Audit committee overhaul under new listco rules

By Wang Yuanyuan, Grandway Law Offices
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Under registration-based listing, regulators are paying more attention to the completeness of internal controls of prospective listed companies, particularly the establishment and operation of audit committees under the board of directors.

The draft for comments on the Amendments to the Company Law, issued on 24 December 2021, strengthened the audit committee’s position in the operation and governance of a company. The Rules Governing the Listing of Stocks on the Shanghai Stock Exchange (Draft for Comments) and the Rules Governing the Listing of Stocks on the Shenzhen Stock Exchange (Draft for Comments), issued on 10 December 2021 (collectively, the new rules) provided detailed definition on an audit committee’s position in the regular operation of a prospective listed company.

Original provisions

Before the introduction of the new rules, provisions on audit committees included articles 38 and 39 of the Guidelines for the Corporate Governance of Listed Companies promulgated by the China Securities Regulatory Commission (CSRC), the Guidelines of the Shanghai Stock Exchange for the Operation of Audit Committee under the Board of Directors of Listed Companies, articles 2.5.3, 2.5.6 and 2.5.12 of the Guidelines of the Shenzhen Stock Exchange for Standardised Operation of Listed Companies, and the Rules Governing the Listing of Stocks on the Beijing Stock Exchange.

Truthfully, audit committees have not received sufficient attention. Most listed companies have only the minimum number of members required by law for their audit committees and, except for one independent director being required to have a financial background, no such requirement exists for other members. Therefore the audit committee cannot effectively supervise the company’s finance and accounting.

Overhaul under new rules

Wang Yuanyuan, Grandway Law Offices, Audit committee overhaul under new listco rules
Wang Yuanyuan
Partner
Grandway Law Offices

Under articles 64, 125 and 153 of the draft for comments on the Amendments to the Company Law, limited liability companies, joint stock companies and solely state-owned enterprises may set up special committees, such as audit committees, composed of directors under the board of directors, according to the articles of association and other provisions. The audit committee is responsible for supervising the company’s finance and accounting. Where more than half the members of its audit committee are non-executive directors or external directors, the company is permitted not to have a board of supervisors, or any supervisor.

The listing rules (drafts for comment) for both the Shanghai and Shenzhen stock exchanges provide in their respective article 4.2.12 that a listed company shall establish an audit committee under the board of directors, and its internal audit department shall be accountable to and report to the audit committee.

The draft for comment of the Amendments to the Company Law expressly provides that the audit committee has equal standing to the board of supervisors, and may replace the board of supervisors when more than half its members are non-executive directors or external directors; and that the audit committee supervises the company’s finance and accounting, and exercises other functions and powers specified in the articles of association. Both listing rules (drafts for comment) define the relationship between the internal audit department and the audit committee, in that the internal audit department is accountable and reports to the audit committee.

Our advice

Although the new rules are still in the process of soliciting comments, the audit committee, as a special committee with professional accounting and financial capability, has become highly valued by regulators for improving corporate internal control.

The author believes companies undergoing pre-listing tutoring, including those to be listed on the Beijing Stock Exchange, should consult the new rules and strive for effective, procedure-based operation of an audit committee from the following aspects, to achieve comprehensive and effective internal control.

(1) Clarify the internal position of an audit committee. The audit committee is a standing special committee under the board of directors. In terms of internal structure, the internal audit body should report to the audit committee, and the audit committee should report to the board of directors. When establishing an audit committee, prospective listed companies should clarify its legal status.

(2) Ensure a high-functioning system. (i) From the aspect of system improvement, expressly defined in the company’s articles of association, the exact responsibilities and authorities of the audit committee, and the relationship between the internal audit body and the audit committee.

(ii) Clarify the reporting and working rules between the internal audit department and the audit committee, with attention paid to bridging the internal audit system and the working rules of the audit committee.

(iii) Clarify the audit committee’s composition and the system of electing, removing and assessing its members, and give preference to directors with financial backgrounds.

(3) Strengthen procedure-based functioning of the audit committee. The function of an audit committee intersects and integrates with that of the board of directors, the board of supervisors, independent directors and the internal audit department, and most audit committee members have dual or multiple roles. Companies are advised to ensure the audit committee’s independence by paying attention to the following:

· Clarify the ranking between audit committee members and members of other departments, and differentiate the multiple roles of audit committee members to avoid any overlap of functions and authority;

· Provide the audit committee with a separate workplace and dedicated staff, and set up a separate working file recording the procedures and results of the audit committee; and

· Establish a daily working, reporting and meeting system for the audit committee, and manage it at the standards for a standing department.

Wang Yuanyuan is a partner at Grandway Law Offices

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