Hksi_study_manual_l16_eng.pdf k1n2r

Important Note As of 3 March 2014, the Securities and Futures Commission has changed the terminology used in the Codes on Takeovers and Mergers and Share Repurchases (“the Codes”) from share “repurchases” to share “buy-backs.” As a result, the Codes have been renamed the Codes on Takeovers and Mergers and Share Buy-backs. The change in terminology applies to this study manual.

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STUDY MANUAL FOR

PAPER 15 SPONSORS (PRINCIPALS) AND PAPER 16 SPONSORS (REPRESENTATIVES)

of

the Licensing Examination for Securities and Futures Intermediaries

First Edition, September 2013

Published by: Hong Kong Securities and Investment Institute First edition © Hong Kong Securities and Investment Institute 2013

24/F, Wing On Centre, 111 Connaught Road Central, Hong Kong Telephone: (852) 3120-6100 Examinations hotline: (852) 3120-6220 hip hotline: (852) 3120-6170 Training hotline: (852) 3120-6200 Fax: (852) 2899-2611 Email: [email protected] Website: www.hksi.org

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of the copyright owner.

ISBN: 978-988-19913-4-8

Disclaimer This manual is for educational purpose only and does not form any legal and/or expert opinion or advice in whatsoever form by the Hong Kong Securities and Investment Institute (“HKSI”) and/or its consultants and shall not be so relied upon. While every effort has been made to ensure its accuracy, the HKSI and/or its consultants give no warranties and/or representations in relation to any materials in and/or contents of this manual. Under no circumstances shall the HKSI or its consultants be liable for any direct or indirect or implied loss or damage caused or alleged to be caused by reliance on any materials in and/or contents and/or omissions of this manual. Without prejudice to the generality of the foregoing, the HKSI and/or its consultants shall have no such liability regarding the fitness for purpose, quality or merchantability of the manual, whether express or implied, statutory or otherwise.

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A Note from the Consultants The significant developments Hong Kong has undergone in the last several years as a venue for raising capital is largely a result of the increased number of mainland China enterprises seeking access to international capital and the status associated with listing on an open international exchange. Additionally, foreign companies with important markets in China may perceive the Hong Kong IPO market as a venue of choice by virtue of its geographical proximity to China and its standing as a sophisticated marketplace, as well as Hong Kong’s reputation for upholding the rule of law. These developments have not come without associated challenges to maintain and develop standards. This manual deals with one component of Hong Kong’s overall success as an IPO market, namely, the role of the sponsor, a role that has come under greater scrutiny following incidents, some minor and some notably quite major, where sponsors failed to properly execute their functions. The recent consultation on IPO sponsors undertaken by the regulators (HKEx and the SFC) and the industry seeks to strengthen and protect the market: the authority of sponsors and their ability to manage the listing process has been facilitated; the ways that sponsors can be licensed or ed have been expanded; and the process of assessing and handling sponsor’s work product has been streamlined. Underlying these developments is an expectation of the regulators that sponsors must move toward higher quality work through the adoption of stronger attitudes to standards, ethics and professional integrity. A clarification as to the criminal liability of sponsors working on prospectuses under the Companies Ordinance has also been proposed and at the time of writing is expected to come into law in 2014, though no draft Bill has as yet been published. In addressing the sponsor regime and these developments in this manual, we have taken a different approach to the construction of the syllabuses for Principals and representatives from the HKSI’s other manuals: we have combined two syllabuses into a single manual, using a graphic device (shaded text) to differentiate the two. We have employed this combined approach: •

to encourage representatives to read further into and gain a better understanding of the scope of the sponsor role, should they wish to do so; and

•

to assist representatives who have already studied the manual and ed the representatives’ exam to prepare for sitting the Principal’s examination should they wish to proceed to that status at a later time.

Our writing of the manual was greatly facilitated by the HKSI’s development team, Ireen Yeung and Katherine Chan, whose commitment to the many detailed aspects of producing this manual undoubtedly improved the finished product. Syren Johnstone University of Hong Kong Philippe Espinasse P&C Ventures Limited September 2013

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Acknowledgements Mrs. Edith NGAN CHAN, the Chief Executive of the HKSI, would like to express her gratitude to the following people for their involvement, suggestions and in the development of the study manual: Consultants Mr. Syren JOHNSTONE of the University of Hong Kong, and Mr. Philippe ESPINASSE of P&C Ventures Limited Working Group Mr. Allen TZE of Reorient Financial Markets Limited, and Mr. Nigel DAVIS of the University of Hong Kong Board 2012-2013 Mr. Craig B. LINDSAY (Chairman for 2013), Mr. Anthony Y.T. MUH (Chairman for 2012), Mr. Bryan CHAN, Mr. Ringo K.K. CHIU, Prof. Michael A. FIRTH, Ms. Samantha S.Y. HO, Prof. Simon S.M. HO, Miss Angelina A. KWAN, Dr. Cynthia LAM, Mr. John M. MAGUIRE, Mr. Colin S. SHAFTESLEY, Mr. Derek SHEK, Mr. Trini TSANG, Mr. Philip A. TYE, Ms. Anna WONG, Mr. Peter S.H. WONG, Mr. Stephen Y.K. WONG, Mr. S.F. WONG and Mrs. Edith NGAN CHAN Examinations Committee 2012-2013 Mr. Colin SHAFTESLEY (Chairman for 2013 and 2012), Mr. Bryan CHAN, Mr. Steve H.W. CHAN, Ms. Julia CHARLTON, Mr. Paul K.K. CHENG, Ms. Catherine CHEUNG, Mr. Gary CHEUNG, Mr. Thomas HULME, Prof. Vincent KWAN, Mr. Lionel KWOK, Prof. Kin LAM, Mr. Christopher LEE, Mr. Roger K.K. LEE, Mr. William LEUNG, Mr. Craig B. LINDSAY, Mr. Anthony Y.T. MUH, Mr. David C.K. NGAI, Ms. Barbara SHIU, Mr. Trini TSANG, Ms. Jill WONG, Mr. S.F. WONG and Mrs. Edith NGAN CHAN HKSI Project Team (Development Team, Curriculum & Examinations Department) Ms. Ireen YEUNG (Director of Curriculum & Examinations), Ms. Katherine CHAN (Senior Manager), Mr. Trevor CHU (Manager), Mr. Hugo CHU and Ms. Rose Mary Chan

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Summary syllabus To identify the distinction between the syllabus requirements of the two papers in the table below, the following highlighting system is used: -

no highlighting indicates the whole section is applicable to both Papers 15 and 16;

-

dark grey indicates the section contains materials exclusively for Paper 15;

-

light grey indicates the section is generally applicable to both Papers 15 and 16 but that there are some subsections that contain more detailed information for Paper 15 only.

Topic 1: General framework 1

Background to the sponsor regulatory regime

2

Going public

3

The role of the sponsor in the marketplace

4

Legal considerations

5

Licensing and registration requirements

6

Applicable regulatory codes and rules

7

Compliance advisers

8

SFC’s powers

Topic 2: The Listing Rules and the IPO listing process 1

Methods of listing and offering mechanisms

2

Specific listing requirements for equity securities

3

Corporate istration of the listing applicant

4

Specific issues in practice

5

The initial public offering process

6

Other important considerations

Topic 3: Preparation for an IPO assignment 1

Corporate istration of a sponsor

2

Preparation for managing an IPO

Topic 4: Preparation for a listing application 1

Obtaining assignments and working with third parties

2

Establishing the sponsor role

3

Advising the listing applicant

4

Conducting due diligence

5

Making a listing application

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6

Disclosure and communication

Topic 5: Due diligence 1

Preparation of the listing document-cum-prospectus

2

Conducting a due diligence exercise

3

Meaning of “professional scepticism”

4

Verification

5

Use of experts and other third parties

6

Management Discussion and Analysis of Financial Information and Condition

Topic 6: After prospectus issuance 1

Assessing the sponsor work

2

Compliance advisers

3

Case studies

4

Integrity and consequences

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About the Licensing Examination for Securities and Futures Intermediaries The Licensing Examination for Securities and Futures Intermediaries (“LE”) has been designed to accord with the single licensing regime under the Securities and Futures Ordinance. Papers 1 to 12 have been approved by the Academic and Accreditation Advisory Committee of the SFC (“AAAC”) as a Recognized Industry Qualification and Local Regulatory Framework Paper for meeting the competence requirements of the SFC. Papers 15 and 16 have been approved by the AAAC for the purposes of the examinations under the sponsor eligibility requirements for Type 6 (advising on corporate finance) individuals wishing to engage in sponsor work as Principals and representatives, or relevant individuals respectively. The LE comprises the following fourteen examination papers*: Paper 1: Fundamentals of Securities and Futures Regulation Paper 2: Regulation of Securities Paper 3: Regulation of Derivatives Paper 4: Regulation of Credit Rating Services Paper 5: Regulation of Corporate Finance Paper 6: Regulation of Asset Management Paper 7: Financial Markets Paper 8: Securities Paper 9: Derivatives Paper 10: Credit Rating Services Paper 11: Corporate Finance Paper 12: Asset Management Paper 15: Sponsors (Principals) Paper 16: Sponsors (Representatives) * The LE does not comprise Paper 13 and Paper 14.

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About this study manual This manual has been designed to provide candidates with the information they need for the examination effective from 29 October 2013. Every effort has been made to ensure it is accurate at the time of publication. The manual provides guidance on ethics, sponsor work, and the legal and regulatory requirements governing the conduct of IPO transactions in Hong Kong. It is relevant to responsible officers of Type 6 licensed corporations and executive officers of Type 6 ed institutions seeking approval as Principals via the examination route (i.e. Paper 15) and to Type 6 licensed representatives or relevant individuals intending to engage in IPO sponsor work (i.e. Paper 16). The different topics in the manual review the laws, regulations, codes and guidelines that are relevant to undertaking the role of sponsor in Hong Kong. This includes the roles of the various regulators involved, the licensing, registration and supervision of intermediaries by the regulators, the requirements of the Listing Rules for sponsors and new listing applicants, as well as the regulatory codes issued by the SFC relevant to the conduct of sponsor work. In reviewing these subjects, the manual also discusses common industry practices and standards, as well as the importance of ethics. These subjects are divided into six Topics dealing with the general framework, the Listing Rules and the IPO listing process, preparation for an IPO assignment, preparation for a listing application, and due diligence. The final Topic discusses various case studies in the context of assessing sponsor work and the importance of ethics. Given that the relevant legal and regulatory requirements and market practices covered by the syllabus of the Papers 15 and 16 examinations may be revised, amended or updated from time to time, no express or implied warranty is given by the HKSI that the content of this manual is up-to-date or accurately reflects the current position. For the avoidance of doubt, this manual does not amount to or constitute any legal advice given by the HKSI and shall not be so relied upon. Candidates are reminded to keep abreast of any updates or amendments of the relevant legal and regulatory requirements and market practices by making reference to the relevant information published by the relevant authorities. For the purpose of the examination, however, unless updates on the relevant part of the manual are provided by the HKSI, examination questions will only be based on materials in the manual that are still current. Each topic in the manual consists of an overview, the expected learning outcomes, the study text itself, revision questions and answers, a brief summary and a checklist. Note: words carrying a masculine meaning are to be taken to include the feminine, and vice versa.

Important note to readers This manual combines the study materials for two papers as follows: Paper 15 Principals’ examination:

The whole manual (i.e. all text with or without any shading)

Paper 16 Representatives’ examination:

Only text without any shading.

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Learning outcomes Candidates are advised to use the “Learning Outcomes” section of each topic as an indication of the way in which the topic material is to be studied. It indicates the key areas of knowledge which they are expected to master and on which examination questions will be based. However, they may be tested on any aspect of the study manual unless it is specifically ruled out in the manual. Revision questions and checklists Revision questions and checklists are included in each topic to help reinforce candidates’ understanding of the material.

Module plan It is estimated that this study manual of Paper 15 will require a total of 70-80 hours while that of Paper 16 will require a total of 50-60 hours of study time for all six Topics, although candidates may need slightly less or more depending on their work experience and background.

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Updating this study manual Updates are produced at appropriate intervals to reflect changes in applicable laws, rules, regulations, codes and market practices in Hong Kong. Once an update is released, an announcement will be made on the HKSI website and the latest version of the E-Study Manual will be available for candidates to via the HKSI Online Registration and Enrolment System. Major updates made to the last version will also be placed at the end of the E-Study Manual for candidates’ reference. Candidates are advised to visit the HKSI website and log on to the HKSI Online Registration and Enrolment System regularly during their studies to ensure that they have the latest version of the E-Study Manual prior to taking the examination.

About the Papers 15 and 16 examinations Paper 15 is the special examination on ethics, sponsor work, and the legal and regulatory requirements governing the conduct of IPO transactions in Hong Kong for the purposes of the SFC’s eligibility criteria for Principals. Paper 16 is the relevant examination for the purposes of meeting the SFC’s eligibility criteria for representatives or relevant individuals engaged in sponsor work. Each of the Papers 15 and 16 examinations consists of 40 multiple-choice questions to be completed within 60 minutes. The mark is 70%. The study manual and its subsequent updates are the only source of materials for the setting of the questions, and candidates therefore need to study only the manual and updates to prepare for the examinations. The purpose of the examinations is to test candidates’ understanding of sponsor work, in particular the legal and regulatory requirements governing the conduct of IPO transactions in Hong Kong, as well as their general understanding of related matters with which practitioners at a Principal level (for Paper 15) and representative level (for Paper 16) should reasonably be expected to be familiar, including the practice and ethics of undertaking sponsor work. Since the securities and futures industry changes rapidly, the latest regulatory and market information may not be immediately included in this manual. Unless updates on the relevant information in the manual are provided by the HKSI, however, examination questions will only be based on the manual where the information is still current.

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List of useful websites 

Securities and Futures Commission www.sfc.hk/



Hong Kong Monetary Authority www.hkma.gov.hk/



Hong Kong Exchanges and Clearing Limited www.hkex.com.hk/



Department of Justice, HKSAR Government: Bilingual Laws Information System: www.legislation.gov.hk/



Hong Kong Legal Information Institute: Hong Kong Ordinances www.hklii.hk/eng/hk/legis/ord/



Companies Registry www.cr.gov.hk/



Hong Kong Securities and Investment Institute www.hksi.org/

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Licensing Examination for Securities and Futures Intermediaries on Study Manual for Paper 15 - Sponsors (Principals) & Paper 16 - Sponsors (Representatives) To:

Hong Kong Securities and Investment Institute

Attn.:

Curriculum and Examinations Department

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Topic 1: General framework Table of contents Topic overview

1

Learning outcomes

1

1

Background to the sponsor regulatory regime

2

Brief introduction to the sponsor regime

2

Going public

5

The primary capital market and Hong Kong in the global context

5

The role of the sponsor in the marketplace

7

Core regulatory roles and responsibilities of a sponsor Conceptual distinction from underwriter roles The sponsor’s role and the integrity of the commercial marketplace Multiple sponsors Other aspects of primary equity capital market transactions

7 7 9 9 9

2 3

4

Legal considerations

11

Securities and Futures Ordinance Companies Ordinance Other legal considerations

11 16 17

Licensing and registration requirements

18

Sponsor Guidelines

18

Applicable regulatory codes and rules

22

Codes and guidelines issued by the Securities and Futures Commission (“SFC”) Corporate Finance Adviser Code of Conduct Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited

22 23 24

7

Compliance advisers

26

8

SFC’s powers

27

Supervision and investigation Investigations of possible offences, etc. Offences Discipline SFC Disciplinary Fining Guidelines Co-operation with the SFC Public

27 27 28 28 29 30 30

5 6

Topic summary

31

Checklist

31

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Topic overview This Topic introduces the context of the work of a corporate finance adviser undertaking sponsor work on an initial public offering (“IPO”). It also introduces the general commercial, legal and regulatory framework within which a sponsor acts. The Topic commences with an introduction to the sponsor regulatory regime and its importance in the context of Hong Kong’s role as a primary capital market. The major legal considerations are then introduced, including the core licensing and registration requirements as well as the core regulatory rules and codes that affect the undertaking of sponsor work. The Topic concludes with a review of the powers of the Securities and Futures Commission (“SFC”) to supervise and investigate, and to apply disciplinary measures in cases of non-compliance with relevant regulations.

Learning outcomes At the end of this Topic, candidates should be able to: (a) understand Hong Kong’s primary capital market in the context of the global capital market; (b) understand the core regulatory roles and responsibilities of a sponsor and its relationship with the integrity of the Hong Kong market; (c) describe the roles and responsibilities of all parties involved in listings, especially sponsors, underwriters and compliance advisers; (d) understand the process of underwriting/syndication in a public offering; (e) identify the specific laws, regulations, codes and guidelines that have an impact on sponsor work; (f) describe the core licensing and registration requirements that apply to persons engaged in sponsor work; (g) demonstrate an understanding of the Corporate Finance Adviser Code of Conduct (“CFA Code”); (h) realize the importance of the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited (“Listing Rules” or “LR”) and the Rules Governing the Listing of Securities on the Growth Enterprise Market (“GEM”) of The Stock Exchange of Hong Kong Limited (“GEM Listing Rules” or “GLR”); (i) understand the functions of compliance advisers; and (j) outline the powers of the SFC.

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1

Background to the sponsor regulatory regime Brief introduction to the sponsor regime

1.1

Sponsors effectively act as the principal gatekeepers of market quality in a listing exercise and as such have a crucial role in the protection of investors. This is of particular importance in view of certain features of the Hong Kong market, including the unusually large proportion of listed companies and listing applicants whose domicile and main operations are located outside Hong Kong, the greater number of connected or related party transactions, and the extensive base of retail and institutional investors.

1.2

The listing of securities is primarily governed by the Listing Rules, which require all applicants seeking a listing on The Stock Exchange of Hong Kong Limited (“SEHK”) to appoint one or more sponsors for their listing application. A sponsor must be a licensed corporation or a ed institution holding a Type 6 licence or registration (advising on corporate finance) that is permitted under its licence or certificate of registration to undertake work as a sponsor (the licensing and registration requirements are discussed in section 5 below). A sponsor is expressly made responsible under the Listing Rules for preparing the company for listing, for lodging the formal listing application and all ing documents with the SEHK and the SFC, and for dealing with the SEHK on all matters arising in connection with the application. Note: The GEM Listing Rules tend to follow the structure and content of the Listing Rules, subject to some differences that reflect the different nature of the Main Board of the SEHK (“Main Board”) and GEM. References to the Listing Rules in this manual should be taken to cover the equivalent GEM Listing Rules. Where relevant, the differences in these two sets of rules will be indicated.

1.3

Sponsors play a unique role in leading and coordinating the entire process of a listing exercise. As personnel involved in sponsor work are expected to uphold high standards and to work in an ethical way and are subject to regulatory requirements above and beyond those that apply to corporate finance advisers not engaged in sponsor work. These are discussed in greater detail in sections 3, 5 and 6 below, and include: (a) the Listing Rules; (b) the Additional Fit and Proper Guidelines for Corporations and Authorized Financial Institutions applying or continuing to act as Sponsors and Compliance Advisers (“Sponsor Guidelines”) issued by the SFC; (c) certain provisions of the CFA Code; and (d) certain provisions of the Code of Conduct for Persons Licensed by or ed with the Securities and Futures Commission (“Code of Conduct”), in particular, paragraph 17, which specifically applies to licensed corporations or ed institutions undertaking sponsor work.

1.4

The responsibilities and scope of the sponsor role have been developing in recent years as new challenges arise in connection with listing exercises, in particular, IPOs. With a view to, among other things, maintaining the integrity of the market and improving the standards and competitiveness of the Hong Kong IPO market, there has been an increased focus on certain shortcomings with respect to the perceived or actual competence and integrity of sponsor firms. A thematic review of IPO sponsors undertaken by the SFC between 2009 and 2011 revealed some common problems particularly in relation to the quality of due diligence work and the adequacy of internal systems and controls over sponsor work. Where sponsors fail to substantially complete their due diligence before making a listing application, draft listing documents also fail to contain adequate and balanced disclosure about listing applicants. Sponsors that allocate insufficient staff or staff without adequate experience and skills to

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undertake sponsor work, or fail to properly supervise and review work undertaken by representatives, place themselves in an untenable position as regards meeting their regulatory obligations. In some cases, sponsors were unaware of their actual regulatory obligations. Topic 6 discusses these and other shortcomings that have led to problems in meeting the commercial objectives of listing applicants (such as delayed or cancelled IPOs), or to regulatory discipline in respect of the sponsors themselves. 1.5

As a result, regulatory changes to the IPO sponsor regime have been introduced to address such shortcomings. Their implementation should: (a) provide sponsors with more authority over an IPO through a streamlined and shorter regulatory process; (b) enable sponsors to manage the listing process more effectively, in particular leading to the production of a better quality first proof listing document, and better management of the overall deal risk; and (c) enhance market confidence and investor protection. Note: For further information, see the SFC’s Consultation Conclusions on the regulation of IPO sponsors issued on 12 December 2012.

1.6

Important reforms as of 1 October 2013 include the following: (a) publication of a substantially complete draft of the listing document (“Application Proof”) must now be filed with a listing application. From 1 April 2014, the Application Proof will also (with a few exceptions) be simultaneously displayed on the website of the Hong Kong Exchanges and Clearing Limited (“HKEx”). In addition, from 1 October 2013, a near final prospectus (in the form of a Post Hearing Information Pack or PHIP) will need to be published after hearing by the SEHK, and no later than on the start of institutional book-building, on the website “HKExnews”. Note: Further details about the publication of the Application Proof and requirement to publish a PHIP, including transitional arrangements, are set out in sections 5 and 6 of Topic 4. (b) reliance on experts and meaningful Management Discussion and Analysis of Financial Information and Condition (“MD&A”); and Note 1: Sponsors should ensure that the scope of experts’ work adequately covers the reliability of the information provided to such experts and that it critically assesses expert reports against the totality of the sponsor’s knowledge of a company and its industry sector to ensure that overall disclosure to the public is coherent and consistent. The use of experts is discussed more fully in section 5 of Topic 5. Note 2: Sponsors should also work closely with company management to produce a relevant, adequate and comprehensible MD&A. MD&As are discussed more fully in section 6 of Topic 5. (c) initiatives to enhance the sponsor’s role: any sponsor should be appointed by a listing applicant at least two months before a listing application. Note 1: Sponsors should notify the SEHK of any instances of non-compliance with the Listing Rules as well as upon the occurrence of material developments requiring disclosure and explain why, if and when they cease to act for a listing applicant. Note 2: Sponsors should get the commitment of the listing applicant and other professional advisers to fully co-operate with the sponsors in discharging their duties and listing applicants have responsibilities to assist their sponsors. Note 3: Sponsor fees must be specified in a sponsor’s of engagement and be related solely to the sponsor role (other services such as underwriting should

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accordingly be charged for separately). 1.7

The SFC’s consultations in 2012 further developed earlier reforms of the IPO sponsor regime. In October 2004, policy conclusions and rule amendments introduced changes and clarifications regarding the regulatory regime for sponsors that addressed, among other things: (a) when a listing applicant must appoint a sponsor or compliance adviser; (b) the role and responsibilities of listed issuers in assisting sponsors; (c) undertakings and declarations required to be given by sponsors to the SEHK; (d) independence requirements for sponsors; and (e) the roles and responsibilities of sponsors including the due diligence the SEHK expects sponsors should typically perform.

1.8

The SFC has powers to take action against sponsors that fail to discharge their duties properly. Examples of enforcement cases are provided in Topic 6.

Revision questions: Question 1: What type of regulatory licence must a sponsor hold to engage in sponsor work? Answer 1: A sponsor must be a licensed corporation or a ed institution holding a Type 6 licence or registration (advising on corporate finance) that is permitted under its licence or certificate of registration to undertake work as a sponsor. Question 2: Is there any difference between the regulatory obligations of corporate finance advisers and sponsors? Answer 2: Personnel involved in sponsor work are subject to regulatory requirements above and beyond the requirements that apply to corporate finance advisers that are not engaged in sponsor work.

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2

Going public The primary capital market and Hong Kong in the global context

2.1

There are a number of reasons why a company may choose to go public through a listing exercise. Shareholders (whether those of a business initially founded by a family, or financial shareholders, such as private equity or venture capital firms) can achieve liquidity for their holdings, while corporates themselves can through a stock exchange listing raise funds for their development and capital expansion plans. Other reasons for conducting a listing exercise may include attracting international investors to a company’s , for example, in the case of listing of a state-owned enterprise in People’s Republic of China on the SEHK.

2.2

The sale of existing shares (or “offer for sale”) and the issue of new shares (or “offer for subscription”) are frequently combined in an IPO. IPOs can also take the form of spin-offs or de-mergers from existing businesses (whether listed or unlisted). Companies may also secure a listing without offering any shares to investors, for example, when they are already listed on another stock exchange via a “listing by way of introduction”. Companies can choose to have the SEHK as the main exchange on which they list (a “primary” listing), or as a second marketplace for their securities (a “secondary” listing). A listing on the SEHK and another stock exchange may also happen simultaneously through a “dual listing” exercise. Methods of listing on the SEHK are further discussed in Topic 2.

2.3

According to the World Federation of Exchanges, Hong Kong has ranked as a top-5 global IPO market for a total of 11 years and was the No.1 IPO fund-raising centre globally between 2009 and 2011, ahead of the New York Stock Exchange, the London Stock Exchange, the NASDAQ Stock Market and Singapore Exchange Limited. In addition, according to HKEx, Hong Kong is an important venue for the raising of equity capital by listed companies, with the equivalent of US$327 billion raised in follow-on share offerings between 2003 and 2012.

2.4

At the end of 2012, HKEx ranked as the No.1 stock exchange in the world in of market capitalization relative to gross domestic product, emphasizing the importance of the exchange and the financial industry to the economy of Hong Kong. According to the Bank of New York Mellon, as at October 2011, US$544 billion in funds were invested in Hong Kong-listed equities.

2.5

According to the SEHK, as at the end of February 2013, a total of 1,554 companies were listed on the SEHK, representing a market capitalization of over HK$22,660 billion. For the month of February 2013, the average daily securities turnover on the exchange by value was over HK$70 billion, about 70% of which was made up by equity securities. As at the end of February 2013, a total of 736 H shares, red chips and mainland China private enterprises were listed on the SEHK.

2.6

Hong Kong differs from other major jurisdictions in several ways. First, as outlined above, the unusually large proportion of listed companies and listing applicants whose domicile and main operations are located outside Hong Kong lends particular importance to the role of sponsors. Second, historically, the participation of retail investors in IPOs has been significant, and explains the presence of claw-back triggers (which increase the size of the public offer relative to that of the institutional offer, depending on the level of oversubscription of the public offer) and which are unique to Hong Kong IPOs. Third, the China dimension is a unique characteristic of the SEHK. As at the end of February 2013, more than 47% of the companies listed on the SEHK were either H share companies, red chips or mainland China private enterprises. Such companies also ed for more than 56% of the SEHK’s market capitalization and for over 71% of the equities turnover by value.

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2.7

Initially (although there have been a handful of exceptions in the past) only companies incorporated in Hong Kong, mainland China, Bermuda or the Cayman Islands could list on the SEHK. The list of jurisdictions accepted for listing in Hong Kong has since been expanded to include an additional 21 jurisdictions as at 29 April 2013. This development is relatively recent and was introduced partly in response to interest from international companies in a Hong Kong listing.

2.8

In addition to ordinary shares, issuers are now also able to list units in real estate investment trusts and business trusts on the SEHK, as well as to conduct IPOs denominated in offshore Renminbi under the dual counter structure. The exchange includes a number of companies that are also listed on exchanges in other jurisdictions, and which have chosen Hong Kong, as their primary or secondary place of listing, alongside other marketplaces. Another fairly recent development is the ability of companies (especially foreign issuers) to list Hong Kong Depositary Receipts (“HDRs”) rather than shares on the SEHK.

2.9

Companies can choose to list on the SEHK on the Main Board (on which both shares and HDRs can be listed) or on GEM, a second board that also acts as a stepping-stone towards the Main Board.

2.10

As a listing venue, Hong Kong upholds high standards in of disclosure and the process through which listing applicants are assessed prior to achieving a listing for their shares or units on the SEHK. Sponsors have a particularly important role in ensuring that Hong Kong maintains its reputation as a strongly regulated marketplace, especially in the light of the cross-border nature of the majority of listings on the SEHK. The IPO process in Hong Kong differs from purely disclosure-based regimes in other countries. In Hong Kong, one or more sponsors must be appointed by a listing applicant to assess its suitability for listing, effectively act as a guide in relation to the listing exercise, conduct due diligence, assist with the listing document and help the issuer and its shareholders navigate the Listing Rules and relevant regulatory requirements. As such, the SEHK’s approval process places a particular focus on the critical role sponsors play in Hong Kong. Note: The listing requirements for equity securities are discussed in Topic 2.

Revision question: Question 3: In what ways does Hong Kong IPO market differ from other major jurisdictions? Answer 3: See section 2.6 above.

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3

The role of the sponsor in the marketplace Core regulatory roles and responsibilities of a sponsor

3.1

The overarching market regulatory functions of a sponsor are set out in paragraph 17.1(b), Code of Conduct as being the provision of: (a) general assurance to the SEHK and the market that: (i) the listing applicant is in compliance with the Listing Rules and other relevant legal and regulatory requirements; (ii) the listing document offers sufficient particulars and information to allow investors to form a valid and justifiable opinion of the listing applicant’s shares, financial condition and profitability; and (b) advice and guidance for the listing applicant in relation to the Listing Rules and other relevant regulatory requirements.

3.2

LR Chapter 3A dovetails with the above overarching regulatory functions in requiring a sponsor to: (a) be closely involved in the preparation of the new applicant’s listing documents; (b) conduct reasonable due diligence inquiries (see Topic 5, which discusses due diligence in detail, and section 5 of Topic 4 which discusses the declaration a sponsor is required to give to the SEHK regarding its due diligence exercise); (c) ensure the SEHK’s procedural requirements as regards submission of documents and publicity materials under LR 9.03 and 9.05 to 9.08 are complied with; (d) use reasonable endeavours to address all matters raised by the SEHK in connection with the listing application and compliance with the requirements of the Listing Rules, including the provision of further information and documents at the SEHK’s request in a timely manner; (e) attend and accompany the listing applicant to such meetings as the SEHK may require; and (f) comply with the of the sponsor’s undertaking and statement of independence given to the SEHK (discussed in section 2 of Topic 4).

3.3

How these various requirements are to be fulfilled in practice is introduced in subsequent topics of this manual. However, in one way or another, each of the above requirements set out the framework within which a sponsor should be executing its overarching responsibilities.

Conceptual distinction from underwriter roles 3.4

The sponsor has responsibility to assess the suitability of a listing candidate, and is also responsible for due diligence and disclosure, liaising with the regulators, and coordination of the work of all other parties, including the reporting ants, legal advisers, experts and other third parties, working on an IPO.

3.5

A sponsor firm can also have other roles when working on an IPO, essentially of an underwriting and marketing/selling nature. However, it is important to appreciate that the special regulatory status attached to the role of a sponsor is not relevant to the other roles a sponsor firm might play in connection with a listing exercise.

3.6

A sponsor firm is often (but not always) appointed as global coordinator (or t coordinator or, more rarely, co-global coordinator), which is essentially a coordination role of the various aspects of an IPO, including documentation, valuation and marketing work.

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There are a number of similarities between the work of a sponsor and that of a global coordinator, although the activities carried out by a sponsor differ in that it is also responsible for liaising and coordinating with the regulators (the SEHK and the SFC), whereas a global coordinator that is not acting as a sponsor has no such responsibility. 3.7

Another role commonly bundled with that of global coordinator is that of bookrunner (or t bookrunner or, more rarely, co-bookrunner). This is a marketing function that is primarily concerned with the marketing of shares (or units) to investors through the building of a book of demand, and with making recommendations to the issuer on the allocation of shares (or units) to investors. This is a role that an investment bank which acts as a sponsor can also have (and generally has, or should have, in order to ensure allocations are properly conducted in compliance with the applicable rules and regulations), and which is often combined with that of global coordinator. Global coordinators are normally also appointed as bookrunners, however, bookrunners are not always also appointed as global coordinators.

3.8

Global coordinators and bookrunners are also usually appointed as lead managers, which, in some transactions (although rare nowadays), entitles them (as with the global coordinator’s role) to a praecipium from the management, underwriting and selling fees payable to the of the syndicate in an IPO. As with the bookrunner role, lead managers are not necessarily appointed as bookrunners and global coordinators and, when this is actually the case, their role will usually be limited to writing pre-deal research report and underwriting a portion of the shares offered or sold. In particular, lead managers that do not also have other senior roles or titles will generally not sell stock to investors in an IPO. Some of these titles can also be further qualified or differentiated from those of other syndicate through the addition of a fairly rare “senior” (or other) prefix, for example “senior lead manager”. Note: A praecipium is a portion of the management and underwriting fees carved out for senior of a syndicate of underwriters.

3.9

Other, more junior, underwriting and selling roles (again, usually limited to writing pre-deal research report and underwriting a portion of the shares offered or sold) include: (a) senior co-lead manager; (b) co-lead manager; (c) senior co-manager; (d) co-manager; (e) sub-underwriter; and (f) selling group member. It is now rare for roles below co-lead manager to be included in underwriting syndicates. When this is the case, firms appointed in such roles are not usually also required to write pre-deal research reports.

3.10

There has been a recent trend, on the part of issuers from the mainland China in particular, to establish a large number of senior roles in large transactions in Hong Kong, for example, multiple houses in sponsor and especially global coordinator and bookrunner roles. This creates additional complexities in of coordinating the various aspects of such transactions, especially when some of these titles are only confirmed closer to launch.

3.11

A sponsor, when also appointed as a global coordinator, bookrunner and lead manager, may also be appointed as the stabilizing manager in the case that the IPO includes an overallotment option (or “Greenshoe option”). Topic 2 discusses the role of the stabilizing manager.

3.12

Issuers must also appoint receiving banks alongside other underwriters for the collection of money and retail clients’ applications under public offer tranches. These are usually

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commercial banks with branch networks, through which applications for shares (or units) in an IPO can be made by of the public. A number of these also offer facilities to apply for such securities through dedicated, -protected on-line portals. 3.13

Lastly, it is becoming increasingly common for issuers and their shareholders to appoint financial advisers (often with no equity research and securities distribution capabilities) to help safeguard their interests. Such financial advisers, who must be licensed or ed to carry out activities regulated by the Securities and Futures Ordinance (“SFO”), are often appointed ahead of sponsors and underwriters and indeed can play a role in the appointment of firms in such capacities. Financial advisers’ interaction with sponsors is discussed in Topic 4.

The sponsor’s marketplace 3.14

role

and

the

integrity

of

the

commercial

As mentioned above, the role of sponsors includes assessing the suitability of applicants for listing and coordinating the entire listing exercise, from the appointment of other parties, to conducting due diligence, to liaising with the SEHK and the SFC with respect to the listing application. In this way, sponsors play an essential role in maintaining the integrity of the SEHK as a commercial marketplace and in safeguarding the interests of the investing public. Sponsors failing to properly discharge their duties affect not only any future business that might come their way, but also the reputation of sponsors more generally, and of Hong Kong as an international financial centre. Accordingly, sponsors are subject to significant scrutiny by the SFC, and may also face severe sanctions, in certain cases. Examples of enforcement cases are provided in Topic 6.

Multiple sponsors 3.15

While a listing applicant is only required to appoint one sponsor, there may be cases where appointing additional sponsors becomes desirable. For example, this may be the case when the sponsor initially chosen by the listing applicant does not satisfy the independence test (see Topic 4). The issuer or listing applicant may also find it desirable to appoint more than one firm as t sponsors with complementary strengths, for example in a particular jurisdiction or industry sector.

3.16

Where more than one sponsor is appointed (which remains solely a commercial decision on the part of the issuer), one sponsor must be designated as the primary channel for communication with the SEHK. The SEHK expects that this would normally be a sponsor that is independent of the listing applicant. However, all sponsors appointed owe the same duty of care to the listing applicant and share the same responsibilities under the Listing Rules, including with respect to the advice they provide, the due diligence they undertake, and their own potential liabilities.

3.17

Appointing more than one sponsor, however, calls for increased coordination to avoid inefficiencies in the execution process and, ultimately, any failures in uncovering issues pertaining to the applicant. All sponsors must work tly to achieve these aims. Where one or more of the sponsors are not independent of the listing applicant, this necessarily gives greater importance to the role of sponsors that qualify as independent. The issue of impartiality and independence is discussed further in Topic 4.

Other aspects of primary equity capital market transactions 3.18

As mentioned above, a sponsor may also act in a (usually senior) underwriting and marketing/selling capacity in an IPO. While these are distinct from sponsor duties in their strictest sense, it is important to avoid information asymmetries between such roles (when

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not also carried out by a sponsor). Sponsors should also ensure there is no asymmetric information dissemination to potential investors. 3.19

Sponsors not involved in such roles should keep abreast of developments with respect to the involvement of other firms in the IPO through the syndication process, which will affect disclosure in various places in the offer document (among other areas, the cover of the listing document, the list of parties involved in the IPO and the “underwriting” – sometimes referred to as the “plan of distribution” – section).

3.20

They should also be kept informed of roadshow arrangements (and of the jurisdictions in which the IPO will be marketed). This will, for example, affect disclosure under the “underwriting” and “selling restrictions” sections of the listing document, for which the sponsor will be directly responsible. When an IPO is marketed in the United States (“US”) to qualified institutional buyers under a Rule 144A private placement, there may also be implications in of disclosure, including with respect to financial information and the MD&A.

3.21

Similarly, the allocation of stock to investors should be discussed among sponsors, as this will affect disclosure in announcements and other documents filed with the SEHK and published in the media.

3.22

Lastly, the stabilization of the share or unit price of a newly listed company through the use of an over-allotment option (or “Greenshoe option”) should also be discussed among sponsors as this also weighs on disclosure, both in the listing document and in announcements and filings made with the SEHK.

Revision questions: Question 4: Can a sponsor firm appointed to an IPO have other roles in the IPO? Answer 4: Yes, it will be common for a sponsor to be involved in underwriting and marketing/selling capacities. Question 5: What are the requirements regarding how many sponsors a listing applicant may appoint? Answer 5: At least one sponsor who is independent of the listing applicant must be appointed. Multiple sponsors may also be appointed.

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4

Legal considerations

4.1

The two principal items of legislation of relevance to sponsor work are the SFO and the Companies Ordinance (“CO”). In addition, sponsors, including staff engaged in sponsor work, should be aware of other potential liabilities under the general law and these are briefly reviewed in the final part of this section.

4.2

The SFO is the main piece of legislation specifically governing the securities and futures industry in Hong Kong. In particular, it defines what activities constitute the regulated activity of advising on corporate finance, regulates public offers of investments, establishes certain types of market misconduct, and contains important provisions regarding disclosure of interests in the voting capital of a listed issuer.

4.3

The CO is also relevant in the context of an IPO as it requires a prospectus to be prepared for every offer of shares (or debentures) to the public in Hong Kong for subscription or purchase. The listing document that is required to be prepared in compliance with the Listing Rules for an IPO will therefore also need to serve the dual purpose of satisfying the prospectus requirements of the CO. Note: An IPO by its nature involves a public offering. However, a listing document would not need to satisfy the CO prospectus requirements if the listing does not involve any public offer. An example of this would be where shares are listed by way of an Introduction (methods of listing are discussed in Topic 2).

Securities and Futures Ordinance Advising on corporate finance 4.4

A sponsor undertaking an IPO assignment will be engaged in the regulated activity of advising on corporate finance (Type 6 regulated activity) and accordingly will need to be appropriately licensed or ed. The SFO defines this activity as giving advice: (a) about compliance with or in respect of the Listing Rules; (b) about compliance with or in respect of the Code on Takeovers and Mergers or the Code on Share Repurchases; (c) about any offer to dispose of or acquire securities to or from the public (including advising holders of such securities concerning acceptance of the offers); or (d) to a listed corporation or public company (or its subsidiary, officers or shareholders) about corporate restructuring in respect of securities.

4.5

A sponsor holding a Type 6 licence or registration will additionally need to be permitted to engage in sponsor work. The licensing and registration requirements for sponsors are discussed in section 5 below. Provision of false or misleading information (s. 384, SFO)

4.6

As will be seen in the topics that follow, a sponsor in the course of undertaking its role is required to provide information to the SEHK (and this will also be provided to the SFC under the arrangements of the dual filing system established by the SFO). Such information includes the sponsor’s disclosures as regards independence, the listing application together with the Application Proof, and the sponsor’s declaration (these issues are discussed further in Topic 4). The sponsor may also provide information in connection with seeking waivers from the Listing Rules, for example, LR Chapter 8, and this is discussed further in Topic 2. Note: The Securities and Futures (Stock Market Listing) Rules (which is subsidiary legislation to the SFO), establishes the dual-filing system and requires that a copy of the

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application documents filed with the SEHK also be filed with the SFC. Such documents are subject to the liability and enforcement framework of the SFO. 4.7

Any statements or information provided to the SEHK or the SFC by sponsors in connection with a listing that are false or misleading in a material particular constitute an offence under s. 384, SFO and are punishable by a fine and/or imprisonment. They also constitute a breach of the Listing Rules and may additionally result in the SFC calling into question the sponsor’s fitness and properness to act as a licensed corporation or ed institution. Accordingly, due care and attention must be given to the accuracy and completeness of any such statements or information provided. In this context, a very high standard is expected. Market misconduct (Parts XIII and XIV, SFO)

4.8

The SFO defines 6 types of market misconduct (see section 4.14 below) that may lead to either istrative proceedings before the Market Misconduct Tribunal (“MMT”) (Part XIII, SFO), or criminal proceedings conducted before a court of law (Part XIV, SFO).

4.9

Market misconduct may be pursued under either one of these routes, the route chosen depending on a number of factors including the nature of the wrongdoing and the strength of evidence. However, once proceedings have been commenced under one of these routes, no proceedings may be commenced under the other route in respect of the same misconduct, i.e. there is no double jeopardy.

4.10

Penalties that may be imposed by a court of law include a fine of up to HK$10 million and/or imprisonment for up to 10 years.

4.11

The penalties that may be imposed by the MMT include: (a) disqualifying a person from holding office as a director, liquidator or receiver or from taking part in the management of a corporation for up to 5 years; (b) prohibiting a person from investing or trading in Hong Kong markets for up to 5 years (a “cold shoulder order”); (c) ordering a person to pay reasonable costs and expenses incurred by the Government and the SFC; and (d) ordering a person to pay to the Government any profit gained or loss avoided, plus compound interest.

4.12

In addition to the foregoing, market misconduct may also result in liability to pay civil damages to any person who has suffered pecuniary loss as a result of the market misconduct.

4.13

Officers of a corporation (which includes responsible officers) are required to take all reasonable measures to ensure proper safeguards against the corporation engaging in market misconduct. Where a corporation has committed an act of market misconduct, an officer may also be liable to the same extent if (a) he has aided, abetted, counselled or procured the misconduct, or (b) the misconduct took place with his consent or is attributable to his recklessness.

4.14

The types of market misconduct are: (a) insider dealing; (b) disclosure of false or misleading information inducing transactions; (c) stock market manipulation; (d) false trading; (e) price rigging; and (f) disclosure of information about prohibited transactions.

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The first three of these are likely to be of most relevance to the undertaking of sponsor work and will be briefly introduced below. Insider dealing (ss. 270 and 291, SFO) 4.15

Insider dealing in relation to a listed corporation takes place: (a) when a person connected with the corporation (see Note 1 below), and having information which he knows is “inside information” (see Note 2 below) in relation to the corporation, deals in the listed securities or their derivatives of the corporation or a related corporation, or counsels or procures another person to deal in such listed securities or derivatives; or (b) when a person, who is contemplating or has contemplated making a takeover offer for the corporation and knows that the information is inside information in relation to the corporation, either deals or procures as above. Note 1: Persons connected with a corporation include its directors, employees, substantial shareholders, those with a position of access to inside information (such as a corporate finance adviser advising a corporation) and connected persons of another corporation where the inside information relates to transactions between the two corporations. Note 2: The term “inside information” in relation to a corporation means specific information about the corporation, a shareholder or officer of the corporation, the listed securities of the corporation or their derivatives, which is not generally known to the persons who are accustomed or would be likely to deal in the listed securities of the corporation but which would, if it were generally known to them, be likely to materially affect the price of the listed securities.

4.16

There are a number of defences to insider dealing, of which the most relevant to sponsors acting as corporate finance advisers is the Chinese wall defence. Under this defence, a corporation would not be liable for insider dealing if an effective information barrier operated between the persons engaging in the dealing and the persons possessing the inside information. Misrepresentation (ss. 107 and 108, SFO)

4.17

Both the directors of an issuer and sponsors may be liable under the provisions of ss. 107 and 108, SFO.

4.18

Under s. 107, SFO, it is a criminal offence punishable by fine and/or imprisonment for a person to make any fraudulent or reckless misrepresentation for the purpose of inducing another person to: (a) enter into or offer to enter into (i) an agreement to acquire, dispose of, subscribe for or underwrite securities, or (ii) a regulated investment agreement; or (b) acquire an interest in or participate in, or offer to acquire an interest in or participate in, a collective investment scheme (“CIS”). See s. 107, SFO for definitions of fraudulent and reckless misrepresentation, and also section 4.21 below.

4.19

The civil remedies for misrepresentation are established under s. 108, SFO, which is similar to s. 107, SFO but in addition covers negligent misrepresentation. Section 108, SFO provides that where a person makes any fraudulent, reckless or negligent misrepresentation which induces another person to: (a) enter into or offer to enter into (i) an agreement to acquire, dispose of, subscribe for or underwrite securities, or (ii) a regulated investment agreement; or

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(b) acquire an interest or to participate in, or offer to acquire an interest in or to participate in, a CIS; the person making the misrepresentation will be liable to pay compensation by way of damages in respect of any pecuniary loss incurred by the other person as a result of relying on the misrepresentation. A court may grant an injunction in addition to or as a substitute for damages. 4.20

The liability to civil remedies is extended to every director of a company which has made a misrepresentation, except to the extent it is proved that a director did not authorize the making of that misrepresentation.

4.21

These different types of misrepresentation are defined in the SFO as follows: (a) A fraudulent misrepresentation is any statement which is known to the person making the misrepresentation, at the time it is made, to be false, misleading or deceptive. (b) A reckless misrepresentation is any statement which, at the time it is made, is false, misleading or deceptive, and is made recklessly. (c) A negligent misrepresentation is any statement which, at the time it is made, is false, misleading or deceptive, and is made without reasonable care having been taken to ensure its accuracy. It should be noted that each of these definitions is extended to cover promises, forecasts and material omissions. Disclosure of false or misleading information inducing transactions (ss. 277 and 298, SFO)

4.22

There are two key elements to this market misconduct: (a) disclosure of information that is false or misleading as to a material fact (or the omission of a material fact) and knowing or being reckless as to the information being false or misleading; and (b) the information is likely to induce a person to subscribe for or deal in securities or affect their prices.

4.23

Sponsors participating in such disclosures may be liable and so it is very important that all information is properly verified prior to its release (see Topic 5 for a discussion of due diligence and verification). Stock market manipulation (ss. 278 and 299, SFO)

4.24

Executing two or more transactions in listed securities with a view to increasing, decreasing, maintaining or stabilizing the price of those securities and with the intention of influencing the investment decisions of other persons may amount to stock market manipulation. This misconduct is highly relevant to persons (stabilizing managers) who may be engaged by a listing applicant to assist in stabilizing its share price in the period immediately following it being itted to listing. However, such stabilizing actions will not constitute stock market manipulation provided that they are undertaken in accordance with the Securities and Futures (Price Stabilizing) Rules (stabilization is further discussed in sections 6.17 to 6.22 of Topic 2). Other relevant provisions of the SFO

4.25

Once a company has become listed, it will be subject to additional legal obligations. While the sponsor will not be directly involved in the issuer’s compliance concerns after listing, the sponsor does have an obligation to ensure that the issuer and its directors are aware of, and

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capable of complying with, applicable legal and regulatory requirements. Parts XIVA and XV are two key areas and are briefly summarized below. Note: However, the compliance adviser (a role sometimes undertaken by the sponsor after listing － see section 7 below) will be involved in the issuer’s compliance with its regulatory announcement obligations pursuant to Part XIVA, SFO. Disclosure of inside information (Part XIVA, SFO) 4.26

Part XIVA, SFO imposes on listed companies an obligation to disclose inside information to the public as soon as reasonably practicable after the information has come to their knowledge, subject to specified exceptions (ss. 307B and 307D, SFO). Note 1: See section 4.15 Note 2 above for the definition of inside information. Note 2: Part XIVA, SFO is a relatively new development (effective from 1 January 2013) that in effect gives statutory backing to certain obligations regarding disclosure of price sensitive information previously imposed on listed companies by the Listing Rules.

