Issuers’ lending activities under spotlight of HKEx: Red flags and investigation focus

Suspicious Lending Behaviour

Whether issuers are already in the business of money lending or are expanding their commercial operations into Loans, regulators will always scrutinise suspicious cases. Understanding the key red flags that draw HKEx’s attention will help to identify areas that warrant issuers’ careful evaluation and robust risk management in lending activities.

A loan cycle can generally be categorised into the below stages, each of which presents various challenges and potential red flags:

HKEx will take an interest in issuers’ Loans if any of these red flags are present, even if there is no breach of disclosure or shareholders’ approval requirements under HKEx’s Listing Rules (Listing Rules). Issuers should therefore exercise caution to avoid such red flags.

HKEx’s Investigation Focus and the Practical Tips Behind

While the HKEx is tightening its grip on issuers’ lending activities, their investigation focus is turning towards scrutinizing three areas: directors’ duties, internal controls and disclosure obligations on the Loans. 

Not only do these focal points provide an insight into HKEx’s enforcement actions, they can also serve as useful guides on the practical actions issuers and directors can adopt to effectively manage the regulatory requirements and credit risks from the Loans.

Case Studies and Consequences of Breach

1. HKEx’s Sanctions and Disciplinary Actions

In the recent enforcement cases, HKEx’s found that issuers involved in ill-considered Loans may often have directors and senior management failing to take active steps to safeguard issuer’s assets.

In this regard, HKEx has taken reputational sanctions against the directors, such as public censures, directors unsuitability statements and prejudice to investors interests statements². HKEx may also pass orders against issuers for remedial or rectification actions (e.g. conduct independent internal control review).

In the case of Hong Kong Resources Holdings Company Limited, HKEx imposed disciplinary actions against the issuer and relevant directors for, among other things, failure to disclose accurate and complete information in an interim report regarding auditors’ concerns over problematic loans, and inadequate internal controls for a lending businesses.

In China Saite Group Company Limited, the issuer and relevant directors did not provide timely and accurate information to HKEx during the investigation on the questionable loans. In particular, the INEDs had failed to apply independent judgment on the concerns leading to audit issues. The issuer and relevant directors, including a former chairman, faced public censure from HKEx. The issuer was subsequently delisted.

2. Other Legal or Regulatory Implications

The outflow of funds through Loans gives rise to risks of misappropriation of funds, or false or misleading financial statements. The HKEx has made it clear that it will refer its findings and cooperate with other regulators and law enforcement agencies when necessary, including SFC, the Accounting and Financial Reporting Council and the Hong Kong Police.

An example of the cooperation HKEx sought during one investigation is the case of China Ecotourism Group Limited, where the SFC assisted in obtaining evidence regarding some problematic fund flows.

Conclusion: Stay vigilant and be proactive

Material lending transactions and material asset impairments have formed part of the HKEx’s thematic reviews of issuers’ annual reports in recent years. Hence, even in absence of any breaches of the Listing Rules, questionable Loans are constantly on the regulator’s radar. 

HKEx has vowed to take issuers’ problematic lending activities very seriously. Proper directors’ oversight and effective internal controls over lending businesses are considered by the HKEx as essential to safeguard shareholders’ interests. Accordingly, issuers and their directors must always stay vigilant and have a questioning mindset when handling Loans.