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Issued by the Shanghai Stock Exchange (SSE) on November 19, the SSE Guide to Self-regulation of Listed Companies No. 2 - Financial Indicators for Delisting: Operating Income Deduction and the Business Guide to Information Disclosure for the Companies Listed on the SSE STAR Market No. 9 - Financial Indicators for Delisting: Operating Income Deduction (hereinafter collectively referred to as the Guides) came into effect from the date of publication. An SSE official in charge answered questions from the press regarding the release of the Guides.
Q1: Can you brief us on the background and significance of the release of the Guides?
A: In order to implement the Implementation Plan for Improving the Delisting Mechanism for Listed Companies issued by the CPC Central Committee for Strengthening Overall Reform, further enhance the exit mechanism based on the market and rule of law, purify the capital market ecosystem, and protect the legitimate rights and interests of investors, the SSE had started a new round of reform for the delisting system, and issued the new delisting rules at the end of 2020.
In terms of financial indicators for delisting, the new delisting rules have added a new combination of financial indicators, whereby the net profit before or after deducting non-recurring gains and losses is negative and the operating income is less than 100 million yuan. All this aims to more accurately profiling the sustainability of a listed company as well as clearing out shell companies. When applying the indicators, the new delisting rules clarify that the deduction items for operating income are “the business incomes that have nothing to do with the main business, and the incomes without commercial reality”, and require that when a company’s audited net profits before or after the deduction of non-recurring gains and losses is negative, the company should disclose in the annual report the deductions from the operating income and the amount of operating income after the deduction, and that the annual audit accountant should issue a special verification opinion on whether the deductions from the operating income are accurate.
In order to regulate the standards for the two aforementioned deduction items for the operating income and clarify the regulatory requirements, in April 2021, the SSE issued to listed companies and annual report audit agencies the Notice of Implementing the Issues Concerning Operating Income Deduction in the New Delisting Rules (hereinafter referred to as the Notice). Since its release, the market has been operating well as expected. After the disclosure of the 2020 annual reports, the delisting risk alert was imposed on a total of 42 companies in the SSE market, of which 25 were put under *ST as a result of triggering the newly-added financial indicators for delisting. As 2021 is a crucial year for the implementation of the new delisting rules, the SSE summarized the cases of operating income deductions in the 2020 annual reports of the listed companies and the regulatory experience for higher a uniformity of the implementation standards. To achieve the end, the SSE rationalized and revised the standards for operating income deduction on the basis of the Notice before formulating the Guides, which is now officially released in the market after soliciting opinions from all listed companies and audit institutions engaged in securities services.
Q2: What are the main guidelines for the formulation of the Guides?
A: The Guides have been formulated to clarify the specific deductions from operating income in the financial indicators for delisting, improve the enforceability of the indicators, and further implement the new rules for delisting.
First, we have adhered to the goal-oriented principle with targeted crackdown on shell companies. In the process of formulating the Guides, the SSE sorted out the shell companies without the ability to continue operations, and summed up the common methods for such companies to maintain their shells by inflating their operating incomes. With an aim to precisely crackdown on the shell companies, we have taken a goal-oriented approach to set the standards for deduction, so as to “delist all that should exit”.
Second, the deduction items for operating income are clarified in the form of “definition + enumeration”. As the operating income deductions are similar in nature to non-recurring gains and losses, the method of “definition + enumeration” can better describe the characteristics and specific content of operating income deductions. Therefore, the Guides enumerate specific deduction items based on the definition of “business incomes that have nothing to do with the main business and incomes without commercial reality”.
Third, strengthening the verification requirements of audit institutions and holding intermediary agencies accountable. As audit institutions play an important role in the regulation of delisting for financial factors, the Guides clarify the verification requirements for audit institutions, urging audit institutions to effectively act as “gatekeepers” and provide investors with authentic, accurate and complete information.
Q3: What are the key points and main considerations for the specific deductions from operating income in the Guides?
A: The specific deductions for operating income in the Guides include the key points in the following three aspects.
First, the requirements for deduction for trade and quasi-loan businesses are elaborated. The SSE found in its regulatory practice that some shell companies inflated their operating incomes by suddenly developing the trade, quasi-loan and other businesses, so as to avoid delisting. Generally characterized by little investment and low costs of entry and exit, the trade and quasi-loan businesses are difficult to turn into a stable business model, and cannot fundamentally change the essence of a shell company. In order to avoid such circumstances, the Guides stipulate that deduction should be made on the incomes form the trade business and the qualified quasi-loan businesses newly added in the current fiscal year and the previous fiscal year. In addition, it is clarified that the incomes from the unqualified quasi-loan businesses, including the interest incomes from the funds lent out, should be deducted every year to prevent the listed companies from switching out of the real economy, as those businesses have nothing to do with the main business.
