Hong Kong has become one of the world's leading destinations for initial public offerings and has recently experienced record years in terms of the number of listings and overall deal value. The Hong Kong market has also experienced an increasing number of problematic situations involving recently listed companies that have prompted initiatives toward regulatory reform. One area of concern for Hong Kong regulatory authorities has been the quality of listed issuers and the vetting process undertaken by IPO sponsors during the listing process. Following on the heels of a report issued in March 2011 by the Securities and Futures Commission of Hong Kong (the "SFC") that focused on deficiencies found in the work performed by sponsors in the listing process, the SFC published a two month1 consultation paper on May 9, 2012 (the "Consultation Paper") containing proposals to enhance the regulation of sponsors in Hong Kong that emphasize improving the quality of due diligence performed by sponsors.
Key proposals in the Consultation Paper include:
- clarifying that sponsors have civil and criminal liability for
untrue statements (including material omissions) in a
- requiring the draft prospectus accompanying the listing
application submission (the "Form A1 Submission") to be
published on the website of the Hong Kong Exchanges and Clearing
Limited (the "HKEx");
- limiting the number of sponsors for each listing to as low as
one and requiring each sponsor to be independent;
- requiring sponsors to complete the vast majority of due
diligence prior to the Form A1 Submission;
- requiring sponsors to report any material information
concerning non-compliance with applicable legal or regulatory
requirements by the listing applicant; and
- requiring sponsors to be able to demonstrate, at the time of
issue of the prospectus, that it is reasonable for the sponsor to
rely on the expert sections of the prospectus.
In addition to clarifying the liability regime in the Companies Ordinance of Hong Kong (Cap 32) (the "Companies Ordinance"), the other proposals would consolidate all existing and newly proposed sponsor obligations into the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (the "Code of Conduct"). The Consultation Paper indicates that the SFC plans to implement the amendments to the Code of Conduct as soon as practicable although no definitive timetable has been announced, but that the implementation of the proposals dealing with sponsor liability will be subject to further consultation and the legislative process.
Sponsor liability for untrue statements (including material omissions) in a prospectus
Sections 40 and 40A of the Companies Ordinance impose civil and criminal liability for untrue statements (including material omissions) in a prospectus on the following four groups of persons: (i) each director of the listing applicant at the time of issue of the prospectus; (ii) each individual who has authorized himself or herself to be named as a director in the prospectus or as having agreed to become a director; (iii) any promoter of the listing applicant; and (iv) each person that has authorized the issue of the prospectus. The Consultation Paper notes that although it has been argued that sponsors fall within the category of persons having authorized the issue of the prospectus, there is no Hong Kong case law to support this argument. The Consultation Paper proposes to clarify the Companies Ordinance to include sponsors within the group of persons that may be subject to potential civil and criminal liability. If implemented, these proposals would establish a framework in which sponsors could be subject to potential legal action from public shareholders, prosecution by the Hong Kong Department of Justice, and investigations and remedial orders by the SFC. The SFC believes that subjecting sponsors to this liability regime should "further encourage sponsors to prepare and review disclosures in a prospectus critically so as to provide a high level of assurance that the information disclosed is accurate, relevant, concise and meaningful for investors," thereby furthering the protection of investors.
Publication of the prospectus accompanying the Form A1 Submission
Under the current framework, until finalized and publicly issued all submissions of the prospectus to the Stock Exchange of Hong Kong Limited (the "HKSE") and the SFC are made on a confidential basis, other than the publication of the WPIP2 immediately prior to the start of the roadshow. In an effort to improve the quality and completeness of listing applications, the Consultation Paper includes proposals to require the draft prospectus accompanying the Form A1 Submission to be published on the website of the HKEx. The Consultation Paper is silent as to whether there is any expectation that the written comments and responses exchanged between the regulators and the listing applicant and subsequent amendments to the prospectus would also need to be published on the HKEx's website.
Limiting the number of sponsors in an IPO
There is currently no limitation on the number of sponsors a listing applicant can appoint to shepherd it through the IPO process, although at least one needs to be independent from the listing applicant. The SFC is concerned that the practice of appointing multiple sponsors has affected the standard of sponsors' work. Where an independent sponsor has been appointed in order to meet the independence requirements, the SFC is further concerned that the non-independent sponsor nonetheless leads the sponsor process, thereby undermining the purpose of the independence requirements. To address these concerns, the SFC is proposing to permit listing applicants to appoint only one sponsor that must be independent. Alternatively, the SFC may consider permitting multiple sponsors, all of which would have to be independent. If approved, this proposal could have significant implications for sponsors.