4.27

The main exceptions provided for are: (a) where the disclosure is prohibited under a restriction imposed by an enactment or a court order; or (b) the corporation takes reasonable precautions to preserve the confidentiality of the information and that confidentiality is in fact preserved, and: (i) the information concerns an incomplete proposal or negotiation; (ii) the information is a trade secret; or (iii) the SFC grants a waiver on disclosure prohibited by overseas legislation or restriction orders.

4.28

Officers are under a duty to take all reasonable measures to ensure proper safeguards exist to prevent a breach of a disclosure requirement. Where they have not done so, they may be in breach of Part XIVA, SFO.

4.29

Breaches of the disclosure requirements are subject to proceedings before the MMT, which has the power to impose a range of orders, including imposing a fine of up to HK$8 million (s. 307N, SFO).

4.30

Persons in breach of the disclosure requirements are also subject to civil liability to pay damages to any other person who has suffered pecuniary loss as a result of the breach, provided the court considers it fair, just and reasonable in the circumstances.

4.31

The SFC has issued the Guidelines on Disclosure of Inside Information (“GDII”) to assist corporations to comply with their obligations under Part XIVA, SFO. The GDII provide examples and discuss issues in particular situations to illustrate the SFC’s views on how the relevant provisions of the SFO should be operated.

4.32

Accordingly, a sponsor should ensure that a listing applicant possesses appropriate and effective systems and procedures that (i) enable the timely identification, assessment and handling of inside information, and (ii) facilitate directors meeting their obligations in this regard. Disclosure of interests (Part XV, SFO)

4.33

The following persons are obliged to disclose their interests in the relevant share capital of a listed company: (a) directors and chief executives, who are required to disclose all interests; and (b) persons interested in 5% or more of the company’s voting shares.

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4.34

What constitutes an “interest” is widely defined and includes both long and short positions, interests in equity derivatives (such as warrants, options, etc.), and attributed interests (for example, through trust arrangements or corporate shareholdings).

4.35

Disclosures must be made to the listed corporation and to the SEHK within the prescribed timeframe: (a) on being itted to listing, an initial disclosure obligation is triggered and interests must be disclosed within 10 business days; and (b) all changes of interest after the initial listing must normally be disclosed within 3 business days after either (a) the relevant event or (b) the day on which the person comes to know about the occurrence of the relevant event. Note: The SFC has released a useful guide, “Outline of Part XV of the SFO－Disclosure of Interests” which can be found on the SFC’s website.

Companies Ordinance 4.36

In addition to the SFO, it will be necessary for sponsors to consider the requirements of the CO. It is the CO that requires listing applicants conducting a public offer to issue a prospectus complying with the requirements of the CO, concerning both its content and registration under the CO (s. 38D for companies incorporated in Hong Kong and s. 342C for those incorporated elsewhere).

4.37

The SFC has been approved to review such prospectuses under the CO and to issue a certificate of exemption for registration under the CO.

4.38

In order to avoid duplication of regulation between the SFC, the SEHK and the Registrar of Companies, the SFC’s functions under ss. 38B(2A)(b), 38D(3) and (5) and 342C(3) and (5), CO, to the extent that they relate to any prospectus that is concerned with any shares or debentures of a company that has been approved for listing on the SEHK, have been transferred to the SEHK.

4.39

The SEHK vets every such prospectus and has the power to authorize its registration by the Registrar of Companies under the CO.

4.40

The procedural requirements for the review of a prospectus by the SEHK for the purposes of the CO are set out in LR Chapter 11A. The SEHK will review a prospectus for compliance with the Listing Rules concurrently with reviewing it for compliance with the relevant provisions of the CO.

4.41

If the SEHK is satisfied that the prospectus delivered to it pursuant to LR 9.11(33) or 9.22(2) should be authorized for registration under the CO, it will issue a certificate under s. 38D(5) or s. 342C(5), CO. It is the responsibility of the issuer to deliver the prospectus and any ancillary documents to the Companies Registry for registration pursuant to s. 38D(7) or s. 342C(7), CO (as the case may be).

4.42

The issue of a certificate of authorization by the SEHK does not constitute a form of confirmation that the prospectus complies with the requirements of the CO. Civil and criminal liability

4.43

The CO also provides for civil and criminal liability for material misstatements (including both untrue statements and omissions) in a prospectus. Sections 40 (for Hong Kong incorporated issuers) and 324E (for all other issuers) provide for civil liability, and ss. 40A (for Hong Kong incorporated issuers) and 342F (for all other issuers) provide for criminal liability.

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4.44

While it is clear that directors are potentially liable under these sections, other aspects of them are subject to some doubt. In particular, there has been a divergence of opinion as to the applicability of these provisions to sponsors. The SFC has proposed amending the provisions so that they state with certainty that sponsors do have statutory liability. However, such amendments have not as yet been made.

Other legal considerations 4.45

Both sponsor firms and individuals working at sponsor firms continue to be subject to the general law. The following are of particular relevance to the financial community. Prevention of Bribery Ordinance (“PBO”)

4.46

A sponsor and its staff may in the course of undertaking sponsor duties be regarded for legal purposes as agents of the listing applicant. Section 9, PBO makes it an offence for an agent to solicit or accept unfair advantages that might induce him not to act in the best interests of his principal. It also makes it an offence to offer an advantage to an agent. Conspiracy to defraud

4.47

Conspiracy to defraud is an offence under the common law. It involves two or more persons acting dishonestly with a view to practising a fraud on one or more victims. It may also be effected via a series of dishonest acts. For example, the concealing of material information or the falsification of financial data in the course of undertaking a sponsor role may constitute this offence. It is clear that the acts involved in committing this offence fall well below the standards of integrity and honesty expected of licensed or ed persons. General criminal law

4.48

Individuals (whether or not they are directors or senior management of the sponsor firm) may also be criminally liable in connection with offences committed by the sponsor firm under any ordinance if they are found to have aided, abetted, counselled or procured the offence (s. 89, Criminal Procedure Ordinance).

4.49

Directors and other officers concerned in the management of a sponsor firm are also subject to criminal liability under s. 101E of the Criminal Procedure Ordinance if the sponsor firm has committed an offence with their consent or connivance.

Revision questions: Question 6: Why is the CO of relevance to sponsors working on IPOs? Answer 6: The CO requires a prospectus to be prepared for every offer of shares (or debentures) to the public in Hong Kong. Question 7: Name three types of market misconduct. Answer 7: See section 4.14 above. Question 8: Who is required to disclose their interests in the relevant share capital of a listed issuer under the provisions of the SFO? Answer 8: Directors, chief executives, and any person whose interest is 5% or more.

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5

Licensing and registration requirements

5.1

As already mentioned, an intermediary wishing to undertake sponsor work must be (i) licensed or ed to engage in Type 6 regulated activity (advising on corporate finance) and (ii) permitted under the of its licence or registration to engage in sponsor work. This section deals with the eligibility requirements for engaging in sponsor work, which are set out in the Sponsor Guidelines. Note: While the provisions of the Listing Rules will also apply to sponsors, these provisions are dealt with in subsequent topics of this manual in the context of the requirements applicable to a sponsor when executing the sponsor role.

5.2

Although not having the status of laws, the SFC’s codes are nevertheless of considerable importance, and compliance with them should be regarded as a necessary requirement in undertaking sponsor work in Hong Kong. The SFC will regard any breach of any of the SFC’s codes (or the Listing Rule requirements) as casting doubts on the fitness and properness of the sponsor.

Sponsor Guidelines 5.3

The SFO requires all licensed or ed persons to be fit and proper. The Sponsor Guidelines set out the specific competence requirements for persons licensed or ed for Type 6 regulated activity who wish to engage in sponsor work. The requirements are additional to those set out in the Fit and Proper Guidelines applying to all licensed and ed persons, and cover the sponsor firm itself, persons within the firm acting as Principals or representatives/relevant individuals of the firm, and the requirements for continuing professional training (“T”).

5.4

It is the responsibility of the sponsor and its senior management to ensure that staff undertaking sponsor work are appropriately licensed or ed, are competent and meet the criteria set out in the Sponsor Guidelines. Note: In this Topic, and generally in this manual, the term “senior management” will mean a sponsor’s board of directors, managing director, chief executive officer, responsible officers, executive officers and other senior management personnel. This follows the approach taken by the SFC in its codes, although paragraph 17 of the Code of Conduct uses the term “Management”, which is equivalent to the term “senior management” as used herein. The sponsor firm

5.5

In addition to the requirements imposed by the Securities and Futures (Financial Resources) Rules, a sponsor is required to have a minimum paid-up capital of not less than HK$10 million. Principals

5.6

A sponsor must appoint at least two Principals whose primary roles will be to supervise Transaction Teams engaged in undertaking sponsor assignments, and to be involved in making key decisions as to how that work is undertaken. Each of them must satisfy the eligibility criteria and at least one of them must satisfy the “Option 1” criteria (see section 5.14 below). Note: The specific responsibilities of Principals and the formation of Transaction Teams are discussed further in section 2 of Topic 4.

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5.7

The above is a minimum requirement and the senior management should assess the volume, size, complexity and nature of the sponsor work that it undertakes in determining how many Principals are required to properly discharge its role in supervising the Transaction Team(s).

5.8

The appointment of a Principal must be made by the senior management of the sponsor firm and a written endorsement provided to the SFC that gives information as to how the individual concerned satisfies the eligibility requirements (see sections 5.10 to 5.18 below). The SFC should be notified within 7 business days of any appointment or cessation of appointment. Upon receiving an endorsement, the SFC may require further details to be provided.

5.9

Records should be kept to demonstrate compliance with the Sponsor Guidelines. Such records should cover the appointments made, or ceased, as well as the associated decisionmaking process. Eligibility criteria for Principals

5.10

To be eligible to act as a Principal, the individual must be: (a) a responsible officer (for a licensed corporation) or executive officer (for a ed institution) of the sponsor firm; and (b) satisfy one of the eligibility criteria under Option 1, Option 2 or Option 3 summarized below. While these criteria are only concerned with initial eligibility, persons appointed as Principals must ensure that they remain competent in their role at all times.

5.11

An individual may only be appointed as a Principal under Options 2 or 3 if the sponsor to which he is being appointed already has at least one other Principal who is approved as a Principal under Option 1. In other words, there must always be at least one Principal qualifying under Option 1 for the other two options to become available as routes to appointment.

5.12

Each of the three options requires the individual to have corporate finance experience which would include providing advice on one or more of the following matters: (a) IPO transactions; (b) notifiable or connected transactions (LR Chapters 14 and 14A); (c) rights issues or open offers governed by the Listing Rules; (d) takeovers and share repurchases governed by The Codes on Takeovers and Mergers and Share Repurchases, and (e) other significant transactions or equity-fund raising. Such experience may include experience in markets other than Hong Kong that have comparable legal and regulatory requirements for listings and public offers.

5.13

A sponsor should be aware of avoiding duplication when attributing experience gained from a specific transaction to multiple Principals.

5.14

Option 1 is based on having at least 5 years of corporate finance experience in respect of companies listed on the SEHK, which must include a substantial role in advising a listing applicant as a sponsor in at least two completed IPO transactions on the SEHK.

5.15

Option 2 requires a high level of experience gained in recognized jurisdictions (Australia, the United Kingdom, or the US) through undertaking corporate finance work on listed companies and undertaking due diligence as a result of leading IPO transactions, and the completion of a refresher course or special examination on ethics, sponsor work, and the

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legal and regulatory requirements governing the conduct of IPO transactions in Hong Kong within the 6 months preceding the appointment as a Principal. 5.16

Option 3 requires an active and substantial participation in due diligence work in at least four completed IPO transactions in Hong Kong, at least 5 years of corporate finance experience in respect of companies listed on the SEHK, and the completion of a special examination on ethics, sponsor work, and the legal and regulatory requirements governing the conduct of IPO transactions in Hong Kong within the 6 months preceding the appointment as a Principal.

5.17

When assessing whether an individual has played a substantial role in an IPO, the SFC will consider the extent to which the individual has been involved in the roles required of a Principal, for example leading and supervising, and making key decisions in relation to, a due diligence exercise (for further examples, see paragraph 1.4.2 Note (2) of the Sponsor Guidelines).

5.18

The SFC may exercise its discretion to grant a dispensation from strict compliance with the Option 1 eligibility requirement if there are valid and justifiable grounds (see paragraph 1.4.2 Note (2) of the Sponsor Guidelines). Representatives and relevant individuals

5.19

Persons wishing to engage in sponsor work as representatives or relevant individuals will need to the relevant examination for Type 6 licensed representatives and relevant individuals engaging in sponsor work within the period 3 years prior to and 6 months after their first engagement in such work.

5.20

Persons who have engaged in sponsor work on at least one completed IPO transaction as a Type 6 licensed representative or relevant individual within the 3 years prior to 1 October 2013 are exempted from the above requirement.

5.21

A representative or relevant individual who ceases to be licensed or ed for more than 3 years will need to the examination as described in section 5.19 above.

5.22

It is an obligation of a sponsor firm to ensure that its staff engaged in sponsor work have satisfied the relevant examination requirements. A sponsor should be able to demonstrate this to the SFC upon request. Standard of information provided

5.23

Individuals and firms submitting information to the SFC in connection with the eligibility criteria should ensure the accuracy and completeness of the information provided as such submissions are also subject to the provisions of s. 384, SFO, which may entail criminal penalties in respect of false information (see sections 4.6 to 4.7 above). Continuing professional training (“T”)

5.24

A sponsor must ensure that adequate training is provided both initially and on an ongoing basis. Such training should be sufficient to ensure compliance with the sponsor’s operational and internal control policies and procedures, as well as all applicable legal and regulatory requirements.

5.25

Training should be relevant to the skills required by responsible officers, executive officers, licensed representatives and relevant individuals to carry out their respective roles in relation to sponsor work. Such training should constitute at least 50% of the 5 T hours (or any other amount of T hours as required by the SFC from time to time) that such persons are required to undertake annually as holders of a Type 6 licence/registration (advising on corporate finance).

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Revision questions: Question 9: How many Principals must be appointed by a sponsor firm? Answer 9: At least two. Question 10: Is it sufficient that a representative engaged in sponsor work holds a Type 6 licence? Answer 10: No, they must also meet the other eligibility requirements for sponsor work. See sections 5.19 to 5.22 above.

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6

Applicable regulatory codes and rules Codes and guidelines issued by the Securities and Futures Commission (“SFC”)

6.1

All sponsors are required to hold a Type 6 licence or registration and accordingly are subject to the codes and guidelines issued by the SFC that apply to all holders of such licences/registration. While this section will introduce the regulatory rules of specific relevance to sponsor work, sponsors nevertheless need to be aware of all regulatory rules that affect the conduct of their business, including the provisions of the Code of Conduct and the Management, Supervision and Internal Control Guidelines for Persons Licensed by or ed with the Securities and Futures Commission (“ICG”).

6.2

The Code of Conduct applies, with limited exceptions, to all persons licensed by or ed with the SFC. It sets out the conduct requirement to which they must adhere to ensure they remain fit and proper. The Code of Conduct is based around nine general principles in relation to: (a) honesty and fairness; (b) the need to act with due skill care and diligence and in the best interests of the client and the integrity of the market; (c) capabilities; (d) information about clients; (e) information for clients; (f) conflicts of interest; (g) compliance; (h) client assets; and (i) the responsibility of senior management.

6.3

The ICG applies to all persons licensed by or ed with the SFC. It is concerned with the key areas of business controls, namely: (a) management and supervision; (b) segregation of duties and functions; (c) personnel and training; (d) information management; (e) compliance; (f) audit; (g) operational controls; and (h) risk management.

6.4

The remainder of this section will provide an overview of the CFA Code and the more general provisions of the Listing Rules that relate to sponsors’ duties. Subsequent topics will return to the regulatory rules that are specifically concerned with sponsor work and how it is to be undertaken in practice: (a) the CFA Code; (b) Paragraph 17 of the Code of Conduct; and (c) the Listing Rules.

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Note: A full list of codes and guidelines can be found on the SFC’s website. 6.5

In reviewing these regulatory requirements it will be noted that there are some overlaps in the provisions as set out in each of them. In the case of any conflict between the provisions of the CFA Code and the Code of Conduct, those of paragraph 17, Code of Conduct shall prevail. However, where the Listing Rules impose a higher standard of conduct on sponsors than codes issued by the SFC, the Listing Rules shall prevail.

Corporate Finance Adviser Code of Conduct 6.6

The CFA Code sets out the requirements and guidelines in respect of the conduct of corporate finance advisers and therefore covers sponsor work. It serves as one of the benchmarks against which a sponsor’s fitness and properness will be measured. Accordingly, breaches of the CFA Code will reflect adversely on the fitness and properness of a sponsor.

6.7

The CFA Code requires a sponsor to maintain an effective compliance function headed by a designated compliance officer, independent of other business functions, and reporting directly to senior management. Where necessary, such a function may be assumed by senior management.

6.8

The compliance function should have the competence, resources and experience to monitor compliance with the sponsor’s internal policies and procedures as well as applicable laws and regulations.

6.9

Other provisions of the CFA Code are mainly concerned with the following matters: (a) the proper licensing or registration of the corporate finance adviser’s staff for the duties they are engaged in; (b) the need for corporate finance advisers to maintain a high standard of integrity and fair dealing; (c) the demonstration of adequate resources, competence and staff suitability; (d) the adoption of an appropriate written staff dealing policy; (e) the implementation of a watch list and restricted list system for the proper monitoring of personal dealings and proprietary trading; (f) the avoidance of conflicts of interest and, where they cannot be avoided, ensuring a proper response (such as withdrawal from the mandate or obtaining client consent) to ensure the client receives fair treatment; (g) the maintenance of effective and operational Chinese walls; (h) ensuring that advice given to a listing applicant is impartial (discussed further in Topic 4); (i) ensuring that a corporate finance adviser does not offer or accept inducements in connection with client transactions unless appropriate disclosure to the client has been made; (j) the need to act with due skill, care and diligence and observe proper standards of market conduct; (k) the need to undertake reasonableness checks to assess the relevant experience and expertise of work undertaken by experts or other professionals (discussed further in Topic 5); (l) the need to act in the best interests of clients at all times and to understand a client’s business through obtaining relevant information about such client (discussed further in Topic 4);

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(m) the need for both the corporate finance adviser and its client to co-operate and adopt open and truthful communication with the regulators (discussed further in section 6 of Topic 4); (n) cases where the client is not in compliance with the relevant regulatory requirements, when the corporate finance adviser should advise the client to bring the matter to the attention of the regulators; where the client declines to do so without valid reasons, it should consider the need to cease acting for that client; and (o) the need to safeguard the confidentiality of client information, including taking reasonable steps to ensure that other persons who receive confidential information from the corporate finance adviser avoid an accidental leak of information. 6.10

Where a regulatory issue arises on a transaction, sponsors are encouraged to consult the regulators at an early stage to seek guidance.

6.11

Sponsors should also note that firms acting in the capacity of a corporate finance adviser and giving advice to a listing applicant are required by the CFA Code to co-operate fully with the sponsor and not to engage in any conduct that would unreasonably or adversely affect the sponsor in discharging its duties.

Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited 6.12

There are a number of rules which address various aspects of the SEHK’s functions and which cover participation in the facilities of the SEHK, trading on the SEHK, clearing and settlement and, of most relevance to the sponsors, listing on the SEHK.

6.13

The principal function of the SEHK is to provide a fair, orderly and efficient market for the trading of securities (LR 2.01). The Listing Rules have been issued by the SEHK to prescribe the requirements for the listing of securities on the SEHK. These comprise both requirements which have to be met before securities may be listed and continuing obligations with which an issuer and, where applicable, a guarantor must comply once listing has been granted. The Listing Rules are approved by the SFC whose approval is also required for any changes to the Listing Rules.

6.14

The Listing Rules reflect currently acceptable standards in the marketplace and aim to ensure and maintain investors’ confidence in the market, in particular, that: (a) applicants are suitable for listing; (b) the issue and marketing of securities is conducted in a fair and orderly manner and investors are given sufficient information to enable them to make a properly informed assessment of an issuer and the securities for which listing is sought; (c) investors are kept fully informed by listed issuers, and any information which might reasonably be expected to have a material effect on market activity in, and the prices of, listed securities is disclosed immediately; (d) all holders of listed securities are treated fairly and equally; and (e) directors of a listed issuer act in the interests of its shareholders as a whole － particularly where the public represents only a minority of the shareholders.

6.15

The Listing Rules are not exhaustive. Additional requirements may be imposed and a listing may be made subject to special conditions whenever the SEHK considers it appropriate (LR 2.04). Both new applicants and listed issuers are encouraged to seek informal and confidential guidance from the SEHK wherever necessary.

6.16

Sponsors should also note the content of the SEHK’s Listing Decisions, Guidance Notes, Guidance Letters, Rejection Letters and Frequently Asked Questions which frequently

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contain useful guidance as to how specific rules may apply to specific factual scenarios (discussed further in sections 4 and 6 of Topic 2). Revision question: Question 11: What is the relevance of the CFA Code to sponsors? Answer 11: The CFA Code sets out the requirements and guidelines in respect of the conduct of corporate finance advisers and therefore covers sponsor work. It serves as one of the benchmarks against which a sponsor’s fitness and properness will be measured.

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7

Compliance advisers

7.1

The Listing Rules require an issuer to appoint a compliance adviser during an initial period after being itted to listing, whose core role being to assist the issuer comply with certain of its Listing Rule obligations during such a period. Only firms eligible to act as sponsors are also eligible to act as compliance advisers, and it will sometimes be the case that one of the sponsors involved in the listing may be appointed to act as the compliance adviser.

7.2

Sponsor firms subsequently undertaking the role of compliance adviser will continue to be subject to the SFC codes discussed in the previous section applicable to intermediaries holding a licence or registration for Type 6 regulated activity. Breaches of those codes or specific obligations as compliance adviser will also be relevant to the SFC’s determination of the continuing fitness and properness of the intermediary. In the event that a licensed corporation or ed institution ceases to be eligible to act as a sponsor, it shall also cease to be eligible to act as a compliance adviser.

7.3

The appointment and roles of compliance advisers are further considered in Topic 6 in the context of assessing the effectiveness of a sponsor’s work in the period after the issuer is itted to listing.

Revision question: Question 12: Are sponsors the same as compliance advisers? Answer 12: No, they have different roles though to be eligible to act as a compliance adviser one must also be eligible to act as a sponsor.

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8

SFC’s powers

8.1

Ongoing compliance with the legal and regulatory obligations to which a sponsor is subject is an important matter. The SFO empowers the SFC to conduct supervision and investigations of licensed and ed persons, including those acting as sponsors, and to apply disciplinary measures where such persons have failed to meet the relevant requirements. Note: The SFC’s powers also extend to certain matters pertaining to listed companies. While the syllabus of this manual does not encom these powers, sponsors should note that where the SFC is investigating a listed company, the role of a sponsor in the company’s listing, including documents obtained or produced in the role of sponsor, may be subject to the SFC’s powers in this regard.

Supervision and investigation 8.2

The SFC has the power to: (a) make enquiries and obtain documents and answers in relation to listed corporations (s. 179, SFO), intermediaries and their associated entities (s. 180, SFO) and specified transactions (s. 181, SFO); and (b) investigate, among other things, possible breaches of the SFO, misfeasance and activities that are not in the public interest (ss. 182 and 183, SFO).

8.3

The SFC may conduct supervisory inspections for the purposes of ascertaining whether an intermediary or its associated entity has complied with the SFO and any related notices and requirements, any and condition of any licence or registration, or any other condition imposed.

8.4

The SFC may authorize a person (usually a member of its staff) to inspect the premises of a licensed corporation, and ask for documents and explanations from the licensed corporation, an associated entity, a related corporation or an associated entity of a related corporation.

8.5

The authorized person may in writing require the person giving an answer to: (a) the answer within a reasonable period by a statutory declaration; or (b) make a statutory declaration that he cannot give an answer because it is not within his knowledge, stating the reasons. A statutory declaration may be taken by the authorized person.

Investigations of possible offences, etc. (ss. 182 and 183, SFO) 8.6

These are key provisions of the SFO that give the SFC considerable powers to investigate, among other things, possible breaches of the SFO, misfeasance and activities not in the public interest. The SFC may also investigate to determine whether to take disciplinary action under Part XI, SFO.

8.7

The SFC may authorize an employee (or another person with the consent of the Financial Secretary) to carry out an investigation. The person so authorized may investigate any person, who is required to: (a) provide documents and explanations; (b) attend before the investigator and answer questions; (c) give the investigator all reasonable assistance;

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(d) his evidence by making a statutory declaration; or (e) make a statutory declaration that he is unable to provide the evidence for reasons to be stated, if such is the case.

Offences 8.8

A person who, without reasonable excuse, fails to comply with the requests of an investigator appointed by the SFC or provides false or misleading responses is guilty of an offence. Officers or employees of a corporation who cause or allow the corporation to commit the offences are also subject to liability.

8.9

The SFC may apply to the court to order a person who does not comply with requirements made by the authorized person or investigator under relevant provisions to do so (s. 185, SFO).

8.10

An employee of the SFC, an authorized person or an investigator may, in appropriate circumstances, apply to a magistrate for the issue of a warrant: (a) authorizing specified persons, a police officer and such other persons as may be necessary to assist in the execution of the warrant to enter specified premises, if necessary by force, at any time within 7 days; (b) requiring any person on the premises to produce any relevant documents; (c) prohibiting any person to erase or alter or remove any relevant documents; and (d) authorizing the specified persons to: (i) search for, seize and remove any relevant documents; and (ii) retain such documents for 6 months, a period which may be extended (s. 191, SFO) .

8.11

Any person who destroys, falsifies, conceals or otherwise disposes of any documents required to be produced under Part VIII, SFO is guilty of an offence.

Discipline 8.12

Section 194, SFO provides that if a “regulated person” is guilty of “misconduct”, or is considered not a fit and proper person, the SFC may: (a) in the case of a licensed corporation or representative, revoke or suspend the licence in respect of all or part of the regulated activity; (b) in the case of a responsible officer (see Note below), revoke or suspend approval as a responsible officer. Note: A responsible officer is a licensed representative who (i) actively participates in or supervises a regulated activity, (ii) is nominated by the licensed corporation as a responsible officer, and (iii) is approved by the SFC as a responsible officer. (c) publicly or privately reprimand the regulated person; (d) prohibit the regulated person from applying for a licence, registration, approval as a responsible officer or entry in the Hong Kong Monetary Authority (“HKMA”) , or to act as an executive officer; and (e) separately or in addition order the regulated person to pay a penalty up to the greater of HK$10 million or 3 times any profit gained or loss avoided as a result of his misconduct.

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“Regulated person” here refers to a licensed corporation, a licensed representative, a responsible officer of a licensed corporation, or a person involved in the management of the business of a licensed corporation. “Misconduct” in this context includes contravention of any of the following: (i) the provisions of the SFO (and certain parts of the CO); (ii) the and conditions of any licence or registration with the SFC; and (iii) any act or omission relating to regulated activities which is prejudicial to the public interest. 8.13

Similar provisions are set out in s. 196, SFO, where “regulated person” refers to a ed institution, an executive officer of a ed institution, a person involved in the management of a ed institution or an individual whose name is recorded on the HKMA as engaged in a regulated activity.

8.14

Sections 195 and 197, SFO define other circumstances where disciplinary action may be taken by the SFC, including suspension or revocation of a licence or registration in the event of: (a) bankruptcy or receivership or arrangements with creditors; (b) failure to satisfy a levy of execution; (c) mental incapacity of individuals or directors; or (d) the conviction of individuals, corporations or directors for an offence which casts doubts on their fitness and properness. The suspension or revocation may be applied to the entire regulated business or to a specific part of it.

SFC Disciplinary Fining Guidelines 8.15

Clearly, certain types of misconduct are more serious than others: the more serious is the misconduct, the greater the likelihood that the SFC will impose a fine and that the fine will be larger. Misconduct which is intentional or reckless, damages the integrity of the market, causes losses to or imposes costs on others, or provides a benefit to the intermediary itself or other persons, is normally regarded as more serious than cases where these factors are absent (e.g. negligent but not intentional misconduct, misconduct which causes no losses, etc.).

8.16

In determining the seriousness of the misconduct, the SFC will also consider other factors, including but not limited to whether: (a) a breach of fiduciary duty is involved; (b) the misconduct reflects serious or systematic weaknesses in management or internal control systems; (c) the intermediary or individual reports the conduct and co-operates with the SFC; and (d) the intermediary takes remedial steps such as: (i)

compensating clients;

(ii) disciplining any staff concerned; and (iii) preventing recurrences, and so on.

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Co-operation with the SFC 8.17

The SFC’s Guidance Note on Cooperation with the SFC further explains the SFC’s approach to intermediaries that co-operate in disciplinary proceedings. The SFC has indicated that it will take co-operation into as a means of reducing the type of sanction and that the maximum reduction is either by one order of magnitude (e.g. from a revocation of licence to a suspension) or 33%, particularly if the co-operation is spontaneous and extensive. While all the circumstances of the case will need to be considered, the SFC has indicated that ways of co-operating with the SFC include: (a) taking a positive approach to bringing the disciplinary case to an early conclusion (e.g. indicating the facts or issues which are not in dispute); (b) accepting disciplinary liability for the matter at an early stage in the investigation; and (c) taking remedial steps to rectify problems and/or to compensate clients for any loss.

Public 8.18

Disciplinary actions, other than minor ones such as private reprimands, will be communicated to the media and placed on a public , which will include relevant details of the intermediary and the disciplinary action taken. (See Schedule 4, Securities and Futures (Licensing and Registration) (Information) Rules for full details).

8.19

In Topic 6 we will discuss some disciplinary cases against sponsors as a means of illustrating the SFC’s exercise of its powers.

Revision questions: Question 13: For what purpose may the SFC exercise its powers to conduct supervisory investigations? Answer 13: The SFC may conduct supervisory inspections for the purposes of ascertaining whether an intermediary or its associated entity has complied with the SFO and any related notices and requirements, any and condition of any licence or registration, or any other imposed condition. Question 14: What disciplinary sanctions are available to the SFC where a regulated person has engaged in misconduct? Answer 14: See section 8.12 above.

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Topic summary This Topic provided an overview of the sponsor regulatory regime in Hong Kong including the relevant governing laws and regulations. It commenced with a review of Hong Kong’s role as a primary capital market and explained the different roles of key functionaries in the area, including those of the sponsor, the underwriter and the compliance adviser. The role of the sponsor as part of the system preserving the integrity of the market was discussed. This led to a discussion of the laws and regulations, including the applicable licensing and registration requirements for persons undertaking sponsor work. The CFA Code was briefly reviewed and its relationship with other regulations issued by the SFC explained. Finally, the powers of the SFC as a regulator of persons engaged in sponsor work were reviewed, including its disciplinary powers.

Checklist Below is a checklist of the main points covered by this Topic. Candidates should use the list to test their knowledge. 

Sponsors effectively act as the principal gatekeepers of market quality in a listing exercise.



The Listing Rules require all applicants seeking a listing on the SEHK to appoint one or more sponsors for their listing application.



The work of sponsors is subject to regulatory requirements, including the Sponsor Guidelines, the CFA Code, the Code of Conduct and the Listing Rules.



Recent regulatory changes have been introduced to address certain shortcomings with respect to the competence and integrity of sponsors.



Listings by way of introduction, dual listings and secondary listings.



The SEHK differs from other listing venues in several ways. It includes a high proportion of cross-border listings (particularly from mainland China) and historically, the participation of retail investors has been significant.



The SEHK has recently added new jurisdictions in which companies that seek a listing can be incorporated.



Listing is possible on the Main Board as well as on GEM.



Sponsors are involved in preparing the listing documents and also provide advice and guidance to the listing applicant in relation to the Listing Rules and other relevant regulatory requirements.



The role of sponsors is different from that of the underwriters.



The roles undertaken by an underwriter may include those of global coordinator, bookrunner, lead manager and other more junior roles.



It is possible to appoint more than one sponsor, in which case one must be designated as the primary channel for communication with the SEHK.



Even if not appointed in an underwriting capacity, sponsors must be involved in the syndication process, roadshow arrangements, allocation and stabilization, as these may affect disclosure.



The two principal items of legislation of relevance to sponsor work are the SFO and the CO.

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

The SFO in particular covers advising on corporate finance, provision of false or misleading information, market misconduct, insider dealing, misrepresentation, disclosures of false or misleading information inducing transactions, stock market manipulation, disclosure of inside information and disclosure of interests.



Sponsors are also subject to the general law, in particular in relation to the PBO, conspiracy to defraud and general criminal law.



The Sponsor Guidelines lay down specific competence requirements for sponsor firms, Principals, representatives and relevant individuals.



The eligibility criteria for Principals, representatives and relevant individuals.



T requirements.



In relation to sponsors, the CFA Code covers the conduct of business and standards of work, competence, conflicts of interest, Chinese walls, duties to clients, communication with regulators and personal dealings.



A sponsor may also be separately appointed as compliance adviser to a newly listed company.



The SFC’s powers of supervision and investigations in connection with offences.



The SFC Disciplinary Fining Guidelines and public .

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Topic 2: The Listing Rules and the IPO listing process Table of contents Topic overview

1

Learning outcomes

1

1

Methods of listing and offering mechanisms

2

Introduction Offer for subscription Offer for sale Placing Introduction Transfer of listing from Growth Enterprise Market to the Main Board

2 2 2 3 3 3

Specific listing requirements for equity securities

5

2

Introduction Dual filing

5 11

Corporate istration of the listing applicant

13

Introduction Directors and board committees Authorised representatives Audit committee Remuneration committee Company secretary Appointment and removal of auditor

13 13 15 15 16 16 16

Specific issues in practice

18

Listing Decisions and guidance materials Qualification and suitability ing standards and financial information Acceptable jurisdictions Investor considerations Valuation considerations Profit forecasts Special listing situations

18 18 22 24 25 30 30 31

5

The initial public offering process

34

6

Other important considerations

38

Introduction Prospectus quality Contractual and related matters

38 38 40

3

4

Topic summary

46

Checklist

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Topic overview This Topic provides an overview of the requirements of the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited (“Listing Rules" or “LR”), the overall listing process and some of the typical issues of importance that arise in the course of that process. The Topic commences with an introduction to the general methods of listing and the specific requirements of the Listing Rules as regards the listing applicant and the listing procedures. The requirements that apply to the corporate istration of the listing applicant are then discussed. The Topic then proceeds to discuss a number of more detailed issues that a sponsor may encounter in practice and which will require a more careful consideration of the detailed requirements of the Listing Rules and how they apply to the circumstances of the listing applicant. The importance of understanding the Listing Decisions and guidance materials of The Stock Exchange of Hong Kong Limited (“SEHK”) is discussed, some of the more relevant of which are reviewed. An overview of the initial public offering (“IPO”) process then explains how the underwriting and syndication process works in the context of the requirements reviewed in earlier parts of the Topic. The Topic concludes with some important considerations which a sponsor must attend to in a listing application process, including ensuring the prospectus is of adequate quality, pricing and allocation decisions, and claw-back arrangements.

Learning outcomes At the end of this Topic, candidates should be able to: (a) understand the methods of listing relevant to IPOs and typical offering mechanisms; (b) describe the basic criteria for an initial listing of securities on the SEHK; (c) understand the listing application procedure, including the requirements concerning the content of listing documents; (d) explain the requirements imposed on the directors and board of a listed issuer; (e) demonstrate an understanding of the relevance of Listing Decisions and guidance materials; (f) describe the IPO process; (g) explain other important considerations that affect the listing application process; and (h) understand the relevance of mechanisms such as allocation, claw-back and price stabilization.

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Methods of listing and offering mechanisms Introduction

1.1

This manual focuses on matters relating to listing applicants who are accessing the public market via an IPO. However, there are various methods by which securities may be listed and, in the case of a new listing, more than one method may be involved, for example, combining an offer for subscription with a placing. The sponsor will have to propose the most appropriate method(s) and ensure that the listing applicant understands the reasons for its recommendations. There are more than ten methods by which shares may be listed on the SEHK (LR Chapter 7). The methods relevant for new listing applicants are: (a) offer for subscription; (b) offer for sale; (c) placing; and (d) introduction. Once an issuer is listed, new shares may also be listed via any of the following methods: (e) rights issue; (f) open offer; (g) capitalisation issue; (h) consideration issue; (i) exchange or substitution; (j) transfer of listing from the Growth Enterprise Market (“GEM”) to the Main Board of the SEHK (“Main Board”); and (k) other methods.

1.2

An initial listing which raises a large amount of capital will normally include an offer for subscription for a tranche (or part) allocated to the general public, and a tranche for institutions. It is likely that the institutional tranche will make up the major part of the funds being raised. Listings on the Main Board will normally include some form of public offering, although a listing on GEM can be solely conducted by way of a placement,

1.3

An issuer should always consult the SEHK as early as possible to obtain confirmation that the method of listing it proposes to use will be appropriate.

Offer for subscription 1.4

An offer for subscription is an offer to the public by or on behalf of an issuer of its own securities (LR 7.02).

1.5

The offer must be fully underwritten. In the case of offers by tender, the SEHK must be satisfied that the basis of allotment is fair, to ensure equal treatment of every investor who applies at the same price for the same number of securities.

Offer for sale 1.6

An offer for sale is an offer to the public by or on behalf of the holders or allottees of securities already in issue or agreed to be subscribed (LR 7.06). Accordingly, an offer for sale raises no new capital for the issuer.

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1.7

In an IPO, an offer for subscription and an offer for sale can be (but are not always) combined, in such a way that the issuer raises new capital from investors through the offer for subscription, while at the same time all or some of its shareholders sell all or part of their holding through the offer for sale.

1.8

In the case of offers by tender, the SEHK must be satisfied that the basis of allotment is fair to ensure equal treatment of every investor who applies at the same price for the same number of securities.

Placing 1.9

A placing is the obtaining of subscriptions for or sale of securities by an issuer or intermediary, mainly from or to persons selected or approved by the issuer or intermediary (LR 7.09).

1.10

LR Appendix 6 sets out the applicable criteria. A new applicant may not be allowed to be listed by way of placing only if there is likely to be a significant public demand for the securities.

1.11

Preliminary arrangements and placings may be allowed for the purpose of disposing of securities before the start of dealing in order to comply with the requirement in LR 8.08(1) that a minimum prescribed number of securities be held by the public.

Introduction 1.12

An introduction is an application for listing of securities already in issue. Since the securities for which listing is sought are already of such an amount and are so widely held that adequate marketability can be assumed, no marketing arrangements are required (LR 7.13). Accordingly, an introduction raises no new capital for the issuer.

1.13

Introductions will normally be appropriate where: (a) the securities for which listing is sought are already listed on another exchange; (b) the securities of the issuer are distributed in specie by a listed issuer to the shareholders of that listed issuer or to the shareholders of another listed issuer; or (c) a holding company is formed and its securities are issued in exchange for those of one or more listed issuers.

1.14

An introduction will only be permitted in exceptional circumstances if there has been a promotion (i.e. marketing) of the shares in the company in Hong Kong within the 6 months prior to the proposed introduction, and where such promotion was made subject to a listing being granted.

Transfer of listing from Growth Enterprise Market to the Main Board 1.15

A company listed on GEM may apply to transfer its listing to the Main Board in a simplified way provided that it satisfies the requirements of LR Chapter 9A (the rules regarding withdrawal of listing are not applied). In particular, it must satisfy the following requirements: (a) meets all qualifications for listing on the Main Board, subject to certain exceptions; (b) has completed at least one full financial year after its listing on GEM and complied with the annual reports distribution requirements under the Rules Governing the Listing of Securities on the Growth Enterprise Market of The Stock Exchange of Hong Kong Limited (“GEM Listing Rules” or “GLR”); and

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(c) has not been the subject of any disciplinary investigation by the SEHK in relation to a serious breach or potential serious breach of the Listing Rules for at least 12 months preceding the transfer application and until the commencement of dealings in its securities on the Main Board. However, in this case the company does not need to appoint a sponsor.

The offering mechanism 1.16

A company to be listed on the SEHK through an IPO will generally offer shares to both institutional and retail investors so as to satisfy the requirement for a minimum number of shareholders under the Listing Rules (300 for the Main Board and 100 for GEM). Fixedprice IPOs are rare nowadays and accordingly the offering mechanism normally starts with a price range, which is used by the bookrunner(s) to canvass demand from institutions in what is known as a book-building process, typically lasting for around 2 weeks. The price range itself is determined through from institutions following the publication of pre-deal research reports and a process known as pre-deal investor education (“PDIE”) or premarketing, through which institutional investors provide early to the bookrunners and other underwriters on the relative attractiveness and valuation of the issuer in an IPO.

1.17

During the second week of book-building, the public offer to retail investors is initiated following the publication of the listing document, with the public applying for shares at the top end of the price range (subject to reimbursement if the final offer price is ultimately set below that level). In Hong Kong, the typical initial size of the public offer is 10%, with the remaining 90% set aside for institutional investors.

1.18

At the end of the public offer, the sponsor(s), global coordinator(s) and bookrunner(s) will consider both the demand generated by all categories of investors, as well as the quality of the book of demand compiled from institutions, to recommend a final offer price to the issuer.

1.19

The level of applications received under the public offer may also trigger a claw-back mechanism, whereby additional shares may be set aside for retail investors (for further details see section 5.8 below). Allocations to individual investors (both retail and institutional) are then made at the offer price and before the company is itted to listing on the SEHK and trading in its securities begins.

Revision question: Question 1: Name four methods by which a new applicant may list its shares on the SEHK. Answer 1: Offer for subscription, offer for sale, placing and introduction.

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2

Specific listing requirements for equity securities Introduction

2.1

The core qualitative and quantitative requirements the SEHK expects to be met for a listing applicant to be considered suitable for listing are set out in Chapter 8 of the Listing Rules. A sponsor will need to ensure the listing applicant is able to meet these requirements at the time of being itted to listing and on an ongoing basis. This will require the sponsor to examine the listing applicant’s circumstances, including its internal control systems and processes (for example, its ability to comply with its disclosure obligations). This section reviews the SEHK’s requirements. The more specific obligations of the sponsor in this regard are discussed in Topics 4 and 5.

2.2

It should be noted that in all cases the SEHK retains the discretion to waive some of these requirements as well as the right to accept candidates to listing.

2.3

As explained in greater detail below, it is also sometimes (but not always) the case that some of the quantitative and qualitative requirements can be lowered, for example, the minimum public float in the case of very large IPOs where liquidity and the breadth of distribution can generally be assured, or continuity of management for companies operating in certain industry sectors. Basic criteria

2.4

For an initial listing of securities on the Main Board, the following rules, among others, apply: (a) The issuer must be duly incorporated (LR 8.02). (b) The issuer must not be a private company within the meaning of s. 29, Companies Ordinance (“CO”) (LR 8.03). (c) Both the issuer and its business must, in the opinion of the SEHK, be suitable for listing (LR 8.04)－for example, an applicant with assets that are primarily cash or short-dated securities (such as bonds, bills or notes with less than one year to maturity) would not normally be regarded as suitable for listing, except where the issuer or group is solely or mainly engaged in the securities brokerage business. (d) The issuer must satisfy at least one of the following quantitative tests: profit test; market capitalisation/revenue/cash flow test; market capitalisation/revenue test (LR 8.05) (see sections 4.13 to 4.20 below). (e) A new applicant must have a trading record of at least the 3 preceding financial years under substantially the same management, while ownership should be substantially the same for at least the most recent financial year (LR 8.05(1), 8.05(2)(a)-(c), 8.05(3)(a)(c)). (f)

In the case of a new applicant, the latest financial period reported on by the reporting ants must not have ended more than 6 months before the date of the listing document (LR Chapter 4 and 8.06).

(g) There must be an adequate market in the securities – that is, sufficient public interest in the business of the issuer (LR 8.07). (h) Minimum public float must be the higher of HK$50 million or 25% of the issuer’s total issued share capital. For issuers with an expected market capitalisation of over HK$10 billion at the time of listing, the SEHK may accept a lower percentage of between 15% and 25% (LR 8.08(1)(a), (b)&(d)).

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(i) There must be a sufficient spread of shareholders, with a minimum of 300 shareholders (LR 8.08(2)). (j) Not more than 50% of the securities in public hands at the time of listing can be beneficially owned by the 3 largest public shareholders (LR 8.08(3)), save for bonus issue of options, warrants, etc.. (k) Where any controlling shareholder or director of a new applicant has an interest in a business apart from the applicant’s business which competes or is likely to do so, this fact must be disclosed (LR 8.10(1) and (2)). (l) A new applicant applying for a primary listing on the SEHK must have sufficient management presence in Hong Kong, which will normally require at least 2 of its executive directors to be ordinarily resident in Hong Kong, except as otherwise permitted by the SEHK (although this is often waived in practice in the cases of some mainland China issuers (i.e. issuers from the People’s Republic of China other than the regions of Hong Kong, Macau and Taiwan (“PRC issuers”)) and some overseas issuers. (m) The securities for which listing is sought must be freely transferable. This may include partly paid shares if their transferability is not unreasonably restricted (LR 8.13). (n) The persons proposed as directors must meet the requirements of LR Chapter 3. (o) The issuer must appoint an approved share registrar to maintain its of in Hong Kong (LR 8.16). 2.5

The quantitative tests referred to above are as follows: (a) Profit test Profits attributable to shareholders for the most recent year must not be less than HK$20 million and those for the 2 preceding years must not be, in aggregate, less than HK$30 million. (b) Market capitalisation/revenue/cash flow test The issuer must have a market capitalisation of at least HK$2 billion at the time of listing, revenue of at least HK$500 million for the most recent audited financial year, and positive cash flow from operating activities of at least HK$100 million in aggregate for the 3 preceding financial years. (c) Market capitalisation/revenue test The issuer must have a market capitalisation of at least HK$4 billion at the time of listing, and revenue of at least HK$500 million for the most recent audited financial year.

2.6

However, a number of the above criteria, including the quantitative tests, are subject to important qualifications that will be relevant in practice to understand.

2.7

The SEHK may accept a shorter trading record period and/or may waive the profit or other financial standards requirements in certain cases, as set out in the Listing Rules.

2.8

In addition, if there is likely to be significant public demand for its securities, a new applicant may not list by way of placing only. The Listing Rules set out certain procedures to be adopted in the allocation of shares in IPOs. For further details, see sections 6.12 to 6.16 below.

2.9

Other issues that may need to be examined closely and dealt with appropriately include the following: (a) where the listing applicant is seeking to rely on the profit test, not all profits consolidated into its s may be acceptable for the purposes of this test (see sections 4.14 to 4.15 below for further details);

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(b) ensuring the public float requirement is met will require a detailed understanding of who among its shareholders may be considered as part of the public float (see sections 4.24 to 4.28 below for further details); (c) financial disclosures made by listing applicants may also need to comply with other regulatory requirements, for example, banks regulated by the Hong Kong Monetary Authority (“HKMA”) must also comply with the Financial Disclosure by Locally Incorporated Authorized Institutions, issued by the HKMA; (d) for GEM listing applicants, s prepared in accordance with Generally Accepted ing Principles in the United States of America (“US GAAP”) are acceptable if the company is listed, or will be simultaneously listed, on either the New York Stock Exchange or the NASDAQ National Market; (e) the undertakings the SEHK require controlling shareholders to give not to dispose of or charge their shares for specified periods after the company is itted to listing (see sections 4.58 to 4.59 below for further details). Note: Section 4 below provides a more detailed discussion of these and other issues and qualifications that commonly arise in practice. GEM 2.10

The basic requirements for listing contained in the GEM Listing Rules are not the same as those for the Main Board and the following summarizes some key differences. (a) A new applicant must have a trading record of at least 2 financial years with a positive cash flow from operating activities in the ordinary and usual course of business (before changes in working capital and taxes paid) of at least HK$20 million in total for the 2 financial years immediately before the issue of the listing document. (A shorter period may be acceptable in the circumstances specified in GLR 11.14.) (b) The applicant must have been under substantially the same management throughout the 2 full financial years immediately before the issue of the listing document and up until the date of listing. (c) Shorter periods of trading records, ownership and control and management continuity may be acceptable in respect of newly-formed “project” companies (such as a major infrastructure project), natural resource exploitation companies, and in exceptional other circumstances. However, the cash flow requirement of HK$20 million must still be met. (d) The market capitalisation at the time of listing must be at least HK$100 million. (e) The equity securities in the hands of the public at the time of listing should be held among at least 100 persons.

2.11

A new applicant for listing on GEM is free to decide on its offering mechanism and may list on the SEHK by way of placing only.

