1.1 - Objective - Hong Kong Sponsor Due Diligence Guidelines

March 2016

Chapter 1.2 – Nature of the Due Diligence Guidelines

Chapter 1

Due Diligence Guidelines –

Introduction

1. Objective

These due diligence guidelines have been developed as an initiative of Hong Kong sponsors for the purpose of promoting standards in the conduct of due diligence in respect of Hong Kong listings of equity securities1 with a view to maintaining the integrity of the Hong Kong market and, in particular, to assuring the quality of information disclosed in listing documents.

1 In some cases a listing will involve equity interests other than shares, for example a REIT. Where a listing agent is appointed for a listing of units in a REIT, the provisions of Paragraph 17 of the Code of Conduct apply to the listing agent by virtue of footnote 2 to Paragraph 17 of the Code of Conduct.

Disclaimer

HKCFEF Limited and the contributing law firms, accountants and sponsors are not offering these due diligence guidelines as legal, financial or professional advice or services and they should not be relied upon as such. These due diligence guidelines should not be used as a sole basis for any decision, action or inaction and are not meant to serve as a substitute for the advice of qualified professionals. See here for the full terms and conditions.

Table of Contents

March 2016

Chapter 1.2 – Nature of the Due Diligence Guidelines

None

Table of contents

Preface
Glossary

1 – Introduction

1.1 – Objective of Due Diligence Guidelines
1.2 – Nature of the Due Diligence Guidelines
1.3 – Approach Adopted by the Due Diligence Guidelines
1.4 – Structure of the Due Diligence Guidelines

2 – General Principles

2.1 – The Scope and Purpose of Due Diligence
2.2 – The Principal Responsibility for Accuracy and Completeness of the Listing Document
2.3 – Approach
2.4 – Materiality
2.5 – Verification
2.6 – Primary Role of the Sponsor and its Advisers for the Conduct of Due Diligence
2.7 – Reasonable Reliance on Third Parties and Experts
2.8 – The Desirability of Direct Third Party Confirmations
2.9 – When Due Diligence is Complete
2.10 – The Basis for the Subsequent Assessment of Due Diligence

3 – Approach and Scope

3.1 – Reasonable Judgement
3.2 – Stock Exchange Listing Rules
3.3 – Standards

4 – Submission Readiness

4.1 – Reasonable Due Diligence
4.2 – Completeness of Information in an Application Proof
4.3 – Resolving Fundamental Compliance Issues
4.4 – Identifying Material Issues

5 – Disclosure to the Market

5.1 – Overall Disclosure
5.2 – Disclosure: Non-Expert Sections
5.3 – Disclosure: Expert Sections

6 – Verification Practice

6.1 – Appropriate Verification
6.2 – Verification of Material Information
6.3 – Verification and Independent Due Diligence Steps for Material Matters

7 – Knowing the Listing Applicant and its Management

7.1 – Due Diligence on Directors and Key Senior Management
7.2 – Due Diligence on Major Business Stakeholders
7.3 – Appendix I
7.4 – Appendix II – Recommended Topics to be Covered in Directors’ Training

8 – Business Model

8.1 – Business Model – General
8.2 – The Listing Applicant’s Operating Environment
8.3 – Due Diligence on a Listing Applicant’s Industry
8.4 – Sustainability
8.5 – Reliance
8.6 – Illegality and compliance of the business operations
8.7 – Trends and Patterns
8.8 – Changes Affecting the Business Model
8.9 – Regulatory Guidance on Specific Industries
8.10 – Appendix I – Examples of Questions Raised by Regulators in the Past to Test Business Sustainability

9 – Interviews of Major Business Stakeholders

9.1 – Overview
9.2 – Selection of Interviewees
9.3 – Interview Timing and Preparation
9.4 – Arranging and Conducting Interviews
9.5 – Establishing the Identity and Authority of Interviewees
9.6 – The Interview and Follow-up
9.7 – Irregularities During Interviews
9.8 – Records of Interviews
9.9 – Appendix I

10 – Controlling Shareholders’ Relationship with the Listing Applicant

10.1 – Understanding Controlling Shareholder(s)
10.2 – Independence, Delineation and Competition Issues
10.3 – Disclosure in Listing Document
10.4 – Other Relevant Due Diligence Guidelines

