Chapter 12

Due Diligence Guidelines –

Financial

11. Changes Subsequent to Latest Balance Sheet Date

11.1 Standards

11.1.1 Regarding the preparation of a listing document, a sponsor should assess whether there has been any material change since the date of the last audited balance sheet, including any matter that might impact upon the listing applicant’s business model, performance, prospects or financial condition. [Paragraph 17.6(d)(viii) of the Code of Conduct]

11.1.2 Paragraph 38 of Part A of Appendix 1 to the Listing Rules requires the inclusion in the listing document of a statement by the directors of any material adverse change in the financial or trading position of the group since the end of the period reported on in the accountants’ report, or an appropriate negative statement.

11.1.3 This statement/confirmation is required to be made up to and as of the date of publication of the listing document. [Exchange Guidance Letter GL38-12]

11.1.4 Paragraph 13(c) of Practice Note 21 provides that typical due diligence inquiries in respect of each new applicant and the preparation of its listing document and supporting information include assessing whether there has been any change since the date of the last audited balance sheet included in the listing document that would require disclosure to ensure the listing document is complete and not misleading.

11.1.5 Paragraph 34(1) of Part A of Appendix 1 to the Listing Rules requires the inclusion of the following information in a listing document:

(a) general information on the trend of the business of the group since the date to which the latest audited accounts of the listing applicant were made up;

(b) a statement as to the financial and trading prospects of the group for at least the current financial year, together with any material information which may be relevant thereto, including all special trade factors or risks (if any) which are not mentioned elsewhere in the listing document and which are unlikely to be known or anticipated by the general public, and which could materially affect the profits; and

(c) the state of the group’s order book (where applicable) and prospects for new business including new products and services introduced or announced.

11.2 Guidance

11.2.1 The Listing Rules require a listing document to include a statement as to the financial and trading prospects of the group for at least the current financial year, together with any material information which may be relevant to them. This is forward looking information considered by the Stock Exchange to be necessary to assist investors to make a fully informed decision on the listing applicant (and on the securities for which listing is sought).

11.2.2 Inclusion of a profit forecast in a listing document helps potential investors to assess the applicant’s likely future financial performance and to compare it with the trend presented in the historical financial information of the trading record period. [Exchange Guidance Letter GL41-12 at paragraph 2.3]

11.2.3 The “no material change” statement (and any related discussion) contained in the listing document, is a further part of the information relevant in this context.

11.2.4 Inclusion of a profit forecast is not mandatory under the Listing Rules, and in more recent times there has been an increasingly common trend not to include a profit forecast.

11.2.5 Where an applicant decides not to include a profit forecast in its listing document, the Stock Exchange has emphasised its expectation that there should be sufficient information in the IPO listing document on (i) any material changes after the trading record period and (ii) the applicant’s future prospects. [Exchange Guidance Letter GL41-12 at paragraph 2.2]

11.2.6 The Stock Exchange normally expects qualitative and quantitative disclosure to be made in the Summary and other relevant sections of the listing document to give significant highlights to investors. The disclosure must enable investors to have a sense of materiality of the adverse changes.[Exchange Guidance Letter GL41-12 at paragraph 4.3 and Attachment 1 to Exchange Guidance Letter GL27-12]

11.2.7 In case of deterioration of financial performance of the listing applicant, the Stock Exchange expects disclosure in the listing document of selected figures of updated key operating data (e.g., sales volume, average selling price, production volume, etc.). [Exchange Guidance Letter GL41-12 at paragraph 4.3]

11.2.8 The Stock Exchange has emphasised that the necessity to disclose adverse changes is not negated by mitigating factors which reduce the potential impact of financial or operational loss to the listing applicant. The adverse changes should be highlighted in the “Risk Factors” and “Financial Information” sections of the listing document. [Exchange Guidance Letter GL41-12 at paragraph 4.4]

11.2.9 The Stock Exchange has stated that the sponsor should assess whether there is any adverse change which has taken place or is expected to take place in the near future, in the technological, market, economic, legal or operating environment in which the applicant operates. [Exchange Guidance Letter GL41-12 at paragraph 4.2]

11.2.10 The SFC has highlighted instances of failure to disclose significant changes in the cost structure of listing applicants. [See SFC Dual Filing Update of August 2011]

11.2.11 Reference should be made to prevailing regulatory guidance for any specifically identified / mandated disclosure requirements. [See Exchange Guidance Letter GL41-12]