2.12

Both the Main Board and the GEM Listing Rules do not impose conditions on the new issue price. However, new shares cannot be issued at a price below their nominal value. Procedures for listing application

2.13

LR Chapter 9 sets out the procedures and requirements for applying for a listing of equity securities on the Main Board, whether by new applicants or listed issuers. These include: (a) the sponsor is responsible for lodging the formal application for listing and all ing documents and for dealing with the SEHK; and

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(b) the SEHK must receive a “substantially complete” proof of the listing document (an “Application Proof”) and the timetable with the listing application form, Form A1 (set out in Appendix 5 of the Listing Rules). 2.14

The following is a summary of the procedure and the principal documents required to be lodged with the SEHK. The Listing Rules contain the full details and a complete list of documents.

2.15

A new applicant must submit a Form A1 together with various documents, including the following (for details, see LR 9.10A(1) and LR 9.11): (a) a cheque for the initial listing fee; (b) such number of copies of the Application Proof as required by the SEHK; (c) an undertaking and statement of independence from each sponsor in the form set out in Appendix 17 of the Listing Rules; (d) an undertaking from the compliance adviser in the form set out in Appendix 20 of the Listing Rules; (e) a final or advanced draft of all requests for waiver from the requirements of the Listing Rules and the provisions of the CO from the sponsor and the directors/proposed directors; (f) a certified copy of the certificate of incorporation (or equivalent document) of the applicant; (g) a draft letter from the sponsor confirming the sufficiency of working capital, where applicable; (h) a written confirmation and undertaking signed by each director/supervisor and proposed director/supervisor pursuant to LR 9.11(3a) and (3b); and (i) a final or an advanced draft of the profit forecast memorandum (LR 9.11 (10)).

2.16

All publicity material released in Hong Kong relating to an issue of securities by a new applicant must be reviewed by the SEHK before release and must comply with all applicable statutory requirements (LR 9.08). However, the following documents are not subject to this requirement: (a) the Application Proof; (b) the Post Hearing Information Pack (“PHIP”); and (c) the statements published by a listing applicant on the website of Hong Kong Exchanges and Clearing Limited (“HKEx”) to the effect that no reliance should be placed on media reports about any published Application Proof or PHIP. Note: See sections 5 and 6 of Topic 4 for a more detailed discussion of the Application Proof and the PHIP respectively.

2.17

At least 4 clear business days prior to the hearing date, various other documents must be submitted (LR 9.11(18)-(22)), including the following: (a) the number of copies of the final proof of the listing document required by the SEHK; (b) a confirmation from the listing applicant’s legal advisers that the articles of association of the listing applicant are consistent with the Listing Rules and the laws of its place of incorporation; and (c) unless previously provided, all executed requests for waivers from the requirements of the Listing Rules and the provisions of the CO.

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2.18

The SEHK may delay the timetable if the applicant does not reply to its enquiries on a timely basis, or the revised proof of the listing document or any of the documents required to be submitted to the SEHK cannot be submitted when due.

2.19

Before bulk printing of the listing document, the documents that must be submitted to the SEHK (LR 9.11(24)-(28a)) include the following: (a) a final proof of the formal notice, where applicable; (b) a final proof of any application form for acquiring the securities; and (c) a final copy of all draft documents submitted in of the listing application.

2.20

As soon as practicable after the hearing, but on or before the date of issue of the listing document, the following documents must be lodged with the SEHK (LR 9.11(29)-(32)): (a) a copy of each of the English and Chinese versions of the listing document, which must be signed by every director and by the company secretary and be dated; (b) a copy of the formal notice; (c) a copy of the written notification issued by Hong Kong Securities Clearing Company Limited (“HKSCC”) stating that the securities will be eligible securities (see Note below); (d) every written undertaking and confirmation from the listing applicant, its shareholders and/or other relevant parties to the SEHK referred to in the listing document; and (e) the original signed sponsor declaration(s) required by LR 3A.13 in the form in Appendix 19. Note: “Eligible securities” are those accepted by HKSCC from time to time as eligible for deposit, clearance and settlement in the Central Clearing and Settlement System (“CCASS”) in accordance with the General Rules of CCASS.

2.21

In the case of a listing document which constitutes a prospectus under the CO, the following documents must be lodged with the SEHK not later than 11 am on the intended date of authorization of the prospectus (LR 9.11(33)): (a) an application for authorization for registration; (b) 2 printed copies of the prospectus, duly signed; and (c) in respect of every translation of the prospectus (whether Chinese to English or English to Chinese), a certificate issued by the translator certifying the translation.

2.22

Various other documents must be delivered to the SEHK before dealings commence including the sponsor’s declaration to the SEHK (Form E of Appendix 5) concerning: (a) compliance with the Listing Rules including the public float requirements; (b) details of the number of shareholders; and (c) the number of placees at the time of listing (LR 9.11(34)-(38)).

2.23

Normally, no more than 10% of any securities being marketed for which listing is sought may be offered to employees or past employees on a preferential basis (LR 10.01). Any preferential treatment must be approved by the SEHK. The applications for such treatment must be made on separate application forms. Reference should also be made to LR Practice Note 20. Contents of the listing documents

2.24

LR Chapter 11 sets out the requirements for the contents of listing documents relating to equity securities. The main features are explained below.

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2.25

Offers for subscription, offers for sale, placings by or on behalf of a new applicant, introductions, rights issues, open offers, capitalisation issues and an exchange or substitution all require listing documents.

2.26

Subject to LR 11.09, listing documents must contain all the specified items of information which are set out in either Part A (new applicant) or Part B (existing issuer) of LR Appendix 1. Special requirements for listing documents issued by mineral companies, overseas issuers, PRC issuers and investment companies are set out in LR Chapters 18, 19, 19A and 21 respectively. Note: A mineral company is a company whose major activity is the exploration for and/or extraction of natural resources (i.e. mineral and/or petroleum); a project company is one engaged in “infrastructure projects” (construction of roads, bridges, power plants, airports, etc.); investment companies include unit trusts, mutual funds or any other collective investment scheme.

2.27

In addition to the detailed requirements of LR Chapter 11, an overriding principle is set out in the Securities and Futures (Stock Market Listing) Rules (“SMLR”) (reproduced in LR Appendix 12), that any listing application must contain such particulars and information that will allow an investor to make an informed decision on the issuer and the securities for which listing is sought.

2.28

Illustrations of a pictorial or graphic nature may be included in a listing document provided they are not misleading.

2.29

Listing documents must not contain reference to future profits or contain dividend forecasts based on an assumed future level of profits unless ed by a formal profit forecast. The principal assumptions, including commercial assumptions, on which the profit forecast is based must be stated. The ing policies and calculations for the forecast must be reviewed by the reporting ants. In addition, the sponsor must report that they have satisfied themselves that the forecast has been made by the directors after due care and careful enquiry, and this must be clearly stated. Requirements at the time of listing

2.30

The publication requirements are set out in LR Chapter 12. A formal notice with the information in LR 12.04 must be published in accordance with LR 2.07C (e.g. publication on its own website and HKEx’s website) on the date of issue of the listing document in respect of an offer for subscription, a placing of a new applicant where 25% or more of the amount placed is made available to the general public, and a placing of a class new to listing where 25% or more of the amount is made available to the general public. There are other situations which also require a notice, as described in LR 12.03.

2.31

The notice must state, for instance, the name and country of incorporation of the issuer; the amount and title of securities for which listing is sought; and the date on which listing is expected to commence.

2.32

With regard to any offer for subscription or offer for sale, an announcement of the results of the offer, and the basis of allotment where there has been excess applications, must be published not later than the morning trading session or any pre-opening session of the next business day after the allotment letters are posted.

2.33

An issuer shall, once any of its securities have been itted to listing, comply with the Listing Rules from time to time in force. LR Chapter 13 sets out the continuing obligations which an issuer is required to observe, and draws attention to additional continuing obligations set out in LR Chapters 3, 3A, 4, 6, 8, 10, 11, 12, 14, 14A and Appendix 16. The directors of an issuer are collectively and individually responsible for ensuring the issuer’s full compliance with the Listing Rules.

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Obligation of disclosure 2.34

Issuers must be aware of the requirements of both LR 13.09 and Part XIVA, Securities and Futures Ordinance (“SFO”). (See Topic 1, sections 4.26 to 4.32 for a discussion of Part XIVA, SFO.)

2.35

LR 13.09 requires an issuer to release information, as soon as reasonably practicable, after consultation with the SEHK, to the market that is necessary to avoid a false market in its securities. An example of where this may apply is where trading activity is affected as a result of rumours in the market.

2.36

GLR Chapters 14 and 15 set out the requirements for listing documents and prospectuses. The main differences to note with the GEM are the publication requirements set out in GLR Chapter 16, which require all publications and notices to be published on the GEM website. Such requirements have been introduced to save costs to the issuer, and entail an investor in the GEM market having access to this website (that is, having a computer and Internet access). Publication of the Application Proof and PHIP

2.37

From 1 April 2014, the Application Proof will (with a few exceptions) need to be published on the website “HKExnews”. In addition, from 1 October 2013, a near final prospectus (in the form of a PHIP) will need to be published after hearing by the SEHK, and no later than on the start of institutional book-building, on the website ”HKExnews”. Further details about the publication of the Application Proof and requirement to publish a PHIP, including transitional arrangements between 1 October 2013 and 31 March 2014 and 30 September 2014 respectively, are set out in sections 5 and 6 of Topic 4.

Dual filing 2.38

The Securities and Futures Commission (“SFC”) has issued the SMLR and the Securities and Futures (Transfer of Functions－Stock Exchange Company) Order, both made under the SFO. They constitute subsidiary legislation under the SFO and deal with the companies and listing regulation of information disclosure by listed applicants.

2.39

Under the SMLR, companies that disseminate information to the public have to file with the SFC a copy of the disclosure materials, including any prospectuses and listing documents. Any person who intentionally or recklessly provides false or misleading information when making the disclosure is subject to the statutory powers of the SFC, which will be able to employ its existing investigatory powers in gathering evidence and establishing the facts. In appropriate cases, the SFC may prosecute or refer the matter to the Department of Justice to prosecute offenders.

2.40

The intentional or reckless provision of false or misleading information in listing documents and ongoing disclosure materials to specified recipients such as the SEHK will also be subject to liability under s. 384, SFO (see section 4.7 of Topic 1). In addition, private individuals (such as shareholders) will be able to bring an action against such persons in respect of false or misleading communications under s. 391, SFO.

2.41

Clause 3, SMLR sets out a list of requirements for a listing application.

2.42

Clause 5, SMLR requires a company seeking access to the public market to file with the SFC a copy of its listing application to the SEHK. In order to avoid duplication, the clause provides that a company may simply authorize the SEHK to make the filing on its behalf.

2.43

The SFC is able to comment on the draft listing disclosure materials (principally, the prospectus) and object to a company accessing the public market on the basis of insufficient or inadequate disclosure, within 10 business days. The SEHK remains the point of with listing applicants and conducts the front-line review. Arrangements are in place

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between the SFC and the SEHK to ensure consistency of the comments given to the listing applicant. 2.44

Clause 6(2), SMLR empowers the SFC to object to a listing if the applicant does not comply with the applicable rules and requirements or if it appears that the listing would not be in the interest of the investing public or in the public interest. The SFC has stated that, in the event it makes an objection, the applicant would have a full right of appeal to the independent Securities and Futures Appeal Tribunal for a fresh review. (This would require amendments to the list of specified decisions in Schedule 8, SFO.) Details of the appeals procedure are included in section 5 of Topic 4.

2.45

The SMLR provide for the suspension of dealing in a security as directed by the SFC under certain circumstances. Clauses 8 and 9 of the Rules provide for rights to make representations by the issuer or the SEHK. Professionals and intermediaries including financial advisers will be able to make representations on behalf of the issuers.

Revision questions: Question 2: What quantitative test(s) must a listing applicant satisfy to be eligible for listing? Answer 2: A listing applicant must satisfy one of the following quantitative tests: profit test; market capitalisation/revenue/cash flow test; market capitalisation/revenue test. Question 3: In an IPO, which party is responsible for lodging the formal application for listing and all ing documents and for dealing with the SEHK? Answer 3: The sponsor. Question 4: What is dual filing? Answer 4: Dual filing refers to the requirements under the SMLR for listing applicants to file listing applications to the SFC through the SEHK.

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3

Corporate istration of the listing applicant Introduction

3.1

The Listing Rules also include requirements pertaining to the directors and board of a listing applicant. These requirements address in particular the appointment and composition of the board and draw a distinction between executive directors and non-executive directors. It is a requirement for the boards of listed issuers to include non-executive directors that are independent. Criteria for their appointment as well as considerations relating to their independence are set out below. Boards of listed companies must also appoint specific committees to examine issues that include audit and remuneration. The Listing Rules also provide for the governance of director share dealings and for the appointment of authorised representatives. Lastly, this section will examine requirements for the appointment of a company secretary as well as the appointment and removal of a listed company’s auditor.

3.2

In all cases, sponsors have a duty to ensure that all such appointments are made in accordance with the Listing Rules as well as other applicable laws, rules and regulations and that management and other parties appointed in the above corporate istration roles are not only suitably qualified, but also aware of their responsibilities in the context of a listing on either the Main Board or GEM, as appropriate.

Directors and board committees 3.3

Chapter 3 of the Listing Rules sets out the SEHK’s requirements as regards directors and the board of a listed issuer. Sponsors have an obligation to be satisfied that the directors and the board are in a position to comply with these requirements once the listing applicant is itted to listing. The requirements are reviewed in the following sections and the sponsor’s obligations in this regard are further discussed in Topic 4.

3.4

The board of directors of an issuer is collectively responsible for its management and operations. The SEHK expects the directors, both collectively and individually, to fulfil their duties to a standard at least commensurate with that established by Hong Kong law (LR 3.08; GLR 5.01). Directors of a company to be listed are required to undertake to use their best endeavours to ensure that the listed company complies with the Listing Rules and other applicable laws and provisions relating to securities.

3.5

Directors are required to: (a) act honestly and in good faith in the interests of the company as a whole; (b) act for proper purposes; (c) be answerable to the issuer for the application or misapplication of its assets; (d) avoid actual or potential conflicts of interest; (e) disclose any conflicts of interest in any contracts; and (f) apply an appropriate degree of skill, care and diligence as may reasonably be expected of a person of the knowledge and experience associated with the type of position the director holds. Directors must ensure that they have a general understanding of the issuer’s business and monitor its affairs actively. Those who fail to discharge their duties and responsibilities may be subject to disciplinary action by the SEHK and civil and/or criminal liability under Hong Kong law or the laws of other jurisdictions.

3.6

It will be necessary for the listing applicant to have sufficient management presence in Hong Kong, and LR 8.12 states that this normally means having at least 2 executive directors who are ordinarily resident in Hong Kong, although this requirement may be waived for the

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People’s Republic of China (“PRC”) or overseas issuers subject to appropriate conditions that ensure the SEHK is sufficiently able to communicate (including to attend meetings) with the directors. This will include the need for each director to possess valid travel documents to enter Hong Kong and for their information (including mobile, office phone and facsimile numbers, and email address) to be provided to the SEHK. Independent non-executive directors 3.7

There must be at least 3 independent non-executive directors (“INEDs”) on the board of directors. At least one of the INEDs must have appropriate professional qualifications, or ing or related financial management expertise (LR 3.10; GLR 5.05).

3.8

“Appropriate ing or related financial management expertise” refers to experience as a public ant or auditor or as a chief financial officer, controller or principal ing officer of a public company or in performing similar functions, experience with internal controls and in preparing or auditing comparable financial statements, or experience in reviewing or analysing audited financial statements of public companies.

3.9

In addition, at least one third of the board must be INEDs (LR 3.10A; GLR 5.05A).

3.10

Persons who are proposed to act as INEDs must submit to the SEHK a written confirmation of their independence in the light of the factors below, which are set out in LR 3.13, and state if there are any other factors that affect their independence. A proposed INED will need to confirm whether he: (a) holds more than 1% of the total issued share capital of the listed issuer (a person holding an interest of 5% or more will normally not be considered independent); (b) has received an interest in any securities of the listed issuer as a gift or has other financial assistance from the listed issuer or a connected person (except if the director receives the shares from the listed issuer or its subsidiaries as part of his director’s fee or pursuant to a share option scheme established under the Listing Rules); (c) is a director, partner or principal of a professional adviser which provides (or has, within one year immediately prior to the date of the proposed appointment, provided) services to either (i) the listed issuer, its holding company or any of their respective subsidiaries or connected persons, etc., or (ii) the listed issuer’s controlling shareholder or its associates (or if there is no controlling shareholder, its chief executive or any director (other than an INED) or their associates); (d) is an employee of a professional adviser as mentioned above who is involved in the provision of services during the same period; (e) has a material interest in any principal business activity of, or is involved in any material business dealings with, the listed issuer, its holding company or their respective subsidiaries or with any connected persons of the listed issuer; (f) is on the board specifically to protect the interests of an entity whose interests are not the same as those of the shareholders as a whole; (g) is or was connected with a director, the chief executive or a substantial shareholder of the listed issuer within the two years immediately prior to the date of his proposed appointment (a connected person includes any person cohabiting as a spouse with, and any child, step-child, parent, step-parent, brother, sister, step-brother and step-sister of, a director, the chief executive or a substantial shareholder of the listed issuer); (h) is or has at any time during the 2 years immediately prior to the date of his proposed appointment been an executive or director (other than an INED) of the listed issuer, of its holding company or of any of their respective subsidiaries or of any connected persons of the listed issuer; and

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(i) is financially dependent on the listed issuer, its holding company or any of their respective subsidiaries or connected persons of the listed issuer. 3.11

The above cases are included in the Listing Rules for guidance only. When assessing a director’s independence, the SEHK may take of other factors it considers relevant to a particular case. Directors’ share dealings

3.12

The SEHK regards it as highly desirable that directors should own shares in the listed issuer for which they act as directors.

3.13

A director must not deal in any of the issuer’s securities when he is in possession of inside information. A director must not deal in any such securities during the time from the ending of the issuer’s financial period to the date of the results announcement.

3.14

In addition, every director must comply with the Model Code for Securities Transactions by Directors of Listed Issuers (“Model Code”) set out in LR Appendix 10 (LR 3.17). This code sets out the standards the SEHK requires all listed issuers and their directors to meet. Any breach of the required standards will be regarded as a breach of the Listing Rules. In principle, a director should ensure that all dealings in which he is or is deemed to be interested are conducted in accordance with the Model Code. A listed issuer must disclose in its annual and interim reports whether it has adopted the code and whether its directors have complied with it. In the event of any non-compliance with the required standard, details of such non-compliance and an explanation of the remedial steps taken by the issuer to address such non-compliance must be disclosed in its annual and interim reports.

3.15

An issuer may adopt its own code on no less exacting than those set out in the Model Code. Any breach of its own code will not be regarded as a breach of the Listing Rules as long as the required standard under the code is met.

3.16

The required standard of securities transactions applicable to issuers listed on the GEM and their directors is set out in GLR 5.48 to 5.67. Any breach of this standard will be regarded as a breach of the GEM Listing Rules.

3.17

The Listing Rules also contain important appendices that set out the SEHK’s views on the principles and implementation of good corporate governance, the “Corporate Governance Code and Corporate Governance Report” (LR Appendix 14; GLR Appendix 15).

3.18

Directors of listed issuers may be removed by an ordinary resolution in general meeting (LR Appendices 3 and 13B; GLR Appendices 3 and 11B).

Authorised representatives 3.19

Every listed issuer must appoint 2 authorised representatives to act, at all times, as the listed issuer’s principal channel of communication with the SEHK. The authorised representatives must be: (a) for companies listed on the Main Board – either 2 directors, or a director and the listed issuer’s company secretary (LR 3.05); (b) for companies listed on GEM – 2 individuals from among the issuer’s executive directors and company secretary (GLR 5.24).

Audit committee 3.20

Every listed issuer must establish an audit committee (LR 3.21): (a) consisting of non-executive directors only; (b) with a minimum of 3 ;

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(c) with the majority being INEDs; (d) with at least one member who is an INED with appropriate professional qualifications or ing or related financial management expertise; and (e) chaired by an INED. 3.21

Written of reference for the audit committee of the listed issuer that clearly establish the committee’s authority and duties must be approved and made available by the board of directors.

Remuneration committee 3.22

An issuer must establish a remuneration committee chaired by an INED and with a majority of INEDs.

3.23

The board of directors must approve and provide written of reference for the remuneration committee which clearly establish its authority and duties.

3.24

An announcement containing the relevant details and reasons must be published immediately in the case that the issuer fails to set up a remuneration committee or at any time has failed to meet any of the other requirements in LR 3.25 and 3.26. Any such failure must be rectified within 3 months.

Company secretary 3.25

An issuer must appoint a company secretary who possesses academic or professional qualifications or relevant experience acceptable to the SEHK.

3.26

The company secretary of the issuer must be a member of The Hong Kong Institute of Chartered Secretaries, or a solicitor or barrister, or a certified public ant or have some other qualification acceptable to the SEHK (LR 3.28).

3.27

The relevant experience considered by the SEHK includes length of employment with the issuer, knowledge of the Listing Rules, SFO, CO, Takeover Codes, etc., and professional qualifications in other jurisdictions.

3.28

The company secretary of an issuer must undergo no less than 15 hours of relevant professional training in each financial year.

Appointment and removal of auditor 3.29

An issuer must appoint an auditor to hold office from the conclusion of each annual general meeting until the next annual general meeting. Any removal of the auditor before the end of its term of office must be approved by shareholders at a general meeting. A circular proposing the removal of the auditor, with any written representations from the auditor, must be sent to shareholders not less than 10 business days before the general meeting. The auditor must be allowed to attend the general meeting and make written and/or verbal representations to shareholders at the meeting.

Revision questions: Question 5: What are the potential consequences to directors of listed companies that fail in their duties? Answer 5: Directors who fail to discharge their duties and responsibilities may be subject to disciplinary action by the SEHK and civil and/or criminal liability under Hong Kong law or the laws of other jurisdictions. * Text that has been shaded is exclusively for Paper 15 Papers 15 & 16 Version 1.0

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Question 6: Must a listed issuer’s board contain any INEDs? Answer 6: Yes, there must be at least 3 and at least one-third of the board must be INEDs. Question 7: Is a director of a listed company prevented from dealing in shares of that company? Answer 7: See sections 3.13 to 3.16 above.

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4

Specific issues in practice Introduction

4.1

It is the responsibility of sponsors to guide listing applicants not only in respect of their qualification and suitability for listing, but also throughout the execution of the IPO process. This will include an understanding of listing decisions and guidance materials as well as a thorough knowledge of the financial disclosure expected in connection with a listing on the SEHK. Also relevant will be knowledge of the rules adhering to profit forecasts and the valuation of property interests. Sponsors should also be cognizant of the rules pertaining to pre-IPO and cornerstone investors, as well as connected and related-party transactions. This section will conclude with an overview of spin-offs and the rules applicable to mineral companies.

Listing Decisions and guidance materials 4.2

In addition to considering the requirements of the Listing Rules, sponsors may need to consider the contents of other guidance materials published by the SEHK. Such guidance materials take the form of Listing Decisions, Guidance Notes, Guidance Letters and Rejection Letters. While these published materials provide useful sources of information, clarification and guidance on how the SEHK interprets the Listing Rules on various matters, they do not override the Listing Rules and are not binding on the SEHK.

4.3

Listing Decisions arise in the course of the Listing Division and the Listing Committee undertaking their respective functions in considering and making decisions on various matters concerning the application of the Listing Rules to specific factual circumstances. Listing Decisions are published with a view to enhancing transparency. However, as they are based on the specific circumstances of the listing applicant, the degree to which a particular Listing Decision based on these facts is applicable to another set of facts will need to be considered carefully. No Rejection Letter has been issued by the SEHK since 2010. The approach now appears to be issuing Listing Decisions, which serve the same function.

4.4

Unlike Listing Decisions, Guidance Notes and Guidance Letters are not referenced to a specific set of facts, but are published by the SEHK where it determines it is desirable to clarify how it will interpret and apply certain Listing Rules.

4.5

The SEHK also publishes from time to time Frequently Asked Questions focusing on various subjects and these may also provide useful sources of information. Note: Listing Decisions and guidance materials can be easily found through HKEx’s “Listing Rules Guidance Search”. See http://www.hkex.com.hk/eng/gse/index.aspx

Qualification and suitability 4.6

As previously discussed (see section 2.4 above), to be eligible for listing, a listing applicant must: (a) have an adequate trading record of at least 3 completed financial years under substantially the same management (the “Track Record Period”); (b) satisfy at least one of the 3 quantitative tests set out in LR 8.05 in respect of the Track Record Period; and (c) otherwise be regarded as suitable for listing. However, the relevant Listing Rules are subject to qualifications that require a more detailed consideration of the Listing Rules and the circumstances of the listing applicant.

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Note: The requirement is based on financial years not calendar years. A financial year may be more or less than a calendar year. The Listing Rules define a financial year as “the period in respect of which any profit and loss of a company laid or to be laid before it in general meeting is made up, whether that period is a year or not”. Companies will sometimes have financial years not equal to a calendar year, where, for example, it is adjusting its financial year-end date. Trading record 4.7

The latest financial year of the Track Record Period must end not more than 6 months before the date of the listing document. Where the date of the listing document falls outside this 6month period, a further ant’s report will need to be produced to ensure that the latest financials presented in the listing document cover an interim period ending not more than 6 months prior to the date of the listing document (normally referred to as the “stub” period).

4.8

A listing applicant may not, during the most recent year of its Track Record Period, change the period of its financial year. However, its subsidiaries may do so provided it is for the purpose of aligning their financial period with that of the listing applicant.

4.9

During the Track Record Period, a listing applicant may undergo various developments as a normal part of its business development. In particular, the assessment of its trading record may be affected where it has: (a) undergone a material change in management or ownership; (b) acquired or plans to acquire a new business; or (c) been newly formed as a result of companies being newly formed into a group.

4.10

In these circumstances, the SEHK should be consulted at an early stage for confidential advice before submitting the listing application. It is essential that full information as to the relevant circumstances is provided. In this regard, Practice Note 3 of the Listing Rules provides guidance on how the SEHK applies the trading record requirement in these circumstances, and the following factors are relevant to consider: (a) materiality of the new business, including its expected contribution to any profit forecast (if material, the application may be rejected); (b) whether the new business is in a similar business line and part of a logical growth trend of the listing applicant’s business; (c) whether the management of the new business is retained and integrated with the management of the listing applicant; (d) how long ago the new business was acquired (it being relevant to consider the ability of management to manage the enlarged business); and (e) whether a group has been formed merely as a means of satisfying listing requirements or enhancing its attractiveness as a new listing applicant.

4.11

The SEHK may also consider the audited s of the group companies for the Track Record Period and will normally expect that such s do not contain any qualifications in respect of the latest 2 financial periods that may be significant to investors.

4.12

In situations where a listing applicant does not carry out any trading activity during part of its financial year, such a period would not be counted as part of its trading record. This might occur, for example, where the listing applicant has engaged in various preparatory work in advance of generating revenue from an ordinary course of business. Note: Preparatory work might include items such as expenses incurred in business planning, construction of factory facilities, procurement of raw materials, preliminary negotiations with potential customers or trial production.

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Profit test 4.13

The profit test is a common means by which a listing applicant seeks to meet the quantitative tests. In calculating the profit test, care should be taken that the following matters have been taken into .

4.14

The profit test requires that “profit attributable to shareholders” be used. This refers to the after-tax profit figure, sometimes referred to as net profit. Note: A number of other exchanges use different profit figures for similar calculations. For example, the Australian Securities Exchange considers consolidated operating profit, while the New York Stock Exchange and the Singapore Exchange both use consolidated profit before tax.

4.15

Extraordinary items, i.e. profits (or losses) attributable to activities outside the normal course of the listing applicant’s usual business, must be excluded. While such items will normally be identified in the s as extraordinary items, it is the sponsor’s responsibility to examine this issue, where necessary with the involvement of the reporting ants. In the Hong Kong context, extraordinary items are commonly found to include profits arising from share trading activity and profits arising from the disposal of real property (in each case where this is not the usual business of the listing applicant).

4.16

A common issue that arises is whether profits consolidated into the listing applicant’s s that arise from its group companies may be included in the profit test calculation. The treatment of these profits is as follows: (a) Subsidiary undertakings: profits of subsidiary undertakings may be included; Note: Subsidiary undertakings will normally include companies in which the listing applicant owns more than 50%. However, the relevant ing standards will need to be considered (for Hong Kong incorporated companies, see the definition of parent and subsidiary undertakings in the Twenty-Third Schedule of the CO). (b) Associated companies: the ing practices of a listing applicant will often include profits from companies that are not subsidiary undertakings by using an equity method of ing. This will include the listing applicant’s associated companies, i.e. companies in which its ownership is less than 50%. Any such profits should be excluded for the purposes of the profit test calculation. (c) t ventures: where a listing applicant consolidates profits from a t venture that is not regarded as a subsidiary undertaking, it will be necessary to look at the exact arrangements of the t venture. Arrangements where the t venture partners each owns 50% of the venture may imply that the listing applicant is unable to exert absolute control over the venture. Where there is an insufficient element of control, the profits arising from the t venture may need to be excluded. Note: Where absolute control is lacking, some Listing Decisions have found it sufficient for the listing applicant to exercise negative control through having veto rights over certain matters (for example, see SEHK’s Listing Decision LD34-3 from 2003).

4.17

Other items that may be included in a listing applicant’s s that have been found to be problematic in the past include unrealized gains arising on a book revaluation exercise and compensation payments in relation to a termination of contract. The variety of potential sources of profits under applicable ing standards merely underlines the sponsor’s obligation to examine a listing applicant’s source of profits carefully, possibly with reference to the reporting ants and past Listing Decisions. The sponsor will need to give careful consideration to such issues on a case-by-case basis and, where uncertainty remains, the sponsor should consider consulting the SEHK for guidance.

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Market capitalisation/revenue/cash flow test 4.18

Only revenue arising from the principal activities of the listing applicant may be included in the revenue calculation of this test. Gains and revenue arising incidentally as well as from mere book transactions should be excluded from the calculation. Note: “Book transactions” refers to book-keeping transactions such as ing writebacks and banner barter transactions (i.e. two companies enter into barter trades with each other ascribing a high notional value to the transaction). Market capitalisation/revenue test

4.19

Only revenue arising from the principal activities of the listing applicant may be included in the revenue calculation of this test. Gains and revenue arising incidentally as well as from mere book transactions should be excluded from the calculation.

4.20

The SEHK may accept a shorter trading record period provided that: (a) the directors and management of the listing applicant have at least 3 years’ experience in the same industry; and (b) management continuity is established for the most recent financial year. However, mineral companies relying on these provisions will need to comply with additional requirements (see sections 4.86 to 4.92 below). General waivers

4.21

The Listing Rules expressly contemplate waivers of the trading record period and/or the financial requirements of the above three quantitative tests in certain cases, including mineral companies and newly formed project companies (see also sections 4.86 to 4.92 below).

4.22

The SEHK also reserves the right to grant other waivers. For example, the SEHK stated in a press release dated 5 June 2009 that granting a waiver to listing applicants from strict compliance with the existing profit test may be warranted in certain circumstances, such as in the context of a major financial crisis. Where the negative impact is temporary in nature, these listing applicants should not automatically be rendered ineligible for listing. In addition, the SEHK reserves a general right to grant a waiver where the listing applicant has completed at least 2 years’ financials and the SEHK regards the listing to be in the interests of the issuer and investors. It will also be necessary to satisfy the requirement that investors have sufficient information to be able to make an informed investment decision. Where a listing applicant may wish to seek such a waiver, it is desirable that the SEHK be consulted at an early stage. Suitability

4.23

LR 8.04 requires the listing applicant and its business to be “suitable for listing”. While the Listing Rules themselves contain no further provisions on what this means, some guidance can be obtained from various Listing Decisions and Rejection Letters. The following 2 factors have been found to render a listing applicant unsuitable: (a) excessive reliance on a single customer or supplier that gives rise to a significant risk for investors; (b) commission of illegal acts or demonstrated serious non-compliance with applicable regulations, particularly where this may indicate issues with the integrity, competence and suitability of the listing applicant, directors and senior management.

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The above list is derived from the particular facts of previous situations, and a sponsor will need to assess the relevant facts of the particular listing applicant that has engaged it and, where appropriate, consult the SEHK in advance of making any listing application. Public float 4.24

An issuer must, on ission to listing, and on a continuous basis thereafter, comply with the required minimum public float. This requires the issuer to maintain a specified minimum percentage of its issued securities in the hands of the public, the primary concern of the SEHK being to ensure there is an adequate spread of shareholders that will foster an open market in the securities of the issuer and that a false market is avoided. The required percentage is generally not less than 25%.

4.25

The above minimum level may be reduced, on application, for listing applicants with an expected market capitalisation of more than HK$10 billion. The level may, subject to conditions, be reduced to between 15% and 25%.

4.26

Listing applicants with other classes of share capital (for example, that are listed on other regulated markets) may aggregate its public float across all regulated markets for the purposes of meeting the SEHK’s public float requirements, provided that its expected market capitalisation on the SEHK represents at least 15% of its total issued share capital and satisfies the minimum HK$50 million requirement (see section 2.4(h) above). Note: Some listed companies currently have public floats of between 10% and 15% owing to exemptions granted prior to the present set of rules coming into effect.

4.27

For these purposes, “public” means persons who are not: (a) a connected person; Note: “Connected person” is a defined term in the Listing Rules and means a director, chief executive or substantial shareholder of the issuer (or in the present context, the listing applicant) or any of its subsidiaries or an associate of any of the foregoing and, for a PRC issuer, includes a supervisor of the listing applicant. (b) a person whose purchase of the securities has been financed directly or indirectly by a connected person; or (c) a person who is used to take directions from a connected person in relation to the holding of the securities.

4.28

Where a listing applicant, after being listed, fails to comply with the public float requirement, it will normally be required to take steps to restore the applicable minimum public float. The SEHK may also impose a suspension until the float is restored, although it may refrain from doing so where it is satisfied that steps will be taken to restore the public float and the market remains open and not false.

ing standards and financial information 4.29

A listing applicant’s s must be prepared in accordance with either Hong Kong Financial Reporting Standards or International Financial Reporting Standards. For PRC issuers, the s may be prepared under China ing Standards for Business Enterprises. Any significant departure from such ing standards must be disclosed and explained and, to the extent practicable, the financial effects of such departure quantified.

4.30

For Main Board listing applicants, s of an overseas-incorporated issuer prepared in accordance with US GAAP or other ing standards may be acceptable by the SEHK under certain circumstances.

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4.31

The Listing Rules require that sufficient information should be given to potential investors to enable them to make a properly informed assessment of an issuer.

4.32

The Listing Rules (Paragraph 32, Part A, Appendix 1) require a listing document to include a statement as at the most recent practicable date (which must be stated) of the total amount of debt securities, borrowings, indebtedness, mortgages, contingent liabilities and guarantees, of the new listing applicant on a consolidated basis. They also require the listing document to include a commentary on the new applicant’s (i) liquidity and financial resources and (ii) capital structure.

4.33

The Listing Rules (Paragraph 36, Part A, Appendix 1) require the listing document to include a statement by the directors that in their opinion the working capital available to the group can meet the group’s requirements for at least 12 months from the date of publication of the listing document or, failing that, how additional necessary working capital may be provided. In practice, this statement is almost always a clean statement, since otherwise there may be issues regarding the general suitability of the applicant for listing.

4.34

A listing document should also normally include: (a) in the financial information section, the net current asset (liabilities) position of the applicant stating the composite assets and liabilities as at the most recent practicable date, and a management discussion of the net current asset (liabilities) position; Note: The most recent practicable date should normally be the same as the indebtedness statement date and not more than two calendar months before the listing document is issued. (b) an analysis and explanation of the sources and uses of cash, including the material changes in the underlying drivers (e.g. cash receipts from sales of goods and cash payments to acquire inventories). The presentation should be tailored to the listing applicant and some specific disclosures relating to the applicant’s principal business may be more relevant and informative for investors. Identifying the sources and uses of cash at the outset can also enhance the analysis of material changes in the underlying drivers in respect of the applicant’s performance; (c) an analysis of and information on factors materially affecting the listing applicant’s liquidity, for example: (i) funds needed to meet contractual obligations, maintain current operations, complete projects and achieve stated objectives or plans; (ii) commitments for capital or similar major expenditures, including those to be undertaken in the near future such as (1) amounts for capital expenditure on major projects; (2) sources and amounts of funds set aside for major projects; and (3) estimated cash payments and receipts for the next 2 years, etc.; (iii) likely future cash requirements associated with known trends and uncertainties, and details of the anticipated time periods for their resolution; and (iv) relevant legal/regulatory requirements and/or restrictions; (d) where applicable, a discussion and analysis of the amounts or ranges involved for material external debt financing, the likelihood of obtaining the financing at acceptable to the applicant, the nature and the of the financing, other features of such arrangements, and their impact on the new listing applicant’s cash position and liquidity. A negative statement should be included if there are no external financing plans; (e) a discussion and analysis of material covenants relating to outstanding debt (or covenants applicable to the companies or third parties in respect of guarantees or other contingent obligations) and their impact on the applicant’s ability to undertake

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additional debt or equity financing, etc.. A negative statement should be included if there are no such covenants; and (f) any other material information pertaining to indebtedness, liquidity, financial resources and capital structure relevant for an investor to make a properly informed assessment of the financial position and prospects of the listing applicant. For example, the impact of any deterioration of the credit markets and/or tightened monetary policies that may affect the availability of existing banking facilities, or whether the applicant has suffered from any cancellation of orders or default in payments by customers. 4.35

The indebtedness statement should normally be dated as at the most recent practicable date before the issue of the listing document. In addition, a new listing applicant is usually expected to disclose in the indebtedness statement details of its banking and other facilities as at the most recent practicable date. This should normally include the amounts of total available facilities and indebtedness, maturity profile, interest rates, security and guarantees, etc..

4.36

Listing applicants with net current liabilities, negative operating cash flows during most of the Track Record Period, significant capital commitments, high gearing ratios and/or significant reclassification of long-term debts to short-term debts will need to disclose these circumstances (as applicable) in their listing documents. Having regard to these circumstances, the directors will need to state in the listing document (i) the basis upon which they form the view that the listing applicant can meet the working capital requirements for at least 12 months from the date of the listing document, and (ii) any material defaults in any payments due and/or breaches of finance covenants during the Track Record Period. The sponsor and reporting ants will also need to state in the listing document the basis on which they concur with the directors’ view (it is unlikely that a listing application would proceed if the sponsor and reporting ants did not concur), including any relevant stress tests on the directors’ key assumptions.

4.37

Where a listing document is required to contain a statement by the directors as regards sufficiency of working capital, the sponsor will need to prepare a final confirmation letter before bulk printing of the listing document confirming that sufficiency. Such confirmation should be based on the sponsor’s own due diligence work, having regard to the relevant confirmations provided by the listing applicant and the reporting ants. The confirmations of the sponsor and the reporting ants should have the same date. Note: The confirmations provided by the listing applicant and the reporting ants must be copied to the SEHK and the SFC. Refer also to LR 9.11(28) (GLR 12.23A(1)).

4.38

Further information on, and requirements for, the Management Discussion and Analysis of Financial Information and Condition (“MD&A”) can be found under Topic 5.

Acceptable jurisdictions 4.39

As already mentioned in section 2.7 of Topic 1, initially (although there have been a handful of exceptions in the past) only companies incorporated in Hong Kong, mainland China, Bermuda or the Cayman Islands were able to list on the SEHK. The list of jurisdictions accepted for listing in Hong Kong have since been expanded to include an additional 21 jurisdictions as at 29 April 2013. This development is relatively recent and was introduced in part in response to interest by international companies to list in Hong Kong.

4.40

As at 29 April 2013, overseas jurisdictions (other than the PRC, Bermuda and Cayman Islands) that the Listing Committee has formally ruled to be acceptable as an issuer’s place of incorporation are: Australia, Brazil, the British Virgin Islands, Canada-Alberta, CanadaBritish Columbia, Canada-Ontario, Cyprus, , , Guernsey, the Isle of Man, Italy, Japan, Jersey, the Republic of Korea, Labuan (East Malaysia), Luxembourg, Singapore, the United Kingdom and the states of California and Delaware in the United States (“US”).

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The current list of acceptable jurisdictions is published on HKEx’s website, and contains hyperlinks to relevant Listing Decisions and issuers’ listing documents for ease of reference. 4.41

The SEHK encourages potential overseas issuers and their advisers to consult with it early on any jurisdiction acceptance issue before submitting a formal listing application. The SEHK will accept filing in cases after consultation with the Listing Committee (SEHK’s Guidance Letter GL 12-09).

4.42

The SEHK follows a simpler process for subsequent issuers from jurisdictions that have already been considered and accepted. In particular, such subsequent issuers do not need to complete a detailed line-by-line comparison of shareholder protection matters in the t Policy Statement regarding the Listing of Overseas Companies dated 7 March 2007. Instead, where the jurisdiction was accepted on the basis that differences in shareholder protection standards were addressed by the previous issuer amending its constitutional documents or by other means, the SEHK will accept subsequent issuers adopting similar arrangements. However, in so doing, any subsequent issuer must also consider its own constitutional documents and circumstances and decide what amendments to its constitutional documents are necessary or what other means are available to address the shareholder protection differences.

4.43

The process for the acceptance of new overseas jurisdictions is set out in the Listing Decision reporting on the acceptance of (SEHK’s Listing Decision LD 71-1). In particular, sponsors should note that the SEHK: (a) allows cross-benchmarking with recognized or accepted jurisdictions to demonstrate the acceptability of a new jurisdiction; (b) adopts purposive interpretation of shareholder protection equivalence requirements rather than textual equivalence; (c) does not rigidly require issuers to change their constitutional documents; and (d) does not require issuers to regularly review laws of jurisdictions of incorporation (SEHK’s Guidance Letter GL 12-09).

Investor considerations 4.44

Listing applicants may secure commitments from investors to raise financing ahead of the formal launch of their IPOs. This can be done in several ways. First, pre-IPO investors may provide funding in exchange for a stake in the capital of the issuer once it becomes listed. Such arrangements and investments are subject to several conditions, which are detailed below.

4.45

Second, a listing applicant may also secure commitments from cornerstone investors who agree to subscribe for a guaranteed allocation of shares at the offer price. Further information on placings to cornerstone investors can be found in the ensuing sections.

4.46

Because the existence of cornerstone investors is sometimes critical to the success of an IPO, including when market sentiment is weak, some listing applicants and their controlling shareholders, sponsors or other syndicate may be willing to offer to some cornerstone investors direct or indirect benefits by side letter or otherwise, other than a guaranteed allocation at the IPO price. Accordingly, sponsors should bear in mind that, where there is any form of direct or indirect benefits by side letter or otherwise, other than a guaranteed allocation, given to investors (see Note below), these investors should be reclassified as pre-IPO investors, which will significantly affect the listing timetable unless the arrangements with such investors are unwound (SEHK’s Guidance Letters GL 43-12 and GL 44-12). Note: Examples of such other benefits would include a waiver of brokerage commission, a put option from the controlling shareholder or any other person to buy back the shares after

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listing, sharing of underwriting commissions, an assurance that the applicant will re-invest the IPO proceeds in funds managed by the cornerstone investor, an agreement to allow allocation of shares in another IPO, or any other transaction or arrangement entered into on non-arm’s length commercial in connection with the acquisition of the shares. Pre-IPO investors 4.47

As a company progresses towards a hoped-for IPO, it is not unusual for it to raise financing via arrangements that will allow investors to profit from the company being floated on a public market (normally referred to as “pre-IPO investments”). A typical form of pre-IPO investment would be a debt security convertible into shares on the listing of the company, but there are a variety of forms that such an investment could take and the rights that may go together with the investment. These arrangements may also give rise to new share issuances around the time of the company’s listing. Pre-IPO investments are a concern when considered in the light of LR 2.03, which requires, among other things, an orderly issue and marketing of the shares to be listed as well as an equal and fair treatment of all shareholders (including investors who will become shareholders at the time of an IPO).

4.48

The listing document will need to disclose all pre-IPO investments, including details on investors and the of the investments, and the SEHK has issued guidance on how it will regard pre-IPO investments in view of the Listing Rules. This means that a listing applicant will need to have regard to the SEHK’s guidelines in structuring its pre-IPO investments. A sponsor will need to examine the of existing pre-IPO investments for compliance with those guidelines as it will have to provide confirmation to the SEHK that the pre-IPO investments comply with the relevant requirements. Investments with that would not be in compliance with the guidelines will need to be commercially resolved so as to come into compliance prior to submission of the listing application, failing which the investment will need to be unwound or the listing date has to be postponed until compliance with the SEHK’s requirements can be achieved. The following sections summarize the main issues. Note: For details of the SEHK’s guidelines, please refer to SEHK’s Guidance Letters GL4312 and GL44-12. Candidates are not expected to know the detailed content of these Guidance Letters.

4.49

Pre-IPO investments must be completed by no later than: (a) 28 days before the first submission of the first listing application form; or (b) 180 days before the expected first day of trading of the listing applicant’s shares. Note: Completion means that the funds have been irrevocably settled on the applicant.

4.50

Where the listing applicant has issued pre-IPO investments in the form of convertible instruments (such as convertible bonds or convertible preference shares), additional disclosure will be required in the sections of the listing document dealing with financial information and risk factors. In addition, the presence of any of the following types of in the instrument will require close examination as to whether they comply with the SEHK’s guidelines: (a) the conversion price is linked to the IPO price or the listing applicant’s market capitalisation; (b) reset mechanisms on the conversion price; or (c) mandatory or partial conversions.

4.51

While the SEHK recognizes that pre-IPO investments do attract special rights, rights that represent an unequal treatment of shareholders will not be allowed to survive the listing. Where the following types of rights in pre-IPO investments exist, there will be a need for closer examination:

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(a) price adjustments; (b) put or exit options; (c) director nomination rights; (d) veto rights; (e) anti-dilution rights; (f) profit guarantees; (g) negative pledges; (h) prior consent for certain corporate actions/changes in articles; (i) exclusivity rights and no more favourable ; (j) information rights; (k) representation/attendance rights; (l) right of first refusal and tag-along rights; or (m) compensation provisions in the event the company is not itted to listing within a specified period of time. 4.52

Pre-IPO investors can be regarded as part of the public float provided the usual public requirements apply to them (see sections 4.24 to 4.28 above) notwithstanding any lock-up to which they may be subject. Cornerstone investors

4.53

In an IPO, a portion of IPO shares under the placing tranche are often the subject of a preferential allocation to certain investors, commonly known as “cornerstone investors”. Cornerstone investors are generally major institutional fund management companies, sovereign wealth funds or Hong Kong tycoons, and are introduced to an IPO to provide added confidence to other investors in an investment in the company. Under these arrangements, cornerstone investors receive a guaranteed allocation of shares at the final offer price.

4.54

Placings to cornerstone investors normally follow these principles: (a) their allocation must be made at the IPO price; (b) it is subject to a lock-up, usually of at least 6 months after the date of listing; (c) cornerstone investors are not entitled to board representation, and are independent of the listing applicant, its connected persons and their respective associates; (d) details of the arrangements pertaining to the investment, including the identity and background of the investors, are included in the listing document; and (e) the shares form part of the public float despite the 6-month lock-up requirement (LR 8.08, GLR 11.23) provided the investor is a member of the public for the purpose of LR 8.24 (Notes 2 and 3 to GLR 11.23).

4.55

Sponsors should bear in mind in particular that the issue and marketing of securities must be conducted in a fair and orderly manner and that all holders of listed securities be treated fairly and equally (LR 2.03(2) and (4) and GLR 2.06(2) and (4)). Other relevant considerations are that information contained in the prospectus must be accurate and complete in all material respects and not be misleading or deceptive (LR 2.13(2) and GLR 17.56(2)).

4.56

In practice, prospective cornerstone investors are usually ed by the global coordinator and bookrunner banks early in the IPO process to assess their investment interest, and asked

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to enter into non-disclosure agreements pursuant to which they are provided with an advance copy of the prospectus. They are also usually offered the opportunity of one or more meetings or conference calls with the senior management of the issuer. Their investment commitment, once confirmed, is then evidenced through the g of a cornerstone subscription agreement whereby they agree to subscribe for a set amount of shares at the offer price and to commit to a 6-month lock-up on the sales of such shares postlisting. Their commitment can be expressed as a number of shares or as a fixed monetary amount. 4.57

The cornerstone subscription agreement (the detailed contents of which remain confidential) usually includes an agreed description of the investor, which is included in the listing document alongside details of each cornerstone investor’s commitment. It should also be noted that cornerstone investor commitments are usually “protected” against the reallocation of stock from the placing tranche to the public offer tranche if a claw-back is triggered as a result of significant over-subscription by retail investors of the public offer. Lock-ups

4.58

No further shares or securities convertible into equity securities of a listed issuer may be issued or form the subject of any agreement to such an issue within 6 months of the date of listing. In addition to the above restrictions pertaining to the issuer itself, the SEHK imposes certain restrictions on the disposal of securities by controlling shareholders following a company's new listing. Any person regarded as a controlling shareholder at the time of listing shall not: (a) dispose of his shares in the listed issuer in the period commencing on the date by reference to which disclosure of the shareholding of the controlling shareholder is made in the listing document and ending on the date which is 6 months from the date on which dealings in the securities of a new applicant commence on the SEHK, or (b) dispose of his interest (including existing or new options, rights, interests or encumbrances in the shares) in the issuer if such disposal would result in him ceasing to be a controlling shareholder in the period of 6 months commencing on the date on which the period referred to above expires.

