Chapter 16

Due Diligence Guidelines –

Material Contracts

2. Ensuring Compliance with Listing Qualifications

2.1 Standard

Before submitting an application on behalf of a listing applicant to the Stock Exchange a sponsor should come to a reasonable opinion that: …the listing applicant is in compliance with all relevant listing qualifications under Chapter 8 of the Listing Rules (except to the extent that waivers from compliance with those requirements have been applied for to the Stock Exchange in writing) [(the “Listing Qualifications”)]. [Paragraph 17.4(c)(i) of the Code of Conduct]

2.2 Recommended Steps

2.2.1 In reviewing the material contracts entered into by the Group, the sponsor must identify and note any non-compliance with the Listing Qualifications arising from the material contracts.

2.2.2 When reviewing the material contracts, the sponsor should consider the following:


Explanatory notes

Does any material contract reveal a miscalculation of the parameters for the profit test, the market capitalisation/revenue/cash flow test, or the market capitalisation/revenue test (the “Qualifications Tests”)?10 See also Chapter 12 “Due Diligence Guidelines – Financial”.

The sponsor should ascertain whether any balance sheet or income statement line items (e.g., revenue, profit, cash flow) derived outside the ordinary course of the listing applicant’s business have been included (which should not otherwise have been included) in the parameters for performing the Qualifications Tests.

For instance, certain revenue arising from a material contract should be excluded from being classified as “revenue” to perform the Qualifications Tests because such revenue arose outside the ordinary course of business of the listing applicant.

The determination of the parameters for the Qualifications Tests depends largely on the nature of the listing applicant’s business model and the characteristics of its industry.11

Does any material contract reveal any business in which a controlling shareholder or director of the listing applicant is interested which competes or is likely to compete directly or indirectly with the listing applicant’s business?12 See also Chapter 10 “Due Diligence Guidelines – Controlling Shareholders’ Relationship with the Listing Applicant”.

The sponsor should request and review a copy of any contract entered into by a controlling shareholder or director of the listing applicant or their associates which relates to any business commitment falling within the scope of the listing applicant’s business.

The sponsor should assess the scope of the listing applicant’s business and whether there is any non-competition undertaking made by a controlling shareholder or a director of the listing applicant or their associates.

If there is any such non-competition undertaking, the sponsor should ascertain whether all the listing applicant’s businesses are covered in the restricted scope of activities of the controlling shareholder or director.

Does any material contract reveal any significant reliance by the listing applicant on a third party which may render the listing applicant unsuitable for listing?

The sponsor should request and review copies of contracts, entered into by the listing applicant with its major suppliers and customers which are material to the operation of the listing applicant’s business.

The Stock Exchange may consider a listing applicant unsuitable for listing if there is uncertainty as to the sustainability and prospects of the listing applicant’s business, and significant operational and/or financial reliance by a listing applicant on its controlling shareholder is a factor that may be considered in assessing business sustainability.13 Heavy reliance on a major customer may also render a listing applicant unsuitable for listing.14

See also sections 4 and 5 of Chapter 8 “Due Diligence Guidelines – Business Model”.

Does any material contract impose financial obligations which may affect the ability of the listing applicant to have sufficient working capital for at least the next 12 months from the date of publication of the listing document?15

The sponsor should review the material contracts to identify any significant financial commitment, contingent or otherwise, which may impact on the listing applicant’s working capital requirements.

Examples include cornerstone investment agreements and debt subscription agreements in relation to pre-IPO investments.

Are there any material contracts which may be contrary to the guidance issued by the Stock Exchange on pre-IPO investments?

The sponsor should review subscription agreements, shareholders’ agreements and investment agreements in connection with any pre-IPO investment to ascertain:

– the listing applicant’s pre-IPO and post-IPO shareholding structures;

– the listing applicant’s contractual obligations;

– whether the pre-IPO investments will be completed either (i) at least 28 clear days before the date of the first submission of the first listing application form; or (ii) 180 clear days before the first day of trading of the listing applicant’s securities;16 and

– whether there are atypical rights/obligations attached to pre-IPO investments.17


10. Listing Rule 8.05.

11. Paragraph 4.2 of Exchange Guidance Letter GL46-12: In determining whether any income can be counted towards the trading record and profit requirements, the Exchange must be satisfied that, based on the facts and circumstances of a particular case, the income was actively derived from commercial transactions in the applicant’s ordinary business throughout the trading record period, rather than from unrealised fair value movements. Accordingly, the Exchange considers that adjustments will need to be made to exclude the unrealised fair value gains on biological assets to demonstrate compliance with the three-year trading record and profit requirements under Listing Rule 8.05(1)(a) (See paragraph 4.4 of Exchange Guidance Letter GL46-12);

