that there be a 3 month deadline for the announcement, in which case the announcement must include the balance sheet.

Announcement system

Inevitably, companies will also moan about the cost of printing extra information (balance sheets, cashflow statements etc) in larger spaces in the newspapers, while the newspapers will benefit from increased advertising revenue. What we really need is for the SEHK to catch up with the 20th century before it's over, and start publishing all announcements, interim reports, annual reports, circulars and prospectuses on the Web. For an example of what can be done, look no further than Singapore ( which site is already well-developed. Eventually, it should be possible to make newspaper publication voluntary, as the public has web access.

The Web-based news system should include a full and searchable archive as it accumulates. The whole thing must be free of charge, paid for out of the levy from trading and from listing fees.

  1. Yes, it is appropriate to introduce quarterly reporting. The data should already be available to management on at least a monthly basis (or else they do not have adequate controls) so I see no reason why it cannot be made public. Thousands of US companies seem to have no problem with this, and HK should not be any different. As with interim reports, I don't think an audit is necessary. The deadline would ideally be 45 days, but many companies may claim difficulties, particularly with China operations, so you had better start with 2 months, the same deadline as interim reports, since the work involved is the same.
  2. No. See also A(vi) above. Perhaps the Exchange leans towards having an interim audit, or audit review, with the aim of reducing the risk of fraud by the executive directors. I do not believe that audit reviews (as compared with a full audit) are likely to help much. If directors are going to defraud a company then they will probably also make it difficult to detect without full access to the books and physical assets (such as stock taking), which would take you towards a full audit. To fully audit the interim report would make it as time consuming and costly as the annual audit. Instead, take comfort from the fact that expanded disclosure requirements should improve transparency, which in itself is a deterrent to fraud.

B. Financial Disclosure by Conglomerates

  1. Yes. In addition, I believe all listed issuers, not just financial conglomerates, should disclose their off-balance sheet financial assets and liabilities. For example, many ordinary companies take out interest rate or currency swaps, or futures, in the course of their treasury management. Others (such as metal traders) might use commodity futures to hedge. We should be told what the value of these positions is at the balance sheet date. There was a famous case involving Metalgesellschaft in Germany, which exposed horrendous futures-related losses a few years ago.
  2. No. There is no point in trying to define the intangible. Most of the disclosure items would simply not be applicable unless financial activities, such as money lending, or stock market investment, are being undertaken. So requiring every company to comply with them would not place an undue burden on those who have no such activities. Hence I think the disclosure rule should apply to all companies.

    If you seek to apply the rules only to "financial conglomerates" then some companies will find a way to avoid being classified as such. Better to apply the rule to everybody. If you take a percentage-of-profits test, then the test doesn't work if the activity makes a loss, or if it takes a lot of risk but doesn't make much profit. Similarly, off-balance sheet assets wouldn't count in the net assets test, and borrowing could offset assets, reducing the net assets involved but increasing the risk to the issuer. Finally, if you seek to limit only to larger companies ($1bn of assets or $300m deposits) then you are basically saying that smaller companies should have lower disclosure standards, which is hardly fair to the investors in them.

  3. Yes.

C. Management Discussion and Analysis

  1. Yes. One thing the Exchange should have realised long ago, is that in Hong Kong, family controlled companies have little incentive to volunteer information to their investors. The only time they want to stimulate interest in the shares is if they want to use further equity financing or sell down. Therefor, if we put "guidance" in the rules, it will often be ignored. The current rule is so tentative as to be a waste of space. It reads guidance on those matters which the directors may wish to consider...". It looks like it was watered down from a stronger initial draft!
  2. Yes.
  3. Yes.
  4. Yes. As well as commenting on orders in hand (which, for most companies other than manufacturers, is meaningless) the directors should comment on "current trading" since the period end. Retailers, for example, know what their sales are doing daily or weekly. This would bring the report "up to date".

D. Timely Public Disclosure

  1. Yes.
  2. Yes.
  3. Yes.
  4. Yes, this would help in certain cases. For example, item (c) talks about "significant" new investments. It would be appropriate to introduce a threshold at 5% of profit or net assets which would require a press announcement, but not a circular to shareholders. That is, it would be a "notifiable transaction" but not a "discloseable transaction". You had better rename the latter, so there is no confusion about disclosure threshold. So we would have 5%: notifiable, 15%: material, 50%: major, 100%: very substantial.

    For profit variation, the problem with comparison to last year is that profits can vary by large percentages, particularly if last year's figure was close to zero (on either side of it) or negative. So percentage tests are not helpful. I would suggest that you require (a) immediate disclosure of any item which would be treated in the accounts as an "exceptional" profit or loss (such as a provision for diminution in the value of investments, or a large bad debt write-off) and (b) announcement if the directors believe that the median of analysts' forecasts for the current year is more than 10% different from the likely outcome. Of course, this pre-supposes that there are analysts covering the company, which is not always the case. Directors should take reasonable steps to inform themselves of what analysts are saying. This should be easy, because the directors will know which research firms cover the company, as they talk to them.

    By requiring early disclosure of exceptional items, you remove a lot of the potential for nasty (or even pleasant) surprises in the results.

  5. See (iv) above.

©, 1999

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