Due Diligence Guidelines –
3. Financial Content of the Listing Document
3.1 Typical Financial Content
3.1.1 The principal financial information typically found in Hong Kong listing documents can conveniently be considered in three categories:
(a) “Core Financial Content”, comprising:
(i) audited financial statements (in the form of an accountants’ report);
(ii) where applicable, any unaudited interim financial statements;
(iii) where applicable, any substantive pro-forma information on the listing applicant for the track record period (for example, where there is a significant acquisition or reorganisation preceding listing, or planned at the time of listing); and
(iv) profit forecast (if included in the listing document);
(b) Management Discussion and Analysis (“MD&A”), including:
(i) commentary on liquidity and financial resources; and
(ii) applicable financial and operating data (not directly extracted from the audited or interim financial statements) relevant to the MD&A section: (performance indicators relevant for purposes of the MD&A section will often include operational or financial data which are sourced, and which need to be substantiated, otherwise than from the audited or interim financial statements); and
(c) “Technical Content”, comprising:
(i) working capital statement;
(ii) formal indebtedness statement;
(iii) “no material change” statement; and
(iv) pro forma financial statistics commonly including net tangible assets and earnings per share.
3.2 Rules on Core Content
3.2.1 With limited exceptions (effectively only for secondary listing applicants which are granted dispensation to include existing audited financial statements), a listing document issued by a new applicant must contain an accountant’s report (Listing Rules 4.01 and paragraph 37 of Part A of Appendix 1 to the Listing Rules).
3.2.2 Paragraph 31 of Part II of the Third Schedule to the Companies (Winding Up and Miscellaneous Provisions) Ordinance similarly requires a listing document which is a prospectus to include a report by the auditors.
3.2.3 Both the Listing Rules and the Companies (Winding Up and Miscellaneous Provisions) Ordinance ordinarily require the report to cover historic results for a period of three full financial years.
3.2.4 Under Listing Rule 8.06, the latest financial period reported on in the accountant’s report must not have ended earlier than 6 months before the date of the listing document.
3.2.5 Listing Rule 8.21 contains rules restricting the ability of listing applicants to change financial year end within the final year of the track record period or during the period of any profit forecast.
3.2.6 Listing Rules 4.04 and 4.05 prescribe the basic content requirements for an accountants’ report in a listing document.
3.2.7 The financial information required under Listing Rule 4.04 includes: history of results, balance sheet, cash flow statement, statement of changes in equity, additional disclosures for financial conglomerates and other matters of specifics (e.g., earnings per share, movements on reserves, statement of indebtedness, details of principal accounting policies, significant events post reporting period and a “sweeper” requirement covering any other matters which appear to the reporting accountants to be relevant).
3.2.8 Listing Rule 4.05 sets out specific supplementary detail concerning the financial information required to be disclosed under Listing Rule 4.04.
3.2.9 Under paragraph 37 of Part A of Appendix 1 to the Listing Rules, the accountants’ report must, in addition, comply with the provisions of Appendix 16 to the Listing Rules applicable to accountants’ reports in listing documents.
3.2.10 Listing Rule 4.05A requires disclosure of additional pre-acquisition financial information where a new applicant has acquired any material subsidiary or business during the trading record period in a transaction which would have been classified as a major transaction or very substantial acquisition under the applicable ratio tests in Chapter 14 of the Listing Rules.
3.2.11 An accountants’ report is required (either as part of the main report, or often in the form of an additional report) on the results (and balance sheet contribution) of any business or subsidiary acquired, agreed to be acquired or proposed to be acquired since the date to which the latest audited accounts are prepared. Exchange Guidance Letter GL 32-12 contains guidance on (among other things) what is meant by “agreed to be acquired or proposed to be acquired”. It makes clear that the requirement will apply as long as there is an intention to acquire a subsidiary or business (even if there is no legally binding agreement).
3.2.12 General guidance is contained in Exchange Guidance Letter GL 32-12 on situations where there have been acquisitions by the listing applicant during or subsequent to the trading record period and prior to the listing date, or where acquisitions are under consideration (or have been agreed to) but not yet completed at the time of listing. Dispensations may occasionally be appropriate from normal requirements for additional specific disclosure (for example, in cases involving (i) applicants for a secondary listing or (ii) where the acquisition is immaterial).7
3.2.13 Paragraphs 32 and 33 of Part II of the Third Schedule to the Companies (Winding Up and Miscellaneous Provisions) Ordinance contain separate parallel requirements that a listing document which is a prospectus should include a separate report by the auditors on any business or company which is to be purchased out of the proceeds (or any part of the proceeds) of the issue.
3.2.14 Listing Rule 4.14 states that, in preparing the accountants’ report, the Reporting Accountant must make such adjustments (if any) as are in its opinion appropriate for the purposes of the accountants’ report. Where adjustments are made, a written statement (the “Statement of Adjustments”), signed by the Reporting Accountant, is required to be made available for public inspection. The Companies (Winding Up and Miscellaneous Provisions) Ordinance (at sections 38D(3) and 342C(3), and paragraph 42 of the Third Schedule) contains separate requirements, applicable to a listing document which is a prospectus, for preparation and registration of a formal statement of adjustments in circumstances where such adjustments are made.