11 – Connected Persons and Connected Transactions

11.1 – Introduction
11.2 – Identifying the Listing Applicant’s Connected Persons and Connected Transactions
11.3 – Sponsor’s Confirmation in relation to Continuing Connected Transactions for which a Waiver is Sought
11.4 – Reliance on Connected Persons
11.5 – Other Relevant Due Diligence Guidelines
11.6 – Appendix I – Listing Decisions Published by the Stock Exchange

12 – Financial

12.1 – Scope and Key Interdependencies
12.2 – Overview
12.3 – Financial Content of the Listing Document
12.4 – Financial Review Process (Overview)
12.5 – Detailed Financial Review Process
12.6 – Underlying Financial Statements
12.7 – Accounting Review Process
12.8 – Audit Review Process
12.9 – Management Discussion & Analysis
12.10 – Unaudited Financial Content
12.11 – Changes Subsequent to Latest Balance Sheet Date
12.12 – “Red Flags” and Similar Irregularities
12.13 – Modeling
12.14 – Forecasts and Projections
12.15 – Tax
12.16 – Timing and “Bring-Down”
12.17 – Records
12.18 – Quantitative Qualifications for Listing
12.19 – Appendix I – Common Categories of Discussion Topics
12.20 – Appendix II – Tax Discussion Points and Sample Tax Questions for the Reporting Accountant and Tax Advisers

13 – Internal Controls

13.1 – Understanding a Listing Applicant’s Procedures and Systems
13.2 – Scope of Work
13.3 – Appointment of Internal Controls Consultant
13.4 – Advice and Guidance to Listing Applicant to Remedy Material Deficiencies
13.5 – Timing of Internal Controls Due Diligence
13.6 – Steps to be Taken When Material Deficiencies Remain Outstanding

14 – Distributors, Franchisees and Consignees

14 – Understanding a Listing Applicant and its Business, Performance, Financial Condition and Prospects

15 – Anti-Corruption, Anti-Money Laundering and Sanctions

15.1 – Acquire a Thorough Understanding of the Listing Applicant and Assess the Legality and Compliance of its Business Operations
15.2 – Performance of Anti-Corruption, Anti-Money Laundering and Sanctions Due Diligence

16 – Material Contracts

16.1 – Understanding the Listing Applicant
16.2 – Ensuring Compliance with Listing Qualifications
16.3 – Assessing Any Potential Non-Compliance with Legal and Regulatory Requirements

17 – Legal and Regulatory Compliance and Legal Proceedings and Disputes

17.1 – Legality and Compliance of Business Operations
17.2 – Dealing with Material Non-Compliance
17.3 – Material Legal Proceedings and Disputes
17.4 – Appendix I

18 – Interaction with Third Parties including Expert Advisers

18.1 – Seeking Assistance and Reasonable Reliance
18.2 – Qualifications and Competencies
18.3 – Expert Resources
18.4 – Independence
18.5 – Third Parties Scope of Work
18.6 – Third Parties Bases and Assumptions
18.7 – Consistency and Sufficiency of the Work Results
18.8 – Guidance
18.9 – Appendix I – Sample Questions for Third Parties Including Expert Advisers

19 – Foreign Lawyers

19.1 – Engagement of Foreign Lawyers
19.2 – Understanding of Business, History and Background
19.3 – Reliance on Legal Opinions and Advice
19.4 – US “10b-5” Letters
19.5 – Appendix I – Foreign Lawyers

20 – Accountants

20.1 – Standard for Due Diligence on Accountants
20.2 – Qualification and Experience of Accountants
20.3 – Work Scope of Accountants
20.4 – Bases and Assumptions
20.5 – Review of the Accountant’s Report
20.6 – Interviews with Accountants
20.7 – Special Circumstances
20.8 – Appendix I – Accountants
20.9 – Appendix II – Accountants

21 – Inspection of Assets and Property Valuers’ Reports

21.1 – Inspection of Assets
21.2 – Property Valuers’ Reports

22 – Environmental

22.1 – Introduction – Environmental Due Diligence
22.2 – The EDD Process
22.3 – Review of Results, Rectification and Disclosure
22.4 – Appendix I – Environmental Due Diligence

