If you saw the lights dim recently, it was because the Stock Exchange scrapped a requirement for listed companies to disclose large accounts receivable, which could have warned investors about impending disaster. Dressed up as a "minor and housekeeping" rule amendment without consultation, the change is illustrative of the urgent need to increase investor representation on the Listing Committee, to produce pro-investor policy reform. And that's where HK needs your help.

Blackout on Receivables
24 March 2006

On 17-Feb-06, the Stock Exchange of Hong Kong Ltd (SEHK) announced what it called "minor and housekeeping amendments" to the Listing Rules. Why such an innocuous title? Because it did not go through any public consultation process before making the amendments, so it could not admit that one of the amendments is a serious step backwards for disclosure in Hong Kong, effective 1-Mar-06.

The Listing Committee, which as we have said before, is dominated by issuers and their advisers, has seen fit to roll back the disclosure on large "accounts receivable" (the money a customer owes to a listed company), by exempting such accounts receivable from disclosure as "advances to entities" unless they did not arise in the ordinary and usual course of business or were not on normal commercial terms.

The rules previously required disclosure of credit extended to a single customer if it exceeded 8% of market capitalisation or total assets of the listed company. So if 8% of shareholders' wealth was bet on a single customer remaining solvent, then shareholders were told about it, and they could reach their own judgement, based on the credit worthiness of the customer. Furthermore, each 3% increment in exposure (to 11%, 14% and so on) had to be disclosed. These rules had been in effect since 31-Mar-04.

Prior to 31-Mar-04, the disclosure threshold under Practice Note 19 was 25% of net assets (not total assets), with 10% increments triggering further disclosure, although when the listed banks whinged about having to disclose large loans, the exchange backed off and issued a "no action" letter on 17-May-04, so they were never held to the tighter 8% standard. In fact, the only disclosure under the old standard by a bank that we know of is the belated announcement on 11-May-04 by BOC Hong Kong (Holdings) Ltd (2388), the local arm of Bank of China, which disclosed that it had lent over 25% of its net assets (4.9% of its loan portfolio) to a group of HK-listed companies, which wasn't named, but from the description it was obvious that it was Cheung Kong and its various associates, including Hutchison Whampoa.

A big step backwards

The abolition of disclosure on accounts receivable is a great shame, and it is inconsistent with the goals of a disclosure-based market. The disclosure allowed investors to have price-sensitive information that they might not otherwise receive until it was too late. Do you remember why Peregrine Investment Holdings Ltd collapsed? It was because of a very large bridging loan, made in the ordinary course of business, on normal commercial terms, to an Indonesian taxi company. That's the kind of information which, if disclosed to investors, would indicate that their company may be taking large amounts of concentrated credit risk, and would be likely to affect the share price.

Other examples of accounts receivable leading to difficulties include the recently delisted Wanasports Holdings Ltd (8020), a retail franchisor, which collapsed after supplying large amounts of inventory to franchisees for which they were not paid. The accounts receivable were disclosed in this announcement.

In another case, the rule was breached by Thiz Technology Group Ltd (8119) which belatedly admitted on 18-Apr-05 to having given credit to a single customer amounting to 84% of Thiz's market value. That was after we pointed out the probable breach in our article of 21-Mar-05.

Now why did the Listing Committee create the new exemption for accounts receivable? Put simply, because listed companies don't like having to disclose their weaknesses, and listed companies and their advisers dominate the committee.

There was also a commercial concern that if one customer could read in the press how much credit had been extended to another customer, then the first customer would want the same credit too. So what? If anything, the disclosure obligation incentivised companies to keep their credit exposure to each customer below the 8% threshold, which is a good thing - it stops them from moving into the finance business when they have no expertise in credit analysis. If there was any scope for amending the rules, then what the committee should have done (subject to consultation) is to allow the credit to be disclosed on a no-names basis provided investors were told the independently-assessed credit rating of the customer, so that they could take that information into account in assessing the risk of loss, and provided any change to the credit rating was subsequently disclosed. And if the customer had no credit rating, then it would have to be named.

Fewer tests

In another amendment, the Listing Committee reduced the number of disclosure triggers applied to advances to entities other than accounts receivable. In the past, when comparing the advance (or loan) with the listed company, the loan was divided by market capitalisation (known as the "consideration ratio") as well as total assets (or prior to 31-Mar-04, net assets). The market capitalisation test now no longer applies, so this effectively raises the disclosure threshold for companies whose market capitalisation is less than their total assets, which in many cases it is. Of course, raising the disclosure threshold reduces the number of disclosures.

Now we agree that there was a problem with the market capitalisation test for advances to entities, because in theory it required continuous comparison of advances with a market capitalisation which moves with the share price. So it was difficult to administer. The solution, though, should have been to make the test only at month-ends (based on month-end accounts and month-end market capitalisation), striking a balance between cost of administration and the need for disclosure. Instead, the test has been scrapped altogether.

Not housekeeping

It is remarkable that it can take so long to get pro-investor reforms through the Listing Committee, involving endless consultation (the last round took over 2 years, and the proposals were diluted along the way), whereas when a pro-issuer reform is wanted, it is dressed up as a "minor and housekeeping" amendment and passed without public consultation.

This of course is remarkable, but not surprising given the structure of the Listing Committee. It's one of the reasons that Hong Kong is now the only remaining significant market in Asia that does not require main board listed companies to report quarterly, and one which gives the longest period (4 months) to produce annual results when the international standard is 60 days or less. To amend these rules, you need Listing Committee approval. In a speech on 17-Nov-05, Secretary for Financial Services and the Treasury, Frederick Ma, said:

"Our regulatory framework is in every aspect on a par with international standards."

Judge for yourself.

You can make a difference

Your editor, an elected independent non-executive director of HKEx, was recently appointed by the board of HKEx to the Listing Nominating Committee, a committee of 6 people, 3 from the SFC and 3 from HKEx, which appoints members of the Listing Committee. Wearing this hat, we strongly urge experienced investors, including professional asset managers, who are willing to play a key role in moving Hong Kong's market forward, to volunteer to serve on the Listing Committee. Your market needs you.

© Webb-site.com, 2006

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