4.59

Controlling shareholder(s) of a new applicant must undertake to the issuer and the SEHK to disclose any pledge/charge of any securities beneficially owned by him/them in favour of an authorised institution made within the period commencing on the date by reference to which disclosure of the shareholding of the controlling shareholder(s) is made in the listing document and ending on the date which is 12 months from the date on which dealings in the securities of a new applicant commence on the SEHK.

4.60

As outlined above, shares placed in an IPO with cornerstone investors are generally subject to a lock-up period for at least 6 months following the listing date.

4.61

The SEHK does not permit further issues of shares or securities convertible into equity securities of a listed issuer within 6 months of listing except for: (a) the issue of shares pursuant to a share option scheme under LR Chapter 17 and GLR Chapter 23; (b) the exercise of conversion rights attaching to warrants issued as part of the IPO; (c) any capitalisation issue, capital reduction or consolidation or sub-division of shares; (d) the issue of shares or securities pursuant to an agreement entered into before the commencement of dealing and disclosed in the issuer's listing document; (e) the issue of shares or securities to be traded on the Main Board by a listed issuer that has successfully transferred its listing from GEM to the Main Board under LR Chapter

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9A; and (f) for GEM issuers, the issue, among other things (i) for the purpose of an acquisition of assets which would complement the listed issuer's business and the acquisition does not constitute a major transaction or above (i.e. a very substantial disposal, very substantial acquisition or reverse takeover); and (ii) does not result in a controlling shareholder of the listed issuer ceasing to be a controlling shareholder after the issue. Competing interests and independence 4.62

The controlling shareholder or the directors of the listing applicant may be engaged in businesses related to the business of the listing applicant and/or may have business dealings with the listing applicant, and in such cases the following issues will need to be attended to.

4.63

Where the controlling shareholder or a director (other than an INED) has an interest in another business that may compete with the business of the listing applicant, the listing document will need to disclose details of that other business (or businesses).

4.64

In the case of a controlling shareholder’s competing business, the listing document will also need to disclose, among other things, why that business is not a part of the listing applicant’s business. In particular, it will be necessary to demonstrate that the listing applicant will be able to operate independently of and at arm’s length from the controlling shareholder’s other business.

4.65

Practically, in order to mitigate such conflicts of interest and ensure the continued independence of the issuer from the controlling shareholder or directors, it may be necessary to enter into arrangements such as rights of first refusal for commercial transactions that may conflict with the business of the issuer. In all cases, sponsors will need to assess the specific circumstances of individual issuers or listing applicants and advise on the best course of action. The existence of very significant competitors or conflicts of interest will affect suitability for listing. Continuing connected transactions

4.66

Where there are transactions between the listing applicant and the controlling shareholder, the controlling shareholder’s other business and/or any other connected person of the listing applicant which will continue after listing is granted, the requirements of Chapter 14A, Listing Rules will need to be considered to the extent such arrangements may constitute continuing connected transactions. Note 1: A continuing connected transaction is defined in LR Chapter 14A as a transaction between an issuer and a connected person that is undertaken on a continuing or recurring basis and includes the provision of goods or services or financial assistance. Note 2: The general definition of “connected person” (see section 4.27(a) above) is extended by LR 14A.11. While it is important to consider the extended definition for the purposes of assessing any continuing connected transactions of the listing applicant, detailed knowledge of this extension to the definition is not required for the purposes of this manual.

4.67

In particular, the listing applicant will need to seek from the SEHK a waiver from the announcement and independent shareholder approval requirements of Chapter 14A, Listing Rules. The waiver sought must be in relation to each specific continuing connected transaction, as general waivers will not be granted.

4.68

In addition, the sponsor will need to state in the listing document, in respect of each transaction for which a waiver has been sought, whether the transaction is: (a) in the ordinary and usual course of business of the listing applicant; (b) on normal commercial ; and

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(c) fair and reasonable and in the interests of the shareholders as a whole. 4.69

Where such conditions are not satisfied, it may be preferable to discontinue the connected transaction arrangements ahead of the listing or to restructure such transactions so that they can satisfy the conditions for obtaining a waiver from the SEHK. In all cases, sponsors will need to assess the specific circumstances of individual issuers or listing applicants and advise on the best course of action.

Valuation considerations Property valuation 4.70

Under the general disclosure obligation in the CO and the Listing Rules (for listing applicant, see LR 11.07 and GLR 14.08(7); for listed issuer, see LR 14.63(2)(a) and GLR 19.63(2)(a)), a listing document must contain sufficient particulars and information necessary for an investor to make an informed decision.

4.71

Material property interests should be disclosed. Such information must be meaningful for investors to make an informed decision regarding an investment in the company. The SEHK expects listing applicants and their sponsors to consider materiality and to disclose property valuations and/or relevant information on material property interests. Materiality is not defined in the Listing Rules. In considering the materiality of a property interest, listing applicants and sponsors may consider: (a) whether the property interest (individually or in aggregate) is used for a reportable segment of the listing applicant and whether it contributes a significant portion of revenue to the applicant; (b) any encumbrances on the property or use of the property that may, at any time, directly or indirectly affect the applicant’s operations; (c) any defects relating to the property or its operations affecting business or operations in a major way, for example, breach of environmental regulations or title defects; and (d) any re-development potential for the property that may affect the listing applicant’s financial position. The carrying amount of a property interest must be ascertainable from the books and records of the applicant in addition to being consolidated into its balance sheet.

Profit forecasts 4.72

The decision to include or not include a profit forecast or a profit estimate in a listing document is purely voluntary. A profit forecast is any forecast of profits or losses, whereas a profit estimate is an estimate of profits or losses for a financial period which has ended but for which the results have not yet been audited or published.

4.73

Where a profit forecast is included, the principal assumptions on which it is based should be stated in the listing document. Principal assumptions should address the major factors that may affect a profit forecast. These major factors include, among others, political and economic condition, foreign exchange rate, inflation rate, interest rate and tax rate. The assumptions must provide useful information to investors to help them in forming a view as to the reasonableness and reliability of the forecast.

4.74

Where a profit estimate is included, although for the purposes of the Listing Rules it is regarded as a profit forecast, the requirement to state assumptions is not applicable in this case as a profit estimate is related to a financial period that has ended. Factors affecting a profit estimate are therefore already known and there is no need to include any assumptions.

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4.75

While the inclusion of a profit forecast is voluntary, the submission of a profit and cash flow forecast memorandum to the SEHK to demonstrate an applicant’s sustainability is a requirement under LR 9.11(10) applicable to a waiver from inclusion in the ants’ report its consolidated results for each of the 3 financial years immediately preceding the issue of the listing document.

4.76

If an applicant includes a profit forecast in its Application Proof, the profit forecast memorandum should cover the same period of the profit forecast. However, if a profit forecast is not included in the applicant’s Application Proof, the profit forecast memorandum should cover the period up to the forthcoming financial year end date after the date of listing. In either case, the memorandum must be accompanied by a cash flow forecast memorandum that covers at least 12 months from the expected date of publication of the listing document and which includes the principal assumptions, ing policies and calculations for the forecasts (LR 9.11(10)(a)(b)).

4.77

It is important that profit forecasts are calculated in a realistic way and attained by companies post-listing in order for these companies to establish and demonstrate their credibility in the eyes of investors. Sponsors should note that they are required to provide and publish a certificate for any profit forecast when it is included in the listing document. Accordingly, barring exceptional changes in the listing candidate’s circumstances, their own credibility as sponsors may also be at risk and expose them to liability when a profit forecast published in the listing document is not attained.

Special listing situations Spin-off listings 4.78

A spin-off listing occurs where a listed issuer decides to seek a separate listing for one of its businesses. All issuers planning for a spin-off are required to submit spin-off proposals to the SEHK for approval.

4.79

Where an entity to be spun-off by an existing issuer is to be listed on the Main Board, the proposed spin-off entity must satisfy all requirements of the Listing Rules for listing applicants, including the basic listing criteria (Ch 8, Listing Rules).

4.80

The SEHK will not normally consider a spin-off application within 3 years of the date of listing of the parent since the original listing of the parent company will have been approved on the basis of the parent’s portfolio of businesses at the time of listing, and since the expectation of investors at that time would have been that the parent would continue to develop those businesses.

4.81

For the SEHK to consider approving a spin-off listing, it must be satisfied that the parent will, after the spin-off, retain a sufficient level of operations and sufficient assets to its separate listing status, and continue to be able to satisfy the minimum profit requirement under the Listing Rules (unless a waiver is granted by the SEHK).

4.82

In addition, there should be a clear delineation between the business(es) retained by the parent company and the business(es) of the spun-off company, including (i) independence of directorship and management and (ii) independence of istrative capability. There should also be clear commercial benefits, both to the parent and spun-off company in the spin-off, which should be elaborated upon in the listing document and no adverse impact on the interests of shareholders of the parent resulting from the spin-off.

4.83

In the case of a spin-off listing, sponsors must also pay particular attention to ongoing and future connected transactions between the parent company and the spun-off company.

4.84

Shareholder approval of any spin-off is required where any of the percentage ratios of the transaction is 25% or more (LR 14.07). Existing shareholders of the parent company should also be provided with an assured entitlement to shares in the spun-off company, either by

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way of a distribution in specie of existing shares in the spun-off company, or by way of preferred application in any offering of existing or new shares in such company unless shareholders’ approval to the contrary is obtained. 4.85

An issuer must announce its spin-off listing application by the time it lodges its listing application form (Form A1 or its equivalent in any overseas jurisdiction). Mineral companies

4.86

In addition to satisfying the requirements of LR Chapter 8, a mineral company which has applied for listing must also meet the requirements of LR Chapter 18, in all cases to the SEHK’s satisfaction.

4.87

A mineral company must first establish that it has the right to participate actively in the exploration for and/or extraction of natural resources, either through control over a majority (i.e. an interest of more than 50% by value) of the assets in which it has invested together with adequate rights over the exploration for and/or extraction of natural resources, or through adequate rights (arising under arrangements acceptable to the SEHK) which give it sufficient influence in decisions over the exploration for and/or extraction of the natural resources.

4.88

Companies may rely on exploration and extraction rights held by third parties if they participate in mineral and/or exploration activity under t ventures, product sharing agreements or other valid arrangements if they can demonstrate such agreements give them sufficient influence over the exploration for and extraction of resources and reserves. The SEHK normally expects listing applicants to have an interest of at least 30% in assets relevant to extraction of reserves, but those with interests of less than 30% may also be considered provided that they actively operate mining projects. In addition, rights granted under specific government mandates will be recognized. Companies yet to commence production may not be able to demonstrate rights relevant to extraction until closer to the actual time of extraction, and risks relevant to obtaining such rights must be disclosed. If there are novel arrangements, applicants should consult the Listing Division of the SEHK in advance.

4.89

A mineral company applying for listing must also establish that it has at least a portfolio of (a) indicated resources; or (b) contingent resources identifiable under a reporting standard and substantiated in a Competent Person’s report. Further information on such reporting standards and Competent Person’s reports can be found under Topic 5. The portfolio in question must be meaningful and of sufficient substance to justify a listing. In addition, if it has commenced production, it must provide an estimate of cash operating costs, including those associated with nine defined categories listed under LR 18.03(3).

4.90

Lastly, a mineral company must demonstrate that it has available working capital for 125% of the group’s present requirements, that is for at least the next 12 months, which must include: (a) general, istrative and operating costs; (b) property holding costs; and (c) the cost of any proposed exploration and/or development; and ensure that its working capital statement in the listing document (LR 8.21A) states it has available sufficient working capital for 125% of the group’s present requirements, that is for at least 12 months from the date of its listing document.

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4.91

A mineral company seeking a waiver from the trading record period and/or the financial requirements will need to demonstrate that its directors and senior managers as a group have sufficient experience relevant to the exploration and/or extraction activity in which the listing applicant is engaged. The SEHK regards this issue as a question of fact and will take into , among others, their practical responsibilities and experience as well as academic and professional qualifications (see SEHK’s Listing Decision LD53-13 for further discussion of this issue). In this regard, individuals will need to have a minimum of five years’ relevant industry experience. Management’s experience may not necessarily be in the same commodities or minerals as the applicant’s operations and may include experience of other commodities or minerals which have mining processes that do not differ materially from those of the applicant and whose skills are transferable to the applicant’s mining activity. Management’s significant contribution to the mining industry and/or any mineral companies may also be relevant, as will consideration of whether the majority of the applicant’s core management team involved in its daily operations has sufficient experience in the exploration and/or extraction activity which the mineral company is pursuing. In this respect, emphasis will be placed on practical experience in relevant exploration and/or extraction activity, rather than general management and marketing experience ancillary to the exploration and/or extraction activity.

4.92

If waiver is sought in respect of the financial requirements under LR 8.05, the mineral company will further need to demonstrate that any failure to meet those requirements is due to it being in a pre-production, exploration and/or development phase, or that it has a clear path to commercial production, or is able to present a demonstrable path to profitability. A company that is in production but with poor economic performance over the Track Record Period will not normally qualify for a waiver. Mineral companies relying on an exemption from the financial standard requirements (LR 8.05) must focus on natural resource exploration and/or extraction. This does not have to be their sole activity but should be their main business activity.

Revision questions: Question 8: By when must pre-IPO investments be completed? Answer 8: Pre-IPO investments must be completed by no later than 28 days before the first submission of the first listing application form or 180 days before the expected first day of trading of the listing applicant’s shares. Question 9: What are the main characteristics and purposes of bringing cornerstone investors to an IPO? Answer 9: See section 4.53 above. Question 10: What are the listing requirements specific to mineral companies? Answer 10: See sections 4.86 to 4.92 above. These are also detailed in Chapter 18 of the Listing Rules.

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5

The initial public offering process

5.1

The execution of IPOs is generally articulated around 3 broad modules, covering documentation, valuation and marketing aspects. As will be seen in the ensuing topics, much of the time spent working on an IPO is devoted to preparation, including commercial, financial and documentary due diligence, documentation and verification, with the marketing process per se (except for early marketing to cornerstone investors, as explained above) usually lasting only a few weeks. Further information on the key building blocks of executing an IPO can be found under section 5 of Topic 4. The following sections focus more particularly on the marketing (also called equity capital markets) aspects of an IPO.

5.2

The IPO process involves a number of parties, both in the preparation of the listing documents and in the marketing of the shares to be listed. The sponsor, which is often – but not always – the lead underwriter (i.e. ultimately underwriting the largest number of shares in the offer), will coordinate this process, which includes putting together the underwriting syndicate.

5.3

For an IPO being offered only to Hong Kong investors (usually with a smaller IPO fund raising size), the process is straightforward. Once the sponsor is appointed by the issuer, and following completion of the preparatory work phase, it will firm up its discussions with the other underwriters, usually three to four parties, to offer shares to investors in a coordinated fashion.

5.4

In respect of the public offer component of an IPO, the public offer underwriting agreements will be signed with the issuer before the prospectus can be ed; once ed, the prospectus will be printed. If the issue is fully subscribed, the underwriters will have no further significant risk. If the issue is not fully subscribed, the underwriters will have to take up such shares in proportion to their underwriting commitments.

5.5

In respect of the placing tranches, the underwriting agreements (more commonly referred to as placing agreements) are normally signed after the IPO has been priced and orders have been gathered from institutions rather than before, unlike the practice for public offers to retail investors.

5.6

The underwriting agreements for both the public offer and the placing tranches normally contain force majeure clauses whereby the underwriting obligations can be relinquished under exceptional circumstances. The execution of the underwriting agreements for the placing tranche and that for the public offer tranche are normally conditional upon one another.

5.7

In an IPO involving, say, both a placing to institutions and an offer for subscription or sale to public investors (which retail and institutional investors can apply for), the lead sponsor will generally have the ability to place shares around the world to its institutional clients as well as to investors in Hong Kong.

5.8

The lead underwriters/global coordinators will devise a roadshow (i.e. the process whereby the senior management of the company formally presents the investment story to investors) around Hong Kong and, for larger issues, around the world. In the case of an IPO with a placing tranche, it is common for the roadshow to be conducted simultaneously with a “book-building” process, where underwriters build up indications of interest from their clients in shares. For issues with both public offer and placing tranches, Practice Note 18 of the Listing Rules requires the placing tranche be subject to a claw-back mechanism to meet any excess demand from the public offer in Hong Kong, meaning that shares originally allocated to the placing tranche would have to be re-allocated to the public tranche according to a fixed formula. Placings are subject to the requirements of LR Appendix 6, which provides, among other things, that not more than 75% may be placed directly and that the balance must be made available to the general public.

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5.9

The underwriters will send out placing or confirmation letters by e-mail, telex and/or similar media to clients who have indicated they will take shares, so that they can formally confirm their commitments and allocations.

5.10

Investors are prohibited from lodging multiple applications for issues of shares. Sponsors therefore have to establish measures to help identify multiple applications.

5.11

Most new listings will include a tranche reserved for an offer to the general public, except in the case of a GEM listing. In large issues, the initial allocation for the public tranche (subject to claw-back as explained above) is usually as little as 10%, but this can also be an even smaller percentage in extremely large, i.e. multi-billion US$, IPOs (with a waiver). A certain amount of shares can also be reserved for the management and staff or other parties designated by the issuer (in which case it should not represent more than 10% of the offer). The sponsor has to ensure that all shares are allocated in a fair manner.

5.12

The sponsor is responsible for ensuring that the issuer issues an announcement containing the results of the public offer on the next business day after allotment.

5.13

It is also common practice for underwriting and other agreements entered into by the underwriters to make reference to an over-allotment option that allows the bookrunners to allot (i.e. sell) more shares to investors than initially planned. While this option allows the bookrunners to deal with a greater than expected demand for the shares being offered, it is also a tool that helps the stabilizing manager to engage in stabilizing actions. (The use of the over-allotment option as a stabilizing tool is discussed further in sections 6.17 to 6.22 below.) Note 1: The over-allotment option is also often referred to as a “Greenshoe option”, named after the company that first used it.

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IPO process & sponsor workflow Sponsor’s preliminary discussions with potential listing applicant Sponsor’s preliminary due diligence on listing applicant’s suitability

Sponsor formally engaged by listing applicant/SEHK informed of engagement Transaction Team established/Engagement of professional advisers

Work commences on drafting the listing document Due diligence and verification work Appointment of experts and other third parties Preparation of ant’s report Discussions with potential cornerstone investors (if any) are initiated

Listing application prepared and submitted, and Application Proof (“AP”) published 1 Sponsors’ declarations provided (LR Appendix 17) Preparation of marketing/roadshow Listing Division reviews and comments on AP/Sponsor responds Listing Division recommends/rejects application

SEHK approves/rejects application at listing hearing If application accepted: Sponsors’ declaration provided (LR Appendix 19) Pre-deal research published PDIE PHIP published Finalization of cornerstone investors’ commitments (if any) Price range established/Red herring published/Start of book-building and roadshow

Listing document-cum-prospectus finalized, ed and issued together with the formal notice Public offer commences/closes Pricing, allocations, announcement of results of public offer and refund cheques (if any) issued Listing of shares/Trading commences

1

Subject to transitional provisions – see section 5 of Topic 4

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Revision question: Question 11: When are the underwriting agreements normally signed in an IPO? Answer 11: In respect of the public offer component of an IPO, the public offer underwriting agreements will be signed with the issuer before the prospectus is ed. In respect of the placing tranches, the underwriting agreements (more commonly referred to as placing agreements) are normally signed after the IPO has been priced and orders have been gathered from institutions.

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6

Other important considerations Introduction

6.1

There are other considerations sponsors should bear in mind in relation to the Listing Rules and to how IPOs are conducted in Hong Kong. Below, we will first highlight how Principals and their teams should focus on the quality of the listing document and on sections of the listing document to which they should devote particular attention. A brief description of the various types of agreements entered into in connection with an IPO will follow, together with a description of reporting ants’ comfort letters and opinions provided by legal advisers. The section will conclude with an overview of how IPOs are priced and allocated, and a review of arrangements that can be entered into for price stabilization.

Prospectus quality 6.2

Sponsors should pay particular attention to the quality of listing documents to ensure that incomplete or deficient versions are not submitted to the regulators. This may arise as a result of over-reliance on or over-delegation of sponsor responsibilities to conduct due diligence to other parties (including legal advisers and experts), or as a result of a “boxticking” mentality and over-reliance on the regulatory commenting process. Sponsors should bear in mind that due diligence and disclosure are not the responsibility of the regulators and that they are first and foremost responsible for guiding listing applicants through the process, even when third party experts are involved in the listing process. The contents of a prospectus, the due diligence process and how to avoid pitfalls are all discussed in detail in the ensuing topics.

6.3

With respect to prospectuses, sponsors and their teams should pay close attention to the following areas/sections in particular: (a) as with the rest of the listing document, the prospectus cover should be accurate and not misleading. However, because this is what investors will initially focus on at a glance when reading the listing document, particular thought should be given to its contents and layout also being clear and legible. (b) many investors (and market commentators) will initially focus on the “summary and highlights” section of the listing document. Sponsors should ensure that it is comprehensible and readable; that it is (like the rest of the prospectus) concise, easy to read and drafted in plain language; and that it enables investors to decide whether they might be interested in the offer, and read the rest of the listing document with a view to a better understanding of the investment opportunity. In particular, it will not generally be appropriate for this section to include paragraphs that have been cut and pasted from elsewhere in the listing document. The text in this section should be a high-level overview and drafted separately. Only information considered relevant and necessary for a particular applicant should be included, ensuring that the content is consistent with the key messages contained in the listing document and roadshow presentation. (c) similarly, the “risk factors” section should be presented in a concise way, organized logically and easy to read. As with the other parts of the listing document, plain language should be used. Sponsors should in particular ensure that risks (which constitute matters that are difficult for applicants to mitigate and which would have significant effects on the applicants if they occurred) should be relevant to listing applicants rather than risks generally applicable to companies in a given industry sector or operating in certain markets. The nature and extent of the risks should be explained where possible and meaningful quantitative disclosure should also be made of the risks, where the focus should be on the risks themselves rather than on background information on such risks. Individual risks should be identified but repetition and

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overlapping should be avoided. Risk factors should also be presented with appropriate headings and sub-headings, without mitigating facts, and start with the most important risks, followed by less important factors. Disclosure should be consistent, should not include outdated risk factors and should avoid disclaimer statements that lack specificity. (d) the “industry overview” should provide investors with a fair and balanced disclosure of the overall industry information relevant to the applicants’ business to enable readers to form an opinion of the investment. This section normally contains, among others, statistics and data extracted from commissioned research reports and/or official public documents. The sources and reliability of these statistics and data should be disclosed prominently and discussion of only general information that is not relevant to the applicants’ business and industry and/or out-of-date should be avoided. Presentation of market shares and rankings should be fair and balanced, and information on the competitive landscape and competitive advantages of the listing applicant should be included and substantiated both quantitatively and qualitatively. Historical price trends of raw materials and final products, where relevant, may also feature (SEHK’s Guidance Letter GL48-13); (e) the “history and development section” should only disclose historical developments which investors will need to know to make an informed investment decision. It should therefore only include material information on the applicant’s establishment, development, corporate structure and shareholding (SEHK’s Guidance Letter GL49-13); and (f) the “business section” should only disclose information in relation to the listing applicant’s business model which investors will need to have to make an informed investment decision – and accordingly should only explain the material components of that business model. Disclosure should be specific rather than generic, and should also tie to other sections of the listing document (for example, to the financial information section). It should therefore include information on key areas, e.g. market and competition, suppliers, customers, production, products and services, etc.. Presenting information using tables, charts and diagrams also ensures clear, concise and precise disclosures (SEHK’s Guidance Letter GL50-13); (g) the section on “directors, supervisors and senior managers” should include summarized information about them, e.g. full name, age, position, etc., and their respective biographies. Specifically, these should include, in each case: (i) the academic background (including the names/locations of universities/colleges accredited by competent accreditation bodies, level of education, major of studies) and professional qualifications, including when (month/year) obtained and the granting authorities; (ii) previous working experience relevant to the position in the applicant (in tabular format, if excessive), including how the individual gained access to relevant industry knowledge/experience in relation to the applicant’s businesses, names and principal business activities of companies previously engaged in, roles and responsibilities and period of services; and (iii) current and past directorships in any listed companies in the last 3 years (or an appropriate negative statement) (SEHK’s Guidance Letter GL62-13). Sponsors should check whether the academic accreditation bodies are authorised by competent authorities to grant accreditations or otherwise advise the applicant to remove references to the academic accreditation bodies from the listing documents or to disclose the fact that the academic accreditation bodies are not authorised to do so.

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Sponsors should also ascertain whether the courses attended were long distance learning courses or online courses and if so, specify them in the listing documents. Lastly, the role and composition of audit committee, remuneration committee, nomination committee, and other committees (if applicable) should be included, identifying the chairperson of each committee. Remuneration of the directors, supervisors and senior management, and incentive plan for senior management and key employees should also be stated, as should any deviation from the Code Provisions of Appendix 14 to the Listing Rules (Appendix 15 to GLR ) (e.g. why the same individual acts as chairman and chief executive officer, succession plan, etc.). (h) the “use of proceeds” section is also an important part of the listing document and a detailed breakdown of the use of proceeds should be given. Where there are no current or specific plans for all or a material portion of the proceeds (generally 10% or more), the listing document must include a statement to that effect and discuss the principal reasons for the offering. In this respect, references to “working capital” or “general corporate purposes” do not constitute current or specific plans for the proceeds, and in such cases a reasonably detailed explanation must be given of how the working capital is to be applied or what the general corporate purposes are. Where proceeds are to be used to acquire properties from any connected persons or their associates, the listing document must disclose the basis for determining the cost of such acquisitions. Where the proceeds are to finance acquisitions of businesses, the listing document must disclose the identity of the businesses (acquired or to be acquired) or, failing which, the nature and a short description of the types of businesses to be sought, the acquisition strategy and the status of any related negotiations. Where proceeds are to be used to discharge debt, the listing document must disclose the interest rate and maturity of such debt. If the debt was incurred within one year before the date of the listing application, the listing document should describe how the borrowing was used (unless for working capital purposes). The use of proceeds section should also discuss the effect on the amount of proceeds and their use where the offer price is variable or where there is an over-allotment option. Listing applicants may change the use of proceeds due to certain contingencies if these are discussed specifically and alternatives clearly described. Any material change of use of proceeds may constitute inside information if such information was not previously disclosed in the listing document and a listing applicant must make an announcement to notify investors of the change after listing. Where the IPO includes an offer for sale, the listing document should state the amount expected to be raised from the selling shareholder and that the proceeds do not belong to the listing applicant. Other sections of the listing document, such as the MD&A, are discussed in later topics.

Contractual and related matters 6.4

A number of agreements are entered into in connection with an IPO to evidence the commercial and other arrangements between the issuer, its principal shareholders, the main working parties (including the sponsor, the senior underwriters and their advisers), the SEHK and investors. The following list is not an exhaustive one but serves to provide an overview of the various types of agreements that sponsors may be involved in drafting and/or reviewing. A number of these agreements are also discussed in following topics. (a) Non-disclosure agreements are usually entered into between the listing applicant and investment banks pitching to act in a senior role for a new IPO mandate. In addition,

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such agreements will be entered into between the issuer, the bookrunners and potential cornerstone investors. (b) Mandate or engagement letters are entered into between the listing applicant and the sponsor as well as between the listing applicant and the senior underwriters (global coordinators and bookrunners). In addition, engagement letters are signed between each of the legal adviser firms and the client they represent (i.e. the listing applicant, the underwriters or potentially one or more of the principal shareholders of the listing applicant, in the event these are being represented by separate counsel). Engagement letters/agreements are also entered into between the listing applicant and each firm of experts as well as with each of the third parties (reporting ants, property valuers, human resources and remuneration consultants, advertising agencies, roadshow consultants, financial printers, call centres, translators, receiving banks, share registrars, etc.) appointed to work on the IPO. (c) Cornerstone subscription agreements are entered into between the listing applicant, the bookrunners and the cornerstone investors committing to guaranteed allocations of shares in the IPO. (d) An underwriting agreement is signed between the listing applicant and its principal shareholders and the underwriters of the public offer tranche to evidence the underwriting of the shares by the syndicate appointed for the public offer ahead of their sale to retail investors. Underwriting agreements normally include force majeure clauses. (e) A placing agreement is signed between the listing applicant and its principal shareholders and the underwriters of the institutional offering to evidence the underwriting of the shares under that tranche between pricing of the IPO and settlement, (f) An inter-syndicate agreement is signed between all the underwriters of the IPO to govern the relationship between the underwriters of the retail and institutional offers. (g) Placing or confirmation letters are entered into between the underwriters and allottees of shares. (h) A stock borrowing agreement is normally signed between the issuer, or more commonly one of its principal shareholders, and the investment bank appointed to act as stablizing manager for the allotment of the over-allotment option (see below). Legal opinions, comfort letters, etc. 6.5

As will be more fully developed in later topics, the various legal advisers working on an IPO as well as the reporting ant will be providing a variety of legal opinions/letters/reports about information in the listing document. While some of these may be required by the SEHK, obtaining others represents good general market practice.

6.6

Accordingly one or more legal opinions will normally be provided by each of the firms of legal advisers involved in an IPO and for each of the jurisdictions for which they have provided advice. Such legal opinions will opine, for example, on the due incorporation of the issuer, its power to conduct the IPO and on the due execution and delivery of IPO documents. Legal advisers may also furnish the underwriters with one or more due diligence reports about matters such as shareholding arrangements, litigation, licences, insurance policies, intellectual property, sale and purchase agreements, t venture agreements, corporate information, restructuring agreements, acquisition and ancillary agreements, privatization agreements, bank facility and capital markets agreements, tenancy agreements, service agreements, etc..

6.7

If an IPO is marketed in the US pursuant to a private placement to institutions under Rule 144A, then US legal opinions are also sought and delivered pursuant to federal laws. These

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normally include a “no-registration” opinion that confirms that the offering does not need to be ed in the US and a 10-b-5 letter (also called disclosure letter), which is a confirmation by US counsel that on reviewing the prospectus, and having conducted business and documentary due diligence, nothing has come to their attention to suggest that such prospectus contains any untrue statement of a material fact or fails to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading. A disclosure letter will only be issued on the version of the prospectus distributed to US investors (i.e. in particular not in relation to the version that is made available to retail investors in Hong Kong). Disclosure letters pursuant to other jurisdictions may also be issued by other firms of legal advisers working on the IPO on other versions of the prospectus. 6.8

Similarly, the reporting ant will normally be requested by the sponsor to produce a comfort letter in relation to the integrity of selected financial information disclosed in the listing document, and to comment on changes in selected financial statement items subsequent to the latest period reported on in the ants’ report for an IPO. Such selected financial information includes the ants’ report, the s and notes thereto usually featuring at the back of the listing document (in the so-called “F” or “I” pages), as well as financial information that can be found throughout the various sections of the listing document.

6.9

The comfort letter is addressed to the listing applicant as well as to the sponsor and Hong Kong and international underwriters and is usually produced in several versions: one for the Hong Kong (i.e. public offer) prospectus; and where the IPO involve a US placing tranche, one for each of the prospectuses published in relation to the Rule 144A tranche (targeted at large US institutions) and Regulation S tranche (i.e. targeted at institutional investors outside the US) respectively.

6.10

In preparing a comfort letter, the reporting ant has to comply with applicable professional standards. The contents of a comfort letter will vary according to the offer structure for, and distribution of the IPO, the nature of the information in the listing document and the procedures agreed on by management, sponsor and the reporting ant. Typically, the reporting ant will be requested to report on the following three areas: 

selected financial information;



non-financial information derived from ing records; and



change in financial position.

In respect of selected financial and non-financial information, the reporting ant reports the procedures carried out and the findings obtained. However, it is customary for the reporting ant to state its findings on the subsequent changes in historical financial information included in the listing document in the negative form, and thus such assurance is also commonly referred to as negative assurance. 6.11

For the purposes of due diligence, it is important that sponsors do not rely on such opinions, letters or reports at face value and these must be assessed with a questioning mind (we return to the sponsor’s role in relation to such matters in section 5 of Topic 5). Issuers, sponsors, legal advisers and reporting ants (as appropriate) are however advised to agree on the contents of such opinions, letters or reports as soon as practicable so as to avoid unnecessary misunderstandings, complications or delays nearer the launch of the IPO. Pricing IPOs, allocation and claw-back

6.12

IPOs are fundamentally priced on the basis of the demand that has been gathered from investors. This process usually starts with PDIE, also sometimes called pre-marketing. This is the process through which is obtained from institutional investors by the

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syndicate of underwriters, following the publication of pre-deal research. Such then enables the sponsor and senior underwriters to agree with the issuer on a price range pursuant to which the IPO will be marketed to institutions in a book-building process. 6.13

The top end of that price range is normally the price at which retail investors in Hong Kong will initially pay for their subscription applications for shares in the public offer, subject to reimbursement if the final offer price is set below that level.

6.14

At the end of book-building, the sponsor, senior underwriters and issuer will agree on the final offer price, having regard to the absolute amount of demand that has been gathered from investors (i.e. the number of times each tranche of the IPO has been subscribed) as well as, importantly, the quality of such investor demand. Quality is obviously a subjective notion and refers to the likelihood, in the best judgement of the sponsor and senior underwriters, that investors to whom shares will be allocated will sell such allocations in the aftermarket – and how soon. This is based on their knowledge of the (predominantly) institutional investor universe, experience of prior transactions and each institution’s investment style. Ideally, a book of demand should be allocated to a core group of long-term investors that will remain as shareholders over a considerable period of time, with a smaller amount of shares allocated to investors with a shorter-term investment horizon, to create liquidity post-listing. However, this is not always possible, depending on the demand that has been gathered in the book-building process.

6.15

In Hong Kong, there is limited flexibility for the underwriters to allocate shares between institutional and retail investors as such allocation is governed by a fixed formula under the Listing Rules. Typically, 10% will initially be allocated to the public offer tranche (sometimes less in the case of extremely large IPOs where a waiver to that effect is obtained). That 10% will then increase in line with the level of over-subscription of the public offer tranche through claw-back triggers, as follows: (a) for a public offer that is subscribed between 15 times and less than 50 times, 30%; (b) for a public offer that is subscribed between 50 times and less than 100 times, 40%; and (c) for a public offer that is subscribed 100 times or more, 50%. As explained earlier in this Topic, such levels may be adjusted downwards in the case of very large IPOs to avoid too large an absolute amount of stock being allocated to retail investors.

6.16

Allocations to institutions are conducted manually on a line-by-line basis after initial allocation runs have been conducted by bands and according to an algorithm. On the other hand, allocations to retail investors are conducted solely according to an algorithm, taking into the size of the orders placed by the public. Allocations to the public are conducted on an equitable basis and multiple applications are rejected. Public offers in Hong Kong separate retail investors into two equal pools: pool A which includes investors applying for shares representing HK$5 million or less in total, and pool B which includes retail investors applying for more than HK$5 million and up to the value of that pool (reallocation between pool A and pool B is possible in the event of a shortfall in demand in one of the pools). Note: For further details, see Practice Note 18 of the Listing Rules; however, such details of Practice Note 18 are outside the scope of this manual. Price stabilization

6.17

The immediate aftermarket of an IPO, once the issuer has been listed and its shares can be exchanged among institutional and retail investors on the SEHK, sometimes exhibits volatility and imbalances between short-term buyers and sellers. Accordingly, a mechanism has been devised to enable the stabilization of the share price (in the case of IPOs raising

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HK$100 million or more only) by the underwriters on behalf of the issuer. An investment bank, which is usually one of the bookrunners, is appointed for that purpose under the title of stabilizing manager. 6.18

The over-allotment option is a tool used to conduct stabilizing actions as it enables the bookrunners to over-allocate, thereby creating a short position that can be covered either by buying shares in the market (i.e. where the market price has dropped below the IPO offer price, on-market purchases provide buy-side for the share price) or by exercising their rights under the over-allotment option (i.e. where the market price remains at or increases above the IPO offer price). Note: Stabilizing actions may only be conducted in accordance with the Securities and Futures (Price Stabilizing) Rules which permit stabilizing actions to be conducted during the period from the start of trading to 30 days after the last day of lodgement of application forms under the Hong Kong public offer tranche.

6.19

More specifically, the over-allotment option gives the underwriters the right to allocate, at the same time as the shares constituting the rest of the IPO are allocated, additional shares at the IPO offer price. This can be structured either (i) as a further issue of shares by the issuer, or (ii) as a sale of shares by an existing shareholder, typically the controlling shareholder. Note: While only structure (i) above would increase the amount of capital raised by the issuer, both structures of the over-allotment option affect the base size of the IPO.

6.20

The over-allotment option will be paired with a stock borrowing and lending agreement to cover the short position created by the over-allocation in order that the activity does not constitute naked short selling. Note 1: A naked short sale is a sale of securities where the seller either does not already own the securities or does not have a presently exercisable and unconditional right to obtain the shares and vest them in the buyer. Naked short sales are prohibited by s. 170, SFO. Note 2: A stock borrowing agreement entered into by a controlling shareholder will not be subject to the lock-ups described in sections 4.58 to 4.61 above provided the applicable Listing Rules are complied with.

6.21

The over-allotment option (and corresponding stock borrowing and lending agreement) will typically be for an amount of up to 15% of the IPO size. Such shares are then allocated to investors at the same time as the rest of the allocable book of demand (demand permitting).

6.22

Once the shares start trading, if the share price remains consistently above the offer price, no stabilizing actions will be necessary. However, if the share price falls below the offer price, the stabilizing manager may buy shares in the market at a price not exceeding the IPO offer price in an attempt to the share price. If the share price stabilizes (i.e. subsequently trades above the IPO offer price), the stabilizing manager will cease to carry out any further market purchases. Conversely, if the share price remains below the offer price, then the stabilizing manager may keep buying shares on the market up to the number of shares under the over-allotment option.

Revision questions: Question 12: What sections of the prospectus must sponsors pay particular attention to where its quality is concerned? Answer 12: See section 6.3 above. Question 13: What percentage of an IPO is generally allocated initially to the public offer tranche?

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Answer 13: 10%. Question 14: What mechanism can be used to stabilize the share price on start of trading for an IPO greater than HK$100 million? Answer 14: An over-allotment option.

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Topic summary This Topic provided an overview of the requirements of the listing process and some of the important issues that sponsors should be aware of. The various methods of listing and offering mechanisms and the general procedures for listing equity securities were reviewed. The importance of HKEx’s Listing Decisions and guidance materials was introduced, followed by a consideration of some of the more detailed issues in the Listing Rules that a sponsor may need to consider carefully in the light of the specific circumstances of the listing applicant. The underwriting and syndication processes were reviewed. The Topic concluded with a discussion of important matters that a sponsor will need to attend to in the listing application process.

Checklist Below is a checklist of the main points covered by this Topic. Candidates should use the list to test their knowledge. 

There are more than 10 methods by which shares may be listed on the SEHK. These include offers for subscription, offers for sale, placings, introductions, rights issues, open offers, capitalisation issues, consideration issues, exchange or substitution, transfer of listing from GEM to the Main Board, and other methods.



Claw-back triggers enable an issuer to set aside more shares for retail investors.



The quantitative tests for listing include the profit test, the market capitalisation/revenue/cashflow test and the market capitalisation/revenue test.



Listing applicants must satisfy requirements concerning their management trading record and continuity of ownership, and the listing applicant and its business must also be suitable for listing.



For listing applicants, the latest financial period reported on by the reporting ants must not have ended more than 6 months before the date of the listing document.



Listing applicants must also satisfy public float requirements as well as requirements concerned with the number of shareholders.



Sponsors should be familiar with the procedures and timetable to apply for listing on the SEHK.



LR Chapter 11 sets out the requirements for the content of listing documents relating to equity securities. Offers for subscription, offers for sale, placings, introductions, rights issues and several other types of issue all require listing documents.



Sponsors must be familiar with the requirements and procedures for the publication of the formal notice on the date of the listing document.



The Application Proof must be published on the website ”HKExnews” (subject to transitional provisions).



A PHIP must be published after listing hearing approval by the SEHK, and no later than the start of institutional book-building, on the website ”HKExnews” (subject to transitional provisions).



Prospectuses and listing documents must be filed with both the SEHK and the SFC under the dual filing regime.

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

A listing applicant must appoint at least 3 INEDs and at least one third of the board must be INEDs.



Sponsors must be familiar with the criteria for qualification as an INED.



Restrictions apply on share dealings by directors.



Every listed issuer must appoint authorised representatives and a company secretary, and establish an audit committee and a remuneration committee. Sponsors must also be familiar with the rules for the appointment and removal of an auditor.



The latest financial year of the Track Record Period must end not more than 6 months before the date of the listing document.



A listing applicant may not, during the most recent year of its Track Record Period, change the period of its financial year.



The profit test requires that “profit attributable to shareholders” be used, and items attributable to activities outside the normal course of the listing applicant’s usual business, must therefore be excluded.



Only revenue arising from the principal activities of the listing applicant may be included in the revenue calculation of the market capitalisation/revenue test and the market capitalisation/revenue/cash flow test.



Sponsors must be familiar with the ing standards and financial information required of an issuer.



As at 29 April 2013, 21 jurisdictions are accepted for listing on the SEHK, in addition to Hong Kong, mainland China, Bermuda and the Cayman Islands.



Rules governing the appointment of pre-IPO and cornerstone investors and to lock-ups for controlling shareholders, cornerstone investors and listed issuers.



Considerations relating to competing interests and independence and continuing connected transactions.



Requirements for property valuation.



The decision to include or not to include a profit forecast or profit estimate in a listing document is voluntary.



Practice Note 15 of Listing Rules and requirements for spin-off listings.



There are specific requirements for the listing of mineral companies.



The execution of IPOs is generally articulated around 3 broad modules: documentation, valuation and marketing.



IPOs often include both a placing to institutions and an offer for subscription or sale to public investors.



Considerations relating to book-building, the IPO roadshow, multiple applications and clawback triggers.



Sections of the listing document to which sponsors must pay particular attention include the prospectus cover, and the “summary and highlights”, “risk factors”, “industry overview”, “history and development”, “business” and “use of proceeds” sections.



The various types of contracts entered into in connection with an IPO.



The various types of legal opinions and comfort letters issued by legal advisers and the reporting ants, respectively.



IPOs are fundamentally priced on the basis of the demand that has been gathered from investors.

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

Institutional allocations are conducted manually on a line-by-line basis after initial allocation runs have been conducted by bands and according to an algorithm for retail investors.



The definitions of pool A and pool B for public offers in Hong Kong.



An over-allotment option (or Greenshoe option) is a mechanism used to stabilize the share price of a newly listed company at the start of trading.

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Topic 3: Preparation for an IPO assignment Table of contents Topic overview

1

Learning outcomes

1

1

Corporate istration of a sponsor

2

Resources, systems and controls Records How to ensure regulatory requirements are met in practice?

2 4 5

Preparation for managing an IPO

9

Authority and key roles of the sponsor Internal management considerations

9 9

2

Topic summary

12

Checklist

12

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Topic overview This Topic provides an overview of what a licensed corporation or ed institution must have in place before undertaking initial public offering (“IPO”) sponsor assignments, i.e. what must be done to put the house in order and prepare to undertake this role. The corporate istration that a sponsor should have established before undertaking an IPO is reviewed. This includes ensuring that its systems and processes, its resources, the implementation of effective Chinese walls, and its record-keeping system are adequate to meet its regulatory obligations. The matters that should be considered before accepting a new mandate are considered. The Topic concludes with the preparations a sponsor must make to manage an IPO, including the formation of a Transaction Team, working with other parties including regulators and financial advisers, and other specific considerations concerning the execution of the IPO.

Learning outcomes At the end of this Topic, candidates should be able to: (a) describe the resources, systems and controls a sponsor is required to have in place before accepting an IPO engagement; (b) recognize the need to consider a sponsor’s resources in the context of other work being undertaken; (c) understand the reporting lines that should be established; (d) explain a sponsor’s record-keeping obligations; (e) explain the usual procedures for vetting proposed new mandates; (f) recognize the need to work with regulators and other third parties; (g) describe the functional role of Principals and Transaction Teams; and (h) understand the scope of a sponsor’s authority as manager of an IPO.

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Corporate istration of a sponsor

1.1

The senior management of a sponsor is ultimately responsible for supervising sponsor work and for guiding a listing applicant on compliance with the legal and regulatory requirements. To be in a position to discharge those responsibilities properly, a number of compliance procedures and controls will need to be established prior to undertaking any sponsor assignment. Note: In this Topic, and generally in this manual, the term “senior management” will mean a sponsor’s board of directors, managing director, chief executive officer, responsible officers, executive officers and other senior management personnel. This follows the approach taken by the Securities and Futures Commission (“SFC”) in its codes, although paragraph 17 of the Code of Conduct uses the term “Management”, which is equivalent to the term “senior management” as used herein.

1.2

The procedures must be recorded in writing and this will normally be dealt with in the firm’s compliance manual, which must also address all relevant regulatory requirements applying to its corporate finance business. The compliance manual should be readily available to all staff involved in its regulated business. The firm’s staff should be offered continuous professional training.

1.3

In addition to the more general matters dealt with under other applicable codes, for example, the need to avoid conflicts of interest, paragraph 17, of the Code of Conduct for Persons Licensed by or ed with the Securities and Futures Commission (“Code of Conduct”) provides for a number of specific issues to be attended to, and these are summarized below.

Resources, systems and controls 1.4

To be in a position to fulfil its duties properly, the senior management of a sponsor will need to have adequate oversight of any sponsor work being undertaken by the sponsor and its staff. This will require senior management to ensure that it: (a) possesses sufficient resources; and (b) has established effective systems and controls that properly implement and facilitate senior management’s oversight of the sponsor work.

1.5

Senior management will need to consider the above matters as part of the sponsor’s general compliance set-up as well as in the context of specific proposed sponsor assignments. The latter will require senior management to assess the firm’s resources, systems and controls prior to accepting each assignment. It should assess the nature, scale and complexity of a prospective assignment and any factors that may affect the standard of work including: (a) its other commitments and the time available to undertake a new assignment; (b) the availability of sufficient staff with appropriate levels of knowledge, skills and experience; and (c) whether such staff are expected to be available throughout the duration of the sponsor role.

1.6

Clear and effective reporting lines and channels will need to be established between senior management and staff engaged in sponsor work (see section 2 of Topic 4 for a discussion of Transaction Teams).

1.7

For these purposes, senior management may designate a committee whose should be independent of the Transaction Team and possess an appropriate level of seniority and expertise for the handling of the following matters as a minimum: (a) acceptance of a mandate to act as a sponsor;

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(b) appointment of the Transaction Team and any significant variation to such appointment; and (c) resolution of suspicious circumstances, difficult or sensitive issues, conflicting information and material non-compliance by a listing applicant. 1.8

Senior management may also delegate operational functions to staff, though any such delegation will not change the fact of senior management being primarily responsible for any sponsor work undertaken.

1.9

The systems, controls and procedures that senior management should establish prior to taking on any assignment should cover at least the following matters: (a) as regards due diligence: (i) how an appropriate due diligence plan is to be formulated; (ii) how a due diligence exercise is to be implemented, including how outstanding steps or deviations from the plan are to be identified, explained and followed up; and (iii) how the standard and extent of due diligence work is to be reviewed; Note: While a client-specific due diligence plan will only be established after an engagement agreement is signed with a listing applicant, a sponsor should be in a position prior to accepting any engagement to be able to prepare such a plan and to keep it up to date as the circumstances of the due diligence exercise may require. (b) the allocation of sufficient staff with appropriate knowledge, skills and experience during the period of the assignment; Note: The SFC considers that prior experience of a similar transaction or section experience would be relevant. (c) how the Principals and the Transaction Team are to be managed and supervised, including ensuring that they do not act beyond their authority; (d) reviews of the performance of the Principals and the Transaction Team; and (e) the reporting of critical matters (including those mentioned in section 1.7 above) for a decision to be made by senior management or its designated committee. Chinese walls

1.10

Undertaking sponsor work will also give rise to the possession of confidential and/or price sensitive information. It is essential that such information is obtained and maintained within an effective system of functional barriers that prevent the flow of such information to other staff not involved in the relevant work. Information should only be provided to staff on a “need-to-know” basis. The obligation to put in place such Chinese walls is a regulatory requirement applying to every licensed or ed corporate finance adviser whether or not they are engaged in sponsor work. Annual review

1.11

The systems and controls that a sponsor has established should be properly documented and reviewed on an annual basis. This is an important step in ensuring their adequacy. Consideration may be given to whether the review takes the form of an internal and/or an external audit. The review should be undertaken according to the sponsor’s assessment of risks related to its operations, business structures and internal systems. In this regard, any complaints either from within or from third parties and any regulatory concern raised by the regulators in the period under review should also be assessed.