23 – Mineral Companies

23.1 – Introduction – Mineral Companies
23.2 – Qualifications for Listing – Mineral Companies
23.3 – Management Experience and Listing Rule 18.04 Waiver of Listing Rule 8.05 Tests
23.4 – Qualifications of a Competent Person
23.5 – Competent Person’s Report
23.6 – Reporting Standards
23.7 – Financial: Cash Costs, Working Capital, Commodity Prices and Path to Profitability
23.8 – Title to Mineral Rights
23.9 – Environmental Issues
23.10 – Compliance with Laws
23.11 – Community Relations
23.12 – Project Development
23.13 – Workflow/Production
23.14 – Transportation and Logistics
23.15 – Sales and Marketing
23.16 – Infrastructure/Utilities
23.17 – Labour Issues and Health and Safety
23.18 – Outsourcing of EPC, Mining and Processing
23.19 – Insurance
23.20 – Risks

24 – Biological Assets

24.1 – Introduction – Biological Assets
24.2 – Independent Valuation Of Biological Assets
24.3 – Experience of Valuer, Scope of Work and Bases and Assumptions
24.4 – Physical Existence, Condition/Development Status, Quantity and Valuation
24.5 – Validity and Accuracy of Licences/ Rights/ Permits
24.6 – Verification of Actual Operations and Consistency and Compliance with Licences/ Rights/ Permits and Records
24.7 – Appendix I – List of Hong Kong Main Board IPOs of Companies Involved in Agricultural Activities/ Biological Assets 2008-2012
24.8 – Appendix II – Examples of Factors for Consideration for Biological Assets
24.9 – Appendix III – Useful Industry Publications

25 – Record Keeping

25.1 – Record Keeping In General
25.2 – Documenting Transaction Team Composition
25.3 – Documenting Due Diligence
25.4 – Documenting Expert Engagements
25.5 – Documenting Bases for Opinions, Assurances and Conclusions under Paragraphs 17.3 – 17.5 and 17.7 of the Code of Conduct
25.6 – Documenting the Consideration of Key Issues arising from Due Diligence and the Elevation of Critical Matters to Key Senior Management
25.7 – Retention Of Records

26 – Sponsor Appointment, Fees, Staffing and Controls

26.1 – Sponsor Appointment
26.2 – Sponsor Fees
26.3 – Sponsor Staffing
26.4 – Sponsor Controls
26.5 – Appendix I – Sample Provisions Suggested to be Included in a Sponsor’s Engagement Letter

27 – Expectations of the Listing Applicant and its Directors during the Listing Application Process

27.1 – Introduction – Expectations of Listing Applicant
27.2 – Standards
27.3 – Guidance

28 – Overall Management of a Public Offer

28.1 – Overall Management and Delegation of Responsibilities
28.2 – Sufficient Arrangements and Resources
28.3 – Appendix I – Mixed Media Offer

29 – Communications with Regulators

29.1 – Introduction
29.2 – SFC’s Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (Code of Conduct)
29.3 – SFC’s Corporate Finance Adviser Code of Conduct (the CFA Code)
29.4 – Rules Governing the Listing of Securities on the Stock Exchange of Hong Kong Limited (The Listing Rules)
29.5 – Appendix 1 – Hyperlinks

30 – Provision of Information to Analysts

30.1 – Information Provided to Analysts in New Listings
30.2 – Appendix I – Recommended Addenda
30.3 – Addendum 1: Analysts’ Dos and Don’ts
30.4 – Addendum 2: Instructions to Research Analysts on Providing Notice to Issuers
30.5 – Addendum 3: Suggested Rider for (a) Presentation Materials for Kick-off Meeting and (b) Hong Kong Publicity Memorandum
30.6 – Addendum 4: Standard Form Research Report Guidelines
30.7 – Addendum 5: Form of Memorandum from Sponsor to Issuer
30.8 – Addendum 6: Suggested Text of Email or other Written Reminder for Issuer’s Counsel
30.9 – Addendum 7: Suggested Insert for Directors’ Training Presentation
30.10 – Addendum 8: Suggested Rider for Invitation to Analysts’ Presentation
30.11 – Addendum 9: Form of Letter to be Signed by Syndicate Members (for exceptional situations)
30.12 – Addendum 10: Suggested Text of Email or other Written Reminder to Underwriters’ Counsel Regarding Review of Research Reports
30.13 – Addendum 11: Suggested Riders regarding the Issuer’s Confirmation to be Included in the International Underwriting Agreement
30.14 – Addendum 12: Suggested Rider for Agreement Among Underwriters

31 – Dealing with “Material Deficiencies” of the Listing Applicant

31.1 – Advice on Material Deficiencies
31.2 – Disclosure of Material Deficiencies

32 – Escalation of Critical Matters

32 – Escalation of Critical Matters to Management