11.3 Steps to be Taken in Connection with the “No Material Change” Statement

11.3.1 The steps the sponsor should take in connection with the “no material change” statement (and any related discussion) typically comprise:

(a) The work undertaken in connection with the working capital statement and any profit forecast (see section 14 below “Forecasts and Projections”);

(b) Review and discussion of any unaudited interim financial statements included in the listing document (see section 10.2.5 above);

(c) Wherever possible, engaging the Reporting Accountant to perform procedures for providing “comfort” on the listing applicant’s financial condition and performance in the “change period” subsequent to the date to which the latest audited financial statements are prepared, preferably (and wherever possible according to the Reporting Accountant’s applicable professional reporting standard) by way of negative assurance (see Hong Kong Standard on Investment Circular Reporting Engagements 400 “Comfort Letters and Due Diligence Meetings” issued by the Hong Kong Institute of Certified Public Accountants (and related Technical Bulletin – AATB 3);

(d) Obtaining copies of, and reviewing, the same management information; and

(e) Detailed discussion with the listing applicant’s management as part of the sponsor’s overall financial review (see paragraph 5.2.4 above and item 15 of the Common Categories of Discussion Topics in Appendix I (“Detailed Financial Review – Discuss developments and any changes since last audited balance sheet date”) and, in particular, supplementary discussion on areas of material significance to the particular listing applicant.

11.3.2 Settling procedures with respect to subsequent changes requires careful consideration of what line items are important in context of the listing applicant’s business and its particular financial statements. It also requires an understanding of what management information will be available to the Reporting Accountant for periods beyond the date of the last audited balance sheet.

11.3.3 In agreeing the appropriate terms and scope of the Reporting Accountant’s comfort letter, the sponsor should normally consider the following questions to discuss with the Reporting Accountant:

(a) Available information: do the management accounts provide a basis on which the Reporting Accountant can provide negative assurance comfort?

(b) Key indicators to review: what are the best available indicators of any deterioration in business or other problems (e.g., sales / short term and long term debt / net current assets / total net assets)?

(c) Significant changes: are there any other line items for which changes could be significant (e.g., cash / receivables / accounts payable / deposits / inventory / gross margins)?

(d) Comparison periods: what are the most suitable comparison periods for key indicators to be reviewed?

(e) What are the procedural constraints on the exercise which limit examination of any key indicators? What more could be done, how long would it take and at what cost?

11.3.4 All of these questions should be discussed with the Reporting Accountant early in the execution process, in conjunction with the discussion on content of the Accountants’ Report and overall presentation of the listing applicant’s financial statements. See section 3.5 above (“Financial Content of the Listing Document – Guidance on Core Historical Financial Content, and Recommended Steps”).

11.3.5 Audit / auditor due diligence is the subject of a separate chapter (Chapter 20 “Due Diligence Guidelines – Accountants”), and detailed reference should be made to that Chapter.

11.4 Steps to be Taken in Considering any Appropriate Listing Document Disclosure

11.4.1 Focused discussion should be held with the listing applicant’s management, and updated / repeated so as to be valid up to the latest practicable time prior to publication of the listing document.

11.4.2 The discussion should always address:

(a) the effect of any significant change recently occurred or expected to take place in the revenue model or cost structure of the listing applicant; and

(b) the question of whether there is any adverse change which has taken place or is expected to take place in the near future, in the technological, market, economic, legal or operating environment in which the listing applicant operates.

11.4.3 See paragraphs 5.2.4 and 5.2.5 above (“Detailed Financial Review Process – Recommended Steps”) and items 15 and 16 of the Common Categories of Discussion Topics in Appendix I (“Detailed Financial Review – Discuss developments and any changes since last audited balance sheet date / Discuss prospects”) with respect to recommended discussions on Developments and any Changes Since last Audited Balance Sheet Date and on Prospects.

11.4.4 Listing document disclosure should be evaluated against any indicators of deterioration in performance.

11.4.5 Reference should be made to prevailing regulatory guidance for any specifically identified / mandated disclosure requirements. [See Exchange Guidance Letter GL41-12]

11.4.6 Exchange Guidance Letter GL41-12 contains a non-exhaustive list of examples of disclosure required in case of any material adverse changes in various stipulated categories of financial, trading and operating metrics (or environment).

11.4.7 See also section 16 below (“Timing and Bring-down”).