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1.12

The annual review and its outcome should be documented and, where the review identifies any instances of material non-compliance, the matter must be promptly reported to the SFC.

Records 1.13

Record keeping is an important means of enabling the sponsor to demonstrate to the SFC that it has complied with the matters it is required to attend to in undertaking its sponsor role. Such records must be sufficient to demonstrate compliance with the Code of Conduct.

1.14

Records should be kept up to date and within the control of the sponsor. This is particularly important in the context of the SFC’s supervisory role and to ensure the sponsor is in a position to provide on request any information sought by the SFC concerning sponsor work.

1.15

A list should be maintained detailing the sponsor work that has been or is being undertaken. This should include the names of client companies, together with the composition of Transaction Teams (including any variations) and the names, titles and roles of staff assigned to each listing. The format of such records will vary depending on the set up and infrastructure of the licensed corporation or ed institution.

1.16

Records for each listing assignment should include the following: (a) the composition of the Transaction Team including any variations in the team composition; (b) the bases on which the sponsor has given opinions, assurances and conclusions to the listing applicant or has reached conclusions on key issues of regulatory concern, including: (i) responsibilities and capabilities of directors under the Listing Rules; (ii) rectification of material deficiencies in the operations and structure, procedures and systems, or directors and key senior managers; (iii) reasonableness of the due diligence exercise; (iv) completeness of information in the advance proof of the listing document (the “Application Proof”); (v) sufficiency of disclosure in the listing document including the expert and non-expert sections referred to in paragraph 17.5 of the Code of Conduct; and (vi) sufficiency of due diligence on expert reports referred to in paragraph 17.7 of the Code of Conduct. Note: Records should include the internal discussions and actions taken in connection with the foregoing. (c) all significant matters arising in the course of the listing process, including internal discussions and actions taken, regardless of whether or not such matters are disclosed in the final listing document; (d) the involvement of senior management in considering the critical matters mentioned in section 1.7 above; and (e) other relevant ing documents and correspondence.

1.17

The following records relevant to due diligence are also required to be kept for each listing assignment (due diligence is discussed in detail in Topic 5, and in Topic 4 concerning due diligence on listing applicants): (a) the due diligence plan, which should identify the required time and skill sets of persons needed to implement the plan; (b) any changes to the due diligence plan and reasons for the changes;

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(c) the nature, timing and extent of the due diligence procedures; (d) the outcome of the due diligence performed and an assessment of it; (e) where due diligence has been conducted by third parties, information relating to the involvement of those parties (see section 5 of Topic 5); and (f) other relevant ing documents and correspondence. 1.18

Records must be kept in Hong Kong for a minimum period of 7 years following the completion of each listing (or termination of the assignment). On completion of a listing transaction

1.19

A sponsor is required to submit to the SFC, within 2 weeks of the first day of dealings following completion of a listing transaction, a team structure chart. The chart is to show, for that transaction, the team structure and the reporting line of each licensed or ed staff with their names, titles and responsibilities, including in advising the listing applicant and/or performance of due diligence. The chart is required to be signed by a Principal who supervised the transaction.

How to ensure regulatory requirements are met in practice? Vetting new mandates 1.20

Any opportunity to act as a sponsor must necessarily be vetted internally by the proposed sponsor firm. There are several purposes of such a vetting process: (a) to satisfy the general KYC (know your client) requirements through which a sponsor obtains all the relevant information necessary for taking a client on-board, including checks in relation to anti-corruption and money laundering issues; (b) to clear any conflicts that might arise from the assignment and assess its own independence from the listing applicant; (c) to assess, on a preliminary basis, the fitness for listing of the proposed candidate, which will be subject to more detailed due diligence investigations later; and (d) to discuss the of, and staffing for, the transaction.

1.21

In all cases, when conducting such a vetting process, sponsors should be mindful of Chinese walls and of the separation between corporate finance/investment banking, research/securities sales, trading, wealth management and asset management functions (and of the provision of information to research analysts in particular). Practically, information about potential sponsor mandates should be considered as sensitive and disseminated only on a “need-to-know” basis to authorized personnel.

1.22

There are various ways a conflict check can be conducted. This may, for example, take the form of a short, internal e-mail sent to a pre-identified list of senior personnel and summarizing in a few lines the proposed assignment, including the name of the listing applicant, its country of origin and industry sector, and the proposed timing and nature of the transaction. Care should be taken to ensure that all the recipients are on the same side of the Chinese wall, or that they have previously been “crossed” by the firm’s compliance function, either on an ad-hoc basis or through their status as “permanent insiders” for compliance purposes. A sponsor firm should set up a system allowing itself to check all its material relationships with the potential client based on the results of preliminary due diligence conducted in connection with the proposed transaction.

1.23

Sufficient time (perhaps a few days) should be allowed for confirmation (or negative confirmation) of the existence (or absence) of a conflict, and it is good practice for a written record to be kept as evidence that such conflict check has been conducted. A conflict might

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for example arise as a result of an existing mandate held by the sponsor firm on behalf of a direct competitor of the listing applicant, or of a company involved in the same industry sector and in the same region/country. 1.24

For the purpose of vetting new mandates, a licensed corporation or ed institution will generally have in place a dedicated committee, comprising senior personnel and tasked with the review of new sponsor mandate opportunities. In practice, these opportunities will often be assessed alongside other roles which a licensed corporation or ed institution may have in a proposed transaction. Such a committee may meet at regular intervals, perhaps weekly, or on a more ad-hoc basis, depending on the level of activity of the licensed corporation or ed institution.

1.25

The of the committee must be clearly identified and of sufficient experience, tenure and seniority to be able to make a judgement on whether or not to take on the proposed new mandate. Each firm will have its own procedures, but it is common for such committees to comprise seasoned personnel responsible for investment banking or corporate finance departments, and personally familiar with the execution of a wide range of similar transactions. Senior personnel from the securities side of the business (perhaps from the equity sales or research department in which case they will have previously been “crossed” either on an ad hoc or permanent basis by the firm’s compliance function, and will also be at arm’s length from the research analysts that may later publish a pre-deal research report on the issuer) are also sometimes in attendance. Personnel from the firm’s compliance function and/or risk management department also often take part.

1.26

Procedures should be in place for the committee to meet only once a quorum has been attained, so as to ensure an appropriate level of seniority and diversity among its attendees and an appropriate “sign off” on a proposed sponsor assignment. Forms and checklists for the approval of new mandates

1.27

The committee will generally examine the opportunity to act as a sponsor according to a proposal produced by the executive (or executives) through whom the prospective mandate has originated (and who will generally – but not always – form part of the Transaction Team). Such executive will also be in attendance at the meeting of the committee to explain the background to, and nature of, the proposed assignment, as well as to answer questions or provide clarifications on the listing applicant, where needed.

1.28

A specific form or checklist is often used for the purpose of submitting a written proposal to the committee, to ensure that all the key areas that ought to have been investigated by the licensed corporation or ed institution in its proposed role as a sponsor have indeed been covered, including in relation to KYC/new client “on-boarding” requirements. This also ensures consistency among the various mandate opportunities that are being assessed. For example, such a form and the areas to be investigated may include, among other things: (a) the full name and ed address of the listing applicant; (b) details of the shareholders, senior management and board of the listing applicant; (c) background information on how the opportunity to take on the sponsor role arose; (d) the rationale for the listing and the form that the listing will take (primary or secondary offering, or a combination of both; or listing by way of introduction for companies that are already listed on an exchange other than The Stock Exchange of Hong Kong Limited (“SEHK”), in which case information on the company’s share price performance, existing research coverage, trading activity and institutional and retail ownership may also be included);

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(e) a summary of the history, principal activities and corporate structure of the company to be listed and for how long it has been in business; (f) particular attention should be paid to suspected related-party transactions that may create issues down the line in the execution phase of the mandate, and/or to other potential issues identified; (g) analysis, based on the information available at the time, of whether the issuer would qualify for listing according to the SEHK’s listing requirements; (h) information about the assignment, for example, whether it is proposed that the listing should be conducted following a group reorganization, or if material acquisitions or disposals have or will be carried out before the proposed listing; (i) summary financials for the listing applicant, details of the reporting ants and of whether prior audits were qualified; (j) confirmation that a conflict check has been conducted (and of the results of such an investigation) and also that the sponsor is independent (or not) of the listing applicant; (k) details of the likely timing of the transaction, length of the assignment and proposed fee and expense reimbursement arrangements for acting as sponsor (and, possibly, in other capacities). In particular, a sponsor must be formally appointed by a listing applicant at least two months before a listing application; (l) information on other licensed corporations or ed institutions that may be involved as a sponsor and/or in other capacities; (m) information on the proposed Transaction Team, including the proposed roles, seniority, prior experience and reporting lines of the various team and information on other assignments they might currently be working on. This should specifically identify the Principal(s) supervising the transaction, as well as the representatives/individuals to be involved in the sponsor work under his/their supervision; (n) information on other engagement ; (o) information on other professional parties involved (if already appointed or known); (p) the project code name for the transaction; and (q) any other relevant information which might be brought to the attention of the committee . 1.29

It is good practice for a written record to be kept of all sponsor proposals discussed by the committee and the decisions made.

1.30

It is also good practice for minutes to be taken of the deliberations of the committee to ensure a proper record of the decision to take on (or not) a proposed sponsor assignment. These should ideally mention as a minimum the date of the meeting, the names of the committee present on that day and details of the proposed transaction that was discussed. Details of particular concerns raised (or of follow-up investigations requested) should also be recorded. The minutes, as well as the committee submission and ing documents, may be kept in electronic form or in off-site storage facilities. It is, however, important to retain such documents in Hong Kong to ensure that they are readily accessible to the regulators when required. The retention period for such documents should be 7 years, in line with the record-keeping requirement under the Securities and Futures (Keeping of Records) Rules.

1.31

The procedures for taking on an assignment to act as sponsor for a new listing are the same whether the company is to be listed on the Main Board of the SEHK or on the Growth Enterprise Market (“GEM”), obviously having regard to their respective listing requirements.

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Internal procedures, addressing pitfalls, and formalizing new mandates 1.32

All the processes pertaining to the execution of transactions should be properly documented, for example by following a compliance procedures manual that details all the internal procedures required within a licensed corporation or ed institution for the execution of an IPO. This can also serve as induction (or reference) for more junior personnel – although nothing replaces the experience of actually working on a variety of transactions. Such manual and procedures should also be reviewed annually and on changes in relevant legal and regulatory requirements.

1.33

It is not only good practice but also a requirement for systems and controls to be in place for management to be kept abreast of developments in the execution of the transaction at regular intervals throughout the assignment. This may perhaps take the form of regular briefing meetings where the status of the transaction is being reviewed and issues that may arise can be discussed in a forum that includes executives who may have faced similar circumstances on other transactions in the past. A number of licensed corporations and ed institutions have dedicated equity corporate finance execution teams that are particularly focused on sponsor and related work, with reporting lines to senior investment banking personnel, whether on a local, regional or global basis. This will also be covered in section 2 of this Topic.

1.34

In the event that suspicious circumstances, difficult or sensitive issues, conflicting information or material non-compliance by a listing applicant subsequently arise, it may be necessary for the Transaction Team (and, chiefly, for the Principal(s) in charge) to revert back to the committee to make it aware of such developments and ultimately to decide whether or not to continue with the mandate to act as sponsor. See sections 2.37 to 2.40 of Topic 5 for a further discussion of dealing with tricky situations.

1.35

Once a new engagement has been confirmed, its should be evidenced through an engagement letter that will include the for work as sponsor for the transaction. These will often be bundled with the of engagement for other roles that the licensed corporation or ed institution may have, but must be based solely on a sponsor’s role. In large transactions where multiple sponsors are appointed, it is not uncommon for a t “mandate letter” to be issued. of engagement are more fully covered under Topic 4.

1.36

In connection with new client on-boarding, as well as throughout the execution of a transaction, it is important for sponsors to keep written records of their due diligence investigations and key discussions with the listing candidate and other relevant parties. By doing so, they will be able to show information about their own enquiries, assessments and actions to demonstrate the basis on which the sponsor’s opinions or assurances in relation to reports and findings are substantiated or arrived at. Such written records, however, do not extend to underlying records of the listing applicant, working papers of experts and third parties or original documents not prepared by the sponsor. As mentioned earlier, in the case of minutes and deliberations of the client onboard committee described above, it is important to retain such documents in Hong Kong (including in electronic form or in off-site storage facilities) and for a period of 7 years.

Revision questions: Question 1: For what period of time must a sponsor keep records? Answer 1: Records must be kept in Hong Kong for a minimum period of 7 years following the completion of each listing (or termination of the assignment). Question 2: Should information about potential sponsor mandates (i.e. before a sponsor is engaged) be regarded as confidential? Answer 2: Yes, see section 1.21 above. * Text that has been shaded is exclusively for Paper 15 Papers 15 & 16 Version 1.0

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2

Preparation for managing an IPO Authority and key roles of the sponsor Responsibility and roles of the sponsor in practice

2.1

The responsibility of a sponsor is to prepare a listing applicant for listing. Its roles include the lodging of the formal application for listing and ing documents with the SEHK, and dealing with the regulators on all matters arising in connection with the application. Accordingly, personnel involved in sponsor work must be familiar with related procedures and have sufficient experience in conducting IPOs and in handling listings of companies on the SEHK. This includes, among other things, carrying out due diligence in detail on the affairs of a listing applicant so as to be satisfied that it is fit for listing; coordinating the work of a number of working third parties; and advising the listing applicant on all matters pertaining to the listing. These will range from advising on the time and cost involved in a listing exercise, to advising on initial and ongoing listing requirements, and making the directors aware of their fiduciary duties.

2.2

As mentioned in the previous section, in order for a sponsor’s role to be fulfilled appropriately, its authority must be absolute. A balancing act may take place where several sponsors are appointed, provided this does not adversely affect the standards required of any of the sponsors. Working with the regulators

2.3

A key component of the work of sponsors is interacting with the SEHK, and sometimes the SFC, in relation to an application for a listing on the SEHK. A common problem that has been noted by the SFC is sponsors placing too much reliance on the regulatory commenting process. This has resulted, in some cases, fundamental issues such as material misstatements and omissions in listing documents surfacing only after enquiries made by the regulators. Sponsors should be aware that the SEHK and the SFC are not responsible for the accuracy of disclosure or the adequacy of due diligence. It is ultimately the responsibility of both the listing applicant and the sponsor to ensure the quality of documents to be submitted in relation to a listing application.

2.4

As such, knowledge of the listing rules, and experience of working with other parties (such as reporting ants, legal advisers or property valuers) and of working on previous transactions, are generally all important in ensuring that appropriate and correct disclosures are made in the listing applications and other related documents and there is no misleading statement or omission of material facts therein, and an efficient and smooth application process for new listing applications is achieved.

2.5

A sponsor should take into the specific situations of each listing application and tailor its work accordingly to ensure that appropriate and effective due diligence on the applicant is conducted.

Internal management considerations Principals and Transaction Teams 2.6

An IPO or new listing Transaction Team must be led by one or more Principals, who have ultimate responsibility for the conduct of the transaction. The Principals will usually be assisted by other licensed representatives and Transaction Team in discharging their duties.

2.7

The role of such individuals is to specialize in the execution of “equity corporate finance” work and to interact on an ongoing basis with issuers and listing applicants, other advisers

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and consultants, and the regulators. However, as outlined above, the circumstances of every listing applicant are always unique and experience acquired through such specialization should not lead to a standardization of due diligence and disclosure. 2.8

When there may be suspicious circumstances, difficult or sensitive issues, conflicting information or material non-compliance by a listing applicant, the Transaction Team must immediately bring these to the attention of the Principal in charge, who should guide the Transaction Team in resolving such issues. The listing application should only proceed if the Principal in charge is satisfied with that resolution.

2.9

However, when such issues cannot be properly resolved, decisions should not be made by the Transaction Team but by senior management, or by a committee designated by senior management for that purpose (see sections 1.6 and 1.7 above). The Principal should accordingly bring the matter to the attention of the relevant persons who should ultimately decide on what basis to proceed or not proceed with the assignment.

2.10

In the case of smaller sponsors where the distinction between senior management and the Transaction Team will perhaps be less well defined, it is important that such senior management have appropriate seniority and expertise. Senior management and Principals

2.11

Principals engaged in an IPO transaction and the senior management of a sponsor have different roles and responsibilities in their respective capacities. The responsible officers of a sponsor, which include the firm's executive directors, have regulatory responsibilities as Type 6 licensed or ed persons as regards the firm's activities as a whole, which are wider in scope than those of a Principal in relation to a specific IPO. Occasionally, a material issue may arise in the context of an IPO that gives rise to different views on how such an issue should best be handled. In such an event, it is important that Principals and responsible officers discuss their differences and reach agreement after a fuller consideration of the firm's regulatory responsibilities. In this regard, a responsible officer not involved as Principal in the day-to-day running of an IPO may bring a degree of independence to any critical issue that might arise. The reporting lines of the Principal and the decision-making processes of the firm at board level will be relevant considerations in this respect. It is important that the decision-making process takes into the firm's regulatory obligations to maintain appropriate standards of ethical behaviour and integrity (see Topic 6 of this manual for further consideration of this issue). If, after deliberation, there remains a real concern or disagreement about how regulatory responsibilities are to be met in practice, it may be appropriate to seek legal advice and/or consult with the SEHK and/or the SFC, as appropriate. Other considerations

2.12

A way of facilitating the flow of information between the various persons involved in a sponsor’s Transaction Team is to set up one or more dedicated, project-based email lists. This ensures that all the relevant individuals (including senior executives, as appropriate) can be kept abreast of developments in the transaction, and monitor the various aspects of sponsor work.

2.13

A key consideration for personnel involved in the execution of a listing exercise concerns Chinese walls. There should be a clear separation (including physical separation) between staff involved in investment banking activities and those conducting research and sales/trading activities. Personnel involved in sponsor work must in particular be aware of the sensitivities associated with the provision of information to research analysts (see section 6.1 of Topic 4). A firm’s compliance function should be consulted in this respect to ensure that no rules or internal procedures are breached.

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Sponsors and public offers 2.14

A core responsibility of a sponsor is to ensure that, where a listing involves a public offer, the offer is conducted in a fair, timely and orderly manner. In order to meet these requirements, and its other responsibilities under the Code of Conduct and the Listing Rules, it is important that a sponsor acts as the overall manager of the offer.

2.15

The arrangements and resources a sponsor puts in place as manager of the offer process should commensurate with the likely interest in, or reception of, the offer by the public. The sponsor will therefore need to assess whether the offer may attract a significant amount of public interest and what arrangements and resources it may need to put in place beyond what may be required in the context of an offering that attracts normal levels of interest.

2.16

The following matters should be specifically considered: (a) arrangements to ensure that listing documents (in electronic and printed form) and printed application forms are readily available to the public during the offer period; (b) whether the sponsor should delegate certain responsibilities to other parties that have sufficient capacity and resources to undertake the relevant responsibilities (the sponsor shall remain primarily responsible for any such delegated responsibilities); (c) the sufficiency of measures to ensure distribution to the public of prospectuses and application forms and for the collection from the public of completed application forms; (d) the sufficiency of measures to ensure the timely and orderly despatch of unsuccessful applications, refund cheques and share certificates following the end of the offer period; and (e) in the cases of an oversubscribed offer, arrangements to conduct balloting fairly and independently of the listing applicant and its associated parties, i.e. the listing applicant should not be involved in the balloting.

2.17

As a corollary to ensuring the offer is conducted in a fair, timely and orderly manner, a sponsor should also draw up appropriate contingency plans to deal with any disorder or failure that might arise in connection with the offer. Such contingency plans should cover the offer period up to the commencement of trading and any other disorder that might arise in connection with the offer.

Revision question: Question 3: Where a member of a Transaction Team identifies suspicious circumstances in a listing applicant, what is the correct course of action to take? Answer 3: He should immediately bring the circumstances to the attention of the Principal in charge.

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Topic summary This Topic laid out the systems, processes and resources that a sponsor must establish before accepting an IPO engagement. Much of this was concerned with establishing an adequate corporate istration to ensure the sponsor role was able to be properly undertaken in compliance with the relevant obligations. The importance of keeping these systems, etc. under review on at least an annual basis was discussed, as was the need to keep sufficient records for the required period to comply with regulatory requirements. The matters that a sponsor must consider before accepting a new engagement were reviewed. The importance of a sponsor having its house in order prior to undertaking an engagement and understanding its role and authority in managing an IPO constituted a central theme of this Topic.

Checklist Below is a checklist of the main points covered by this Topic. Candidates should use the list to test their knowledge. 

The senior management of a sponsor is ultimately responsible for supervising sponsor work and for guiding a listing applicant on compliance with the legal and regulatory requirements.



A number of compliance procedures must be established prior to undertaking any IPO assignment, and are normally recorded in a compliance manual.



A sponsor must possess sufficient resources (including staff with appropriate levels of knowledge, skills and experience) and have established effective systems and controls that properly implement and facilitate senior management oversight.



Chinese walls should be established to prevent the flow of confidential and/or price sensitive information, which should be provided to staff only on a “need-to-know” basis.



A sponsor’s systems and controls should be properly documented and reviewed on an annual basis (such review and its outcomes to be documented).



Record keeping is an important means of enabling a sponsor to demonstrate to the SFC that it has complied in all matters it is required to attend to.



The types of records required to be kept for each listing assignment and the retention period.



On completion of a listing transaction, a sponsor is required to submit to the SFC a team structure chart.



Procedures for conflict checks and vetting new mandates.



The contents of forms and checklists for the approval of new mandate.



New mandates should be evidenced through engagement letters.



The authority of a sponsor must be absolute in order for it to prepare a listing applicant for listing.



A key component of the work of sponsors is interacting with the SEHK and, sometimes, with the SFC.



Transaction Teams must be led by one or more Principals.



Principals are usually assisted by other licensed representatives and Transaction Team .

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

What Transaction Team and the Principal should do when there arise suspicious circumstances, difficult or sensitive issues, conflicting information or material non-compliance by a listing applicant.



Arrangements to ensure public offers proceed in a fair, timely and orderly manner.

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Topic 4: Preparation for a listing application Table of contents Topic overview

1

Learning outcomes

1

1

Obtaining assignments and working with third parties

3

Taking on new assignments Evidencing sponsor and third party mandates Working with other sponsors Financial advisers Legal advisers Reporting ants Other experts Other parties

3 3 3 4 4 5 5 6

Establishing the sponsor role

8

2

3

4

5

6

Submission to the Listing Rules Impartiality and independence Specific circumstances affecting independence Assessing commercial arrangements for independence Appointment as sponsor Formation of the Transaction Team Ceasing to act

8 8 9 10 11 13 14

Advising the listing applicant

15

Assessing a listing applicant for suitability Issues in assessing suitability for listing in practice

15 18

Conducting due diligence

21

Key subjects of due diligence Preparing for due diligence Examples of issues encountered in carrying out due diligence

21 21 23

Making a listing application

25

Quality of information to be contained in the listing application IPO timetable Key building blocks of an IPO Filing and publication of the Application Proof Sponsor’s declaration

25 26 26 27 30

Disclosure and communication

33

Disclosure generally Post Hearing Information Packs Communications with regulators Meeting regulatory requirements in practice

33 33 34 34

Topic summary

37

Checklist

37

Topic overview This Topic focuses on the responsibilities of a sponsor towards the listing applicant and the listing application process, from obtaining the appointment as sponsor and formation of the Transaction Team through to undertaking due diligence and advising the listing applicant leading up to preparation of the listing application. The normal means by which corporate finance advisers obtain appointments as sponsors is reviewed, as well as the practical considerations associated with working with multiple sponsors and with the involvement of other third parties such as financial advisers, legal advisers and reporting ants. The regulatory requirements concerning appointments are then explained, in particular the need for a sponsor to follow the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited (“Listing Rules” or “LR”). The importance of independence and impartiality is considered, as well as the requirements concerning the formation of Transaction Teams. A core function of the sponsor is to assess listing applicants for their suitability to be listed in the light of the Listing Rule requirements. This will call for due diligence to be undertaken on the listing applicant on key issues of importance, including the capabilities of directors and the adequacy of the compliance systems of the listing applicant. The important matters that must be considered prior to submission of the listing application are then reviewed. The sponsor must have formed an opinion based on reasonable due diligence that the information in the listing application complies with the legal and regulatory requirements as to quality and completeness, etc.. This is a precursor to the sponsor being able to give the declarations to the regulators that are required by the Listing Rules. The Topic concludes with a discussion of how information obtained by the sponsor in the course of its role is to be handled. The means by which information asymmetries in the market are avoided is discussed, as well as the sponsor’s duties in communicating with the regulators.

Learning outcomes At the end of this Topic, candidates should be able to: (a) describe the ways a sponsor can obtain an assignment to work on an initial public offering (“IPO”) and the required to be included in a sponsor engagement; (b) understand the issues in working with multiple sponsors; (c) identify the other parties that are normally appointed in connection with an IPO; (d) explain the importance of the undertaking and declarations that a sponsor is required to give to regulators; (e) understand how sponsor independence is assessed and why impartiality in giving advice is important; (f) explain what a Transaction Team is, as well as its formation and functions; (g) explain what is involved in assessing a listing applicant’s suitability for listing, including the special rules applicable to issuers from the People’s Republic of China other than the regions of Hong Kong, Macau and Taiwan (“PRC issuers”) and mineral companies; (h) identify the matters subject to due diligence in the context of accepting a sponsor role and bringing the listing applicant to the listing application stage; (i) understand the standards required for information contained in a listing application; and

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(j) explain the sponsor’s responsibilities as regards disclosure of information and communications with the regulators.

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1

Obtaining assignments and working with third parties Taking on new assignments

1.1

There are a number of ways a sponsor can obtain a mandate for a new listing. For example, it may arise as a result of marketing efforts on the part of the sponsor with a listing candidate and/or its shareholders. This will generally imply some prior level of familiarity with the listing applicant on the part of a sponsor, especially where such marketing efforts have been conducted over a significant period of time, or have arisen as a result of an existing relationship, or involvement of the sponsor in another capacity with the company, perhaps through a lending or financial advisory activity.

1.2

There are also cases where the opportunity to act as sponsor arises as a result of a referral, such as by a prior or existing client, by another licensed corporation or ed institution that is unable to take on such a mandate (for example, as a result of a conflict due to another existing engagement for a client in the same industry sector), or even through financial, legal or other advisers known to the sponsor.

1.3

A new sponsor mandate may also arise as a result of pro-active steps taken by the listing applicant or its shareholders, for example through a “beauty parade” (i.e. a selection process through which potential sponsors are formally assessed) or request for proposals issued to a number of prospective sponsors by the company or, as is becoming increasingly common, by a financial adviser acting on behalf of the company. In such cases, there may not necessarily be a prior relationship between the listing applicant and the sponsor, and knowledge of the company by the sponsor may be more limited in scope or duration.

1.4

In any case, and in particular where the appointment of the sponsor is made following a competitive selection process, the authority of the sponsor must remain absolute for it to be able to perform its role effectively. This may be on a sole basis, or in a t capacity with other sponsors also appointed by the listing applicant.

Evidencing sponsor and third party mandates Engagement letters 1.5

Once the sponsor has vetted the proposed new mandate (discussed in Topic 3) and has made the decision to accept the sponsor role, it is good practice and a requirement to document the of its engagement, including its remuneration and the duration of the assignment. This typically takes the form of an engagement letter, which is negotiated between the parties. The requirements applying to of appointment are discussed in section 2 below.

1.6

As covered in Topic 1, it is common for firms appointed as sponsor also to act in other capacities in an IPO, in particular as global coordinator, bookrunner and/or lead manager. In such a case, there is often one engagement letter covering the engagement of a firm in its various roles. It is also common when various licensed corporations or ed institutions are appointed in these multiple roles, for a t mandate or engagement letter to be signed. A listing applicant appointing more than one sponsor may wish to designate in an engagement letter which sponsor (ideally an independent sponsor) is to be the primary channel of communication with The Stock Exchange of Hong Kong Limited (“SEHK”) with respect to the listing application.

Working with other sponsors 1.7

It has become increasingly commonplace in the case of larger transactions to appoint more than one sponsor. This remains a commercial decision on the part of the listing applicant and there may be good reasons for doing so, perhaps when complementary skills or expertise are

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needed from various houses (e.g. country familiarity, sector experience, multiple viewpoints on difficult issues, development of wider research coverage by more financial institutions after listing, etc.). A balancing act may take place between the various houses where several sponsors are appointed. However, this should not adversely affect the standards required for sponsor work. Additional information and considerations in relation to multiple sponsors are set out under sections 2.14 to 2.17 below.

Financial advisers 1.8

Financial advisers are increasingly appointed alongside sponsors with a view to better protecting the interests of the listing applicant or its shareholders. This may mitigate perceived conflicts of interest that may exist where the sponsor is also acting as an underwriter and placing agent, and whose interests may not necessarily be aligned with those of the listing applicant, especially with respect to the valuation for the shares that may be issued or sold.

1.9

A financial adviser will often have come on board ahead of the appointment of sponsor and senior underwriters and, indeed, will often have been involved in the selection and appointment process for such sponsor and senior underwriters, for example in setting up interviews or in organizing a beauty parade leading up to their selection.

1.10

The role of a financial adviser is distinct from that of the sponsor. While financial advisers must be licensed by or ed with the Securities and Futures Commission (“SFC”) for Type 6 regulated activity (advising on corporate finance) and are also governed by the Corporate Finance Adviser Code of Conduct (“CFA Code”), they are not subject to the same level of responsibilities and obligations as sponsors.

1.11

The CFA Code requires a financial adviser appointed to advise a listing applicant to cooperate fully with, and not unreasonably or adversely to affect, the sponsor in discharging its duties. In particular, it should not impede or restrict the sponsor’s access to communicating with the listing applicant.

Legal advisers 1.12

At least 2 firms of legal advisers must be appointed, one advising the listing applicant (and perhaps its shareholders), and another advising the sponsor and underwriters. However, on occasion, other legal advisers will be appointed, for example to provide legal advice on jurisdictions other than Hong Kong when an offer to investors is made internationally. Legal advisers from the United States (“US”), for instance, must be appointed where the offer structure contemplates a private placement to qualified institutional buyers (in effect, large onshore institutional investors) under Rule 144A of the Securities Act in the US. Note: Compliance with Rule 144A provides an exemption from onerous registration requirements in the US.

1.13

In addition, since many applicants for listing on the SEHK are also incorporated outside Hong Kong, advisers providing legal advice pertaining to the country where the listing applicant is incorporated (or where a significant part of its business is conducted) may be involved, for example, legal advisers as to the laws of the People’s Republic of China (“PRC”) in the case of an IPO of H shares, or by a Red Chip or PRC private enterprise. If a listing applicant has material operations or assets located in jurisdictions other than Hong Kong, or if it has recently undertaken or is about to undertake material acquisitions or disposals in such jurisdictions, legal advisers in those jurisdictions may need to be appointed too. Lastly, there may be a preference for shareholders of a listing applicant to be advised by legal advisers distinct from those advising the listing applicant, which may further add to the number of legal advisers involved in an IPO.

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1.14

In appointing legal advisers, sponsors and the listing applicant (and other parties appointing legal advisers, if appropriate) should ensure that such legal advisers are qualified and have experience (ideally recent experience) of working on similar transactions, that they have appropriate resources to undertake the assignment and also that their appointments will not result in any conflict of interest. The selection process is therefore generally best conducted through interviews and a review of written proposals by such legal advisers, unless perhaps where there is already a strong existing relationship with a firm or firms that are suitably qualified and familiar with the listing applicant, the sponsor, the underwriters and/or other parties.

1.15

The respective scope of work of the various legal advisers appointed to work on an IPO should be clarified at the outset through engagement letters to make sure that their scope of work is sufficient and appropriate. It is good practice to agree what might be included in due diligence reports and legal opinions at the outset of an IPO process. However, the sponsor should not place undue reliance on opinions provided by legal advisers and/or disclosure letters (in particular on so-called 10-b-5 letters provided by legal advisers when a Rule 144A private placement in the US is part of the offer structure of an IPO). The regulatory obligation in Hong Kong to conduct due diligence ultimately rests with the sponsor, and sponsors should review any legal opinion in a reasonably critical way.

Reporting ants 1.16

In addition to legal advisers, a listing applicant must appoint reporting ants. Often – but not always – they will already be working on behalf of the company. Their appointment should follow the same process as for legal advisers, and their qualifications, suitability, independence, appropriate level of resources and absence of conflict should be assessed similarly. It should be noted that some reporting ants also have tax advisory, financial advisory and consulting arms, for example to provide internal control review services to their audit clients. If these other service arms also work for the listing applicant, the reporting ant’s independence and the potential for conflict of interest in also acting as reporting ants should also be discussed and investigated. As with legal advisers, the scope of work of the reporting ants appointed to work on an IPO should be clarified at the outset through an engagement letter.

1.17

The availability of financial information and the comfort on such information to be provided by the reporting ants often have a significant impact on the timetable for an IPO and should be discussed in detail at the outset of a transaction. In particular, it is good practice for the form of comfort letters to be discussed and, as much as possible, agreed at the outset to avoid unnecessary delays and/or misunderstandings at a later stage. Reporting ants are considered as experts. Nevertheless, a sponsor should critically review their work/reports, and should not unduly rely on them without performing reasonable and necessary due diligence.

Other experts 1.18

In addition to reporting ants, other experts may need to be appointed in connection with an IPO to contribute to the listing document. These can include property valuers where a company has significant property assets, mining consultants where a Competent Person’s or Competent Evaluator’s Report is required in connection with the listing of a mining company under Chapter 18 of the Listing Rules, traffic or shipping consultants for transport or shipping companies, or other independent market research firms tasked with providing investors with additional information and disclosure relevant to an investment in the shares of the company.

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1.19

As with legal advisers and reporting ants, the sponsor should satisfy itself that such experts are properly qualified and have the necessary experience and expertise to act in such capacities in connection with an IPO. Their independence, absence of conflicts, qualifications, credentials and experience should be assessed prior to any appointment, which should be evidenced by an engagement letter. While sponsors cannot always reasonably be expected to possess the level of knowledge and expertise of an expert, they should nevertheless critically assess the work/reports of experts with a questioning mind.

Other parties 1.20

Such parties may include, among others, all or some of the following: (a) share registrars and transfer agents; (b) depositary banks (for Hong Kong Depositary Receipts (“HDRs”)), who make arrangements for the issue and redemption of HDRs and ister HDR programmes; (c) receiving banks (for retail offers); (d) human resources and remuneration consultants (to advise on management and employee offers, and on nomination committees); (e) advertising and public relations agencies, who help monitor the media in relation to news about or relevant to a listing applicant and also assist with press releases and communication campaigns, within the constraints of the legal and regulatory framework for IPOs; (f) roadshow consultants, who assist with the logistics and travelling arrangements associated with an IPO roadshow; (g) financial printers and virtual data room (“VDR”) providers, who assist with the typesetting and printing of listing documents and who facilitate the arrangements for documentary due diligence; (h) translators, for example to help translate the offer document from English into Chinese, or vice-versa (in practice, many financial printers offer such services); and (i) call centres, to assist the investing public in securities applications concerned with new types of offerings, for example, as was the case in the early privatizations in Hong Kong in the late 1990s and early 2000s.

1.21

Ultimately, the preparation of a listing document is a collaborative process among the listing applicant, the sponsor and other advisers/third parties. Some of these (such as legal advisers or reporting ants) are subject to their own statutory obligations, and professional standards and ethics.

1.22

It is good practice for decisions made at important meetings with all the above to be minuted, and for regular (perhaps weekly) “catch up” all-party meetings or conference calls to be held to review the status of the tasks undertaken by the various work streams. In addition, (probably less frequent) “steering committee” meetings of senior of the listing applicant and senior management of the sponsor may also be convened to periodically review the timetable for the transaction, discuss critical issues that may arise out of due diligence or to deal in a smaller forum with aspects such as board composition.

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Revision questions: Question 1: Name at least 3 parties other than the listing applicant and the sponsor that would normally be involved in an IPO. Answer 1: Reporting ants, legal advisers, financial advisers, experts and other parties as mentioned in section 1.20. Question 2: How many firms of legal advisers must be appointed in connection with an IPO? Answer 2: At least 2 firms of legal advisers must be appointed, one that acts for the listing applicant (and perhaps its shareholders) and the other that acts on behalf of the sponsor and underwriters.

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2

Establishing the sponsor role

2.1

At the time the Application Proof is submitted to the SEHK, the sponsor (and if more than one, then each of them) must give to the SEHK an undertaking and statement of independence in the form set out in LR Appendix 17.

Submission to the Listing Rules 2.2

The undertaking set out in LR Appendix 17 in effect makes the sponsor subject to the Listing Rules and specifically requires the sponsor to: (a) comply with the Listing Rules applicable to sponsors; (b) use reasonable endeavours to ensure that all information provided to the SEHK is true, accurate, complete and not misleading in all material respects; (c) promptly advise the SEHK and the SFC should it become aware of information that may cast doubt on the truth, accuracy or completeness of information already provided to the SEHK and the SFC; (d) cooperate in any investigation conducted by the Listing Division and/or the Listing Committee of the SEHK. This would include answering promptly and openly any questions addressed to the sponsor, promptly producing the originals or copies of any relevant documents and attending before any meeting or hearing at which the sponsor is requested to appear; (e) give, before dealings in the listing applicant’s shares begin, the Form E declaration to the SEHK concerning compliance with the Listing Rules, including the public float requirements and details of the number of shareholders and the number of placees at the time of listing; and Note: The Form E declaration is in LR Appendix 5. (f) report to the SEHK in writing on any material information concerning non-compliance with the Listing Rules or laws relevant to the listing application; and Note 1: Such obligation applies to information acquired by the sponsor while acting in its role as sponsor. The obligation continues after the sponsor ceases to act as sponsor, whether as a result of early termination of the engagement or as a result of the listing applicant being itted to listing. Note 2: The Code of Conduct for Persons Licensed by or ed with the Securities and Futures Commission (“Code of Conduct”) also requires the sponsor to bring to the attention of the SEHK all material issues relevant to the suitability of the listing applicant or whether the listing may be contrary to the interest of the investing public or the public interest. (g) should the sponsor cease to act as such before completion of the applicant’s listing, report to the SEHK in writing and as soon as practicable the reasons for ceasing to act.

Impartiality and independence 2.3

The statement of independence in LR Appendix 17 requires the sponsor to declare either (i) that it is and expects to be independent, or (ii) that it is not or does not expect to be independent. If the latter applies, the circumstances giving rise to the lack of independence must be stated.

2.4

The statement of independence is important since the Listing Rules require at least one sponsor to be able to demonstrate that it is independent of the listing applicant. However,

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irrespective of a sponsor’s independence status, all sponsors are required to perform their duties with impartiality. 2.5

The SEHK’s requirements in this regard underline that the concepts of impartiality and independence are critical to the proper performance of the sponsor role. The ability of a sponsor to act in this way is one of the first matters a sponsor must consider before accepting any new sponsorship role. Provisions of both the CFA Code and the Listing Rules are relevant in this regard.

2.6

Impartiality may be impaired where the sponsor has a material interest in a transaction with or for a client, or a relationship that gives rise to an actual or potential conflict of interest. Where there is an actual or potential conflict of interest, the CFA Code requires a sponsor not to accept an assignment unless it has first disclosed that material interest or conflict to the client and has taken all reasonable steps to ensure fair treatment of the client. This requirement is a general one that will not be satisfied solely by the submission of the Appendix 17 statement of independence.

2.7

An initial step in considering a potential sponsorship role is to advise a potential listing applicant on its suitability for listing (see section 3 below). The CFA Code also requires that the advice given be impartial and that any opinion on suitability is given independently. For example, in preparing advice, the fees that could be earned (i.e. by giving a potential listing applicant a favourable view on its suitability for listing) should not be taken into .

Specific circumstances affecting independence 2.8

A sponsor will be regarded by the SEHK as not independent if any of the circumstances set out in LR 3A.07 apply at any time between the commencement of the listing application process and the date of listing. The provisions of LR 3A.07 are detailed and deserve careful scrutiny. They are mainly concerned with the presence of a relationship between the sponsor and the listing applicant in the form of shareholdings, debts or guarantees in excess of specified thresholds, and business relationships that may give rise to conflicts of interest or possible independence issues. A sponsor that satisfies any of the following tests would be regarded as not independent: (a) the sponsor holds more than 5% of the issued share capital of the listing applicant (holdings by group companies and directors and their associates are to be included, and holdings arising as a result of an underwriting obligation are excluded); (b) the holding of the sponsor in the listing applicant exceeds or will exceed 15% of the net equity of the sponsor’s ultimate holding company or, where there is no ultimate holding company, the sponsor; (c) any member of the sponsor group, or any director or associate of a director of the sponsor, is an associate or connected person of the new applicant; Note: “Associate” and “connected person” are defined in the Listing Rules and may require careful examination as to their application. By way of example: associates of an individual include their spouses and children under 18; associates of a company include other companies in the same group; connected persons of a company include the company’s directors and substantial shareholders. (d) 15% or more of the proceeds raised from listing of the applicant are to settle debts due to the sponsor (debts that represent sponsor fees due are excluded); (e) amounts due to the sponsor group from the listing applicant group, together with any guarantees given by the sponsor group on behalf of the listing applicant group, exceed 30% of the total assets of the listing applicant;

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(f) amounts due to the sponsor group from the listing applicant group and any of its controlling shareholders and their associates, together with any guarantees given by the sponsor group on behalf of the listing applicant group and any of its controlling shareholders and their associates, exceed 10% of the total assets of the sponsor’s ultimate holding company or, where there is no ultimate holding company, of the sponsor; (g) the shareholdings of a director of the sponsor or its ultimate holding company (or his associates) in the listing applicant exceed HK$ 5 million; (h) an employee or director (or their associates) of the sponsor who is directly engaged in the sponsorship role for the listing applicant holds or will hold an interest in the shares in the listing applicant; (i) the presence of a current business relationship (other than arising from the sponsorship) between the listing applicant (or any of its directors, subsidiaries, holding company or substantial shareholders) and the sponsor group (see Note below) that would reasonably be considered to affect, or give the appearance of affecting, the sponsor’s independence in performing its duties as an independent sponsor; or Note: This covers any member of the sponsor group, employees of the sponsor involved in the sponsor work and directors of any member of the sponsor group (and any associates of such employees or directors). (j) the sponsor or a member of the sponsor group is the auditor or reporting ant of the listing applicant. 2.9

If during the period of its appointment, a sponsor’s independence status changes, it is required to notify the SEHK of the relevant changes as soon as possible after the change occurs. Where the relevant change is that of a sole independent sponsor ceasing to be independent, the SEHK will not accept any further documents in connection with the listing application until such time as an independent sponsor is appointed.

Assessing commercial arrangements for independence 2.10

As mentioned above, prior to taking on a sponsor role, a licensed corporation or ed institution should not only clear potential conflicts that may arise as a result of it already working on other transactions, but also assess its independence from the listing applicant.

2.11

While shareholdings in the listing applicant arising out of underwriting arrangements may not result in a sponsor being considered not independent, payment in shares under contingent fee arrangements or a sponsor receiving shares to be listed as part of its remuneration might affect the independence of the sponsor. Care should therefore be taken when entering into such arrangements.

2.12

Similarly, where a business or lending relationship already exists between a listing applicant and a sponsor (or companies relating to a sponsor), care should be taken to determine whether a sponsor might be considered as not independent under the various tests set out in the Listing Rules.

2.13

Some sponsors in particular may be part of large, multi-service organizations that offer a wide range of financial services and which may already have commercial or business arrangements with the listing applicant. In such a case, assessing the independence of a sponsor may take time. Sponsors appointed after the listing application process has begun may only have a short period of time for such investigations prior to their submission of the Appendix 17 statement (see section 2.3 above), and may perhaps wish to consider clearing the independence test as soon as the likelihood of their being appointed to a sponsor role is identified.

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Multiple sponsors 2.14

Subject to the requirement of having at least one independent sponsor, there is no regulatory restriction on the number of sponsors a listing applicant may engage, though there are practical considerations, as discussed in sections 3.15 to 3.17 of Topic 1.

2.15

A listing applicant with more than one sponsor must designate which sponsor is to be the primary channel of communication with the SEHK as regards the listing application. The SEHK will normally expect the sponsor so designated to be independent from the listing applicant.

2.16

It should also be borne in mind that the independence status of each appointed sponsor must be disclosed in the listing document. This requires the basis on which a sponsor is not independent to be set out.

2.17

Finally, the fulfilment of sponsor duties rests with each sponsor. In other words, one sponsor may not avoid its responsibilities simply because the listing applicant has appointed other sponsors.

Appointment as sponsor 2.18

A licensed corporation or ed institution should ensure that any appointment to act as sponsor is made sufficiently far in advance of the expected date of the listing application. This is necessary to enable the sponsor to properly undertake the work required to prepare a listing application to the required standard, including detailed planning, engagement of other professionals and due diligence.

2.19

The Code of Conduct regards the minimum period required for a sponsor to undertake the relevant work to be 2 months. The Listing Rules provide that a listing application must not be submitted less than 2 months after the last sponsor is formally appointed (i.e. this will normally be the g of the written agreement). Accordingly, should an additional sponsor be appointed after work has already commenced, the 2-month period will re-start from the date of formal appointment of the last sponsor.

2.20

However, the above 2-month period is only a minimum and is subject to the overriding requirement for a sponsor (or, if multiple sponsors, for each of them) to assess the amount of time required to undertake the work necessary to fulfil its responsibilities. In this regard, the sponsor should bear in mind the listing applicant’s expected timetable as well as all other relevant circumstances, including the size and complexity of the listing applicant and the time required to undertake due diligence and to deal with any issues that may arise.

2.21

A sponsor should not undertake an appointment if it considers there is insufficient time to complete the required work (even if this is more than 2 months). Where a listing applicant insists on a timetable involving a period shorter than that which the sponsor considers necessary to complete the work to a proper standard, the sponsor should consider whether it is appropriate to accept, or continue with, the sponsor appointment. Notification to the SEHK

2.22

Where an appointment is made, the sponsor must notify the SEHK in writing of the appointment as soon as practicable, irrespective of whether a listing application has been submitted. A copy of the engagement agreement (or engagement letter/ of appointment) must be provided to the SEHK as soon as the formal appointment is made. of appointment

2.23

The of the appointment, which must be recorded in writing, should clarify the responsibilities of the listing applicant to facilitate the sponsor to fulfil its duties under applicable regulations.

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2.24

The written appointment must impose the following obligations on the listing applicant and its directors: (a) to fully assist the sponsor to perform due diligence, including giving it access to all relevant records for the purposes of the listing application (including procuring access to records of relevant third parties, such as correspondence between the listing applicant and its agents or experts and between experts and the regulators). Where necessary, the listing applicant is to enter into such supplements to the engagement letter with experts to enable the foregoing regarding sponsor’s access to records of experts. (b) to procure the full cooperation of all relevant third parties (such as financial advisers, experts and other third parties) with the sponsor to facilitate its work; (c) to provide every assistance necessary to enable the sponsor to meet its obligations and responsibilities under the Listing Rules and the Code of Conduct in relation to the provision of information to the regulators, including reasons if the sponsor ceases to act; and (d) to keep the sponsor informed of any material change in the information previously given to or accessed by the sponsor.

2.25

In addition, the of appointment should not contain any that might inhibit the sponsor from undertaking its regulatory responsibilities.

2.26

The sponsor’s fees and the basis on which they are to be determined must be clearly set out. This should cover the structure and timing of the payment and any other factors affecting the fees payable.

2.27

The CFA Code requires that where sponsor fees (or any other benefits-in-kind) are offered or are incorporated into the of appointment and are contingent on a successful transaction, such fees (or benefits) must be disclosed to the SFC and/or the SEHK upon request.

2.28

A sponsor may not undertake an appointment on the basis of a “no deal; no fee” arrangement.

2.29

Above all, sponsor fees should appropriately reflect the role and responsibilities to be discharged by a sponsor and should not be confused with fees pertaining to other services, notably book-building, pricing and similar functions governed by underwriting and related agreements. The sponsor fees should not be contingent on the success or the final size of the offering (as underwriting and selling commissions usually are), and any partial payments should be proportional to the amount of work done up to that stage. The total amount of sponsor fees paid and payable should be disclosed in the listing document.