Completing all reasonable due diligence before the Form A1 Submission
Under the current Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited (the "Listing Rules"), listing applicants are required to include an advanced proof of the prospectus in the Form A1 Submission. The HKSE expects this advanced proof to be substantially complete and compliant with the Listing Rules. In addition, at the time of issue of the prospectus, which is often many months after the Form A1 Submission, sponsors are required to make a declaration to the HKSE supported by reasonable due diligence that, among other things, the listing applicant is qualified for listing and the non-expert sections of the prospectus are truthful and complete. The SFC believes that the timing of this declaration may have unintentionally led to instances of sponsors not completing all reasonable due diligence prior to the Form A1 Submission, resulting in important issues arising after the Form A1 Submission. To address this, the Consultation Paper expresses a view that sponsors should not make the Form A1 Submission until the listing applicant is ready for listing and proposes to amend the Code of Conduct to require sponsors to complete all reasonable due diligence prior to the Form A1 Submission (other than due diligence that can only be conducted at a later date such as when there are subsequent transactions or developments involving the listing applicant). For those sponsors not already in the practice of completing all reasonable due diligence prior to the Form A1 Submission, this proposal serves to clarify the SFC's expectations and any ambiguity about the obligations of all sponsors.
Reporting any material information concerning non-compliance with applicable legal or regulatory requirements by the listing applicant
The Consultation Paper includes proposals to require sponsors to report any material information concerning non-compliance with the Listing Rules or other applicable legal or regulatory requirements by the listing applicant to the HKSE as soon as sponsors become aware of such information. Currently, when sponsors become aware of any instances of non-compliance they are only obligated to encourage the listing applicant to report the matter to the HKSE. The obligation of sponsors to inform the regulators only arises when the regulators request information from sponsors.3 In addition, where sponsors cease to act for a listing applicant, sponsors will be required to inform the HKSE of the reasons for ceasing to act. This proposal is intended to avoid instances of non-compliance by listing applicants going unchecked.
Demonstrating reasonable reliance on the expert sections of the prospectus
Unlike the declaration that sponsors are required to make on the non-expert sections of the prospectus, sponsors are not required to give a confirmation to the HKSE that the information in the expert sections (e.g., the accountants' report and the property valuer report) are truthful and complete. Rather, the Listing Rules require sponsors to diligence the qualifications and experience of the experts, the assumptions made by the experts, and the accuracy of factual information relied on by the experts. Given the significant importance of expert sections, the SFC's proposals intend to heighten the standard by which sponsors should vet expert sections of the prospectus. Drawing from standards found in defenses afforded to underwriters in Australia and the United States, the proposals would require sponsors to be able to demonstrate that they reasonably relied on the expert sections of the prospectus. For instance, the SFC notes that sponsors cannot blindly rely on expert sections and that, when facts emerge that call into question the reliability of expert sections, further investigation is warranted.
The Consultation Paper also includes a number of clarifications of existing sponsor requirements, standards and obligations, such as:
- independent due diligence – among other
independent due diligence steps, sponsors are expected to obtain
and review underlying records of the listing applicant, such as tax
certificates, bank statements and contracts, conduct site visits,
interview major stakeholders and obtain information outside the
listing applicant, such as searching public filings and databases,
obtaining third-party confirmations and hiring external agents to
assist in due diligence;
- interview practices – the sponsor is
expected to identify and interview major business stakeholders,
such as customers, suppliers, creditors and bankers, with minimal
involvement from the listing applicant;
- over-delegation of due diligence – sponsors
cannot delegate their due diligence responsibilities to third
parties and remain responsible for the overall due diligence
exercise (i.e., due diligence work undertaken by third parties,
such as lawyers or consultants, is not itself sufficient evidence
that sponsors conducted reasonable due diligence);
- record keeping – sponsors are expected to
maintain records of their due diligence work, including a due
diligence plan, a record of significant issues, the bases for
opinions and conclusions, and the involvement of management in the
process, and sponsors are expected to retain a complete set of such
records in Hong Kong for at least seven years after completion of
the transaction; and
- disclosure of all material issues with Form A1
Submission – the sponsor should ensure that the Form
A1 Submission discloses all material issues known to it which, in
its reasonable opinion, are necessary for the consideration of
whether the applicant is suitable for listing and whether the
listing is contrary to the interests of public investors or the
1. The SFC is accepting comments to questions posed in the Consultation Paper through July 6, 2012.
2. The Web Proof Information Pack, commonly referred to as the "WPIP", is an abbreviated version of the prospectus which omits any disclosure relating to the offering to avoid any implication that it is a prospectus. The WPIP is published on the website of the HKEx prior to the commencement of the roadshow for the purpose of ensuring the equal dissemination of information to potential investors that are unable to attend or view the roadshow. The Consultation Paper seems to suggest that, like the WPIP, the published version of the prospectus accompanying the Form A1 Submission would similarly exclude information relating to the offering.
3 It is important to note, however, that the Listing Rules require sponsors who become aware of information that casts doubt on the truth, accuracy or completeness of information previously provided to the HKSE by a listing applicant to inform the HKSE of such information, which could include legal and regulatory non-compliance issues.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.