Due Diligence Guidelines –
Dealing with “Material Deficiencies” of the Listing Applicant
2. Disclosure of Material Deficiencies
Where these material deficiencies cannot be remedied prior to the submission of a listing application, a sponsor should make adequate disclosure as part of its submission of the listing application, including the nature of these deficiencies, reasons for non-rectification and remedial actions taken or to be taken. [Paragraph 17.3(b)(iii) of the Code of Conduct]
2.2.1 Where the deficiencies cannot be remedied prior to the filing of the listing application, the sponsor should include adequate disclosure in the listing application, including the nature of the deficiencies, reasons for non-rectification and remedial actions taken or to be taken. The sponsor should explain why it believes that the listing applicant is still suitable for listing despite any material deficiencies that cannot be remedied prior to listing and, where appropriate, seek guidance from the regulators.10
2.3 Recommended Steps
2.3.1 Where it is not practicable to remedy material deficiencies prior to the submission of the listing application, the sponsor should disclose details of the relevant material deficiencies as part of the listing application submission, including:
(a) details of the nature of the deficiencies;11
(b) reasons for the non-rectification of the deficiencies identified prior to the submission of the listing application; and
(c) the remedial actions to be taken by the listing applicant to address the material deficiencies.
2.3.2 The sponsor may also consider including, where relevant, disclosure of the potential financial and operational impact of the material deficiencies on the listing applicant.
2.3.3 The sponsor should also explain why it believes that the listing applicant is still suitable for listing despite any material deficiencies that cannot be remedied prior to listing.12
2.3.4 Where there have been non-compliance incidents, the Stock Exchange expects different disclosure in the listing document depending on the categorisation of the non-compliances. The disclosure should be in the form of a table or plain text (whichever presents the issue in a more comprehensible manner).13 No disclosure is required for Immaterial Non-compliance.
2.3.5 For Material Impact Non-compliances, the Stock Exchange expects the following to be disclosed in the listing document:14
(a) reasons for the non-compliance incidents, the nature and extent of the breaches, corresponding risk factors, the identity and position of the directors and senior management involved in the non-compliance incidents;15
(b) whether the listing applicant has been or will be charged or penalised for the non-compliance incidents during the track record period and up to the latest practicable date, with confirmation from the competent authorities.16 Legal opinions should be obtained to confirm the competence of the relevant authorities. Where there are penalties, the actual or maximum penalty (including the amounts) should be disclosed and whether the listing applicant has made provision for this, or if not, the reasons for not making provision. The disclosure should also include the potential operational and financial impact on the listing applicant;
(c) enhanced internal controls to prevent their recurrence (including the identity, position, qualifications and experience of the personnel who are responsible for ensuring the compliances). In the event an independent internal control expert has been separately engaged to review the internal controls,i the listing document should include the identity of and the salient terms of engagement of an internal control expert and its findings and recommendations, and the listing applicant’s timing of implementation of any recommendation of the internal control expert (and the internal control expert’s follow-up review, if any);
(d) how and when the rectification actions were or will be taken; and
(e) the views of the directors and the sponsor, with bases for such views, on whether the listing applicant’s enhanced internal control measures are adequate and effective under Listing Rule 3A.15(5), the suitability of the directors under Listing Rules 3.08 and 3.09 and the listing applicant’s suitability for listing under Listing Rule 8.04.17
2.3.6 As noted in paragraph 1.3.9 above, the Stock Exchange normally expects the rectification of all Material Impact Non-compliances to be completed before listing. Where the Stock Exchange accepts that rectification can be carried out within a short time following listing, the listing document should include disclosure of a legal adviser’s view, with the basis for such view, whether there is any impediment to rectify the non-compliance, and a statement that the listing applicant will disclose progress of the rectification in the interim/annual reports and detailed explanation for any delay in rectification.
2.3.7 For Systemic Non-compliances, the Stock Exchange expects the following to be disclosed in the listing document:
(a) the views of the directors and the sponsor, with bases for such views, on whether the listing applicant’s internal control measures are adequate and effective under Listing Rule 3A.15(5), the suitability of the directors under Listing Rules 3.08 and 3.09, and the listing applicant’s suitability for listing under Listing Rule 8.04; and
(b) the disclosures set out in paragraphs 2.3.5 (a) to (c) above, to the extent necessary to enable investors to make an informed assessment of the listing applicant.18
2.3.8 Material Impact Non-compliances and Systemic Non-compliance should be highlighted in the “Summary and Highlights” section of the listing applicant’s listing document.19
2.3.9 Where appropriate, the sponsor should seek guidance from the regulators.20
2.3.10 Sponsors should also refer to Chapter 17 “Due Diligence Guidelines – Legal and Regulatory Compliance and Legal Proceedings and Disputes”.
11. Sponsors should note paragraph 22(iii) of . In this decision relating to a company with non-compliance incidents, one of the factors taken into account by the Stock Exchange in rejecting the listing application was the failure of the listing applicant to include sufficient disclosure in the listing document of rectification measures and internal controls which were aligned to the non-compliance incidents.
17. There have been instances where the Stock Exchange has cited a failure to include the views of the directors and sponsor in the listing document where there have been material non-compliance incidents among the reasons for rejecting a listing application (for instance Company A referred to in ).
i If the internal control expert is the reporting accountant or another accounting firm, the relevant guidelines and practices of the accounting profession position an internal controls review as private advice to the directors of the applicant (and if they are party to the engagement, the sponsors). Accordingly, in such circumstances the name of the reporting accountant or other accounting firm and details of their work and findings may be prevented from being quoted or referenced in the listing document. One circumstance in which internal controls work may be referenced in the listing document is where it is practicable for the applicant and the sponsor to additionally and separately engage the reporting accountant or other accounting firm to also perform an assurance engagement in relation to internal controls. (Footnote 2 to Exchange Guidance Letter GL63-13)
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.