2.30

Ideally, the engagement of one or more sponsors for an IPO should be kept separate from any other roles a firm may have in the transaction, perhaps through the g of a separate engagement letter. The fees payable to the sponsor and required to be specified in a sponsor’s of engagement must be based solely on a sponsor’s role as such, and not in relation to activities not directly related to sponsor work. Bundling the of engagement of a sponsor with those of the other capacities in which that firm can act in an IPO is technically and legally feasible. However, it may on occasion lead to confusion and misinterpretations if the are not sufficiently clear. Accordingly, these engagements are perhaps best kept separate.

2.31

Other provisions normally found in a sponsor’s of appointment deal with: (a) the scope of the work to be carried out by the sponsor (having regard to the above considerations);

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(b) a confidentiality undertaking on the part of the sponsor (especially where no separate non-disclosure agreement has been entered between the parties); (c) waivers of liability; (d) the ownership of intellectual property for documents and materials arising out of the assignment; (e) the engagement period; (f) termination provisions; (g) successors and assignees of the parties entering into the engagement letter; and (h) the governing law of the engagement.

Formation of the Transaction Team 2.32

Upon being appointed as a sponsor to a listing applicant, the sponsor must form a Transaction Team (see Note below). The team should comprise at least one Principal (see section 5.6 of Topic 1) and staff who have appropriate levels of knowledge, skills and experience, taking into consideration the nature, scale and complexity of the assignment and other factors that may affect the standard of work. Where more than one Principal is appointed, they are tly and severally responsible for the work of the Transaction Team. Note: “Transaction Team” means the staff appointed by a sponsor to carry out a listing assignment.

2.33

The core roles of the Principal are: (a) to supervise the work of the Transaction Team; (b) to be involved in decision-making on key issues that may arise during the execution of the sponsor work; and (c) to respond promptly to any inquiries from the SEHK and/or the SFC about the sponsor work and listing application. Note: (a) and (b) above will require clear and effective reporting lines to be established. Supervisory and reporting responsibilities should be assigned to more experienced staff .

2.34

Of central importance to the Principal’s supervision of the Transaction Team will be ensuring the sponsor’s due diligence responsibilities are properly undertaken. The Additional Fit and Proper Guidelines for Corporations and Authorized Financial Institutions applying or continuing to act as Sponsors and Compliance Advisers give the following as examples of areas that the Principal should be specifically involved in: (a) determining the extent of the due diligence review; (b) determining the resources required to undertake the due diligence work; (c) critically assessing the results of the due diligence exercise; (d) ensuring that any issues arising out of the due diligence exercise are properly addressed and resolved where possible; and (e) assessing the overall adequacy of the due diligence review.

2.35

As the senior management of a sponsor is ultimately responsible for the quality of work undertaken by the Transaction Team, the senior management and the Principal should also ensure that appropriate reporting lines and channels of communication are established between them (see the discussion in sections 2.6 to 2.11 of Topic 3).

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2.36

The of the Transaction Team should possess sufficient knowledge and experience of Hong Kong regulatory requirements and be in a position to undertake the required work throughout the period of the assignment.

2.37

The Code of Conduct recognizes that in some circumstances of a Transaction Team may also be required to participate in the Transaction Team in respect of another sponsor role being undertaken by the licensed corporation or ed institution. This will be acceptable for regulatory purposes provided that: (a) the proper discharge of their responsibilities is not affected; (b) where a Principal supervises more than one Transaction Team, each Transaction Team is able to be properly supervised by at least one Principal; and (c) the sponsor will continue to be able to comply with its obligations in relation to the avoidance of actual or potential conflicts of interest (see sections 2.3 to 2.4 above).

Ceasing to act 2.38

Where a sponsor resigns or the appointment is otherwise terminated early: (a) the listing applicant must immediately notify the SEHK of the resignation or termination; and (b) the sponsor must notify the SEHK of the reasons for its ceasing to act as soon as practicable.

2.39

Where the sponsor that has ceased to act was the only independent sponsor, a replacement sponsor that is independent must be appointed and the appointment notified to the SEHK. The replacement independent sponsor will need to submit a listing application together with a revised timetable, and the declarations and undertakings required by the Listing Rules. The initial listing fee already paid is non-refundable and a new listing fee must be paid. The 2-month minimum period referred to in section 2.19 above would re-start.

Revision questions: Question 3: In what circumstances may the impartiality of a sponsor be impaired? Answer 3: The impartiality of a sponsor may be impaired where the sponsor has a material interest in a transaction with or for a client, or a relationship that gives rise to an actual or potential conflict of interest. Question 4: How soon must a sponsor be appointed by a listing applicant in relation to its proposed IPO? Answer 4: The Code of Conduct regards the minimum period required for a sponsor to undertake the relevant work to be 2 months. The Listing Rules provide that a listing application must not be submitted less than 2 months after the last sponsor is formally appointed. However, this is only a minimum period and is subject to the overriding requirement for a sponsor to assess the amount of time required to undertake the work necessary to fulfil its responsibilities. Question 5: What staff of a sponsor should comprise the Transaction Team? Answer 5: The Transaction Team should comprise at least one Principal and staff who have appropriate levels of knowledge, skills and experience taking into consideration the nature, scale and complexity of the assignment and other factors that may affect the standard of work.

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3

Advising the listing applicant Assessing a listing applicant for suitability

3.1

The central role of a sponsor is to advise and guide a listing applicant in its preparation for listing. This will require a detailed understanding of the circumstances of the listing applicant as well as its ability to satisfy the requirements of the Listing Rules.

3.2

From the outset of its involvement with the listing applicant, the sponsor is required to understand the nature of the listing applicant’s business. This will require it to obtain information about, among other things, the listing applicant’s background, the identity of its controlling shareholder(s), its shareholding structure, and the financial circumstances and investments or corporate objectives in relation to the proposed listing.

3.3

In the course of advising the listing applicant, the sponsor is required to use all reasonable endeavours to ensure the listing applicant understands the relevant regulatory requirements and their implications at all stages of the listing procedure. In the event the sponsor becomes aware that the listing applicant is not able to comply with applicable regulatory requirements, this should be discussed with the listing applicant with a view to resolving the matter, if possible. Issues which cannot be resolved will need to be brought to the attention of the SEHK at the time of making the listing application (see section 5 below).

3.4

In the event of material non-compliance with applicable regulations that the listing applicant does not wish to be brought to the attention of the SEHK, the sponsor should consider ceasing to act. In this context, the sponsor will need to consider its obligations under Appendix 17 of the Listing Rules (see sections 2.2(f) and 2.2(g) above) and its ability to give the declaration set out in Appendix 19 of the Listing Rules (see sections 5.29 to 5.32 below).

3.5

Finally, the CFA Code also imposes a requirement on all corporate finance advisers, including sponsors, to respond to any enquiry by the SEHK or the SFC concerning a possible breach of a relevant regulation in a co-operative and truthful manner and to the best of their knowledge. Listing Rules

3.6

Chapter 8 of the Listing Rules sets out the basic conditions that have to be satisfied as a pre-requisite for a listing applicant to be eligible for the listing of its equity securities, and these conditions have been discussed in Topic 2. The sponsor will need to advise the listing applicant on whether it will satisfy these conditions, or if a relevant waiver may be sought.

3.7

In order to be in a position to advise the listing applicant, the sponsor will need to conduct reasonable due diligence on the listing applicant and possibly also seek guidance from the SEHK as to the application of the eligibility requirements to the specific circumstances of the listing applicant. Sufficient due diligence steps will need to be undertaken well in advance of making a listing application, and should not depend on the SEHK’s comments. Issues should be identified, appropriately disclosed and addressed before the SEHK/SFC reviews the listing application. Due diligence on the listing applicant is further discussed in section 4 below.

3.8

Another important issue for sponsors to recognize early on in the process is Chapter 3 of the Listing Rules, which sets out the requirements concerning directors of listed issuers. This is important as sponsors will need to give a declaration to the SEHK confirming the ability of the directors to run the business and to comply with the Listing Rules and other legal and regulatory requirements (see sections 5.29 to 5.32 below). Note: Section 3 of Topic 2 discusses directors and other corporate istration requirements relevant to the listing applicant.

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PRC issuers 3.9

For issuers that are incorporated in the PRC, there are additional requirements that sponsors must attend to, and these are set out in Chapter 19A of the Listing Rules. While a number of these requirements are similar in nature to those in LR Chapter 3A, Chapter 19A emphasizes the sponsor’s “particular responsibility” in relation to PRC issuers, suggesting a higher degree of examination may be required. The sponsor must satisfy itself, based on all available information, that the PRC issuer is suitable to be listed. This may require the sponsor to undertake a more careful consideration of the company, including its general circumstances and operations.

3.10

The sponsor must satisfy itself, based on all available information, that the directors and supervisors of the PRC issuer: (a) understand their responsibilities; (b) can be expected to honour their obligations under: (i) the undertakings they are required to give under the Listing Rules (in particular, see Appendix 5 Forms H and I); (ii) the Listing Rules; and (iii) applicable PRC laws and regulations; and (c) understand what is required of them under the Listing Rules and applicable laws and regulations. Note: The Listing Rules define a supervisor of a PRC issuer as a member elected to the supervisory committee of the PRC issuer, which under PRC law performs a supervisory function in relation to such issuer’s board of directors, manager and other officers.

3.11

This will require the sponsor to engage with the directors about what their detailed obligations will be as directors of a listed company. This will generally be done together with the legal advisers and will entail a number of discussions covering a variety of topics, for example: (a) the rationale for listing the company; (b) the shareholders accepting a degree of loss of control in the listing candidate (for example, where certain transactions may require the prior approval of the company’s independent shareholders, post-listing); (c) the directors being aware that certain changes in management or at board level may affect the share price and valuation of the company; or (d) the directors being made aware of their fiduciary duties and corporate governance issues, and understanding restrictions on dealings once a company has become listed. It is also vital for the directors to understand the importance of transparency in the areas of both compliance and valuation. In addition, asymmetric dissemination of information is prohibited. This is especially important where, for example, potential cornerstone investors may be introduced by the management or shareholders of PRC issuers in connection with an IPO.

3.12

On occasion, some directors may have difficulty understanding, or may even be unwilling to accept, such requirements. In such cases, involving more senior colleagues or pointing out practices at companies that are already listed and which they may be familiar with can perhaps help address such issues. However, if ultimately no resolution can be obtained on such matters, the sponsor may need to consider reg.

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Properties located in mainland China 3.13

A commonly encountered issue, particularly for PRC listing applicants, concerns the legal status and condition of properties located in mainland China (“PRC properties”). In 1998, the SEHK published the “Clarification on Requirements for Land Use Title of properties situated in the Mainland of the People’s Republic of China” (the “1998 Announcement”), which required all applicants to obtain long-term land use right certificates and/or building ownership certificates (“Title Certificates”) in respect of their PRC properties. Title Certificates are important as they confirm ownership of the subject property. Accordingly, listing applicants holding PRC properties will need to confirm, with the of a PRC legal opinion from a firm authorized by an appropriate PRC authority, whether a Title Certificate has been obtained.

3.14

However, the SEHK’s Guidance Letter GL19-10 has amended some of the requirements for listing applicants and the position is now as follows: (a) Listing applicants that are infrastructure companies: (i) Main Board applicants continue to be subject to the 1998 Announcement as stated above. (ii) GEM applicants are subject to the same requirement as Main Board applicants. However, where the applicants operate under long-term concessionary arrangements that do not provide for Title Certificates, the SEHK may accept other evidence of the right to use the relevant PRC property. (b) Listing applicants that are property companies: (i) Main Board applicants are required to have Title Certificates for all PRC properties completed or under development. (ii) GEM applicants must have Title Certificates in respect of a substantially major portion of its PRC properties. (c) Listing applicants that are neither infrastructure companies nor property companies: (i) Main Board applicants must disclose in their listing documents the risks to their operations of not having Title Certificates for PRC properties. (ii) GEM applicants must have Title Certificates in respect of any PRC property that represents a substantial portion of its assets in of either asset value or profit contribution, or, where the PRC property is otherwise significant to the applicant’s activities, it is expected to have Title Certificate(s) unless the SEHK otherwise permits.

3.15

The SEHK may require Title Certificates to be produced and made available for inspection. Where the issue of a Title Certificate is pending, the SEHK may accept a contract concerning the pending title together with an appropriate legal opinion. Other property issues

3.16

Defective title to property may arise for a number of reasons and where this is the case (whether the property is in mainland China or Hong Kong), the listing applicant will need to make additional disclosures, including the nature of the defect, the director’s views (with basis) on whether the property or properties are crucial to the applicant’s operations, and whether the defect can be corrected and, if so, any remedial steps taken to rectify the defective title. The time and cost (with basis) of any required relocation or demolishment and how this would affect the applicant’s business and financial position also need to be disclosed.

3.17

Sponsors should be aware that specific disclosures need to be made in respect of:

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(a) a PRC property that comprises idle land; (b) an applicant’s business that involves civil defense property projects in the PRC; and (c) an applicant engaging in land resettlement operations. Mineral companies 3.18

Sponsors of listing applicants whose major activity concerns the exploration and/or extraction of natural resources will also need to take note of the requirements of Chapter 18 of the Listing Rules, and satisfy themselves that persons who occupy the role of Competent Person or Competent Evaluator (as such are defined in LR 18.01) satisfy the relevant requirements set out in LR 18.21 to 18.23 and 18.27 (sections 4.86 to 4.92 of Topic 2 also discusses mineral companies).

3.19

Sponsors should ensure that experts appointed to work on an IPO (legal advisers, property valuers, Competent Persons appointed in connection with the listing of a mining company under Chapter 18 of the Listing Rules, etc.) are aware of and understand the relevant requirements, and that all necessary information is accordingly included in the listing document. (The use of experts is further discussed in section 5 of Topic 5.)

3.20

The sponsor will need to be satisfied about all these matters before it is able to give the sponsor’s declaration set out in Appendix 19 of the Listing Rules (see section 5.29 below).

3.21

Where the SEHK is of the view that a PRC issuer’s sponsor is not fulfilling its responsibilities, it may require the issuer to terminate that sponsor and to appoint a replacement, whereupon the SEHK should be notified accordingly.

Issues in assessing suitability for listing in practice Business of the listing applicant 3.22

As previously noted, the SEHK has discretion not to it companies it deems unsuitable for listing and in this regard the sponsor has an important role in assessing and investigating suitability from the outset. It is also important to consider whether the “equity story”, i.e. the business of a listing applicant, is suitable for investors, both institutional and retail. In doing so, criteria such as the sustainability of the company’s business model, its prospects, corporate governance arrangements, organizational structure, management, manpower, systems and controls must all be considered. Valuation

3.23

The valuation of the shares to be listed should also be considered at an early stage, even if such valuation will necessarily be refined over the course of preparing the listing application, also taking into from institutional investors at the pre-deal investor education (“PDIE”) stage. In this regard, a variety of valuation methodologies can be used (sometimes cross-checked against one another), depending on the company and its business. These can range from the more straightforward price-to-earnings ratios to sales and cash-flow multiples, price-to-book or net asset value multiples, and “per-pop” valuations (i.e. by placing a value on each subscriber for the company’s services, for example in the case of a mobile telecommunications or internet company). Dividend yields, embedded value (to value life insurance companies) or discounted cash flow analyses, among other methodologies, may also be used (see also the discussion on valuation issues from the perspective of Listing Rule requirements in sections 4.70 to 4.71 of Topic 2).

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Reorganizations and related-parties transactions 3.24

Sponsors should particularly focus on companies that have undertaken or are about to undertake group reorganizations, or material acquisitions or disposals. It is important that they fully understand the rationale, nature, timetable and structure of these transactions, so that such information can be accurately described in the listing document, and that they can anticipate the impact these may have on the equity story and valuation for the listing applicant. Some of these transactions may also have significant implications for financial disclosure (in particular the use of pro forma s, which in turn may further affect the timetable for the IPO and listing), as well as the nature and level of comfort to be provided by the reporting ants. Sponsors should also advise on the impact of any acquisition during the track record period and on how this may affect the company as regards both its valuation and the quantitative tests set out in LR 8.05.

3.25

Related parties and connected transactions between management or board and the company, or between the company and d or related/linked businesses, should also be thoroughly investigated, and waivers sought where appropriate (see sections 4.66 to 4.69 of Topic 2). Related and connected party transactions may take time to identify through due diligence, but some may already be apparent at the outset of a transaction, and could perhaps impede the ability of a listing applicant to secure a listing on the SEHK. Apart from satisfying the related listing rules and ing requirements, sponsors should also assess the risks associated with a listing applicant relying on related parties and connected transactions, and consider whether such related parties and connected transactions are genuine, whether they are conducted at arm’s length/on normal commercial , and generally how they may affect the listing applicant’s suitability for listing. Sponsors should also consider including appropriate disclosures in the listing documents. Sometimes, a certain level of business reorganization might need to be conducted to address such issues directly. Other issues and governance

3.26

Other examples of areas that typically need to be resolved when dealing with a listing applicant are management, human resources and corporate governance issues. A public company must have well defined and sufficient resources within its head office, which may not necessarily be the case for a privately held business. The regular reporting and disclosure associated with the status of a listed company usually imply reinforcing the finance function, improving risk management and systems as well as procedures and protocols, for example with respect to the segregation of duties, authority to authorize various levels of transaction, processing and asset-safeguarding controls or independent checks.

3.27

Sponsors should also identify early the of senior management who will be meeting investors on the IPO roadshow, as well as those who will be in charge of investor relations after the IPO and listing. Lastly, the appointment of independent non-executive directors (“INEDs”) is also often something that needs to be carried out for listing applicants, ideally at an early stage, so that such INEDs can have enough time to familiarize themselves with the business of the company, and also be in a position to comment meaningfully or ask questions on the listing document. Requirements for the appointment of INEDs and related matters have already been covered in Topic 2.

3.28

Similarly, setting up relevant board committees (audit and remuneration committees and, potentially, a nomination committee) as well as a system to comply with the Model Code for Securities Transactions by Directors of Listed Issuers (see sections 3.14 to 3.15 of Topic 2) should be contemplated at an early stage. How to escalate information to the board, for example to consider whether disclosure is needed or, in the case of a transaction, whether shareholders’ approval is necessary, will also have to be considered.

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3.29

The relationship with controlling shareholders is also an issue that must be investigated by and discussed with sponsors at an early stage. For example, potential conflicts of interest between a company and its controlling shareholders may perhaps be addressed through rights of first refusal or similar arrangements.

Revision questions: Question 6: Are there additional requirements under the Listing Rules for issuers incorporated in the PRC? Answer 6: Yes, these can be found in Chapter 19A of the Listing Rules. Sponsors may also wish to refer to SEHK’s Guidance Letter GL19-10 in relation to land use right certificates and/or building ownership certificates for PRC properties. Question 7: What are the special requirements for mineral companies under the Listing Rules? Answer 7: These are set out in Chapter 18 of the Listing Rules.

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4

Conducting due diligence Key subjects of due diligence

4.1

Due diligence on the listing applicant, including on individuals involved in the management and control of the listing applicant, is an essential step in preparing a listing application and the Application Proof that is required to be submitted together with the application.

4.2

Due diligence by the sponsor will require a number of key issues to be understood about the listing applicant, including its: (a) history and background; (b) business and performance; (c) financial condition and prospects; (d) operations and structure; and (e) procedures and systems.

4.3

Due diligence must also encom individuals involved in the listing applicant, including the personal and business backgrounds of its: (a) directors; (b) key senior managers; and (c) (where applicable) controlling shareholders.

4.4

The information obtained during the due diligence process will put the sponsor in a position to properly advise and guide the listing applicant towards the listing application stage. Taking into the Listing Rules as a whole, and the specific requirements of LR Chapter 8, the sponsor should: (a) advise and guide the listing applicant and its directors as to their responsibilities as a Hong Kong listed company and directors of a listed company in Hong Kong respectively, and ensure that they understand and are in a position to meet their responsibilities; and (b) assist the listing applicant to identify and resolve, to the extent possible, material deficiencies in the company structure and operations, its procedures and systems, or directors and key senior managers.

4.5

Where material deficiencies are identified but not remedied by the time the sponsor is ready to submit the listing application, they will need to be disclosed to the SEHK as part of the application. An explanation of the nature of the deficiencies, why they are not resolved, and the proposed means of remedying them should be given. In addition, the overriding obligation that due diligence at the time of submitting the application must be “substantially complete” must be borne in mind (see sections 5.21 to 5.22 below).

Preparing for due diligence 4.6

Due diligence is a cornerstone of the work undertaken by sponsors in any IPO.

4.7

Preparing for due diligence starts with a clear and comprehensive due diligence plan, which should be documented in the form of a written document introducing aspects to be covered in due diligence with regard to, among other things, existing regulations and other business, operational and valuation matters. These include the scope of due diligence and checklists, the due diligence system and its methodology, such as materiality thresholds and the timing of the due diligence work to be conducted. The due diligence plan also establishes the

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standard of care of those involved in the due diligence enquiries and lists the various parties that will be participating in due diligence. Commercial due diligence 4.8

In practice, there are various aspects to due diligence, the first of which is commercial due diligence, primarily concerned with an in-depth understanding of the business of the company, covering among other things the listing applicant’s: (a) history and background; (b) organizational aspects; (c) strengths, strategies and future plans; (d) business model, practice and other operational aspects; (e) markets, suppliers and customers; (f) quality control; (g) competitors; (h) seasonality; (i) accreditations, certifications and regulatory aspects; (j) awards, material licences and permits; (k) health, safety and environmental aspects; (l) risk management, business interruption and insurance; (m) human resources and corporate governance; (n) information technology and intellectual property; (o) research and development; and (p) material related/connected proceedings.

party arrangements,

material

contracts

and

legal

The main purpose of commercial due diligence is to establish the reality, sustainability and suitability for listing of the business so that it can accurately be described in the listing document, with no material omissions. Such investigations will then feed into the equity story to be marketed to investors by the underwriting syndicate. 4.9

Commercial due diligence should also include site visits, as well as interviews with third parties, such as key suppliers or customers and other major business partners. Financial due diligence

4.10

The second aspect of the matter is financial due diligence, which is primarily concerned with a detailed investigation and understanding of a company’s track record, cost structure, financial position and financial risks, including its relationship with lenders and tax authorities. This would typically include, among other things, building a comprehensive financial model so that assumptions and driving factors can be tested and discussed with management. A sponsor will in particular need to understand the reasonableness of the financial performance of a company, for example, by comparing it with its competitors, industry norms and other market indicators. This should also enable the verification of the earnings forecast that may be included in the listing document. In addition, financial due diligence enables the drafting of the Management Discussion and Analysis of Financial Information and Condition (“MD&A”). Particular emphasis should be placed on producing a meaningful and comprehensible MD&A, where included in the listing document. As with

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commercial due diligence, this should include discussions with third parties, chiefly the reporting ants and lenders to the company. The MD&A is discussed in greater detail in Topic 5. Legal due diligence 4.11

The third aspect to be considered is legal due diligence, which focuses on a review of legal documents (such as material contracts) by the sponsor and the legal advisers working on the IPO. In practice, such documents are generally displayed and available for review in a data room or, increasingly these days, ed on to a -protected VDR. While this process will primarily be conducted by the legal advisers, the sponsors must participate in it to discharge their duties and may not exclusively rely on the legal advisers for the purpose. For example, a sponsor should probe and where necessary query the extent of investigations conducted under a due diligence report produced by legal advisers. A sponsor must at all times closely review and monitor the work assigned to legal advisers and retain control of the due diligence process.

Examples of issues encountered in carrying out due diligence 4.12

Examples of issues commonly uncovered through due diligence investigations can be found in Topic 5, and examples of enforcement cases by the SFC in respect of sub-standard due diligence work in Topic 6.

4.13

Due diligence should be supervised by one or more Principals working on the IPO transaction and reporting to senior management of the sponsor on a need-to-know basis, in particular bearing Chinese wall issues in mind. Clear reporting lines should be established to ensure that staff with sufficient experience are involved in due diligence investigations, that shortfalls in staffing can be remedied at once, and that critical findings are quickly reported and any identified issues elevated and addressed.

4.14

There is not a “one size fits all” aspect to due diligence. While checklists compiled for prior IPO transactions may come in handy, perhaps for companies in a similar industry sector or incorporated in the same jurisdiction, each listing applicant is unique and sponsors should approach due diligence investigations with a fresh mind.

4.15

Due diligence is also an ongoing process. Several questions probing the same issue should be asked, perhaps from different parties, so as to further and cross-check critical aspects.

4.16

Listing applicants may sometimes resent the in-depth probing of their companies during the due diligence process, particularly as such investigations will necessarily infringe on the time they can dedicate to the day-to-day running of their business, or result in their disclosing what they view as “trade secrets” or other key aspects of their business to competitors. The scope, nature and timing of due diligence should therefore be clearly explained and communicated to listing applicants at the outset of an IPO. Where material information is withheld from the sponsor(s), the issue should be elevated to more senior colleagues if no resolution can be obtained. In extreme cases, the sponsor may even consider reg if it is unable to discharge its duties properly and comprehensively.

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Revision questions: Question 8: What are the three main types of due diligence that must be conducted in relation to an IPO? Answer 8: Commercial due diligence (including physical inspection and third party due diligence), financial due diligence and legal due diligence. Question 9: What is the main purpose of commercial due diligence? Answer 9: The main purpose of commercial due diligence is to establish the reality, sustainability and suitability for listing of the business so that it can accurately be described in the listing document, with no material omissions.

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5

Making a listing application Quality of information to be contained in the listing application

5.1

At the time of submitting the listing application, the SEHK expects that: (a) reasonable due diligence has been performed on the listing applicant (save in relation to matters that by their nature can only be dealt with at a later date); and (b) the Application Proof contains all material information which has been obtained as a result of the due diligence exercise up to the date of its submission.

5.2

The due diligence exercise should be sufficient to allow the sponsor to reasonably conclude that the information in the Application Proof is substantially complete (save in relation to matters that by their nature can only be dealt with at a later date) and, in particular, that the listing applicant: (a) complies with the requirements of LR Chapter 8 (or that appropriate waivers have been sought from the SEHK in writing); and (b) has established procedures, systems and controls (including ing and management systems) that: (i) enable it (and its directors) to comply with the Listing Rules and other legal and regulatory requirements on an ongoing basis; and (ii) provide a reasonable basis for the directors to properly assess the financial position and prospects of the listing applicant on an ongoing basis.

5.3

The due diligence exercise should also enable the sponsor to form a reasonable opinion on the ability of the listing applicant’s directors, both collectively and individually, to understand and comply with the legal and regulatory requirements applicable to directors of a listed company in Hong Kong. This will include, among other things, the requirements of the Listing Rules and the disclosure provisions of Part XIVA, Securities and Futures Ordinance (“SFO”) (The special requirements applying to PRC issuers, discussed in sections 3.9 to 3.12 above, should be noted in this regard).

5.4

In forming its assessment of the listing applicant’s directors, the sponsor will need to consider their experience, qualifications and competence to manage the listing applicant’s business in a compliant manner. Where the specific roles of individual directors differ, consideration will need to be given to the knowledge and skills that are relevant to each director’s role.

5.5

The information provided in the listing application should include all material issues which the sponsor reasonably considers to be necessary to a consideration of the applicant’s suitability for listing, and whether a listing of the applicant’s securities is contrary to the interest of the investing public or to the public interest.

5.6

Where material deficiencies are identified but not remedied by the time the sponsor is ready to submit the listing application, they should be disclosed to the SEHK as part of the application. An explanation of the nature of the deficiencies, why they are not resolved, and the proposed means of remedying the same should be given.

5.7

Finally, a sponsor also needs to bear in mind the overarching requirements of s. 3, Securities and Futures (Stock Market Listing) Rules, which, in addition to requiring compliance with the Listing Rules and any applicable law, requires the listing application to contain such information as is necessary to enable an investor to make “an informed assessment of the activities, assets and liabilities and financial position, of the applicant at the time of the application and its profits and losses and of the rights attaching to the securities”.

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5.8

It is critical for a sponsor that the requirements discussed above are fully and properly complied with, as it will need to make a declaration to the SEHK on these matters. It is to this subject that we now turn. Note: A detailed examination of what is involved in undertaking a due diligence exercise is discussed in Topic 5.

IPO timetable 5.9

A clear and realistic timetable should be discussed between the sponsor, the issuer and other parties at the outset of an IPO. The timetable should allow sufficient time for due diligence to be substantially completed and for the listing document to contain all material information obtained as a result of such due diligence exercise. A draft timetable will need to be submitted to the SEHK together with the listing application and will require the agreement of the SEHK. Progress on the listing application will need to be notified to the SEHK on a fortnightly basis and any changes to the timetable will also require the agreement of the SEHK.

5.10

A number of issues can affect the timetable of an IPO, some of which are avoidable, while others are outside the sponsor’s control. Reorganizations, sizeable acquisitions and disposals can all have a material impact on the time necessary for due diligence to be substantially completed and for the listing application to be submitted.

5.11

Another major factor that often affects an IPO timetable is the availability of financial information. Reconciling s to the Hong Kong Financial Reporting Standard or International Financial Reporting Standard, computing pro forma s and conducting audits or reviews all take time and can lead to delays as issues are unearthed and addressed. For example, when audited s expire for the purposes of the listing application, a new audit will become necessary. Nevertheless it will be important to review subsequent management s to information on the latest balance sheet date.

5.12

Other external factors that may delay the timetable (and/or affect the business of the company) may include unforeseen events such as natural disasters, epidemics, acts of terrorism, new legislation coming into force, and of course equity market conditions.

Key building blocks of an IPO 5.13

The timetable of an IPO can usually be articulated around a few distinct building blocks, as follows: (a) a kick-off meeting at which the key working parties (company, sponsor, senior underwriters, legal advisers and reporting ants) will be introduced to each other, and the key offer parameters and timetable for the IPO will be explained by the sponsor and senior underwriters; (b) due diligence, drafting of the offer document and preparation work, culminating with the filing of the listing application, including on the website of Hong Kong Exchanges and Clearing Limited; (c) a review of the listing application, leading to an in-principle eligibility to list; (d) a presentation to the research analysts of the underwriters, who will later draft pre-deal research reports for publication, and a subsequent PDIE phase, during which is obtained from institutional investors, and at the end of which a price range is set for the IPO; (e) the publication of an advanced draft of the prospectus in the form of a Post Hearing Information Pack (“PHIP”), which may be accessed by the public (see sections 6.4 to

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6.6 below), and a “red herring” that is distributed to institutional investors in conjunction with institutional book-building; (f) publication of the offer document and the public offer takes place simultaneously; (g) pricing, institutional allocations and retail balloting; (h) closing, listing and start of trading; and (i) the possible stabilization of the share price for a period of up to 30 days, which may lead to a second closing where all, part or none of the shares in the over-allotment option (if any) are sold or issued. 5.14

Following the start of trading and the end of the stabilizing period, if any, a black out on the publication of equity research by the underwriters is lifted, usually 40 days after listing but depending on the underwriters’ practice, and the lock-ups on sales or the issue of shares by legacy shareholders, cornerstone investors (if any) and the company expire, subject to the Listing Rules and moratorium requirements under the underwriting agreement (unless previously lifted with respect to contractual lock-ups rather than lock ups pursuant to the Listing Rules).

5.15

Judging the appropriate timing for the launch of an IPO is more art than science, and must take into all commercial, financial, legal, regulatory and equity capital markets aspects. Until the publication of the offer document and the start of the public offer, the transaction is not formally “in the market” under Hong Kong regulations, although there are various and increasing degrees of exposure leading to that point, namely the publication of pre-deal research (which, even if addressed to non-institutional investors only, is often leaked to and reported on in the general and financial press), the PDIE and the start of book-building. A key responsibility of the sponsor is to avoid information leaking into the market that may affect disclosure and the offer of shares to investors. In particular, a sponsor should be cognizant of the listing requirement about premature leakage of information, which may lead to a delay in the timetable. Selective dissemination of information should also be prohibited.

Filing and publication of the Application Proof 5.16

The Application Proof, in both English and Chinese, must be filed with the Listing Division of the SEHK and at the same time posted on the website “HKExnews”, i.e. without any pre-vetting from the SEHK. As the Application Proof will be published, the sponsor is effectively under an increased burden to ensure the quality and completeness of the document. Practice Note 22 of the Listing Rules sets out the SEHK’s requirements concerning publication of the Application Proof (and the PHIP). Note 1: Prior to 1 October 2013, no draft of the listing document would be published until an extensive comment and review process had been carried out by the Listing Division. Note 2: The Application Proof procedure, introduced with effect from 1 October 2013, is subject to transitional arrangements, including a period during which Application Proofs will not be published at all, and another when they will be published but only after an initial check. Sections 5.25 to 5.28 below discuss the transitional arrangements. During the relevant transitional periods, the information in sections 5.16 to 5.22 of this Topic should be read with this in mind.

5.17

However, the version of the Application Proof for publication online will need to (i) be redacted from the version submitted for vetting by the SEHK and (ii) include certain warning and disclaimer statements (see sections 5.19 to 5.20 below). The listing applicant will need to provide to the SEHK a confirmation from its legal adviser that these requirements have been complied with.

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Note: Publication is intended to enhance the transparency of the listing application process and improve market efficiency. This, together with the publication of the PHIP after the listing hearing (see sections 6.4 to 6.6 below), is (in spirit) similar to market practice in the US as well as other markets in Asia, including Singapore and Malaysia. Redactions 5.18

The redactions must include the removal of any information about the offering, price or means to subscribe, as well as such other information as is necessary for the publication version of the Application Proof not to be regarded as: (a) a prospectus under s. 2(1) of the Companies Ordinance (“CO”); (b) an ment under s. 38B(1) of the CO; or (c) an invitation to the public in breach of s. 103(1) of the SFO. A listing applicant is not required to publish the Application Proof on its own website. Note: The SEHK’s guidance on permitted and recommended redactions is set out in SEHK’s Guidance Letters GL56-13 and GL57-13. Warning and disclaimer statements

5.19

A listing applicant must include warning and disclaimer statements on the website “HKExnews” and in its published Application Proof to the effect that the Application Proof does not constitute a prospectus, ment or offer to the public. It must also include minimum warning and disclaimer statements concerning the legal status of the document including that: (a) it is in draft form and is subject to change; (b) investment decisions should be made only on the basis of the final listing document and no investment decision should be based on the information in the draft document; and (c) there is no guarantee that there will be an offering and no indication that the listing application has been approved for listing. Note: For these purposes the SEHK has provided reference templates (see Enclosure 1 to SEHK’s Guidance Letter GL57-13); however, these templates are for reference only and are not intended to be prescriptive. A listing applicant can adopt warning and disclaimer statements that contain elements additional to but not detracting from those set out in such templates.

5.20

In addition, a listing applicant, at its own discretion, can publish statement on the SEHK’s website and published Application Proof stating that no reliance should be placed on any media reports relating to its published Application Proof as permitted under the Listing Rules. This statement does not need to be pre-vetted but a copy should be submitted to the SEHK before its publication. However, other statements that do not comply with the Listing Rules will require the SEHK’s pre-vetting and approval before publication. Note: A recommended template is set out as Enclosure 3 to SEHK’s Guidance Letter GL57-13. Substantially complete

5.21

The Application Proof submitted to the SEHK must be in substantially complete form except in relation to information that by its nature can only be finalized and included at a later date. In this regard, the SEHK has provided guidance as to the expected disclosure requirements (see Table A of SEHK’s Guidance Letter GL56-13). If the SEHK considers the Application Proof or other documents submitted not to be substantially complete:

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(a) the SEHK will not review the documents further and shall instead return the same to the sponsor, together with reasons for the return (a “Return Decision”); (b) the returned application will be subject to a moratorium period of 8 weeks during which the application may not be resubmitted; and (c) the names of the listing applicant and the sponsor involved in the Return Decision, and the return date, will be published on the website “HKExnews”. 5.22

The listing applicant and the sponsor both have the right to request a Return Decision to be reviewed by the Listing Committee. Where the Listing Committee upholds the Return Decision, a further appeal may be made to the Listing (Review) Committee, whose decision will be final. Note: Detailed procedures and timetables for the appeal process are set out in LR Chapter 2B. Review of the Application Proof

5.23

The number of rounds of comments and the duration of the internal review by the Listing Division of the SEHK will vary depending on the quality of the Application Proof. While the application review process previously took an average 13 weeks from filing of Form A1 to internal clearance, the SEHK now expects a turnaround time of approximately 25 business days, assuming one round of comments, and of approximately 40 days, assuming two rounds. Under the current regime, the SEHK also generally expects no more than two rounds of comments to be necessary, subject to the quality of the Application Proof. While the SEHK remains the frontline regulator, sponsors will also receive separate comments from both the SEHK and the SFC, as soon as these are available to be ed on. Confidential filings

5.24

Issuers listed on other recognized exchanges for not less than 5 years or with a large market capitalisation (not less than US$200 million) are entitled to make a confidential filing, meaning that they will not need to publish the Application Proof on the website “HKExnews”. In the case of a spin-off from an overseas-listed parent, the SEHK or the SFC (as the case may be) may grant a waiver from the publication requirements on application (see Note 2 below). Note 1: Recognized exchanges for this purpose means any of the main markets of: (a) The Amsterdam Stock Exchange (NYSE Euronext – Amsterdam); (b) The Australian Securities Exchange (ASX); (c) The Brazilian Securities, Commodities and Futures Exchange (BM&FBOVESPA); (d) The Frankfurt Stock Exchange (Deutsche Börse); (e) The Italian Stock Exchange (Borsa Italiana); (f) The London Stock Exchange ( segment, LSE); (g) The Madrid Stock Exchange (Bolsa de Madrid); NASDAQ OMX (US); (h) The New York Stock Exchange (NYSE Euronext (US)); (i) The Paris Stock Exchange (NYSE Euronext – Paris); (j) The Singapore Exchange (SGX); (k) The Stockholm Stock Exchange (NASDAQ OMX – Stockholm); (l) The Swiss Exchange (SIX Swiss Exchange);

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(m) The Tokyo Stock Exchange (TSE); and (n) The Toronto Stock Exchange (TMX). Note 2: Listing applicants seeking waivers will need to have regard to the requirements set out in SEHK’s Guidance Letter GL-57-13. Transitional arrangements 5.25

The following transitional arrangements are currently in effect. The captioned dates are inclusive. From 1 October 2013 to 31 March 2014 (the “Suspension Period”)

5.26

During the first Suspension Period: (a) Application Proofs will not be published on the website “HKExnews”. However, sponsors will still be required to file redacted Application Proofs as if intended for publication so as to familiarize themselves with the procedures; (b) Return Decisions will not result in the publication of the names of sponsors and applicants; (c) a Chinese language version of the Application Proof will not be required. From 1 October 2013 to 30 September 2014 (the “Transitional Period”)

5.27

During the Transitional Period, the SEHK will accept listing applications for detailed vetting only after completion of an initial 3-day check of the Application Proof based on a prescribed checklist, set out in Table B of SEHK’s Guidance Letter GL56-13.The checklist sets out the extent and nature of the initial check. Failure to include the required disclosure described in Table B is likely to lead to a listing application being returned to the applicant as not being substantially complete under LR 9.03(3) or GLR 12.09, as applicable. Note: A listing application may still be returned after the initial 3-day check if the SEHK or the SFC considers the application not to be substantially complete.

5.28

However, the SFC and the SEHK will review the effectiveness of the initial 3-day check during the first 6 months of the Transitional Period to see if the arrangement should continue for the remainder of or beyond the Transitional Period. A separate announcement on the results of the review will be made.

Sponsor’s declaration 5.29

The SEHK uses a form of declaration, set out in the LR Appendix 19, to obtain the sponsor’s signed confirmation as to its satisfaction on compliance with various matters. It is required to be submitted as soon as practicable after the Listing Committee’s hearing of the applicant’s listing application and prior to, or on, the date the listing document is issued. However, the contents of the declaration and the ability of the sponsor to give the declaration should be carefully considered by the sponsor prior to submitting the listing application.

5.30

Where there is more than one sponsor, each sponsor is required to submit the declaration to the SEHK.

5.31

Many of the matters that have been addressed above are covered by the declaration, but there are a few additional items. The sponsor declaration covers: (a) the submission to the SEHK of all the documents it requires; (b) the fact that the sponsor is satisfied, having made reasonable due diligence inquiries, as to:

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(i) the listing applicant’s compliance with LR Chapter 8 (or that appropriate waivers have been obtained); (ii) the sufficiency of information in the listing document to enable a reasonable person to form a valid and justifiable view on the shares, the financial condition and profitability of the listing applicant at the time the listing document is issued; (iii) as regards information in the listing document: •

the completeness of information required by applicable laws and regulations;

•

that it is true, accurate, complete and not misleading in all material respects; and

•

any forward looking statements have been reached after due and careful consideration and on bases and assumptions that are fair and reasonable;

(iv) the adequacy of the listing applicant’s procedures, systems and controls; (v) the experience, qualifications and competence of the directors to run the business and to comply with the Listing Rules and other legal and regulatory requirements; and (vi) there being no other facts relevant to the listing application or the proposed listing of the company’s securities that should be disclosed to the SEHK; and (c) the expert sections of the listing document are in compliance with the regulatory requirements applicable to those sections (the requirements are discussed in section 5 of Topic 5). 5.32

While the SEHK expects the declaration to be signed by the Principal involved in supervising the sponsor work, the sponsor’s senior management (see Note to section 1.1 of Topic 3) as a whole are ultimately responsible for the supervision and quality assurance of the work carried out to the declaration. The declaration should therefore be treated with all appropriate care and attention to the matters it covers. The SEHK will rely on it in the performance of its own functions, and it is also a document subject to s. 384, SFO (see sections 4.6 to 4.7 of Topic 1).

Revision questions: Question 10: What information should be included in the listing application? Answer 10: The information provided in the listing application should include all material issues which the sponsor reasonably considers to be necessary to a consideration of the applicant’s suitability for listing, and whether a listing of the applicant’s securities is contrary to the interest of the investing public or to the public interest. Question 11: What is the sponsor’s declaration that is required to be submitted to the SEHK in connection with an IPO? Answer 11: The SEHK uses a form of declaration, set out in LR Appendix 19, to obtain the sponsor’s signed confirmation as to its satisfaction on compliance with various matters. It is required to be submitted as soon as practicable after the Listing Committee’s hearing of the applicant’s listing application and prior to, or on, the date the listing document is issued. Question 12: Is the Application Proof submitted to the SEHK the same as that published on the website “HKExnews”?

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Answer 12: No, the version published on the website “HKExnews” is subject to redactions and the inclusion of warning and disclaimer statements. See sections 5.18 to 5.20 above. Question 13: What is the definition of a “substantially complete” listing application? Answer 13: There is no formal definition of what constitutes a “substantially complete” listing application, which varies according to the particular applicant. However, SEHK’s Guidance Letter GL56-13 sets out guidance on the information that should normally be included in the Application Proof.

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6

Disclosure and communication Disclosure generally

6.1

The net result of a properly undertaken sponsor exercise should be the production of a listing application and listing document-cum-prospectus that contains relevant and meaningful information, and constitutes a true, accurate and complete disclosure to the public of all material information (including any forward-looking information) related to the listing applicant and its listing application. It is important that information is not made available in an asymmetric manner. For example, research analysts should not receive material information that is not disclosed in the listing document. A sponsor should take reasonable steps to prevent such information asymmetries from arising. Where material information has been provided to research analysts, it needs to be included in the listing document.

6.2

At the time the listing document is issued, it should contain sufficient particulars and information to enable a reasonable person to form a valid and justifiable opinion of the shares and the financial condition and profitability of the listing applicant. The information should be complete, true and accurate and not omit material information. The document as a whole, and each of its parts, should not be misleading or deceptive in any material respect.

6.3

It is the sponsor’s responsibility to have conducted sufficient due diligence to believe that the listing document meets this standard. Such belief should be based on reasonable grounds and should cover information in both expert and non-expert sections of the listing document. Where the sponsor is unable to maintain such a belief, it should consider delaying the issue of the listing document until it is able to resolve the issue giving rise to the doubt. Note: Due diligence is discussed in detail in Topic 5.

Post Hearing Information Packs 6.4

As a means of reducing the potential information asymmetry which may arise as a result of the practice of providing advance drafts of the prospectus (“red herrings”) to institutional investors, the SEHK requires that a PHIP be posted on the website “HKExnews” (in English and Chinese) on receipt of a post hearing letter from the SEHK with a request to post a PHIP, and no later than the publication of a red herring or the start of book-building, provided the material comments of the SEHK and the SFC (if any) have been addressed. Publication of a PHIP is not required immediately if the publication of a red herring and/or the start of book-building are delayed. However, if a revised red herring, or an addendum to it, is published subsequently to an earlier publication, a new PHIP must also be published. Note 1: Practice Note 22 of the Listing Rules sets out the SEHK’s requirements concerning publication of the PHIP (and the Application Proof). Note 2: A listing applicant is not required to publish a PHIP on its own website. Note 3: Unlike the Application Proof procedures, there are no transitional arrangements in respect of PHIPs.

6.5

A PHIP is expected to contain the same information as the red herring, except the redactions and inclusion of warning and disclaimer statements described above in connection with the Application Proof (see sections 5.18 to 5.20 above) with which the PHIP must also comply, including the confirmation of the listing applicant’s legal adviser as to compliance with the same. Note 1: In practice, PHIPs replace Web Proof Information Packs, which will be discontinued under the new sponsor regime.

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Note 2: Guidance on logistical arrangements for the publication of PHIPs can be found in SEHK’s Guidance Letter GL57-13. 6.6

Publication of a PHIP is not needed in the case of a listing by way of introduction if the final listing document is to be published immediately after the obligation to publish a PHIP arises.

Communications with regulators 6.7

In the course of the listing application procedure, there will be frequent communications with the regulators (primarily the SEHK and, sometimes, the SFC) about various aspects of the listing applicant and the sponsor work being undertaken. Such communications should be conducted by staff familiar with the work being undertaken and the relevant regulatory requirements.

6.8

Sponsors are required to engage with the regulators in a truthful, open, cooperative and prompt manner. This will require the sponsor to provide all relevant information and documents that may be required and to answer any questions addressed to it.

6.9

As already mentioned, the sponsor is subject to legal and regulatory obligations as to the quality of information provided to the regulators in the listing application process.

6.10

However, a sponsor will in the normal course need to rely on information or representations given or made by the listing applicant. The CFA Code requires sponsors to advise the listing applicant to use all reasonable endeavours to ensure that any such information and representations are true, accurate, complete and not misleading, that there is no omission or withholding of material information or facts, and otherwise to co-operate fully with the regulators and provide all relevant information on request. A sponsor should obtain confirmation from the listing applicant that it has taken such steps. Moreover, the requirement for a sponsor to adopt an attitude of professional scepticism should be borne in mind at all times (see section 3 of Topic 5).

6.11

In the event the sponsor becomes aware that any information so provided is not accurate and complete in all material respects, or that the listing applicant or the listing application does not comply with the Listing Rules (or other legal or regulatory requirements), it should inform the SEHK/SFC promptly.

6.12

The obligations of the sponsor to communicate with regulators do not end when it ceases to act for the listing applicant (i.e. after the listing date or as a result of cessation or termination of the sponsor role). This means that, if a sponsor subsequently becomes aware of relevant material information that was provided to it during the time it was acting as sponsor, then it should disclose such information to the SEHK/SFC promptly.

Meeting regulatory requirements in practice 6.13

Disclosure within listing applications should neither be driven by regulators’ comments nor by previous prospectuses. As mentioned earlier, the business, corporate aspects and circumstances of each listing applicant are unique and it is the responsibility of the sponsor to ensure that a listing application constitutes a true, accurate, complete (and not misleading) disclosure to the public of all material information, including any forward-looking information, on the listing applicant and its application.

6.14

All the information pertaining to a listing applicant obtained as a result of the due diligence exercise should generally be included in the offer document, unless it might need to be updated closer to publication and in circumstances where it might widely differ from that included at the time of the application (for example a profit forecast, a working capital statement, or perhaps in the case of particularly commercially sensitive information which

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might perhaps have been withheld at the initial stage). This should in particular include the reporting ants’ reports as well as, generally, all of the following: (a) details of the directors (including INEDs) and senior management of the company; (b) a comprehensive description of the business of the company, covering, among other things, the aspects listed; (c) information on material related/connected party transactions, ownership title defects and third party interests; (d) information on internal control systems; (e) compliance records; (f) risk factors; (g) historical financial information and the accompanying reporting ants’ reports (h) expert reports; (i) information on cornerstone investors (if any); (j) information on waivers sought (if any); and (k) information on how to apply for offer shares. LR 2.13(2) (GLR 17.56(2)) provides that the information in the listing document of a listing applicant must be accurate and complete in all material respects and not be misleading or deceptive. To comply with this requirement, an applicant must not, among other things: (i) omit material facts of an unfavourable nature or fail to accord them appropriate significance; (ii) present favourable possibilities as certain or as more probable than is likely to be the case; (iii) present projections without sufficient qualification or explanation; or (iv) present risk factors in a misleading way. 6.15

As noted above, sponsors should take particular care when making information available to selected investors (such as cornerstone investors) or to research analysts ahead of the publication of the offer document. While not a perfect arrangement, the use of non-disclosure agreements to be entered into with prospective cornerstone investors, as well as limiting such potential investors to a reasonable number, may to some extent help in mitigating the risk of information asymmetry between them and public investors. Cornerstone investors and research analysts should also not be provided with information over and above what will ultimately be disclosed to investors under the public offer.

