On 19 November 2021, SZSE published No. 12 Business Guideline for Listed Companies---Operating Income Deduction Matters and No. 13 Business Guideline for listed Companies on the ChiNext Market----Operating Income Deduction Matters (collectively “Deduction Guidelines”). SZSE Press Secretary answered the questions of reporters with respect to relevant matters.

I. Q: How to understand the background and significance of formulating and issuing the Deduction Guidelines?

A: To carry out the Implementation Plan for Perfecting the Delisting Mechanism for Listed Companies, further improve the market-oriented regular delisting mechanism, purify capital market ecology and protect legitimate rights and interests of investors, at the end of 2020, SZSE unveiled the Rules Governing the Listing of Shares on Shenzhen Stock Exchange (Revision in 2020) and Rules Governing the Listing of Shares on the ChiNext (Revision in December 2020) (collectively “Stock Listing Rules”). Specifically, the composite delisting indicator (the “net profit + operating income” indicator) of “the lower of net profits before and after deducting non-recurring gains and losses is negative and operating income is less than RMB 100 million” was added to replace the indicator of “single net profit is negative and operating income is less than RMB 10 million”. The sustainable operation capacity of listed companies was analyzed in dimensions to prevent “shell companies” from avoiding delisting through non-recurring gains/losses, promote market clearing and improve the quality of listed companies.

According to the Stock Listing Rules, a company, if the lower of net profits audited in the last accounting year before and after deducting non-recurring gains and losses (the lower of net profits before and after deduction) is negative, shall disclose operating income deduction and the operating income amount after deduction in its annual report. The operating income shall be deducted by the income from business irrelevant to principal business and the income without commercial substance. Annual audit institutions shall issue verification opinions regarding whether a company's operating income deduction is compliant with the law and the operating income after deduction is accurate.

After the issuance of the Stock Listing Rules, SZSE successively received inquiries from listed companies and relevant annual audit institutions which expected more detailed operating income deduction standards as guidance for practice. To respond to market concerns, in April 2021, SZSE issued the Notice on Operating Income Deduction under New Delisting Regulations (the “Notice”). Following the issuance of the Notice, 502 SZSE-listed companies disclosed operating income deductions in their 2020 annual reports, representing good implementation of the regulations on the whole.

2021 is a critical year for implementing new delisting regulations. To further unify implementation standards, SZSE summarized the operating income deduction by listed companies in their 2020 annual reports and regulatory practice, and drafted the Deduction Guidelines on the basis of the Notice to guide listed companies and annual audit institutions to properly disclose operating income deduction in their 2021 annual reports.

II. Q: What are main ideas for formulating the Deduction Guidelines?

A: First, refining implementation standards and cracking down on intentional avoidance. The operating income deduction is directly associated with delisting. In the practice of operating income deduction by listed companies in their 2020 annual reports, a few companies committed an act of intentional avoidance. Based on the regulatory practice for 2020 annual report, the Deduction Guidelines further refined the implementation standards for operating income deduction, aiming to crack down on “shell companies” and eliminate “zombie enterprises”.

Second, defining intermediary responsibilities and highlighting the role of “watchdog”. The premise of implementing the indicator of “net profit + operating income” is to accurately calculate income and profit, imposing higher requirements on the practice of annual audit institutions. The Deduction Guidelines further highlighted the control responsibilities of annual audit institutions, refined the requirements on their issuance of verification opinions and clarified circumstances subject to key verification.

Third, specifying market expectations and improving service quality. As the disclosure of 2021 annual report has not yet started, the issuance of the Deduction Guidelines will help clarify market expectations and facilitate listed companies to prepare annual reports and prepare for their disclosure. Meanwhile, this move will also help annual audit institutions to understand verification priorities of operating income deduction matters before their mobilization and communicate with listed companies, thereby promoting smooth annual audit.

III. Q: What are main contents of the Deduction Guidelines?

A: Part I is general requirements. First, the scope of application is set forth, i.e., companies, if the lower of net profits before and after deducting non-recurring gains and losses is negative, shall make a deduction from operating incomes. Listed companies shall ensure the accuracy of operating income, non-recurring gains and losses and operating income deduction and shall not avoid delisting by adjusting income, net profit or non-recurring gains and losses. Second, related listed companies shall make operating income deduction in compliance with applicable regulations taking into consideration industrial characteristics, their operation modes, relevance to principal business and commercial substance of trading. Third, listed companies shall present operating income deductions and amounts one by one in the form attached to the Deduction Guidelines.

Part II is about specific deduction items. The Deduction Guidelines require clarification of operating income deduction items in the form of “definition + example”. First, it is clarified that the income from business irrelevant to principal business includes the income from other business than normal operation, non-qualified quasi-financial business income, and income from quasi-financial and trade businesses increased in this and last accounting years. Second, it is clarified that the income without commercial substance includes the income from business at obviously unfair trading price, income from subsidiaries or business consolidated in obviously unfair consideration or non-trading form and the income involved in the non-standard audit opinions.