Exchange Listing Decision LD48-2: In determining whether compensation income arising from the one-time early termination of a contract could be counted towards satisfaction of the profit requirements under Listing Rule 8.05(1)(a), the Exchange needed to be satisfied that, based on the facts and circumstances of the particular case, the income arose from the ordinary and usual course of business of the listing applicant;

Exchange Guidance Letter GL26-12: For business models that rely significantly on forfeited income from prepaid services and products (e.g., slimming and beauty business), the Stock Exchange might not consider the listing applicant suitable for listing if, after considering the totality of the facts, continued reliance on forfeited income would potentially render the business not sustainable, its business model relies on unethical selling methods, or there is concern about the listing applicant’s capacity to provide contracted services/products.

12. Listing Rule 8.10; See also Exchange Listing Decision LD51-2.

13. Paragraph 17 of Exchange Listing Decision LD37-2012: Where a company’s business model is believed to be unsustainable, the Stock Exchange will consider it unsuitable for listing. In the case under review, the listing applicant’s financial reliance on its controlling shareholder was one of a number of factors taken into account in assessing the sustainability of the listing applicant’s business. See also paragraph 3.2(8) of Exchange Guidance Letter GL68-13.

14. Paragraph 5 of Exchange Listing Decision LD107-1: There is no bright line test to determine whether a listing applicant’s reliance on a single major supplier or customer is an extreme case which impacts on suitability for listing. In assessing a case of reliance on a single supplier or customer, the Stock Exchange will take into account:

(a) whether the listing applicant’s business model can be easily changed to reduce the level of reliance. For example, the Stock Exchange will consider its ability to find substitute suppliers or customers and whether it has the necessary skill, technology or network to break off the reliance;

(b) whether the level of reliance is likely to decrease in the future. For example, whether the listing applicant has plans to diversify its business focus to reduce its reliance on a single supplier or customer;

(c) whether the whole industry landscape is dominated by a few players (e.g. the computer technology industry) making it unlikely for companies in the same line of business as the applicant to break off reliance on a major supplier or customer. Under these circumstances, the Stock Exchange will be more ready to deal with the issue by disclosure since the risk of reliance is not specific to the listing applicant;

(d) whether the listing applicant can demonstrate that the reliance is mutual and complementary. For example, whether the supplier or the customer also relies heavily on the applicant; and

(e) whether the listing applicant is capable of maintaining its revenue in the future in light of the reliance. The Stock Exchange will take into account the overall prospects of the industry to assess the viability of the listing applicant’s business. If the whole industry is showing a downward trend, the Stock Exchange will have greater concerns about suitability.

See also paragraph 3.2(4)(iv) of Exchange Guidance Letter GL68-13.

15. Listing Rule 8.21A.

16. Pre-IPO investments are considered completed when the funds are irrevocably settled and received by the applicant. See Interim Guidance on Pre-IPO Investments (Exchange Guidance Letter GL29-12).

17. See Guidance Letter on Pre-IPO Investments (Exchange Guidance Letter GL43-12). Pre-IPO investors may be offered special rights. The range of these special rights is varied and while some rights are typical, atypical special rights or rights which do not extend to all other shareholders, are not permitted to survive after listing to comply with the general principle of even treatment of shareholders under the Listing Rules. Such rights include but are not limited to:

(a) price adjustments which effectively create two different prices for the same securities for pre-IPO investors and other shareholders at the time of listing;

(b) put or exit options granted to pre-IPO investors to put back the investments to the listing applicant or its controlling shareholder;

(c) the right of pre-IPO investors to nominate a director which survives after listing;

(d) veto rights granted to pre-IPO investors over the listing applicant’s major corporate actions; and

(e) anti-dilution rights surviving the listing.

For guidance on pre-IPO investments in convertible instruments, reference should be made to Exchange Guidance Letter GL44-12.


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.

Listing Qualifications non-compliance

Non-Compliance With Listing Qualifications Arising From Material Contract

Ensuring Compliance with Listing Qualifications

Listing Applicant is in Compliance with all Relevant Listing Qualifications Under Chapter 8 of The Listing Rules

Qualifications Tests Material Contracts

Material Contracts Contrary to Pre-IPO Investments

Hong Kong Stock Exchange Guidance Letter GL46-12

Table of contents