6.16

Similarly, it is a requirement, which is normally provided for in research guidelines issued by the legal advisers to the underwriters, that research analysts should not have access to information other than that ultimately to be published in the offer document, while their reports should also not include information on the company that is not available in the prospectus. For such purpose, it is usual for legal advisers to review draft research reports for factual accuracy. In addition, to mitigate leaks to the market at the PDIE stage, pre-deal research reports – which are only distributed to institutional investors, where allowed – should generally carry disclaimers and a legend and be numbered, with written records kept of their recipients. It is also usual for a letter to accompany pre-deal research reports further highlighting restrictions on the disclosure and dissemination of such information beyond the named recipients.

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Revision questions: Question 14: Provide an example of information that might be provided in an asymmetric manner in relation to an IPO. Answer 14: A good example would be research analysts receiving material information not disclosed in the listing document. Question 15: When must a PHIP be posted on the website “HKExnews”? Answer 15: It must be posted on receipt of a post hearing letter from the SEHK with a request to post a PHIP, and no later than the publication of a red herring or the start of book-building, provided the material comments of the SEHK and the SFC (if any) have been addressed.

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Topic summary This Topic commenced with a discussion of how sponsors obtain engagements and, once engaged, their obligations leading up to the submission of the listing application. The matters that should be included in engagement letters were discussed, as well as the practical issues involved in working with other parties during an IPO process. In the course of this discussion we saw how the SEHK assesses the independence of sponsors, and that at least one sponsor must be independent of the listing applicant. The need for all sponsors to act with impartiality was reviewed. The need to form a Transaction Team was explained. The importance of the undertakings and declarations the sponsor must give to the SEHK was discussed, and it was shown how these undertakings and declarations require the sponsor to engage in carefully planned due diligence work in order to be in a position to give them. While due diligence is discussed in detail in Topic 5, this Topic highlighted the key areas of due diligence which must be covered. At the outset this requires a sponsor to assess the suitability of the listing applicant to be listed, including the capabilities of its directors. However, due diligence will ultimately need to ensure that when the listing application is submitted it complies with all applicable legal and regulatory requirements. The Topic concluded with a discussion about how sponsors should handle confidential information and how information asymmetries in the market are to be avoided, as well as the requirements applying to sponsors as regards their communications with regulators.

Checklist Below is a checklist of the main points covered by this Topic. Candidates should use the list to test their knowledge. 

The various ways a sponsor may obtain a new listing assignment.



Sponsor mandates must be evidenced by an engagement letter that documents the of the engagement, as well as the duration and remuneration of the assignment.



More than one sponsor may be appointed in connection with an IPO.



Other parties that may be appointed alongside a sponsor to work on an IPO include financial advisers, legal advisers, reporting ants, other experts and other parties such as share registrars, transfer agents and receiving banks, among others.



Sponsors must give the SEHK an undertaking and statement of independence in the form set out in LR Appendix 17, which in effect makes the sponsor subject to the Listing Rules.



The concepts of impartiality and independence are critical to the proper performance of the sponsor role.



The tests to assess the independence of a sponsor from a listing applicant .



In the case of multiple sponsors, at least one of the sponsors must be independent and one must be designated as the primary channel of communication with the SEHK as regards the listing application.



The Code of Conduct regards the minimum period required for a sponsor to undertake the work required to prepare a listing application to the required standard to be 2 months, and the Listing Rules provide that a listing application must not be submitted less than 2 months after the last sponsor is formally appointed.



The provisions generally found in a sponsor’s of appointment.

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

The core roles of Principals and other Transaction Team .



Requirements when a sponsor resigns or when its appointment is otherwise terminated.



Conditions that have to be satisfied under the Listing Rules to assess a listing applicant’s suitability.



Requirements that a sponsor must attend to in relation to issuers incorporated in the PRC.



Listing requirements for mineral companies.



Equity story, valuation, reorganizations, related-parties transactions, governance and other issues.



Key subjects of due diligence, including commercial due diligence, financial due diligence and legal/documentary due diligence.



Quality of the information to be contained in a listing application.



Factors affecting an IPO timetable and the key building blocks of an IPO.



The sponsor’s declaration set out in LR Appendix 19.



Publication of the Application Proof and PHIPs on the website “HKExnews” and avoiding potential information asymmetry.



Achieving a substantially complete listing application.



Communications with regulators should be conducted by staff familiar with the work being undertaken and the relevant regulatory requirements.



Dealing with cornerstone investors.



Research analysts should not have access to information other than that ultimately to be published in the offer document, and their reports should not include information on the company that is not available in the prospectus.

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Topic 5: Due diligence Table of contents Topic overview

1

Learning outcomes

1

1

Preparation of the listing document-cum-prospectus

2

General meaning of due diligence Specific regulatory requirements Role of the listing applicant and third parties

2 3 4

Conducting a due diligence exercise

6

2.

3. 4. 5.

6.

Planning and managing a due diligence process Involving the listing applicant in the due diligence process Interview practices The due diligence plan, materiality and use of questionnaires Physical inspection Dealing with tricky situations and obligations of the sponsor

7 9 10 10 11 11

Meaning of “professional scepticism”

13

Examples of where professional scepticism is particularly called for

13

Verification

15

Verification in practice

15

Use of experts and other third parties

17

Third parties other than experts Experts Scope of report Selection and management of third party input

17 18 19 20

Management Discussion and Analysis of Financial Information and Condition

23

Topic summary

26

Checklist

26

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Topic overview This Topic explains what is required and involved in undertaking due diligence in the course of preparing a listing document-cum-prospectus, and considers some of the common mistakes and pitfalls to be avoided in doing a proper due diligence exercise. The specific legal and regulatory requirements are reviewed and the roles of the listing applicant and third parties in the process are introduced. The process of conducting a due diligence exercise is considered next, commencing with the need to plan the exercise carefully in advance, and to keep that plan under review as the exercise develops. Sponsors must manage the overall process carefully and keep appropriate records of all enquiries made and responses received. The Topic then moves on to discuss more specifically the role of the listing applicant in the due diligence exercise and how various issues, including interview practices and tricky situations, should be handled in practice. Next, the need to adopt an attitude of professional scepticism when undertaking any due diligence exercise is reviewed, as well as the need to subject all information to a verification process. The use of experts is subject to additional considerations, and this is discussed next together with the use of third parties other than experts. Finally, the considerations which should be taken into in preparing for inclusion in the listing document-cum-prospectus of the Management Discussion and Analysis of Financial Information and Condition (“MD&A”) are discussed.

Learning outcomes At the end of this Topic, candidates should be able to: (a) understand the key laws and rules that govern the contents of a listing document-cumprospectus; (b) know the meaning of due diligence and explain the importance of undertaking due diligence; (c) identify the regulations that govern how a due diligence exercise should be undertaken; (d) understand the roles of the listing applicant and third parties in a due diligence exercise; (e) describe the important features of planning and managing a due diligence exercise; (f) identify the important features of a proper due diligence exercise; (g) demonstrate an understanding of what is required as regards adopting an attitude of professional scepticism in conducting due diligence; (h) understand the role of verification in a due diligence exercise and the production of the listing document-cum-prospectus; (i) be aware of the special requirements applying to the use of experts and other third parties; and (j) describe the main considerations relevant to preparing the MD&A.

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Preparation of the listing document-cum-prospectus

1.1

We have reviewed in Topic 4 the obligations of a sponsor under the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited (“Listing Rules” or “LR”) in having a meaningful and detailed involvement in the preparation of the listing applicant’s listing application submitted to The Stock Exchange of Hong Kong Limited (“SEHK”) and the Securities and Futures Commission (“SFC”).

1.2

The key document is of course the listing document, which will also need to comply with the prospectus requirements of the Companies Ordinance (“CO”) in the context of an initial public offering (“IPO”). Note: For the purposes of this Topic, the listing document-cum-prospectus will simply be referred to as the “listing document”.

1.3

In the preparation of the listing document, the sponsor will therefore need to have regard to the detailed content requirements set out in Appendix 1, Listing Rules and Third Schedule, CO as well as the procedural requirements set out in Chapter 11A of the Listing Rules.

1.4

However, the preparation of the listing document is not merely an exercise in checking off that it satisfies each of those content requirements. The sponsor’s functional role of providing assurances to the SEHK and to the market (see section 3.1 of Topic 1) as well as the undertaking and declaration it is required to give to the SEHK (see Appendices 17 and 19, Listing Rules and sections 2.1 and 5.29 to 5.32 of Topic 4) require it to engage in deeper consideration of the affairs of the company, and its directors and controlling or substantial shareholders.

1.5

Sponsors must at all times keep in mind the overarching requirement that the information in the listing document must contain sufficient particulars and information, having regard to the circumstances of the listing applicant, that will enable a reasonable investor to come to an informed investment decision. This overarching requirement is echoed in s. 3(c), Securities and Futures (Stock Market Listing Rules), LR Appendix 19 and paragraph 17.5, Code of Conduct for Persons Licensed by or ed with the Securities and Futures Commission (“Code of Conduct”) (all of which have been discussed in sections 5.7 and 6 of Topic 4) and paragraph 3 of Schedule 3 of the CO.

1.6

The primary means by which sponsors seek to meet these requirements, and to mitigate the potential risk of legal and/or regulatory liabilities (see sections 4, 6 and 8 of Topic 1), are due diligence and verification. This Topic is concerned with what a sponsor needs to do to satisfy its legal and regulatory obligations in this regard. The topic of verification is discussed in section 4 below.

General meaning of due diligence 1.7

Due diligence can be defined as the process undertaken by sponsors to establish the completeness and accuracy of the information contained in the listing document. It is the primary means by which a sponsor develops a thorough knowledge and understanding of a listing applicant. It will involve the collection, organization and examination of information relevant to the listing applicant.

1.8

In undertaking a due diligence exercise, a sponsor must always be alert to the possible existence of material information which has not yet come to its attention. This will require thoughtful consideration of information that has been provided, or not been provided, and will at times require sponsors to address difficult questions to the issuer and its related persons. In particular, Practice Note 21, Listing Rules requires sponsors to adopt an attitude of professional scepticism when considering the accuracy and completeness of statements

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and representations made, or other information given, to them by a new applicant or its directors, and this is further discussed in section 3 below.

Specific regulatory requirements 1.9

The regulatory requirements we will be specifically concerned with in this Topic are: (a) paragraphs 17.6 to 17.8, Code of Conduct; and (b) Practice Note 21, Listing Rules.

1.10

Paragraph 17.6 of the Code of Conduct sets out the general framework of due diligence expected to be undertaken by a sponsor. It also directs a sponsor to the requirements of Practice Note 21, Listing Rules which a sponsor must have regard to when determining the scope of due diligence inquiries it must make to meet its regulatory obligations and, in particular, to be able to make the declaration set out in LR Appendix 19. The requirements of Practice Note 21, Listing Rules are dealt with in section 2 below. Where there is an overlap in the requirements of Paragraph 17.6 of the Code of Conduct and Practice Note 21, Listing Rules, sponsors will need to comply with the provisions that impose a higher standard (see also section 6.5 of Topic 1). Code of Conduct

1.11

The Code of Conduct requires a sponsor to oversee, and be closely involved in, the preparation of the listing document. The sponsor’s involvement should enable it to gain a detailed knowledge and understanding of the listing applicant which should cover all relevant matters, including the applicant’s business, history, background, structure and systems.

1.12

Material information received by the sponsor, including documents provided and statements and representations made by the listing applicant and its directors, must be independently verified.

1.13

In particular, a sponsor will need to closely examine and assess the following matters concerning the listing applicant: (a) the accuracy and reliability of financial information (this should cover the financial statements of major subsidiaries, internal financial records, tax certificates, regulatory filings and public records); (b) its business performance including financial condition, development, prospects and any financial projection or profit forecast; (c) legality and compliance with applicable laws and regulations, and the existence of any material disputes or proceedings; and (d) any material changes since the date of the last audited balance sheet, including any factors that might impact its business model, performance, prospects or financial condition.

1.14

The above list should not be regarded as exhaustive. Moreover, a sponsor’s due diligence obligations are not restricted to the listing applicant per se.

1.15

A sponsor will need to consider the integrity, qualifications and competence of the listing applicant’s directors to act as directors of a listed company. This is important in the context of the sponsor’s declaration it is required to give under LR Appendix 19. The Code of Conduct requires a sponsor to review the listing applicant’s internal records, board minutes and public filings as they concern directors.

1.16

In addition, the sponsor will need to understand the industry in which the listing applicant operates, including its competitors.

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Requirement for independent due diligence steps 1.17

Implementing the above will require the sponsor to make its own independent inquiries about the following matters, all of which are specifically required by paragraph 17.6 (e), Code of Conduct: (a) appropriate inquiries with persons knowledgeable about the listing applicant’s affairs, including directors, key senior management staff, consultants and controlling shareholder(s); Note: It is important that these inquiries are made directly by the sponsor and not through the listing applicant. (b) an inspection of key physical assets, e.g. production facilities, should be undertaken; (c) major business stakeholders in the listing applicant’s business such as its customers, suppliers, creditors and bankers should be interviewed by the sponsor directly; (d) where a material matter is identified: (i) a review of relevant underlying records and ing documents should be undertaken; and (ii) information should be independently obtained from sources apart from the listing applicant (for example, public records, external confirmations, and third-party data about competitors). Note: Where relevant, the engagement of external agents to perform the relevant checks should be considered.

Role of the listing applicant and third parties 1.18

It is clear from the foregoing that a sponsor conducting a due diligence exercise will interact with, and require the appropriate cooperation and involvement of, both the listing applicant and any third parties involved in the listing process, such as experts. Listing applicant

1.19

The Listing Rules require a listing applicant and its directors to provide all due assistance to the sponsor in undertaking its various tasks and such assistance is critical to the successful undertaking of any due diligence exercise. As discussed in section 2.24 of Topic 4, the of the sponsor’s appointment must impose obligations on the listing applicant that facilitate the sponsor’s role in this regard, including in relation to information and changes thereto, as well as the cooperation of relevant third parties. Third parties

1.20

Inevitably, any due diligence exercise will involve the use of third party experts, i.e. people whose profession gives authority to their statements. Examples of experts include reporting ants, engineers and appraisers, though what types of experts need to be involved in a due diligence exercise will depend on the nature of the listing applicant’s business activities.

1.21

Other third parties who are not performing “expert” roles in the listing process per se may also be engaged in a due diligence exercise for a variety of reasons.

1.22

In both cases, sponsors will need to be aware of their continuing overarching responsibility for due diligence, which they cannot abrogate. Note: The use of experts and other third parties is discussed in detail in section 5 below.

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Revision questions: Question 1: How do sponsors ensure that a listing document contains sufficient particulars and information, having regard to the circumstances of the listing applicant? Answer 1: The primary means by which sponsors seek to meet these requirements, and to mitigate the potential risk of legal and/or regulatory liabilities, are due diligence and verification. Question 2: What is the purpose of a sponsor undertaking due diligence? Answer 2: Due diligence can be defined as the process undertaken by sponsors to establish the completeness and accuracy of the information contained in the listing document. It is the primary means by which a sponsor develops a thorough knowledge and understanding of a listing applicant.

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2.

Conducting a due diligence exercise

2.1

As reviewed in the foregoing section, the Code of Conduct requires a sponsor to exercise reasonable judgement in determining the nature and extent of due diligence work needed to be undertaken.

2.2

Practice Note 21, Listing Rules sets out the SEHK’s expectations of the due diligence a sponsor will typically perform. However, it is not a comprehensive checklist of what a sponsor must do – as already outlined under Topic 4, there is no “one size fits all” approach to due diligence. Accordingly, the scope of a due diligence exercise should be tailored to the particular facts and circumstances of each listing applicant, and sponsors and other advisers involved in due diligence should approach each exercise with a fresh mind, as there is no exhaustive list of due diligence steps that applies in all circumstances. The sponsor at all times needs to use its judgement in determining what is required to fulfil its regulatory obligations.

2.3

The overall due diligence process should be coordinated by the sponsor, even when third party advisers are involved. The involvement of third parties does not discharge the sponsor from its duty to carry out due diligence in areas with which such third parties are concerned.

2.4

As mentioned in Topic 4 (see sections 4.8 to 4.11), there are various aspects to due diligence. First is commercial due diligence, which is primarily concerned with an in-depth understanding of the business of the company. Examples of the areas most particularly covered through commercial due diligence are listed in section 4.8 of Topic 4. The main purpose of commercial due diligence is to establish the reality, sustainability and suitability for listing of the business so that it can also be accurately described in the listing document, with no material omissions.

2.5

Commercial due diligence should also involve physical inspection of production facilities as well as interviews with the senior management of the listing applicant and third parties, such as the listing applicant’s key suppliers or customers. Such interviews should also be conducted with other major stakeholders/business partners, for example creditors and bankers. As each case is unique, Practice Note 21, Listing Rules does not describe the scope of the due diligence exercise on suppliers/customers, nor the manner in which it should be conducted. It is the sponsor’s duty to exercise its professional judgement as to what is necessary and appropriate in the given context. In addition, due diligence on the listing applicant’s suppliers/customers should not in any circumstances be confused with, and limited by, the minimum content requirements of the listing document.

2.6

Background checks on the listing applicant’s senior management and controlling shareholders will also be necessary. Above all, commercial due diligence will involve a critical analysis of the applicant’s business model and those of its competitors. This will include, for example, a review of corporate records and of the legality of the business, as well as an assessment of the reasonableness and risks of the applicant’s business model, actual operations and prospects. It will also include, among other things, an examination of ownership titles and third party interests as well as the applicant’s relationship with various stakeholders.

2.7

Second is financial due diligence, which is primarily concerned with a detailed investigation and understanding of a company’s track record, cost structure, financial position and financial risks. A practical way of doing this is often to build a comprehensive financial model so that assumptions and driving factors can be tested and discussed with senior management. This should also enable the verification of the earnings forecast that may be included in the listing document. Financial due diligence also enables the drafting of the MD&A. As with commercial due diligence, this should include discussions with third parties, chiefly the reporting ants, without the company being in attendance. Particular emphasis should be placed on whether there have been any changes since the date

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of the last audited balance sheet included in the listing document that would require disclosure to ensure that it is complete and not misleading. 2.8

Third is legal due diligence (also sometimes called documentary due diligence), which focuses on a review of legal documents (such as material contracts, information pertaining to asset ownership, the due establishment of group companies, shareholding information, insurance policies, tax returns, etc.) by the sponsor and the legal advisers working on the listing. In practice, such documents are generally displayed and available for review in a data room or, increasingly these days, ed on to a -protected virtual data room . While this process will primarily be conducted by the legal advisers, the sponsor is clearly expected to participate in it to discharge its duties and may not exclusively rely on the work or opinions provided by the legal advisers for such purpose. In particular, the sponsor will be required to assess whether the assumptions on which opinions provided by the legal advisers are fair, appropriate and complete and whether their scope of work is appropriate to the opinion they are required to give.

2.9

In addition to the sponsor and senior underwriters (global coordinators and, perhaps, bookrunners) it is also common for more junior of a syndicate of underwriters to be involved – in a limited way – in due diligence with the listing applicant, often nearer to the publication of pre-deal research through a “syndicate due diligence call” or meeting.

2.10

Verification notes also serve an important purpose when it comes to due diligence, to weigh the accuracy and formulation of all statements made by the listing applicant in the listing document. Verification is discussed in more detail in section 4 below.

2.11

While it is important that sponsors should substantially complete their due diligence prior to the submission of the listing application, due diligence does not stop with the filing of the listing application to the SEHK but extends well beyond that milestone, and also even beyond the publication of the listing document at the start of the public offer. Accordingly, “bring down” due diligence (i.e. further due diligence investigations conducted to ascertain whether there have been any material changes in the circumstances of the listing applicant or material deviations from information disclosed in the listing document, post publication) is often performed at the time of closing and listing and, should the offer structure include an over-allotment option, at the time of the “second closing” (i.e. at the time of the sale or issue of the shares in the over-allotment option, or on expiry of that option, if any). Ideally the sponsor should “keep digging” to review and ascertain relevant information, until this last stage.

Planning and managing a due diligence process 2.12

As mentioned above, a sponsor is required to have regard to the non-exhaustive requirements of Practice Note 21, Listing Rules. Those requirements include the sponsor adequately addressing the following typical matters, though other matters will inevitably need to be considered by the sponsor. The following is a summary of the relevant parts of Practice Note 21, Listing Rules which candidates are encouraged to review for full details. Directors

2.13

The sponsor needs to inquire about the collective and individual experience, qualifications, competence and integrity of the directors. The past experience and credentials of directors should be reviewed with reference to written records of their participation in board meetings of the listing applicant as well as written records of their performance as directors of any other companies (in particular, publicly listed companies). Their financial literacy, corporate governance experience and general competence should be assessed both individually and collectively.

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Note: For the purposes of Practice Note 21, Listing Rules, “directors” refers to both executive and non-executive directors. Compliance with qualifications for listing 2.14

Sponsors will also need to review the listing applicant’s proper incorporation and, in particular, ensure that the financial information provided by the listing applicant demonstrates that it satisfies the basic conditions set out in Chapter 8, Listing Rules. This would normally require the involvement of the listing applicant’s legal, ing and auditing staff as well as its external auditors and reporting ants. The affairs of the listing applicant generally

2.15

The sponsor will need to inquire and make assessments in relation to, among other things, the following matters pertaining to the listing applicant, in all cases in relation to the new applicant’s group of companies: (a) its financial information to be included in the listing document; (b) its business plan and profit and cash-flow forecast or estimate; (c) any material changes since the date of the last audited balance sheet to be included in the listing document; (d) the stated use of proceeds of the issue being reasonable, feasible and in accordance with the needs and circumstances of the listing applicant; (e) a physical inspection of material assets; (f) its production methods; (g) its manner of business management; (h) the business, i.e. non-legal aspects of its material contracts and the of typical sales/service contracts; (i) any legal proceedings and other material disputes it is involved in; (j) the business aspects of any relevant material economic, political or legal conditions; (k) the industry and markets it operates in, including market share and profitability; (l) its competitors; (m) the existence of legal documentation as to ownership of its material assets, including property, plant, equipment, inventory and biological assets; (n) the existence, validity and business aspects of proprietary interests, intellectual property rights, licensing rights, etc.; (o) the technical feasibility of new products, services etc., that are proposed; (p) their stage of business development; (q) information on senior management, directors, key employees and their employment ; (r) the applicant’s relationship with major stakeholders and business partners; (s) the applicant’s relationship with related/connected parties; and (t) internal control and risk management issues and the applicant’s systems and records.

2.16

As further described in section 5 below, a sponsor will need to conduct due diligence on experts, including interviewing experts as to their competence, available resources etc. and as to the adequacy of their reports and the bases and assumptions on which they are based.

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ing and management systems 2.17

The sponsor will need to assess the listing applicant’s ing and management systems as well as the directors’ appreciation of their new obligations as directors of a listed company. This will involve an assessment of the listing applicant’s compliance manuals, policies and procedures, including their corporate governance policies. The assessment will require conducting interviews with all directors and senior managers, and possibly other staff such as the company secretary, any compliance officer, and ing or other staff involved in implementing the management systems and controls (see also the discussion in section 3 of Topic 4).

2.18

Where a sponsor has identified material deficiencies in relation to the listing applicant’s ing and management systems and/or the director’s understanding of the obligations imposed by the Listing Rules, it is the responsibility of the sponsor to bring this to the attention of the board of directors and to make appropriate recommendations for remedying the deficiencies. This may require the sponsor to arrange training sessions for the directors and senior management. Identifying the major risk factors faced by listing applicants

2.19

Another purpose of due diligence is to identify all the major risk factors faced by listing applicants (i.e. matters that are difficult to mitigate and that would have a significant effect on a listing applicant if they were to occur). As discussed in section 6.3(c) of Topic 2, these should be disclosed in a “risk factors” section in the listing document that clarifies the risks and explains why they are material to an investor coming to a properly informed decision in respect of the offering. Keeping of records regarding due diligence

2.20

As discussed in Topic 3, a sponsor is required to keep a record of all sponsor work, including its due diligence work. The specific record-keeping requirements in this regard were also set out in Topic 3 and sponsors should ensure they comply with such requirements.

2.21

Practice Note 21, Listing Rules also reminds sponsors of the importance of documenting their due diligence planning and conclusions. Note: For a discussion of the importance of and requirements for record keeping, see section 1 of Topic 3.

Involving the listing applicant in the due diligence process 2.22

The listing applicant is essential to, and should be fully involved in, the due diligence exercise. This is facilitated by the requirement of the Listing Rules that the of the engagement with the sponsor impose certain obligations on the listing applicant (see section 1.19 above and section 2.24 of Topic 4). In particular: (a) substantial shareholders of the listing applicant and senior management should extend their full cooperation to the sponsor and to the other professional parties throughout the due diligence exercise; (b) communication between the sponsor and the listing applicant should be direct and not conducted via financial advisers or other consultants. As mentioned previously, the authority of the sponsor must be absolute and direct communication with the listing applicant is essential for it to discharge its duties properly and fully; and (c) there should be clearly defined roles and responsibilities for senior management and staff of the listing applicant when it comes to due diligence, so that all areas can be covered extensively throughout the process.

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Interview practices 2.23

The manner in which due diligence interviews are conducted can directly affect the quality and reliability of the information obtained. To the extent interview information is relied on when preparing the listing document, it can also affect the ability of the sponsor (and in turn, investors) to properly assess the listing applicant’s financial condition. In particular, sponsors should the identities of interviewees and follow up on incomplete/unsatisfactory responses. Sponsors should also arrange to receive interview questionnaires or confirmations directly from interviewees, failing which sponsors should perform additional due diligence to satisfy themselves in relation to the results.

2.24

When arranging and conducting interviews with major business stakeholders of the listing applicant such as customers, suppliers, creditors and bankers, the sponsor should ensure that the specific requirements of paragraph 17.6(f), Code of Conduct are complied with. Ensuring interviews are sufficiently independent of the listing applicant is essential (some enforcement cases reviewed in Topic 6 involve a lack of sufficient independence).

2.25

The selection of who to interview should be made by the sponsor independently of the listing applicant and be based on objective and proportionate criteria. Of greater interest will be persons with whom the listing applicant has entered into high value transactions, or entities with special or unusual characteristics.

2.26

When conducting interviews, in addition to establishing the identity of the interviewee, the sponsor should gather relevant information to satisfy itself that the interviewee has the appropriate authority and knowledge for the interview. The interview should be undertaken with the interviewee directly and with minimal involvement of the listing applicant.

2.27

Interviews should comprise in-depth discussions with a view to obtaining adequate and satisfactory responses to all questions raised. Incomplete or unsatisfactory responses or outstanding matters should be followed up. Any irregularities noted during the interview (e.g. interview carried out outside the ed or business address of the interviewee, the interviewee being reluctant to cooperate or giving inadequate answers) should be adequately explained and resolved.

2.28

Finally, as with all steps undertaken in a due diligence exercise, the sponsor should ensure that records of the interviews are kept and that they are reasonably accurate, complete and reliable in all material respects.

The due diligence plan, materiality and use of questionnaires 2.29

In practice, preparing for due diligence starts with a clear and comprehensive due diligence plan, which is a written document that introduces the aspects to be covered by due diligence under existing regulations. These include the scope of due diligence and check-lists, the due diligence system and its methodology, such as materiality thresholds, and the timing of the investigations to be conducted. It also establishes the standard of care of those involved in the due diligence enquiries and lists the various parties that will be participating in due diligence.

2.30

For the purposes of due diligence and disclosure in the listing document, the parties will usually agree at the outset on a materiality threshold, expressed as a monetary amount, above which transactions or assets will be considered, reviewed and discussed. For example, this may be expressed as 5% of total assets as stated in the company’s latest consolidated balance sheet. Other criteria may of course be considered, depending on what is most appropriate for the company that is the subject of due diligence, having regard to its particular line of business and circumstances.

2.31

It is common for the sponsor and legal advisers to draw up questionnaires and lists to assist in due diligence. For example, a comprehensive list of questions covering all aspects of the

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business of the listing applicant might be compiled and disseminated to all its relevant departments, who will then, in turn, discuss each of these during a series of meetings/presentations, involving the sponsor as well as the senior underwriters and legal advisers concerned with the listing exercise. 2.32

Such questionnaires can serve as a useful guide for management presentations (and may perhaps be adapted from, but not be exactly the same as, questionnaires used in prior transactions, perhaps for companies in the same industry sector or incorporated in the same country) for the purpose of commercial due diligence. However, care should be taken to ensure they are not slavishly followed. The objective should be to ensure that all key areas of the business of the listing applicant are covered. In this respect, particular importance must be given to the business context of the applicant, such as its general industry environment, competition or regulatory factors.

2.33

The sponsor should not take answers by the listing applicant or its directors at face value and will have a duty and responsibility to probe, ask multiple questions to multiple parties, as well as to cross-check answers through several parties to satisfy itself about the reality, sustainability and accuracy of the subject area of the due diligence examination. Sponsors should also compare the answers provided with other observable information such as macroeconomic developments, market trends, the performance of other competitors, customers and suppliers, etc.. Sponsors should clarify and follow up any material inconsistencies.

2.34

Answers to be provided by the listing applicant may take the form of verbal confirmation or documents (and usually, a combination of both); however, it is good practice for information pertaining to important areas of the company’s business to be recorded in writing through due diligence notes. As already mentioned, all the statements included in the listing document will themselves be subject to written verification notes.

2.35

It is also common for the various firms of legal advisers involved in an IPO to compile a document request list for legal (also called documentary) due diligence purposes, for example statutes, certificates of incorporation or business registration, property and land titles, material contracts, insurance policies, tax records, licences and ancillary documents.

Physical inspection 2.36

Physical inspection of key assets is a component of any due diligence exercise, and is of particular importance for listing applicants that have substantial physical assets. Examples of items for physical inspection include manufacturing facilities, residential, commercial, hospitality or industrial property assets; mines, oil fields or other natural resources assets such as plantations; marine vessels or fleets of vehicles, etc.. They provide sponsors with a good opportunity to the existence of assets listed in a company’s s, and also that they are in good operational order. Such physical inspection also offer sponsors a chance to interact at some length with staff responsible for running such physical assets or facilities, and to ask additional questions to clarify certain aspects in order to discharge their due diligence duties. It may also be good for a sponsor to observe independently the operations of the listing applicants, say in the situation where the listing applicants are engaged in retail or manufacturing operations.

Dealing with tricky situations and obligations of the sponsor 2.37

There may, on occasion, be situations where the sponsor identifies that some information is missing, or that some of the information provided by the listing applicant appears to be wrong. Sponsors may also encounter staff of the listing applicant or third parties (such as the listing applicant’s suppliers or customers) in the course of their due diligence inquiries that appear to be reluctant to disclose information or to be under pressure not to do so from the

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senior management of the listing applicant, perhaps because such information involves matters that are perceived as confidential or otherwise commercially sensitive to them. 2.38

In such cases, the sponsor should seek to understand the cause and nature of such resistance. Explaining the scope and process of the interviews, as well as the sponsor’s and the listing applicant’s responsibilities to disclose material information under the Listing Rules and the requirement of the listing applicants to fully cooperate with the sponsors can often help to diffuse some of the concerns. It may also be useful to point out market practice on the part of companies that are already listed, and with which the listing applicant may already be familiar.

2.39

The sponsor should be particularly sceptical if the resistance originates or appears to originate from the listing applicant itself. Dealing with such tricky situations may require such issues to be elevated along pre-identified reporting lines, for example, by of the Transaction Team involved in the due diligence exercise to the Principal, or by the Principal to the senior management of the sponsor.

2.40

Ultimately, the sponsor has a duty to reconcile sensitive commercial issues and the need for disclosure, as already addressed in the discussion of paragraph 17.9, Code of Conduct under Topic 3. If no resolution of such issues appears possible, the sponsor may need to consider reg if it is unable to satisfy itself that it has been able to fully discharge its obligations under the Listing Rules and the Code of Conduct.

Revision questions: Question 3: Who should co-ordinate the overall due diligence process? Answer 3: The overall due diligence process should be coordinated by the sponsor, even when third party advisers are involved. The involvement of third parties does not discharge the sponsor from its duty to carry out due diligence in areas with which such third parties are concerned. Question 4: What due diligence needs to be conducted with regard to directors? Answer 4: The sponsor needs to inquire about the collective and individual experience, qualifications, competence and integrity of the directors. These due diligence requirements are set out in LR Practice Note 21. Question 5: What is a due diligence plan? Answer 5: A due diligence plan is a written document that introduces the aspects to be covered by due diligence under existing regulations. These include the scope of due diligence and check-lists, the due diligence system and its methodology, such as materiality thresholds, and the timing of the investigations to be conducted. It also establishes the standard of care of those involved in the due diligence enquiries and lists the various parties that will be participating in due diligence. Question 6: When is physical inspection of key assets required? Answer 6: Physical inspection of key assets is a component of any due diligence exercise, and is required for listing applicants that have substantial physical assets.

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3.

Meaning of “professional scepticism”

3.1

As already mentioned in section 1 above, a sponsor is required to adopt an attitude of professional scepticism when considering any information (including statements and representations) provided to it, whether provided by the listing applicant, its directors or substantial shareholder(s), or third parties such as experts or suppliers or customers of the listing applicant. This requires the sponsor to refrain from simply accepting information as a given but instead to assess the information critically and with a questioning mind. Sponsors should be alert to any information that contradicts or brings into question the reliability of such information.

3.2

It is of critical importance for of a Transaction Team to fully comprehend what an attitude of professional scepticism entails and why it serves the dual needs of fulfilling the sponsor’s regulatory obligations and mitigating its legal and regulatory liabilities.

3.3

In practice, the early identification of incorrect, incomplete or misleading information will help a sponsor (and the listing applicant) to meet the listing timetable and maintain its professional standing in the eyes of the regulators. The latter is an important consideration in the context of preserving the confidence of the regulators in the quality of the sponsor’s work.

3.4

Where an attitude of professional scepticism is lacking, there is clearly a risk of new information coming to light at a late stage in the timetable that could cause a potentially disastrous delay in the listing process. In the event material information comes to light only after the listing application has been itted to listing, a sponsor will need to consider its legal and regulatory responsibilities and liabilities.

3.5

In Topic 6, we review some enforcement cases that could perhaps have been avoided if the sponsor and its staff had adopted the required attitude of professional scepticism.

Examples of where professional scepticism is particularly called for 3.6

Situations where professional scepticism is particularly called for are generally brought to the attention of the sponsor as a result of its initial investigations. Failing satisfactory answers on the part of the senior management of the listing applicant, further probing will be necessary in order for the sponsor to ascertain whether such issues, if left unresolved, may render the business unsuitable for listing.

3.7

Set out below are examples of such situations commonly encountered by sponsors in the course of their due diligence investigations. The list is by no means exhaustive, and sponsors may indeed encounter a variety of other circumstances.

3.8

In particular, customer or supplier concentration, i.e. companies with only a small number of clients or suppliers, should be thoroughly investigated. There may be good reasons why a company only buys or sells its products from a limited number of sources or to a limited number of customers; however, such situations often render companies vulnerable and may give rise to credit and pricing risk issues, among other things. Sponsors may also encounter situations where suppliers or customers appear to be related to the listing applicant itself, raising further concerns about related-party transactions.

3.9

Similarly, companies with long turnover days, high levels of receivables, especially from related customers, or with non-binding or weak agreements with suppliers or customers, should also trigger alarm bells, and give rise to further investigations as they could in effect constitute window dressing for the purpose of the listing.

3.10

Sponsors may also encounter transactions conducted prior to listing and with no apparent justification, such as the sale of an unattractive business to a third party, perhaps at a high

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valuation. Such transactions should also result in further probing and digging as part of the due diligence exercise. 3.11

Other situations may include companies with a short history or track record (for example only barely satisfying the thresholds laid down under the listing requirements), businesses where auditors have changed in the course of the period under review, listing applicants with significant involvement in opaque jurisdictions or in countries known to be the subject of trading restrictions or other sanctions, for example on the part of international organizations or supranational bodies, or with a bad reputation or low ranking in business transparency studies.

3.12

Companies with margins or growth significantly in excess of those achieved by existing or perceived competitors may also harbour suspicious circumstances – if a story seems “too good to be true”, this may perhaps indeed be the case. Similarly, the senior management of companies whose business model may have changed significantly during the period under review need to be questioned as to their motives and intentions.

3.13

In the course of their financial due diligence, sponsors may also uncover odd relationships between a company’s profit and loss and its balance sheet that do not square with its activities. For example, a company involved in manufacturing may have experienced a significant increase in sales while inventory levels appear to be falling. Operational metrics, for example, employee numbers, should also be looked at in some detail, as should the biographies of senior management, for example, their past involvement in failed businesses or businesses that had previously received fines, reprimands or suspension on the part of regulatory authorities.

3.14

In the context of an IPO, transactions mainly consisting of a sale of secondary shares by existing shareholders, or conversely of the issue of new shares but without clear use of the proceeds, or where cornerstone investors are introduced by the issuer’s senior management, should also be looked at carefully.

3.15

Ultimately, sponsors are expected to exercise sound judgement when assessing the business of a company. Where there appear to be issues, questions should be asked, if necessary several times and to different parties, until the sponsor is satisfied that there are no suspicious circumstances associated with the issuer or listing applicant.

3.16

Sponsors should ensure that due diligence is performed as a critical assessment with a questioning mind and be alert to information, including information from experts, that contradicts or brings into question the reliability of such statements, representations and information. In such circumstances, sponsors should perform further due diligence to satisfy themselves in relation to the results, failing which any such remaining issues may need to be elevated by the sponsor’s Transaction Team to the senior management of the sponsor. In extreme cases, the sponsor may even consider reg from its mandate (see sections 2.39 to 2.40 above).

Revision question: Question 7: What is meant by professional scepticism? Answer 7: Professional scepticism means that the sponsor should refrain from simply accepting information as a given but instead assess the information critically and with a questioning mind.

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4.

Verification

4.1

As with the due diligence exercise, verification is required to be undertaken under Practice Note 21, Listing Rules and paragraph 17.6(c), Code of Conduct. Verification serves as a means of mitigating the potential legal and/or regulatory liabilities of the issuer, its directors and the sponsor.

4.2

Verification is a process that should closely follow the due diligence exercise as a means of confirming the accuracy of information obtained in the due diligence exercise. The procedures adopted should be appropriate to the circumstances of the listing applicant and take into the nature and source of the information and the context in which the information is given.

4.3

The verification exercise also serves to identify inaccuracies, incompleteness or doubt concerning the information obtained in the due diligence process. Where such deficiencies are identified, the sponsor should undertake additional due diligence and verification to ascertain the truth and completeness of the matter and information concerned with a view to remedying the deficiencies in the information.

4.4

Such confirmation normally consists of documentary evidence or, where this is not available, by way of confirmation from the directors (for example, in relation to the expression of a director’s belief). However, over-reliance on verbal confirmations by directors or management would not constitute a proper exercise of appropriate due diligence and verification.

4.5

Verification requires a sponsor not to accept the statements and representations made and documents produced by a listing applicant or its directors at face value. Where possible, original documents should be viewed (rather than relying on, for example, photocopies or facsimiles) or documents obtained from reliable independent sources.

Verification in practice 4.6

In practice, verification is usually conducted through the use of “verification notes”, which consist of a list of all the statements and information included in the listing document prepared by the legal advisers to the underwriters. The purpose of such notes is to assist in checking the accuracy of all statements and information.

4.7

While the verification notes are primarily drawn up by the legal advisers, the sponsor is clearly expected to coordinate the entire verification exercise in order for it to discharge its duties. It may therefore not rely exclusively on the legal advisers for such purpose. In particular, the sponsor is required to ensure the completeness of the verification exercise.

4.8

As noted above, in effect, the legal advisers will prepare documents, where each sentence in the listing document is listed, checked and discussed, and signed off by the listing applicant and of its board of directors or any other relevant party (for example, the reporting ants or an expert) appointed in connection with the transaction. An alternative to this “long form” approach is a “short form” process, whereby entire sections of the prospectus can be signed off by the directors, reporting ants, experts or other parties as appropriate. Mere confirmation by the listing applicant is not good verification practice and may not be regarded as reasonable due diligence. If information is confirmed by an expert, sponsors should exercise reasonable judgement and assess the basis of such confirmation. As noted earlier, the sponsor must in particular assess whether the assumptions upon which the expert’s opinion is based are fair, reasonable and complete and whether the scope of work of any third party professional/expert is appropriate to the opinion given.

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4.9

There is no absolute approach to verification, provided that the contents of the listing document are exhaustively and appropriately checked prior to the listing application being filed.

4.10

The long form approach in particular can take time and entail lengthy meetings with multiple attendees, and since the process usually involves senior executives who also have a busy diary and a company (or indeed, companies) to run, the timetable for the IPO or listing should clearly allow for this important exercise. At the time of submitting the listing application, all material information in the listing document should be substantially verified.

4.11

Ultimately, the verification exercise must be exhaustive, but it should also be conducted in an efficient manner. In this respect, the experience gained by sponsors in prior transactions can prove particularly valuable.

Revision questions: Question 8: When should verification be undertaken by sponsors and why? Answer 8: Verification is a process that should closely follow the due diligence exercise as a means of confirming the accuracy of information obtained in the due diligence exercise. Question 9: How is verification conducted in practice? Answer 9: In practice, verification is usually conducted through the use of “verification notes”, which consist of a list of all the statements and information included in the listing document prepared by the legal advisers to the underwriters. Verification can follow a long form or short form approach (see section 4.8 above) or be conducted through other appropriate means.

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5.

Use of experts and other third parties

5.1

As already noted in section 1 above, experts and other third parties are frequently involved in the preparation of a listing document, either to undertake specific due diligence tasks or to provide statements in relation to a matter requiring special professional expertise. The expert report is normally reproduced in the listing document as a self-contained report or opinion ed by the authority of the relevant expert. A reporting ant’s report and a property valuer’s report would be examples typically seen in the expert sections of a listing document. Parts of the listing document other than the expert reports are regarded as nonexpert sections of the listing document and may contain information derived from third party sources based on the general competence of the third parties, such as lawyers who advise on property titles and other consultants.

5.2

However, the use of third parties or experts does not exempt a sponsor from the overarching regulatory responsibilities that apply to it, and so sponsors need to be aware of the correct role they must perform where experts or other third parties are used. This is particularly so given that the sponsor declaration required to be given in the form of Appendix 19, Listing Rules covers both the expert and non-expert sections of the listing document (see sections 5.29 to 5.32 of Topic 4).

5.3

Where a particular third party may be undertaking both expert and non-expert roles, sponsors will need to be aware of the slightly different requirements that apply to each of the distinct roles.

5.4

Both the Code of Conduct and Practice Note 21, Listing Rules should be referred to when using experts and other third parties, although the more detailed requirements imposed on a sponsor are to be found in the Code of Conduct.

Third parties other than experts 5.5

Examples of third parties that a sponsor might engage to assist it include the following: (a) legal advisers (e.g. who undertake verification of title to properties and/or other regulatory compliance); (b) ants (e.g. where they are engaged to review internal controls, i.e. in a role other than as reporting ants); (c) consultancy firms (e.g. who undertake market research); and (d) agencies (e.g. who perform investigative work).

5.6

The work undertaken by such third parties will not in itself suffice to discharge the sponsor’s obligations to conduct reasonable due diligence and the sponsor will accordingly remain responsible for the ultimate work product. Paragraph 17.6(g), Code of Conduct sets out what is required of a sponsor in this regard. Note: Experts in undertaking their duties may also involve the use of third parties, and this is discussed in sections 5.25 to 5.31 below.

5.7

The degree to which a sponsor can rely on a third party’s work may depend on that party’s professional qualifications to undertake the relevant work.

5.8

In relation to any work undertaken by a third party, a sponsor should, as a minimum, consider assessing the following: (a) whether the qualifications and competence of that party are appropriate for the assigned task; (b) the scope and extent of the tasks to be performed by the third party;

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(c) whether the work performed by the third party provides a sufficient basis to enable the sponsor to form its own opinion that reasonable due diligence has been conducted or, alternatively, whether further due diligence is required; (d) whether the results of the work are consistent with all other information known to the sponsor; and (e) whether the results of the work should be incorporated in the listing document and whether they should be brought to the attention of the regulators.

Experts 5.9

Information contained in any expert report should not be untrue, misleading or contain material omissions, and its presentation in the listing document must fairly reflect the views of the expert. It is the sponsor who must undertake sufficient due diligence and critical enquiry in relation to the expert report to be satisfied this is the case. This is part of the sponsor’s role in ensuring the overall integrity of information in the listing document.

5.10

Paragraph 17.7, Code of Conduct sets out what is required of a sponsor in relation to conducting due diligence on expert reports. It is concerned with both the expert used and the content of the statements an expert makes in consequence of performing its role.

5.11

In the first instance, a sponsor should satisfy itself that the expert is: (a) appropriately qualified, experienced and competent to give the opinion; (b) sufficiently resourced; and (c) independent from the listing applicant and its directors and controlling shareholder(s).

5.12

Secondly, the sponsor should assess three important elements of an expert report: its scope, the bases and assumptions on which it is founded and the consistency of its information with other information known to the sponsor. However, in undertaking these assessments the sponsor is not itself expected to be an expert in the matters dealt with in the relevant expert reports. Nevertheless, sponsors should conduct further enquiries if they are aware of any matters raising concern about the work of experts.

5.13

The expert’s report will need to be submitted to the SEHK at the time the Application Proof is submitted, however, at this time the expert’s report may not be in final form in all regards and the following requirements will apply: (a) in the case of the reporting ants: where the ants’ reports on (i) historical financial information, (ii) the pro forma financial information, and (iii) (if applicable) the profit forecast are not able to be finalized, signed and submitted together with the Application Proof, the financial information must be provided in advanced form and the reporting ants will need to provide a written confirmation to the listing applicant (with a copy to the sponsor, the SEHK and the SFC) that no significant adjustment is expected to be made to the draft reports based on the work done as of the date of the confirmation; and Note: Relief from the above requirements is available under SEHK’s Guidance Letter GL6-09A. (b) in the case of other experts: where an expert’s report is not able to be finalized and signed at the time of submitting the Application Proof to the SEHK, the expert is required to provide a written confirmation to the listing applicant (with a copy to the sponsor, the SEHK and the SFC) to the effect that, based on the work done as at the

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date of the confirmation to date, no material change is expected to the expert’s opinion included in the Application Proof. Such confirmation may be made subject to unforeseen events outside the control of the expert (such as changes in valuation due to a new law, etc.). In both cases, the confirmation will need to be updated if there is a delay in the listing timetable that would require the draft reports/an expert’s opinion to be updated. Scope of report 5.14

The sponsor should assess whether the scope of the expert’s report: (a) is appropriate to the expert’s opinion; (b) adequately covers the reliability of information provided to the expert; and (c) is appropriately disclosed in the listing document, which should fairly represent the expert’s opinion.

5.15

The foregoing will require the sponsor to interview the expert and to review whether the and scope of the expert’s engagement, including any applicable limitations, are appropriate in view of all the circumstances.

5.16

The sponsor should be satisfied as to the quality of the factual information that the expert is relying on for the purposes of any section of the report, and that such information is adequately disclosed in the listing document. Where the sponsor has concerns regarding the reliability of information provided to, or otherwise relied on by, the expert, it should, with a view to covering the information in doubt: (a) request that the scope of the expert’s work be expanded; (b) seek the assistance of another third party or expert; or (c) extend its due diligence having regard to the requirements of a proper due diligence exercise (discussed in section 1 above), e.g. to engage a legal adviser to confirm legal title to properties included in a valuer’s report. Note: “Factual information” includes information that the expert states or believes it is relying on or which the sponsor believes the expert is relying on, and any ing or additional information given to the SEHK by the expert or the listing applicant in relation to the expert report.

5.17

In some instances an expert will rely on information prepared by a third party. Such information should be subject to the same due diligence procedures as previously outlined. If the expert has itself undertaken such procedures, the sponsor may rely on the expert’s work in this regard. In all other cases the sponsor will need to undertake those procedures itself.

5.18

Where the expert under consideration is a reporting ant performing audit procedures on information received from a listing applicant under applicable professional standards, the sponsor is not expected to carry out any further due diligence on the information. However, this does not entitle a sponsor to ignore matters that raise concerns about the information underlying the report, and in such instances the sponsor remains obliged to conduct any further enquiries that may be necessary (e.g. obtaining ing information and documents) to resolve such concerns. Bases and assumptions

5.19

The sponsor should assess whether the material bases and assumptions used in the expert report are fair, reasonable and accurate, and that such assumptions are appropriately disclosed in the listing document. In the case of financial information, the sponsor should assess critical ing policies and estimates rather than bases and descriptions.

