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Americans
have learned quite a lesson from the collapse of giant corporations
like Enron and Worldcom over the past few years. The Sarbanes-Oxley
Act 2002 (SOX) was the immediate response by lawmakers to reinforce
confidence in the US stock market. SOX was needed to strengthen the
responsibilities of corporate and chief executives and their
accountability to their stakeholders. It promotes the disciplines of
corporate governance, strengthened internal control and the need for
independent external auditors. The roll out of SOX, a stringent
regulation, ensures that investors are better protected and
investments are more secured. However as many may have found,
difficulties can arise when it comes to practically applying it.
Fortunately a task force, called the Committee of Sponsoring
Organisations of the Treadway Commission (COSO) was formed in the US
to provide the necessary guidance to the market. The key output of
the commission that has helped companies worldwide in their
requirement evaluate internal controls is the Internal Control
Integrated Framework, more commonly known as the COSO
Framework.
Although
China lies on the other side of the world, it has not been lucky
enough to escape from corporate scandals similar to those that the
US has seen in the last decade. Misappropriation of funds at
state-owned banks, collusion between banks and companies for loan
credits and fraudulent financial reporting by large corporations
have been well publicised. In view of the potential adverse impact
of poor corporate governance on the economy, central government and
regulators have pushed forward a series of revised laws and
regulations to reshape the market. The laws adopted have followed a
rules based approach, similar to SOX in the US.
The
age of China “SOX”
On
27 October 2005, the Tenth National People’s Congress conducted
its Eighteenth Meeting at which it passed revisions to the
Securities Law of the PRC (中華人民共和國證券法)
and
the Company Law of the PRC (collectively known as the Two Laws)(中華人民共和國公司法).
The Two Laws lay down the foundation of corporate governance for
both listed and unlisted corporations and detail the requirements
and responsibilities of corporation and securities intermediates to
their stakeholders.
The
Two Laws are now in force, having become effective on 1 January
2006. Key revisions have been made to the following areas:
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directors’
and shareholders’ responsibilities; |
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directors’
nomination / re-appointment / retirement; |
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supervisory committee (董事會)
responsibilities
and their powers to oversee the Board of Directors (BOD); |
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minimum
number of directors meeting/quorum/members, independent
directors; |
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establishment
of internal control systems and policies and procedures; |
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notifiable
transactions; |
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IPO
securities underwriter’s responsibilities, qualification and
conduct; |
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securities
underwriter’s representation that the listing applicant has
complied with all listing rules (i.e. not limited to proper
internal control); |
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insider
dealings. |
Failure
to comply with these new regulations will result in criminal
consequences for the directors of companies or securities
intermediates.
China’s
stock exchanges issue mandatory internal control guidelines
In
June 2006, the Shanghai Stock Exchange (SHSE) issued the “Shanghai
Stock Exchange Guidelines for the Internal Control of Listed
Companies" (上海證券交易所上市公司內部控制指引)
and
shortly afterwards in September 2006 the Shenzhen Stock Exchange (SZSE)
issued the “Shenzhen Stock Exchange Guidelines for the Internal
Control of Listed Companies" (深圳證券交易所上市公司內部控制指引)
,
both in line with the Two Laws. Companies listed on the main board
of these stock exchanges will need to implement these guidelines
effective from 1 July 2006 for SHSE and 1 July 2007 for SZSE.
The
most significant expectations outlined in these guidelines are a
greater onus on the directors and audit committee to be accountable
to shareholders. Companies must undertake an evaluation of their
internal control systems and are required to perform an audit on the
management’s evaluation and attestation of the effectiveness of
its system of internal control. Both the firm and the individual
signing partner of the firm performing this audit will be held
accountable for the opinions they provide.
It
is also interesting to note that the guidelines mirror some of the
principles of the COSO framework such as the promotion of
comprehensive and effective internal control systems and the
enhancement of risk management capabilities.
What
is next?
The
changes are now in place to enable listed companies in China to
further their pursuit of an era of good corporate governance. In the
next issue of Insight, we will look in more detail at the
requirements of the SHSE and SZSE internal control guidelines and
the market reactions to China’s “SOX”.
chris.tam@gthk.com.hk
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