Part III is verification requirements on intermediaries. First, if the operating income of companies is less than RMB 100 million and the lower of net profits before and after deduction is positive, the annual audit institutions shall issue verification opinions on the accuracy of their recognition of non-recurring gains and losses. Second, to avoid conflict between audit opinions and operating income deduction, if standard unqualified opinions are issued but there is income without commercial substance among operating income deductions, annual audit institutions shall conduct verification and give explanations. Third, annual audit institutions shall analyze whether a stable business mode can be formed based on business sustainability and value created by companies.

IV. Q: What are the changes of deduction item in the Deduction Guidelines compared with the Notice?

A: The Deduction Guidelines are drafted on the basis of the Notice and basically follow the provisions of the Notice. In addition, relevant deduction standards are further clarified in light of the regulation compliance in 2020 annual reports.

First, refining deduction requirements on trade and quasi-financial business. It was found in 2020 annual report supervision that, some companies suddenly expanded incomes through trade and quasi-finance to avoid delisting. However, the nature of “shell company” cannot be fundamentally changed because investment in trade and quasi-financial business is generally small and access and exit costs are low. On this basis, the Deduction Guidelines set out that, the income from qualified quasi-financial and trade business added in this and last accounting years shall be deducted, so as to guide listed companies to select the business that can substantially improve sustainable operation capacities during business expansion and transformation. At the same time, unqualified quasi-financial business is irrelevant to principal business. Thus, the income from it (such as income of interest from lending funds) shall be deducted every year to prevent listed companies from turning away from the real economy to the virtual economy.

Second, specifying the principles for analyzing whether business mode is stable. It was found in 2020 annual report supervision that, some companies concentrated efforts on transformation at the year end, and added business irrelevant to principal business and recognized a large amount of income to avoid delisting. The businesses acquired from the transformation are often simplex in customers and low in continuous stability, which won't help improve sustainable operation capacity of companies substantially. On this basis, the Deduction Guidelines list the incomes that don't or can hardly form a stable business mode and require deduction thereof. In addition, it is further clarified what circumstances shall be noted in analyzing whether business mode is stable or not.

Third, one requirement was added that, the income from subsidiaries or business consolidated with obviously unfair consideration or in non-trading form shall be deducted. It was found in 2020 annual report supervision that, some listed companies included relevant enterprises in their consolidated statements to increase operating income to avoid delisting by accepting entrusted voting rights and donation without paying trading consideration. However, it is doubtful whether relevant listed companies can really control the enterprises consolidated via the above methods, and the continuity of the “cooperation” between the two parties is uncertain. On this basis, the Deduction Guidelines set forth that “the income from subsidiaries or businesses consolidated with obviously unfair consideration or in non-trading form during the reporting period” shall be deducted.

V. Q: What about opinion solicitation for the Deduction Guidelines?

A: As operating income deduction has great impact on listed companies, especially the companies with delisting risk, prior to the publication of the Deduction Guidelines, opinions were sought from all SZSE-listed companies, and annual audit institutions engaged in securities service. During the solicitation period, 2,518 (99.6%) of 2,529 SZSE- listed companies expressed their opinions. 2,324 (92.3%) had no objection to the guidelines and 194 (7.7%) put forward opinions or suggestions. 52 out of 73 annual audit institutions gave feedback. 19 had no objection and 33 put forward opinions or suggestions. Overall, the Deduction Guidelines were affirmed by SZSE-listed companies and annual audit institutions. The opinions and suggestions proposed by listed companies and annual audit institutions were mainly about principles for analyzing whether a business mode is stable, the standard for deducting new trade business income and optimization of the forms of disclosing operating income deduction. SZSE analyzed and discussed them one by one, adopted relevant opinions and suggestions, and perfected the Deduction Guidelines through modification.

VI. Q: What relevant work shall be done by listed companies after the Deduction Guidelines take effect?

A: The board of directors of listed companies shall organize relevant personnel to carefully learn new delisting regulations and the Deduction Guidelines and earnestly carry out relevant work such as operating income deduction recognition and information disclosure. If the lower of net profits before and after deduction is negative, reasonable judgment shall be made with reference to the Deduction Guidelines and based on the relevance of incomes to normal business of listed companies and the sustainability, and actual conditions. Regarding information disclosure, relevant listed companies shall promptly disclose a risk warning about circumstances that may trigger a delisting standard and list operating income deductions in detail in the disclosed annual reports.

VII. Q: What shall investors focus on after the release of the Deduction Guidelines?

A: According to new delisting regulations, after the disclosure of 2021 annual reports, in case a listed company triggers the “net profit + operating income” standard for the first time, a delisting risk warning will be given to its stock. If a listed company received a delisting risk warning after disclosure of 2020 annual reports, it shall be delisted upon if relevant delisting circumstance occurs again in 2021. Investors shall pay high attention to the announcements such as annual performance forecasts, performance forecast corrections, preliminary results and risk warnings that may be disclosed by relevant listed companies, prudently make decisions about investment and take effective measures to guard against investment risks.