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Consistency of information 5.20

The sponsor should critically assess whether the information in the expert report is consistent with all other information known to the sponsor, including information presented in the non-expert sections of the report. This would cover: (a) information about the listing applicant: (i) its business model; (ii) its track record; (iii) its operations; (iv) forecasts; (v) the industry sector’s performance; and (vi) any relevant public information; (b) the sponsor’s knowledge and experience of the listing applicant; and (c) the market in which it operates and of comparable companies.

5.21

Where the sponsor identifies material discrepancies, irregularities or inconsistencies, it should conduct follow-up due diligence work to resolve them. Qualified reports

5.22

In the event an expert’s report is qualified, the sponsor must ensure that the qualification is adequately disclosed in the listing document. Engagement of experts

5.23

As will be apparent from the foregoing, it is critical for the sponsor, in carrying out its role properly, to have access to any expert and the report(s) it produces. However, as it is the listing applicant (not the sponsor) that engages experts, the Listing Rules require that the engagement letter with the sponsor oblige the listing applicant to ensure that the under which an expert is engaged provide for such access.

5.24

Such access should include: (a) drafts of the expert report (both written and oral); (b) of engagement; (c) any information provided to, or relied on by, the expert, or provided by the expert to either the SEHK or the SFC; and (d) any and all correspondence between the listing applicant and the expert, and between the expert and the SFC or the SEHK. The SEHK expects that the sponsor should also have the right to take copies of the documents without charge.

Selection and management of third party input 5.25

A wide variety of persons with special areas of expertise may be appointed in connection with a listing exercise to contribute to listing documents. Fundamentally, this will depend on the industry and business of the listing applicant. As stated above, such persons can include, for example, property valuers where a company has significant property assets, traffic or shipping consultants for transport or shipping companies, Competent Persons in the case of listing of mineral companies (LR Chapter 18), or other independent market research firms tasked with providing investors with additional information and disclosure relevant to an investment in the shares of the company.

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5.26

In particular, a sponsor may wish to engage third party professionals to assist it in undertaking tasks related to certain due diligence inquiries. In such circumstances, the sponsor must be satisfied that it is reasonable to rely on information or advice provided by the third party professional. This will include being satisfied as to: (a) the competence of the professional; (b) the scope of work to be undertaken; (c) the methodology proposed to be used; and (d) consistency of the third party professional’s report or opinion with the other information known to the sponsor about: (i) the listing applicant; (ii) its business; and (iii) its business plan(s).

5.27

First and foremost, the sponsor will be tasked with assessing the expert or third party professional’s independence from the sponsor. The sponsor may consider whether a relevant professional body has already set standards concerning independence and if such standards have been met. One means of establishing independence is to obtain written confirmation from the expert that it is independent of the listing applicant and its directors and controlling shareholder(s). In any case, a sponsor should be satisfied as to an expert’s actual independence. This may require the sponsor to confirm directly whether the expert or any of its connected persons has any material interest in the securities or assets of the listing applicant or its connected persons or associates beyond that allowed under the independence tests provided for in LR 3A.07.

5.28

The sponsor will also need to assess the qualifications, credentials and experience of every expert involved against the requirements discussed above (see section 5.11 above) and other specific requirements that the Listing Rules may impose in respect of the experts’ qualifications, and/or bases and/or contents of their reports (e.g. ants’ report, valuation report, Competent Person’s report) prior to any appointment, which should be evidenced by an engagement letter.

5.29

The sponsor should not delegate to experts all their responsibility for due diligence but should maintain supervision over their work and be proactive and critical when assessing expert reports. While sponsors cannot reasonably be expected to possess the level of knowledge and expertise of an expert, they should nevertheless critically assess expert reports with a questioning mind.

5.30

For example, one of the most commonly encountered types of expert used in connection with listings on the SEHK (other than reporting ants and property valuers) are mining consultants. Such consultants are appointed in relation to LR Chapter 18 IPOs to assist, among other things, in the valuation of mineral companies and in assessing mineral resources, reserves and/or exploration results through reports prepared under the JORC Code (the Australasian Code for Reporting of Exploration Results, Mineral Resources and Ore Reserves published by the t Ore Reserves Committee); NI 43-101 (National Instrument 43-101, the (Canadian) Standards of Disclosure for Mineral Projects, including Companion Policy 43-101); the SAMREC Code (the South African Code for the Reporting of Exploration Results, Mineral Resources and Mineral Reserves), or other codes acceptable to the SEHK. Reports by such consultants tend to be of a very technical nature and may not necessarily be easily understood by persons with no background knowledge of mineral companies. Accordingly, sponsors should ensure that they deploy qualified personnel specializing in natural resources or mineral companies to review such reports.

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5.31

Assumptions and conclusions made by such experts should be probed. Information in expert reports should be reconcilable with other information and knowledge gained by sponsors via other means. Sponsors should not rely on them at face value. After carrying out such due diligence work, sponsors, as non-experts, should have no reasonable grounds to believe that the expert report is untrue, misleading or contains any material omission.

Revision questions: Question 10: What are the key requirements for information to be included in an expert report? Answer 10: Information contained in any expert report should not be untrue, misleading or contain material omissions, and its presentation in the listing document must fairly reflect the views of the expert. Question 11: What are the requirements that an expert should fulfil to be acceptable to a sponsor? Answer 11: An expert should be (i) appropriately qualified, experienced and competent to give the opinion; (ii) sufficiently resourced; and (iii) independent from the listing applicant and its directors and controlling shareholder(s). Question 12: What should a sponsor look for in the event of a qualification being included in an expert report? Answer 12: In the event an expert’s report is qualified, the sponsor must ensure that the qualification is adequately disclosed in the listing document.

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6.

Management Discussion and Analysis of Financial Information and Condition

6.1

The MD&A is a section of the listing document that sets out management discussion and analysis of financial performance and condition of a listing applicant. It is in effect an adequate and comprehensible discussion of key financial line items included in the listing applicant’s financial statements. Its purpose is to provide discussion and analysis of the listing applicant’s past performance over the track record period and main trends and factors that are likely to affect its performance, position and prospects in order to enable investors to see the listing applicant through the eyes of management. By reading the MD&A, investors can understand the reasons underlying changes that have taken place across the various years (and interim periods, if relevant) in the key line items.

6.2

On occasion, when a company has effected material acquisitions or disposals in the course of the period under review, it may be necessary to include “pro forma” information (i.e. financial information that has been restated to illustrate how a proposed or completed transaction or event might have affected the financial information presented in the listing document, had the transaction occurred at an earlier date). Pro forma information does not represent a company’s actual financial position or results. It addresses a hypothetical situation and is prepared for illustrative purposes only. A separate (though usually shorter) MD&A may therefore be necessary to discuss pro forma financial information. Sponsors should observe the related requirements regarding preparation of pro forma financial information.

6.3

An MD&A may, for example, typically include the following information: (a) disclaimers and warnings (sponsors should note that the use of disclaimers and warnings will not release a sponsor from its due diligence obligations); (b) a discussion of the basis of presentation for the financial information that is the subject of the MD&A, including any recent developments; (c) a discussion of the key factors affecting the company’s results of operations; (d) a discussion of critical ing policies and estimates; (e) a review of the principal income statement components; (f) a discussion of the changes in key financial line items for the results of operation for the track record period (this will generally include a discussion of segmented information, either by main operating activity or country/region of operation – or both – usually for the revenue and operating profit); (g) a discussion of liquidity and capital resources; (h) a discussion of working capital sufficiency; (i) a discussion of indebtedness; (j) a discussion of capital expenditure and divestment; (k) a discussion of material commitments and contractual obligations; (l) a discussion of off-balance-sheet arrangements and contingent liabilities; (m) a discussion of distributable reserves as well as dividend and dividend policy; (n) a qualitative and quantitative disclosure about risk, such as: (i) credit risk; (ii) liquidity risk; (iii) market risk, e.g. foreign exchange, interest rate and equity price risk; and

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(iv) a discussion of the fair value of financial instruments; (o) a discussion of key financial ratios; (p) a discussion of government, economic, fiscal and monetary policies; (q) a discussion of factors such as seasonality, inflation or the company’s order book; (r) a discussion about the company’s prospects; (s) a discussion of changes in ing policies for the period under review and of recent ing pronouncements; and (t) a discussion on whether there has been any material adverse change in the financial or trading position of the listing applicant and its group since the end of the period reported on in the ant reports. 6.4

As noted above, a separate MD&A may also be included for pro forma information.

6.5

Paragraph 17.8, Code of Conduct requires the sponsor to prepare the MD&A in conjunction with the management of the listing applicant and its other advisers. The MD&A should be relevant, adequate and comprehensible.

6.6

The MD&A should not be mere recitation of figures from the financial statements in narrative form. More than quantifying changes in key financial line items over the period under review, what really matters are the reasons underlying such changes and discussions that can provide investors with insights of the listing applicant’s past performance and future prospects. The MD&A must provide a meaningful explanation of events causing fluctuations in the listing applicant’s financial performance. Sponsors should however ensure that the management of the listing applicant should: (a) avoid excessive or irrelevant disclosure that may overwhelm investors or obstruct them from identifying and understanding material and critical information; (b) focus on identifying matters that materially affected historical financial performance or condition; (c) provide specific and substantive reasons for material fluctuations in the financial items and amount; (d) discuss material factors or events likely to impact the future financial performance or condition of the company; and (e) identify and discuss from an investor’s perspective any exceptional items or unusual ing treatments that require further enquiry or disclosure by, amongst other things, making reference to disclosure or treatments adopted by comparable companies.

6.7

The MD&A should be clear, straightforward and consistent with the financial statements. It should also include cross-reference to other sections of the listing document. Tables and diagrams may also be used. Sponsors should refer to SEHK’s Guidance Letter GL59-13 for further guidance on the expected disclosure in the MD&A in listing documents.

6.8

If a company is unable to explain changes or fluctuations in its key financial line items, it may point to acute weaknesses in its systems, controls and procedures. These should be discussed separately and in some detail with the company’s reporting ants. Sponsors should make recommendations for such weaknesses to be dealt with wherever necessary, and for this to take place both ahead of the listing application and launch of the listing, and on an ongoing basis thereafter (see in particular section 2 of Topic 6).

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Revision questions: Question 13: What is an MD&A? Answer 13: The MD&A is a section of the listing document that sets out management discussion and analysis of financial performance and condition of a listing applicant. It is in effect an adequate and comprehensible discussion of key financial line items included in the listing applicant’s financial statements. Question 14: What is the key purpose of the MD&A? Answer 14: Its purpose is to provide discussion and analysis of a listing applicant’s past performance over the track record period and main trends and factors that are likely to affect its performance, position and prospects in order to enable investors to see the listing applicant through the eyes of management.

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Topic summary This Topic reviewed the legal and regulatory requirements and practical considerations a sponsor must have regard to when undertaking a due diligence exercise. The due diligence process was seen as commencing with a plan specifically developed to suit the circumstances of the listing applicant, and the appropriateness of the plan should be kept under review as the exercise continues. The specific regulatory requirements were reviewed, including the need to adopt an attitude of professional scepticism, the role of verification in relation to due diligence and the production of the listing document-cum-prospectus, and the need to keep records. A due diligence exercise will always require the involvement of the listing applicant and third parties, including experts. How a sponsor should collaborate with these various parties was explained as well as the specific regulatory requirements a sponsor must be aware of where experts are involved. Finally, the matters that should be taken into in preparing the MD&A were discussed.

Checklist Below is a checklist of the main points covered by this Topic. Candidates should use the list to test their knowledge. 

The key document in connection with a listing application to the SEHK is the listing document.



The preparation of the listing document is not merely an exercise in checking off that it satisfies each of the content requirements.



A sponsor is required to engage in deeper consideration of the affairs of a listing applicant, its directors and controlling or substantial shareholders.



Information in a listing document must contain sufficient particulars and information to enable a reasonable investor to come to an informed investment decision.



The primary means by which sponsors meet these requirements (and mitigate the potential risk of legal and/or regulatory liabilities) are due diligence and verification.



Due diligence is the process undertaken by sponsors to establish the completeness and accuracy of the information contained in the listing document.



Sponsors are required to make their own independent enquiries when conducting due diligence.



A due diligence exercise requires the appropriate cooperation and involvement of the listing applicant and third parties involved in the listing process.



Due diligence requirements are explained in Practice Note 21, Listing Rules. However, such requirements are not exhaustive and due diligence must be fully tailored to individual listing applicants.



Commercial due diligence is primarily concerned with an in-depth understanding of the business of a company. It also involves physical inspection of production facilities and interviews with the senior management of the listing applicant and relevant third parties.



Financial due diligence is primarily concerned with a detailed investigation and understanding of a company’s track record, cost structure, financial position and financial risks.



Legal due diligence focuses on a review of legal documents such as material contracts, information pertaining to asset ownership, the due establishment of group companies, shareholding information, insurance policies, tax returns etc..

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

Syndicate due diligence involves more junior of a syndicate of underwriters through a “syndicate due diligence call” or meeting.



Verification notes serve an important purpose in due diligence, to weigh the accuracy and formulation of all statements made by the listing applicant in the listing document.



Due diligence also covers directors and compliance with qualification for listing, in addition to the affairs of the applicant generally.



ing and management systems and directors’ appreciation of their new obligations as directors of a listed company are also the subject of due diligence.



Another purpose of due diligence is to identify the major risk factors faced by listing applicants.



Records should be kept of due diligence planning, work and conclusions.



Direct communication with the listing applicant is essential for a sponsor to discharge its duties properly and fully. However, due diligence also involves third parties apart from the listing applicant itself.



Third party interviews for the purpose of due diligence should be made by the sponsor independently of the listing applicant.



All aspects to be covered during due diligence are included in a due diligence plan.



The due diligence plan should also establish a materiality threshold for due diligence investigations.



Questionnaires are usually drawn up to facilitate due diligence investigations and interviews. Such questionnaires should be unique to each listing applicant.



Tricky situations may result in sponsors needing to explain to listing applicants in greater detail the scope and process of the due diligence investigations.



In certain circumstances, tricky due diligence issues may need to be elevated to the senior management of a sponsor. The sponsor may also need to consider reg if such issues cannot be resolved to its satisfaction.



Sponsors must exercise professional scepticism in relation to due diligence investigations.



Verification serves as a means of mitigating the potential legal and/or regulatory liabilities of the issuer, its directors, and the sponsor.



The verification exercise serves to identify inaccuracies, incompleteness or doubt concerning the information obtained in the due diligence process.



Verification may follow a short-form or long-form approach.



Experts and other third-party professionals may be used to assist in a sponsor’s due diligence work.



Sponsors should assess whether the material bases and assumptions used in expert reports are fair, reasonable and accurate and ensure that these are appropriately disclosed in the listing document.



Experts should be assessed for their independence and competence by sponsors before being retained.



The appointment of experts should be evidenced by an engagement letter.



Sponsors must not rely on experts at face value but approach their work with a questioning mind. This may involve industry sector specialists to review expert reports.



An MD&A is a section of the listing document that sets out management discussion and analysis of financial performance and condition of a listing applicant to provide discussion and analysis of a listing applicant’s past performance over the track record period and main trends

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and factors that are likely to affect its performance, position and prospects in order to enable investors to see the listing applicant through the eyes of management. 

Pro forma information is financial information that has been restated to illustrate how a proposed or completed transaction or event might have affected the financial information presented in a listing document had such transaction occurred at an earlier date.



There may be a separate MD&A for pro forma financial information.



An MD&A is not a mere recitation of figures in narrative form, but is more concerned with the reasons underlying changes in key financial line items.



If a company is unable to explain changes or fluctuations in its key financial line items, it may point to acute weaknesses in its systems, controls and procedures. Sponsors should make recommendations for such weaknesses to be dealt with ahead of the listing application and beyond.

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Topic 6: After prospectus issuance Table of contents Topic overview Learning outcomes 1 Assessing the sponsor work Standards of behaviour, ethics and stakeholders Regulatory considerations Commercial considerations 2 Compliance advisers Connection with sponsor work Appointment and role Assessing corporate governance, risk management and internal controls in practice 3 Case studies Introduction Sponsor theme inspection findings Dual-filing findings Enforcement cases 4 Integrity and consequences Topic summary Checklist

1 1 2 2 2 3 5 5 5 6 8 8 8 9 10 14 15 15

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Topic overview This Topic wraps up the discussion of a sponsor’s legal and regulatory obligations with an overview of the consequences of good and bad sponsor work and the importance of ethics in undertaking sponsor work. The importance of meeting regulatory standards is related to the legitimate expectations of stakeholders in the marketplace as well as the applicable commercial considerations. The role compliance advisers play in a listed issuer’s continuing compliance is introduced. A series of case studies is presented to illustrate how a sponsor’s work is sometimes undertaken without proper regard to the requirements imposed on it, as well as enforcement cases in which the Securities and Futures Commission (“SFC”) has taken disciplinary action. The Topic concludes with a discussion of the importance of integrity when the sponsor role is undertaken, and the positive consequences this brings to both sponsor and marketplace.

Learning outcomes At the end of this Topic, candidates should be able to: (a) understand the relevance of integrity and ethics in the marketplace; (b) describe the role of the compliance adviser in a listed issuer’s continuing compliance; (c) recognize certain deficiencies in the sponsor work and inadequacies in sponsors’ internal systems and controls identified by the SFC; (d) understand the types of enforcement the SFC may undertake in relation to deficient sponsor work; and (e) appreciate the importance of integrity when undertaking a sponsor assignment.

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Assessing the sponsor work Standards of behaviour, ethics and stakeholders

1.1

Sponsors are engaged for a fee in a commercial advisory capacity, however, throughout this manual we have observed that a sponsor’s work reflects, and is measured against, important regulatory concerns. For example, ensuring the quality and completeness of information provided to the investing public is a prerequisite for allowing issuers to access public capital markets. Sponsors occupy a functional role as an impartial gateway in this regard, and we have reviewed various detailed regulations that guide the sponsor and the listing applicant towards meeting such requirements.

1.2

The net result of good sponsor work should be that only candidates suitable for listing reach the stage of making a listing application. However, a fuller assessment of a sponsor’s work necessarily extends beyond this stage and must consider the commercial and regulatory aspects of an initial public offering (“IPO”) and the related interests of the various stakeholders in the IPO market who include: the company seeking to raise capital from the listing, and its directors; the sponsor, and its senior management and employees; other financial institutions involved in the IPO; potential investors in the IPO; and the market of The Stock Exchange of Hong Kong Limited (“SEHK”) taken as a whole.

1.3

Each of these stakeholders has a legitimate expectation that IPOs are executed in a manner consistent with the laws, regulations and market practices that govern IPOs. Proper execution of quality IPOs contributes to the efficiency of capital raising exercises for issuers and investors, the reputation of the financial intermediaries servicing the needs of the capital market, and the overall standing of the marketplace, thus creating a win-win situation for all stakeholders. These expected standards presuppose an ethics in the marketplace for IPOs that sponsors need to be keenly aware of when undertaking their various duties.

Regulatory considerations 1.4

While some of the regulatory requirements applying to sponsors and reviewed in previous topics may be considered procedural in nature, others reflect ethical standards. For example, the Corporate Finance Adviser Code of Conduct (“CFA Code”) requires a sponsor to be honest and of good repute, and to maintain a high standard of integrity and fair dealing. Other and more specific requirements pertain to the maintenance of Chinese walls, the need to avoid or deal with conflicts of interest, the need for impartiality, the proper handling of benefits, and so on.

1.5

It is important that persons engaged in sponsor work understand that fulfilling their regulatory function goes beyond merely a box-ticking exercise against specific regulatory requirements. The sponsor’s regulatory role ultimately arises out of overarching regulatory objectives and principles concerning how a public capital market should be organized and operated, including the following: (a) investors should be fairly treated and adequately informed and protected; (b) the market should be operated in an orderly, fair, competitive and efficient manner; and (c) crime and misconduct should be minimized. To the extent the execution of an IPO fails in ing the above objectives, a number of problems are likely to be created for the stakeholders. Issuers may find it more difficult and expensive to raise capital as investors become more cautious when investing their money. A sponsor that has not fulfilled its regulatory obligations may face regulatory discipline and/or legal liabilities, and it may give rise to reputational issues that may lead to its professionalism and integrity being called into question. The integrity of the Hong Kong listed market may be adversely affected, which can have knock-on effects on the overall

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competitiveness and attractiveness of Hong Kong as a venue for raising capital as well as its overall reputation as a leading international finance centre. Ethical standards of behaviour that are consistent with regulatory objectives are therefore an integral step towards meeting commercial objectives.

Commercial considerations 1.6

The commercial success of an IPO is necessarily assessed from a number of perspectives and over a period of time, and the involvement of the sponsor does not end with the commencement of trading of a company’s shares on the SEHK.

1.7

At the time an IPO is launched, investors may refer to disclosures made in the listing document-cum-prospectus with respect to their investment decisions. This includes existing shareholders (those who are not subject to a lock-up) as well as new investors. This is particularly the case in the first 40 days after listing, where news flow is often scarce as the underwriters are generally unable to publish research reports in what is termed a “quiet” or “black-out” period, and as time is needed for other licensed corporations or ed institutions to initiate research coverage of the newly listed company.

1.8

During the period following ission to listing, investors may continue to refer to information in the listing document and question material deviations from statements made in the prospectus. For example: changes in the use of proceeds as disclosed in the prospectus; earnings not matching any profit forecast included in the prospectus; or changes in the stated strategy of the issuer or listing applicant. In this regard, the judgement of the marketplace will not only be made in respect of the listed issuer but also of the various professional parties involved in the IPO process, particularly the sponsor.

1.9

Disclosure at the time of an IPO also sets the background against which future disclosure is made by a listed company. Accordingly, it is particularly important for issuers and their sponsors to get it right at the outset not only to ensure the initial successful reception of the IPO in the market, but also to foster the ongoing development and growth of the issuer as a publicly held corporation.

1.10

It is important (and a legal requirement under Part XIVA, Securities and Futures Ordinance (“SFO”)) that companies listed on the SEHK should disclose material developments to investors through the SEHK in both good and bad times, and should also be advised how, when and why to do so by sponsors (and after listing, compliance advisers, as discussed below). Such matters concern in particular: (a) announcements of material events or developments; (b) results announcements; (c) financial statements; (d) securities buybacks; (e) trading arrangements; (f) changes in directorships; (g) notices of general meetings of shareholders; (h) proxy forms; (i) results of general meetings of shareholders; and (j) circulars.

1.11

Ultimately, the quality of the information an issuer is willing to share with investors, and how often and how consistently such information is released to the market in no small measure influences how highly a company is regarded in the eyes of both institutional and retail investors. While investor relations very much constitute an ongoing process and

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something that develops over a long period of time, the launch of a company on the public capital markets via an IPO represents a significant new starting point. In this respect, the disclosures made following a thorough due diligence and verification exercise form a platform that defines the issuer’s starting point. 1.12

In addition, a sponsor may also act as compliance adviser to newly listed issuers, and this is discussed in the next section.

1.13

Examples of enforcement cases by the SFC are provided in section 3 below, highlighting where sponsors have failed to discharge their duties properly in connection with their appointment.

Revision question: Question 1: What are the key regulatory objectives and principles around which a public market is organized and operated? Answer 1: See section 1.5 above.

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2

Compliance advisers Connection with sponsor work

2.1

An issuer must have a compliance adviser appointed for the specified period commencing from the date of its ission to listing. This role may only be undertaken by a Type 6 intermediary that is permitted by its licence or registration to engage in sponsor work. However, the role does not need to be undertaken by a sponsor involved in the issuer’s IPO.

2.2

Of particular relevance in this regard is the sponsor’s declaration, which expresses an opinion on (i) the procedures, systems and controls that the issuer has put in place to enable it to comply with applicable laws and regulations, and (ii) the experience, qualifications and competence of the directors of the issuer to perform their roles in compliance with their legal and regulatory obligations (see section 5.31 of Topic 4). In this regard, it will be recalled that it is part of the sponsor’s responsibilities to provide advice and guidance to the listing applicant, and that additional responsibilities apply in relation to the board of a People’s Republic of China (“PRC”) issuer (see sections 3.9 to 3. 12 of Topic 4).

2.3

The ability of the issuer to make a smooth transition into listed status and avoid breaches of the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited (“Listing Rules” or “LR”) will therefore have a general bearing not only on the perception of the issuer in the marketplace but also on the work undertaken by the sponsor and, accordingly, its reputation.

2.4

To the extent that the sponsor work has been handled properly, or inadequately, the role of the compliance adviser may or may not be facilitated.

Appointment and role 2.5

Upon the listing applicant being itted to listing, the Listing Rules require that a compliance adviser be appointed commencing on the date of listing and ending on the date on which the listed issuer has complied with its financial reporting obligations in respect of the first full financial year as a listed issuer (the “Fixed Period”).

2.6

However, the SEHK can direct the listed issuer to extend the period of appointment and specify the responsibilities of the compliance adviser and the circumstances in which the issuer is required to consult the compliance adviser. Such an extension would normally be made in the context of persistent or serious breaches of the Listing Rules by the issuer.

2.7

During the Fixed Period, the listed issuer is required to consult with and seek advice from, the compliance adviser, on a timely basis, in respect of the following matters: (a) prior to the publication of any regulatory announcement, circular or financial report; (b) any potential transaction that might be a notifiable or connected transaction under LR Chapter 14 or Chapter 14A; (c) where the issuer proposes a departure from the stated use of proceeds; (d) where the business activities, developments or results of the listed issuer deviate from any forecast, estimate, or other information in the listing document; and (e) where the SEHK makes an inquiry of the listed issuer, for example, about unusual movements in its share price or trading volume.

2.8

Accordingly, compliance advisers need to have a sufficient understanding of the relevant Listing Rules requirements, including the continuing obligations under LR Chapter 13 and the notifiable and connected transactions rules under LR Chapters 14 and 14A.

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2.9

In the case of a PRC issuer whose authorised representatives are expected to be frequently outside Hong Kong, the compliance adviser must also act as the principal channel of communication with the SEHK.

2.10

Whenever the listed issuer consults the compliance adviser, the compliance adviser is required to discuss with the listed issuer various compliance matters, including, for example, compliance with undertakings given by the directors of the listed issuer, as well as the matters mentioned above.

2.11

As with sponsors, compliance advisers are required to act impartially and must give a written undertaking to the SEHK to comply with the applicable Listing Rules and, in particular, to cooperate with any investigation by the SEHK into the affairs of the listed issuer. While there is no requirement for a compliance adviser to report an issuer’s breaches of the Listing Rules to the SEHK, it is appropriate for a compliance adviser to remind the issuer of its general obligation to do so.

2.12

A listed issuer may not terminate the role of a compliance adviser (except in cases of inadequate performance of the compliance adviser’s duties or a material dispute over fees). However, a compliance adviser may resign, and such an action may well send a negative message to the market.

2.13

In the case of a PRC issuer, the SEHK has the right to require the PRC issuer to terminate the compliance adviser’s mandate and to appoint another where the SEHK is not satisfied the compliance adviser is fulfilling its responsibilities.

Assessing corporate governance, risk management and internal controls in practice 2.14

In practice, the compliance adviser (whose own procedures and systems, as already mentioned above, must be assessed annually) will be tasked with ensuring the listed issuer is properly guided and advised as to compliance with the Listing Rules and other applicable rules and regulations and with assessing corporate governance practices, including the framework to review conflict of interest situations and related party transactions, against the background of public ownership of the listed issuer. The requirements of LR Chapter 13 (Continuing Obligations) and Appendix 14 (Corporate Governance Code and Corporate Governance Report) will be of particular relevance to the compliance adviser’s role.

2.15

It will also be tasked with assessing whether the listed issuer’s risk management and internal controls are adequate and in compliance with regulatory requirements. This may include or cover, among other things: (a) reviewing the risk management framework and processes deployed by the listed issuer in identifying, evaluating, managing and reporting significant risks faced by the listed issuer, including procedures to identify new or changing risks or operational deficiencies that may have a financial impact on the listed issuer; (b) reviewing the budgetary process and variance reporting, including the approval process and investment approval; and (c) identifying the key components of the listed issuer’s ing systems and internal controls for all major cycles, and reviewing these in relation to the adequacy of such controls for ensuring the existence, completeness and accuracy of transactions, the safeguarding of assets and compliance with all applicable laws and regulatory requirements.

2.16

The compliance adviser should also focus on the listed issuer’s organizational structure, in the context of a public listing. This may include a review of: (a) manpower, including the roles and responsibilities of the legal and company secretarial departments;

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(b) reporting flows, including delegations of authority, limits of authority and management oversight; (c) the segregation of duties; and (d) independent checks. 2.17

Other areas to be focused on may include whether the policies and procedures established by the listed issuer to streamline processes, including operational and non-operational policies and procedures, as well as compliance with regulatory requirements, are adequate for a public company. The listed issuer’s business continuity plan, including disaster recovery measures, should also be reviewed, as should its internal and external communication, reporting protocols and monitoring mechanisms in relation to corporate governance, risk management and internal control systems.

2.18

Where any weaknesses or inadequacies have been identified, the compliance adviser should devise a set of recommendations and assist the listed issuer in implementing them, in accordance with an approved implementation plan.

Revision questions: Question 2: When must an issuer appoint a compliance adviser? Answer 2: An issuer must have appointed a compliance adviser commencing from the date of its ission to listing. Question 3: On what matters must a listed issuer seek the advice of a compliance adviser? Answer 3: See section 2.7 above.

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3

Case studies Introduction

3.1

Most sponsors comply with their legal and regulatory obligations. However, from time to time sponsors fail and become subject to SFC disciplinary actions and other legal liabilities.

3.2

This section first reviews the SFC’s findings of a theme-based inspection of sponsor work concluded in 2011 and then looks at some of the common deficiencies in listing application filings that have been identified by the SFC as part of the dual-filing regime. The section concludes with 3 sample enforcement cases of the SFC as a means of demonstrating how the SFC exercises its disciplinary powers where sponsors have failed to fulfil their duties.

3.3

Such findings by no means constitute an exhaustive review or list of all potential failures that may arise on the part of sponsors in fulfilling their legal and regulatory obligations. Ultimately, sponsors are responsible for carrying out due diligence to the highest standard expected in relation to the discharge of their duties. What this will involve will vary depending on individual listing applicants, judgement and experience remains of paramount importance in relation to sponsor work.

Sponsor theme inspection findings 3.4

Between 2009 and 2011, the SFC conducted a theme-based inspection on 17 sponsors focusing on the work undertaken in connection with initial listing applications, in particular, the areas of due diligence work and the adequacy of internal systems and controls over sponsor work. Note: The SFC’s report “Report on Sponsor Theme Inspection Findings, March 2011” can be found on the SFC’s website. Each of the Case Notes below gives examples provided by the SFC of how the relevant inadequacy occurred. Due diligence

3.5

A sponsor is required to ensure that its due diligence work is thorough and is undertaken in a manner consistent with the requirements of Practice Note 21, Listing Rules (see Topic 5) as well as the other requirements that have been discussed generally in Topic 4.

3.6

The SFC identified the following common inadequacies in sponsors’ due diligence inquiries: (a) insufficient due diligence on major business stakeholders such as suppliers and customers; Case Note: inadequate interview practices (failure to identities of interviewees and to follow up on unsatisfactory or incomplete due diligence questionnaires), accepting the genuineness of figures (for example, sales figures) without a more penetrating verification. (b) insufficient due diligence on material change in business shortly before listing; Case Note: a material change in the significance of export sales within 3 months after the last audited balance sheet date but before the listing due to a major new customer not being subjected to any due diligence work despite a change in the risk profile of the business. (c) insufficient due diligence on third party professional/expert’s work (see sections 5.9 to 5.22 of Topic 5); Case Note: the sponsor relied on a legal opinion as to the listing applicant’s compliance with applicable regulations in another jurisdiction despite the legal opinion being inappropriately restricted in its scope and other information known by the

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sponsor that was inconsistent with the facts and assumptions upon which the legal advice was based. (d) non-disclosure of material information during the listing application process; Case Note: a possible breach of laws and regulations in a foreign jurisdiction was not disclosed in the listing document as the sponsor relied on the listing applicant’s view on disclosure rather than on its own assessment of materiality and relevance. (e) questionable disclosure to the SEHK during the listing application process; and Case Note: when the SEHK queried the independence of a major supplier to the listing applicant’s business stated as an independent third party in the listing document, the sponsor failed to inform the SEHK of certain trust arrangements it was aware of which would cause the person in question to be a connected person of the listing applicant. (f) failure to maintain proper due diligence records (sponsors should bear in mind that failure to keep records makes it difficult to demonstrate the work they have undertaken). Internal systems and controls Manpower and resources to undertake sponsor work

3.7

A common problem observed was the allocation of inadequate staff to the execution of the sponsor role. This concerns both the number of staff involved as well as their quality. In this regard sponsors should bear in mind their obligations to form a Transaction Team headed by one or more Principals all of whom have the appropriate levels of skills and experience (see section 2 of Topic 4 for a discussion of this requirement). Case Note 1: the Principal was simultaneously in charge of supervising 7 active Transaction Teams as well as being involved in other corporate finance work. Case Note 2: the sponsor had only 8 licensed representatives, 4 of whom were Principals, yet were collectively engaged in 6 active IPOs. Annual assessment and internal systems and controls

3.8

The SFC also noted that a number of sponsors failed to fulfil their obligations under the Additional Fit and Proper Guidelines for Corporations and Authorized Financial Institutions applying or continuing to act as Sponsors and Compliances Advisers to conduct annual assessments of their internal systems and controls (see section 1 of Topic 3 for a discussion of this requirement). Annual assessments were either not done at all or not properly done. The annual assessment is a mechanism that can assist sponsors in identifying any shortcomings and enabling sponsors and their senior management to be in a position to comply with all applicable legal and regulatory requirements. Sponsor’s declaration

3.9

It should be clear that to the extent there are shortcomings in the sponsor work, the sponsor will not be in a position to make a truthful declaration to the SEHK (see section 5.31 of Topic 4 for a discussion of the declaration content). Where a declaration is made that is not consistent with the work actually undertaken (for example, as to the adequacy of due diligence), it may amount to a breach of the Listing Rules as well as possibly raising questions with the SFC as to the integrity of the sponsor and consequently its fitness and properness to remain licensed or ed. The sponsor will therefore be exposed to regulatory sanctions and possible criminal liability under s. 384, SFO.

Dual-filing findings 3.10

As mentioned in Topic 2, the dual-filing regime means that copies of listing application materials made to the SEHK must also be copied to the SFC.

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3.11

Where the SFC identifies deficiencies in submitted materials, this may result in delays to, or a suspension of, the listing process. Such deficiencies may arise as a consequence of the sponsor failing to fulfil its regulatory obligations, in which case the SFC may question the competence of the sponsor and its fitness and properness to continue to engage in sponsor work. Ultimately, such deficiencies reflect failures in the conduct of the sponsor and its Transaction Team.

3.12

Examples of problems the SFC observed included the following: (a) incomplete submissions, for example, the failure to include required documents under the relevant listing requirements; (b) the drafting of the listing document was substandard, for example, significant errors, excessive typographical errors or inadequate risk warnings; (c) inaccurate responses to queries raised by the regulators due to poor understanding of key factors affecting the historical performance of the listing applicants such as customer profile, competitive advantages, etc.; (d) assertions of critical importance made in the draft listing document e.g. concerning the ongoing viability of the business in the context of adverse business conditions made without being substantiated by an objective analysis; (e) failure to properly identify and explain the relationship between the listing applicant and the owners of the listing applicant’s suppliers who were in fact directors of the listing applicant; (f) inadequate description of the legal and regulatory environment of a listing applicant operating in a regulated industry; (g) failure to vet apparently questionable business practices of the listing applicant for compliance with applicable laws; and (h) failure to critically evaluate the risk to the sustainability of the listing applicant’s business of loss of a major source of revenue. Note: For further examples of problems that the SFC have found with draft listing documents, please see the SFC’s “Dual Filing Update” which is published on its website.

3.13

If information submitted to the regulators is false or misleading, it may also lead to liability under s. 384, SFO (see section 4.7 of Topic 1).

Enforcement cases 3.14

The three cases below review actual enforcement actions taken by the SFC (based on information provided on the SFC’s website). The first demonstrates a significant failure by a licensed corporation in undertaking sponsor work, resulting in a loss of licence and a substantial fine. The second is an example of wrongdoings by licensed representatives. The third is an example of a graded disciplinary response on the SFC’s part according to the nature of the breach and the track record of the intermediary concerned.

3.15

When exercising its powers of enforcement, the SFC’s primary concerns are: (a) to protect investors; (b) to maintain market integrity and confidence; and (c) to hold the wrongdoers able for their actions.

3.16

The SFC’s enforcement process involves three steps: (a) identifying suspected breaches; (b) investigation of such breaches; and

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(c) taking steps to: (i) protect investors and the market; and (ii) punish wrongdoers appropriately. Case 1: Revocation of licence and fine for fundamental failings in executing the sponsor role 3.17

The sponsor concerned (“SP-1”) held licences to carry on Type 1 (dealing in securities), Type 4 (advising on securities) and Type 6 (advising on corporate finance) regulated activities. The enforcement case concerns the role of SP-1 in its capacity as the sole sponsor in relation to the listing application and subsequent listing of an issuer (“Issuer-1”).

3.18

The SFC investigated SP-1’s practices and procedures during the listing process and found a series of significant failures in the discharge of SP-1’s duties as sponsor as stated below. Inadequate and sub-standard due diligence work

3.19

SP-1 failed to perform the following due diligence work: (a) identifying and following up on missing material information concerning transaction figures with suppliers and customers; (b) conducting proper interviews with suppliers and customers (some of which were only conducted over the phone on the day the listing application was submitted); and (c) properly ing franchisees information and transaction records between Issuer-1 and its franchisees. Failure to act independently and impartially

3.20

SP-1 relied too heavily on Issuer-1 in connection with its inquiries into the suppliers, customers and franchisees of Issuer-1. Interviews with such third parties were arranged by Issuer-1 and were all conducted with Issuer-1 present. Confirmations from franchisees as to their independence were obtained via Issuer-1, rather than directly from SP-1. Inadequate audit trail

3.21

SP-1’s due diligence planning and significant aspects of its due diligence work were not adequately documented, e.g. no records were kept on background checks or other due diligence searches conducted on Issuer-1’s suppliers, customers and franchisees. Inadequate staff supervision

3.22

The two Principals of SP-1 did not regard themselves as responsible for the listing application. A significant part of the due diligence exercise was undertaken by junior staff who were inexperienced and inadequately supervised. Breach of sponsor’s undertaking and filing untrue declaration

3.23

In consequence of the above failings, the undertaking and declaration that SP-1 gave to the SEHK were untrue (see sections 2.1 and 5.29 of Topic 4 for a discussion of the requirements of the undertaking and declaration).

3.24

As a result of these failures to discharge its sponsor duties in relation to Issuer-1, the Type 6 licence of SP-1 was revoked and it was fined HK$42 million.

3.25

The SFC’s Executive Director of Enforcement stated that SP-1’s “failure in discharging its sponsor’s duties prejudiced the regulatory assessment of Issuer-1’s suitability for listing and jeopardized the interests of the investing public. The sanctions imposed on SP-1 should make it clear that the SFC condemns such failure in the strongest ”.

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Case 2: Prohibition on individuals participating in the industry arising out of sponsor work failures and falsification of documents 3.26

This case involved two individuals acting as the Principal and licensed representative respectively of a sponsor (“SP-2”) for a new listing applicant (“Issuer-2”). The first individual (“Rep-A”) was the principal supervisor of the second individual (“Rep-B”).

3.27

The listing application for Issuer-2 was successful and it was itted to listing. However, after listing, the SEHK raised questions with SP-2 concerning the correctness of certain material statements in the prospectus.

3.28

The responses to queries, including documents purporting to be records of Issuer-2, were prepared and submitted by Rep-A and Rep-B.

3.29

Rep-A claimed that he had not been responsible for the due diligence exercise, that he had signed the submissions to the SEHK in a purely istrative capacity, and that he was entitled to rely on the work of other staff of SP-2.

3.30

Upon further investigation, it was established that Rep-A was responsible for the failure of SP-2 to conduct adequate due diligence and for responding to the SEHK’s inquiry subsequent to the listing of Issuer-2.

3.31

It was also established that Rep-A had not responded to the SEHK inquiry by conducting a proper inquiry. Instead, Rep-A, with the assistance of Rep-B, falsified documentation to provide to the SEHK as a means of distancing Rep-A from SP-2’s due diligence of Issuer-2. This resulted in the truth being concealed and prevented the SEHK from taking appropriate steps in relation to the misstatements made by Issuer-2 in the prospectus.

3.32

As a result, Rep-A and Rep-B were prohibited from re-entering the industry for a period of 6 years and 4 years respectively.

3.33

In addition, the shares of Issuer-2 were suspended and two individuals concerned in the management of Issuer-2 received jail sentences for conspiracy to defraud in relation to the false information contained in the prospectus.

3.34

The SFC’s Executive Director of Enforcement stated that “the decision makes it clear that sponsors have an important role to play in helping to protect the investing public and their obligations must be performed to a very high standard. Sponsors and their senior staff will be held able for negligent, cavalier or dishonest conduct”. Case 3: Public reprimand and fine in relation to inadequate record keeping

3.35

When undertaking its due diligence work, the sponsor (“SP-3”) failed to maintain proper books and records as required by the CFA Code in relation to: (a) verbal discussions between its staff conducting the due diligence work and management of the issuer; (b) due diligence work on certain transactions involving the issuer and its associated company; and (c) a walk-through test on the issuer conducted as part of the due diligence work.

3.36

As a consequence, SP-3 was unable to provide sufficient for certain representations made to the SEHK or to demonstrate the steps it had taken in relation to these matters.

3.37

SP-3 was publicly reprimanded and fined HK$1.5 million by the SFC.

3.38

In assessing the disciplinary measures, the SFC took into the cooperation demonstrated by SP-3 in the investigation and that SP-3 had no previous disciplinary record.

3.39

The SFC’s Executive Director of Enforcement stated that “sponsors must keep proper records of work done when they perform due diligence and must be ready to provide

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ing documents of their representations to the SEHK upon its request. Sponsors who do not comply risk serious consequences”.

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4

Integrity and consequences

4.1

Section 1 of this Topic emphasized the important role IPO sponsors play in maintaining and fostering the integrity and success of Hong Kong as a leading international primary capital market.

4.2

Sponsors are expected to take the lead role in providing advice and guidance to listing applicants in relation to the Listing Rules and all relevant regulatory requirements. They also provide leadership by coordinating the advice of all other parties involved in an IPO.

4.3

In this respect, the of their engagement must be clear and unambiguous and their authority absolute. The advice and guidance they provide, and their understanding of listing applicants through due diligence inquiries, ensure that material deficiencies and fundamental compliance issues can be identified and addressed at an early stage. Their remit ensures exhaustive and truthful disclosure so that reasonable persons can form valid and justifiable opinions on the business, financial condition and profitability of listing applicants.

4.4

Sponsors that maintain ethical standards of behaviour consistent with the expectations of the marketplace also establish a clear platform for the correct pricing of risk. By contrast, non-disclosure or disclosure that is false, misleading or simply incorrect can lead to mispricing as investors are not presented with all the facts necessary for them to understand and appraise the business of an issuer correctly.

4.5

Sponsors behaving in an ethical way also create a platform on which continued commercial business can be built. A sponsor’s reputation, as well as the standing of its Principals, representatives and other Transaction Team , can help to generate repeat business on the part of issuers and to win IPO business from a wider range of corporate clients. When the sponsor also acts in an underwriting and marketing or distribution role, its reputation will encourage investors to channel orders and secure allocations through that same firm for their primary equity investments.

4.6

Finally, sponsors play an important role in preserving and enhancing the integrity of the IPO market in Hong Kong, by helping to maintain high standards on a par with those of other globally recognized marketplaces, rather than simply in line with less demanding regional developing markets.

4.7

In conclusion, correctly undertaken, essential sponsor work creates a win-win situation for the market, listing applicants and the sponsors themselves. It helps safeguard the reputation of Hong Kong and the SEHK as a leading destination for companies seeking a public listing; it gives confidence to investors choosing to deploy funds in Hong Kong’s capital markets, and it ultimately benefits licensed corporations and ed institutions by generating additional initial and follow-on new issues, as well as sell-side business.

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Topic summary This Topic considered the importance of ethics in undertaking sponsor work. Stakeholders in the marketplace, including issuers, investors, financial intermediaries and the SEHK itself, have legitimate expectations as to how a sponsor should be undertaking its work. The role of compliance advisers in a listed issuer’s ongoing compliance was discussed. Case studies were presented to illustrate situations where a sponsor has failed in fulfilling its obligations, and others were presented that demonstrated the SFC’s ability to take enforcement actions in respect of such failures. The Topic concluded with a discussion of integrity and its consequences.

Checklist Below is a checklist of the main points covered by this Topic. Candidates should use the list to test their knowledge. 

A sponsor’s work reflects, and is measured against, important regulatory concerns.



The net result of good sponsor work should be that only candidates suitable for listing reach the stage of making a listing application.



Standards expected of sponsors presuppose ethics in the marketplace for IPOs that sponsors need to be aware of.



Involvement of the sponsor does not end with the commencement of trading of a company’s shares on the SEHK.



During the period following ission to listing, investors may continue to refer to information in the listing documents and question material deviations from statements made in the prospectus.



Disclosure at the time of an IPO sets the background against which future disclosure is made by a listed company.



It is important (and a legal requirement under the SFO) that companies listed on the SEHK should disclose material developments to investors through the SEHK in both good and bad times.



Sponsors may also act as compliance advisers to newly listed issuers.



A compliance adviser must be appointed commencing on the date of listing and ending on the date on which the listed issuer has complied with its financial reporting obligations in respect of the first full financial year as a listed issuer.



In the case of a PRC issuer whose authorised representatives are expected to be frequently outside Hong Kong, the compliance adviser must also act as the principal channel of communication with the SEHK.



Compliance advisers are tasked with providing guidance to listed issuers on compliance with the Listing Rules and other applicable rules and regulations and with assessing their corporate governance practices, risk management and internal controls.



The SFC can exercise its disciplinary powers when sponsors fail to fulfil their duties.



The main failures or deficiencies in sponsors’ work as revealed in the SFC’s inspection of sponsors, dual-filing review and enforcement cases.



Sponsors play an important role in maintaining and fostering the integrity of Hong Kong as a leading international IPO market.

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Abbreviations

Abbreviations CCASS CFA Code CIS CO Code of Conduct

Meaning Central Clearing and Settlement System Corporate Finance Adviser Code of Conduct Collective investment scheme Companies Ordinance Code of Conduct for Persons Licensed by or ed with the Securities and Futures Commission T Continuous professional training GDII Guidelines on Disclosure of Inside Information GEM Growth Enterprise Market GEM Listing Rules /GLR Rules Governing the Listing of Securities on the Growth Enterprise Market (“GEM”) of The Stock Exchange of Hong Kong Limited HDR Hong Kong Depositary Receipt HKEx Hong Kong Exchanges and Clearing Limited HKMA Hong Kong Monetary Authority HKSCC Hong Kong Securities Clearing Company Limited ICG Management, Supervision and Internal Control Guidelines for Persons Licensed by or ed with the Securities and Futures Commission INED Independent non-executive director IPO Initial public offering JORC Code The Australasian Code for Reporting of Exploration Results, Mineral Resources and Ore Reserves published by the t Ore Reserves Committee KYC Know your client Listing Rules /LR Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited Main Board Main Board of the SEHK MD&A Management Discussion and Analysis of Financial Information and Condition MMT Market Misconduct Tribunal Model Code Model Code for Securities Transactions by Directors of Listed Issuers PBO Prevention of Bribery Ordinance PDIE Pre-deal investor education PHIP Post Hearing Information Pack PRC People’s Republic of China PRC issuers Issuers from the People’s Republic of China other than the regions of Hong Kong, Macau and Taiwan PRC properties Properties located in mainland China SAMREC Code The South African Code for the Reporting of Exploration Results, Mineral Resources and Mineral Reserves SEHK The Stock Exchange of Hong Kong Limited SFC Securities and Futures Commission SFO Securities and Futures Ordinance SMLR Securities and Futures (Stock Market Listing) Rules Sponsor Guidelines Additional Fit and Proper Guidelines for Corporations and Authorized Financial Institutions applying or continuing to act as Sponsors and Compliance Advisers US United States US GAAP Generally Accepted ing Principles in the United States of Papers 15 & 16 Version 1.0

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Abbreviations

VDR

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America Virtual data room

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