3.2.15 Listing Rule 4.11 stipulates that:
(a) the accountants’ report must normally be prepared in conformity with (i) Hong Kong Financial Reporting Standards (“HKFRS”), (ii) International Financial Reporting Standards (“IFRS”) or (iii) China Accounting Standards for Business Enterprises (“CASBE”) in the case of a PRC company that has adopted CASBE for the preparation of its annual financial statements; and
(b) any significant departure from such accounting standards must be disclosed and explained and, to the extent practicable, the financial effects of such departure quantified.
3.2.15A Under Listing Rules 4.04(2) and 4.04(4)(a), where a listing applicant has acquired or intends to acquire a company or business since the latest audited (or advanced draft) accounts have been made up, the Application Proof must include financial information of such company or business acquired or to be acquired.
Pro Forma Financial Information
3.2.16 Listing Rule 4.28 applies where a listing applicant has acquired or proposed to acquire any businesses or companies (subsequent to the date of its most recent audited accounts) which would be classified as a “major subsidiary”. (A “major subsidiary” for this purpose means an enterprise which measures 5% or more under the applicable ratio tests.)
3.2.17 In cases where Listing Rule 4.28 applies, the listing applicant must include stipulated pro forma financial information on the enlarged group in its listing document.
3.2.18 In certain other unusual instances, a listing applicant may also wish to include pro forma financial information in its listing document with respect to a significant transaction occurring during its trading record period or prior to (or in connection with) listing, to provide investors with information about the impact of the transaction.
3.2.19 Listing Rule 4.29 states that wherever a listing applicant includes pro forma financial information in its listing document (whether or not such disclosure of pro forma financial information is required under the Listing Rules), (i) that information must comply with Listing Rules 4.29(1) to (6) and (ii) a report in prescribed terms must be included in the relevant listing document.
3.2.20 Listing Rules 4.29(1) to (6) contain detailed limitations and requirements on pro forma financial content, and reference should be made to those detailed Listing Rules.
3.2.21 Listing Rule 4.29(1) stipulates that pro forma financial information:
(a) must provide investors with information about the impact of the transaction by illustrating how that transaction might have affected the financial information presented in the listing document, had the transaction been undertaken at the commencement of the period being reported on or, in the case of a pro forma balance sheet or net asset statement, at the date reported;
(b) must not be misleading, and must assist investors in analysing the future prospects of the listing applicant; and
(c) must include all appropriate adjustments permitted by Rule 4.29(6), of which the listing applicant is aware, necessary to give effect to the transaction as if the transaction had been undertaken at the commencement of the period being reported on or, in the case of a pro forma balance sheet or net asset statement, at the date reported on.
3.2.22 Listing Rule 4.29(5) stipulates the permitted sources of the base (unadjusted) information (which is normally the audited financial statements within the accountants’ report), and Listing Rule 4.29(6) stipulates that any adjustments must be:
(a) clearly shown and explained;
(b) directly attributable to the transaction concerned and not relating to future events or decisions;
(c) factually supportable; and
(d) in respect of a pro forma profit or cash flow statement, clearly identified as to those adjustments which are expected to have a continuing effect on the listing applicant and those which are not.
3.2.23 Listing Rule 4.29(7) requires that the pro forma information must be reported on by the Reporting Accountant, and the Reporting Accountant’s report must be set out in the listing document.
3.2.24 The Reporting Accountant’s report must confirm (among other things) that the adjustments are appropriate for applicable purposes.
3.2.25 It has traditionally been common, but is not obligatory, to include a profit forecast. (In more recent times there has been an increasingly common trend not to include a profit forecast).
3.2.26 Rule 11.17 states that a new listing applicant must determine in advance, with its sponsor, whether to include a profit forecast in its listing document.
3.2.27 Where a profit forecast is included, it must be clear, unambiguous and presented in an explicit manner and:
(a) the principal assumptions, including commercial assumptions, upon which it is based, must be stated; and
(b) it must be prepared on a basis that is consistent with the accounting policies normally adopted by the listing applicant.
(See paragraph 34(2) of Part A of Appendix 1 to the Listing Rules).
3.2.28 Listing Rule 11.17 requires that the accounting policies and calculations for the profit forecast must be reviewed and reported on by the Reporting Accountant and the Reporting Accountant’s report must be set out in the listing document.
3.2.29 Listing Rule 11.17 further requires that the sponsor must report that it has satisfied itself that the forecast has been made by the directors after due and careful enquiry, and such report must be set out in the listing document.
3.2.30 Listing Rule 11.18 states that any profit forecast appearing in a listing document should normally cover a period which is coterminous with the listing applicant’s financial year end. If, exceptionally, the profit forecast period ends at a half year-end the Exchange will require an undertaking from the listing applicant that the interim report for that half year will be audited. Profit forecast periods not ending on the financial year end or half year-end are not permitted.
