Allegations of fraud and accounting irregularities at Chinese companies are likely to continue for at least the near term and the accusations may hamper the firms’ access to funds regardless of the claims’ merit, Fitch Ratings said.
A string of fraud allegations against Chinese companies listed in North America, often made by investors shorting the stock involved, has sparked a sell-off in China-related equities.
This negative investor sentiment may continue in the short term as many Chinese companies are now being identified as having weak accounting or corporate governance standards, Fitch said in a report on corporate governance on Monday.
“Overseas investors are now undertaking the job that China’s under-developed capital market has hitherto struggled to address – challenging Chinese corporate management to adopt higher international standards,” said John Hatton, Fitch’s group credit officer for Asia-Pacific companies.
Fitch’s study follows a report from Moody’s Investors Service last week which raised similar concerns about 49 Chinese companies and triggered a fall in many of their share prices. .
SIGNS OF WEAKNESS
Fitch said an analysis of its portfolio of 35 Chinese companies, which mainly have credit ratings below investment grade, highlighted a number of different criteria that may point to weak corporate governance or mask problems in their financial controls.
These include having long-serving independent directors, ownership concentrated in the hands of a small number of individuals, significant revenue and capital-expenditure growth and a high cash-to-debt ratio.
While none of these factors mean a company is fraudulent, they can make it harder for the company to rebut allegations of irregularities, Fitch said.
“Today’s report highlights widespread weaknesses which may lead to the ‘event risk’ that any diligent company, albeit adhering to local business practices, could be vulnerable to exaggerated claims of irregularities,” said the report.
Companies which had several weakness indicators include B+ rated China Medical Technologies Inc which is listed on Nasdaq.
Fitch noted that China Medical’s chairman holds 23 percent of its stock, it has at least one independent director who has been on its board for more than five years, has significantly high profit margins, pays a low level of tax and its assets are largely technology platforms that are hard to value.
Two solar panel makers, Hong Kong-listed GCL-Poly Energy Holdings Ltd and New York Stock Exchange-listed LDK Solar Co Ltd , also show several weakness indicators including concentrated ownership and volatile profit margins, it said.
SINO-FOREST NOT INDICATIVE
Sino-Forest , one of the most high-profile targets of fraud allegations, exhibits a number of weaknesses in its financials including a significant growth in revenue and capital expenditure and paying zero tax on cash earnings, Fitch said.
Fitch withdrew its ratings on Toronto-listed Sino-Forest last week, after downgrading it two notches to BB in June.
The agency said the downgrade and subsequent withdrawal were prompted by the company disclosing it did not directly take cash from its customers, but rather they paid its suppliers who restocked the company’s forestry holdings.
It was this, rather than wider concerns over its corporate governance standards, that prompted the ratings withdrawal, it said.
“As a result, the agency does not regard the downgrade rationale for this issuer as indicative of likely pressure on other ratings,” Fitch said.