Moody’s ‘Red Flags’ Chinese firms

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The Chinese flag is not the only one which is red, Moody?s decided to raise a red flag as well.

Moody’s, the credit rating firm, warned of ‘red flags’ at 61 rated Chinese companies that ignited worries about their corporate governance.

Moody?s looked at criteria that ?highlight issues meriting scrutiny to identify possible governance or accounting risks for non-financial corporate issuers in emerging markets? and relate to issues such as weak corporate governance, riskier or more opaque business models, fast-growing-business strategies, poorer quality of earnings or cash flow, and concerns over auditors and quality of financial statements, the report, issued Monday, said.

It noted that in recent weeks, a number of market participants including the U.S. Securities and Exchange Commission are looking into potential problems with the quality of financial reporting from publicly listed Chinese companies.

The report didn’t include any ratings actions. Of the 61 companies, 49 have speculative-grade ratings.

HK-listed companies on radar

Following the ratings, four Hong Kong-listed companies were highlighted as having a particularly large amount of red flags: West China Cement?Ltd. had 12,?Winsway Coking Coal Holdings?Ltd. had 11,?China Lumena New Materials?Corp. had 10, and?Hidili Industry International Development?Ltd. had nine.

West China Cement tumbled 8.1 percent to HK$2.60, the biggest drop on record, according to data compiled by Bloomberg. Moody?s said the company was among Chinese companies triggering ?red flags? for potentially risky business practices.

Moody’s wrote that Winsway, Lumena and Hidili, as companies that mine coal or other minerals, “tend to attract scrutiny because it is often hard to value these assets and reserves in terms of size, value, or ownership rights.”

Tumbling Effect?

Well the markets were not responding to the news very well.

Hong Kong stocks fell, sending the Hang Seng Index to its biggest two-day drop in 18 months, as?Europe?s widening debt crisis threatens exporters? earnings and after Moody?s Investors Service?recent rating.

Esprit Holdings Ltd. (330), which gets most of its revenue fromEurope, sank 4.7 percent. West?China?Cement Ltd. tumbled by a record 8.1 percent after Moody?s said the producer of the building product posed the biggest governance and accounting risks of 61 Chinese companies it analyzed.?China Overseas Land & Investment Ltd. (688), controlled by the nation?s construction ministry, declined 4.8 percent on concern the Chinese government is intensifying property curbs.

Winsway Coking Coal Holdings Ltd., which operates in Mongolia and transports coal to China, sank 7.5 percent to HK$2.98, and China Lumena New Materials Corp., a manufacturer of natural thenardite products, fell 7.6 percent to HK$2.81.?Hidili Industry International Development Ltd. (1393), a coal miner, retreated 5.4 percent to HK$6.15. The companies raised at least nine red flags of 20 criteria examined, according to the Moody?s report.

?Recently, investors have already been nervous about this kind of news, and it?s making them lose confidence in some private Chinese companies,? said KGI Asia?s Kwong. ?In the short term, investors will be more prudent in investing in them.?

The Hang Seng Index fell 2 percent to 21,903.18 at the midday-trading break, the biggest drop since May 23 and the biggest two-day fall since Feb. 8, 2010. All but three stocks declined on the 46-member gauge. The Hang Seng China Enterprises Index of Chinese companies? H shares sank 2.3 percent to 12,212.01.

Almost all the Chinese high-yield companies raised certain flags related to aggressive business practices and quality of earnings because of their rapid growth, the report said.

SEC Investigation

Accounting scandals at Chinese firms listed in the US have increased pressure on regulators in both nations. Since March, 30 US-listed Chinese firms have had their auditors resign and 20 have been delisted.

The Moody’s report comes as U.S.and Chinese officials meet in Beijing to discuss joint supervision of China-based audit firms that review U.S.-listed companies. “This, for sure, is a confidence crisis as it will be difficult for investors to distinguish which Chinese private company is good and which is bad, so they choose to avoid these companies,” said Ben Kwong, associate director of KGI Asia Ltd.

The chairman of the Public Company Accounting Oversight Board, James R. Doty, said he believed Chinese authorities shared the common goal of seeking to protect investors and ensure quality of audits.

?This meeting is the commencement of our accelerated efforts with the People?s Republic of China to forge a cooperative resolution to cross-border auditing oversight,? he said, speaking last week before leaving for China.

Beijing has balked at allowing inspections required by of audit companies operating inside China, contending they would violate its sovereignty. But progress through high-level economic talks has raised the likelihood of an agreement, says Paul Gillis, a professor of accounting at Peking University?s Guanghua School of Management.

?They may let them in jointly, with a team from the Ministry of Finance,? he said.

Scrutiny of auditing has taken on greater urgency as U.S.stock regulators and exchanges have suspended trading in more than a dozen Chinese companies whose shares were listed publicly through so-called reverse mergers, which involve the purchase of an existing public shell company.

Though many of such companies use U.S.-based auditors, the U.S. side has cited as a chief concern a lack of current, accurate information about the companies and their finances.

?Given the potential risks, investors should be especially careful when considering investing in the stock of reverse merger companies,? Lori J. Schock, director of the SEC?s Office of Investor Education and Advocacy, said last month in a statement.

The wave of lawsuits in the U.S.involving U.S.-listed Chinese companies continues to mount. With the arrival of this latest lawsuit, there have now been a total of 27 securities class action lawsuits filed against U.S. listed Chinese companies so far in 2011, representing about one-quarter of all 2011 securities lawsuit filings in the U.S.

Besides the U.S., there have also been concerns by investors in Singapore about Chinese companies, based on the various accounting issues that have come to light, according to an article by Bloomberg. Among other things, the article states that since 2008, more than ten percent of the Chinese companies listed on the Singapore stock exchange have been delisted or had trading in their shares suspended.

Sources: Reuters, Bloomberg, Businessweek, newsfeedresearcher, bbc, dandodiary, googlebulletin

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