Second, the standards for a "stable business model" are specified. In order to prevent the company from protecting its shell through various types of other new businesses, the Guides regard "income generated from businesses that have not formed or are not likely to form a stable business model" as the bottom-line clause of "business income unrelated to the main business." Meanwhile, the standards for judging “a stable business model” are further clarified, such as whether the business has a complete input and processing process and output capacity, whether the business is sustainable, and whether the company has relevant experience in the business and a certain scale of investment.
Third, it is stipulated that deductions should be made on the incomes from the mergers through abnormal transactions. In order to prevent the listed companies from suddenly “controlling” other companies to achieve the “consolidation of financial statements” through entrusted voting rights, granted subsidiaries or businesses and other means to inflate their operating incomes and avoid delisting, the Guides clearly impose the deduction of “the incomes generated from the subsidiaries or businesses merged by the company in the current fiscal year with apparently unfair consideration or through non-trading methods”.
Q4: Can you brief us on the efforts made by the SSE in soliciting opinions from listed companies and audit institutions on the Guides?
A: Since the operating income deductions have a considerable impact on the listed companies, especially those on the verge of delisting, the SSE publicly solicited opinions on the Guides from all SSE-listed companies and the audit institutions engaged in the securities services before the official release. In the process of soliciting opinions, among the 1,994 SSE-listed companies, a total of 1,631 gave feedback, with 1,534 making no objections, accounting for 94.05% of the total; and 97 companies put forward opinions or suggestions on the Guides. Among the 73 audit institutions engaged in the securities service business, 52 gave feedback, with 19 of them making no objections and the remaining 33 submitting opinions or suggestions on the Guides. On the whole, the Guides were endorsed and recognized by listed companies and audit institutions. The feedback from the listed companies and audit institutions mainly focused on the issues such as the definition of the quasi-financial businesses, the deduction standards for the newly added trade businesses, and the standards for judgment of stable business models. The SSE has revised and improved the Guides based on the feedback and suggestions, and will further strengthen practical guidance through training in the future.
Q5: After the Guides are implemented, how should listed companies effectively conduct information disclosure?
A: The board of directors of the listed companies should organize relevant personnel to carefully study the new delisting rules and the relevant provisions of the Guides, and do a good job in the identification and information disclosure of business income deduction items. In terms of identification, the listed companies shall not recognize the incomes from the contracts without commercial reality, and the incomes from the abnormal transactions with no real business or with obviously unfair transaction prices. On this basis, if the audited net profits of a listed company before or after the deduction of non-recurring gains and losses in the most recent fiscal year is negative, the company should refer to the Guides to comprehensively consider the degree of correlation between the relevant incomes and the company’s normal business operations and the sustainability of the incomes, and make reasonable judgments based on the company’s actual situations. In terms of information disclosure, the listed companies should list in the annual report the specific deductions from operating income item by item and the amount of operating income after the deduction in strict accordance with the format requirements in the attachments to the Guides.
Q6: What are the main considerations for the verification responsibility of audit institutions highlighted in the Guides? How should the annual audit accountants conduct effective verification?
A: The new delisting rules specify that the annual report audit institutions shall issue a special verification opinion on whether the operating income deductions are appropriate for a listed company, so as to urge the audit institutions to shoulder their responsibility as “gatekeepers”. Judging from the delisting regulation of the SSE in 2020, the audit institutions played an important part in the regulation of delisting for financial factors. Therefore, the Guides issued this time emphasize the verification requirements for audit institutions and continue to hold audit institutions accountable.
When implementing the Guides, the annual audit accountants should focus on verifying whether the current incomes of a listed company are true and accurate, and take into account the factors such as the company’s size and historical operating conditions to further verify whether the deductions from the listed company’s operating incomes meet the requirements of the Guides and related provisions. If a company records an operating income less than RMB100 million but the net profits before or after the deduction of non-recurring gains and losses are positive, the annual audit accountant should issue a special verification opinion by paying attention to the authenticity, accuracy and completeness of the disclosed non-recurring gains and losses.
Q7: After the release of the Guides, what especially should investors pay attention to?
A: According to the new delisting rules, after the disclosure of the 2021 annual reports, if a listed company triggers for the first time the financial delisting indicator that the net profits before or after the deduction of non-recurring gains and losses are negative and the operating income is less than RMB100 million, it will be put under the delisting risk alert (*ST). The companies that have already been under the delisting risk alert, namely the *ST companies, will be directly delisted if they continue to hit the delisting indicators in 2021. With close attention to the announcements that may be disclosed by relevant listed companies, such as the annual performance forecasts, correction announcements on performance forecast, express reports on performance, correction announcements on express report on performance, and risk reminders, investors should make cautious investment decisions to effectively ward off investment risks.
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