3.2.31 Listing Rule 11.19 states that the assumptions upon which any profit forecast are based must provide useful information to investors to help them in forming a view as to the reasonableness and reliability of the forecast. Such assumptions should draw the investors’ attention to, and where possible quantify, those uncertain factors which could materially disturb the ultimate achievement of the forecast. The assumptions should be specific rather than general, definite rather than vague. All embracing assumptions and those relating to the general accuracy of the estimates made in the profit forecast should be avoided. Furthermore it will not normally be acceptable for assumptions to relate to matters which the directors, by virtue of their particular knowledge and experience in the business, are best able to take a view on or are able to exercise control over since such matters should be reflected directly in the profit forecast itself.
3.2.32 See further sections 11 (“Changes Subsequent to Latest Balance Sheet Date”) and 14 (“Forecasts and Projections”) below.
3.3 Management Discussion and Analysis (“MD&A”)
3.3.1 For guidance on MD&A, see section 9 below (“Management Discussion and Analysis”).
3.3.2 The Stock Exchange has issued detailed guidance on MD&A generally, and on the topic of Liquidity Disclosure, and this is explained in section 9. (See also commentary below on Indebtedness Statement).
3.4 Rules Governing Specific Technical Content
Working Capital Statement
3.4.1 Listing Rule 8.21A(1) provides that a new applicant must include a working capital statement in its listing document.
3.4.2 In making this statement the listing applicant must be satisfied after due and careful enquiry that it and its subsidiary undertakings, if any, have available sufficient working capital for the group’s present requirements, that is for at least the next 12 months from the date of publication of the listing document.
3.4.3 These requirements are repeated in paragraph 36 of Part A of Appendix 1 to the Listing Rules, which requires the listing document to include a statement by the directors that in their opinion the working capital available to the group is sufficient for the group’s requirements for at least 12 months from the date of publication of the listing document or, if not, how it is proposed to provide the additional working capital thought by the directors to be necessary.
3.4.4 Listing Rule 8.21A(1) stipulates that the sponsor to the listing applicant must also confirm to the Exchange in writing that:
(a) it has obtained written confirmation from the listing applicant that the working capital available to the group is sufficient for its present requirements, that is for at least the next 12 months from the date of publication of the listing document; and
(b) it is satisfied that the listing applicant’s working capital confirmation has been given after due and careful enquiry by the listing applicant and that the persons or institutions providing finance have stated in writing that the relevant financing facilities exist.
Listing Rules 9.11(17b) and (28) govern the submission of the relevant letter.
3.4.5 Exchange Guidance Letter GL 37-12 stipulates that a sponsor’s final confirmation letter on the working capital sufficiency statement in the listing document should be based on (i) the sponsor’s own due diligence work, (ii) the applicant’s confirmation referred to in paragraph 3.4.4(a) above and (iii) confirmation from the Reporting Accountants’ to the applicant (which should be copied to the sponsor, the Stock Exchange and the SFC). Both the sponsor’s and the reporting accountants’ confirmation are required to be made on the same date.
3.4.6 The requirements with respect to the working capital statement are enhanced / modified for mineral companies (under Listing Rules 18.03(4) and 18.03(5)).
3.4.7 Listing Rule 8.21A(2) provides an exemption under which the Stock Exchange will not require a working capital statement to be made by a new applicant, whose business is entirely or substantially that of the provision of financial services, provided the Stock Exchange is satisfied that:
(a) the inclusion of such a statement would not provide significant information for investors; and
(b) the new applicant’s solvency and capital adequacy are subject to prudential supervision by another regulatory body.
3.4.8 Paragraphs 23 to 25 of the Third Schedule to the Companies Ordinance require a prospectus to contain particulars of the following:
(a) any bank overdrafts or other similar indebtedness of the company and its subsidiaries, if any, as at the latest practicable date or, if there are no bank overdrafts or other similar indebtedness, a statement to that effect;
(b) any hire purchase commitments, guarantees or other material contingent liabilities of the company and its subsidiaries, if any, or, if there are none such, a statement to that effect; and
(c) the authorised debentures of the company and its subsidiaries, if any, the amount issued and outstanding or agreed to be issued, or if no debentures are outstanding a statement to that effect.
3.4.9 Under the Listing Rules, the listing document is required to include a statement as at the most recent practicable date (which must be stated) of the total amount of debt securities, borrowings, indebtedness, mortgages, contingent liabilities and guarantees, of the new applicant on a consolidated basis. (Paragraph 32(2) of Part A of Appendix 1 to the Listing Rules). This formalised disclosure (which normally also encompasses the Companies (Winding Up and Miscellaneous Provision) Ordinance requirements) is commonly known as the “Indebtedness Statement”.
3.4.10 A new listing applicant is ordinarily expected to disclose in the Indebtedness Statement details of its banking and other facilities including the respective amounts of total available facilities and indebtedness, maturity profile, interest rates, and security and guarantees, etc. (See Exchange Guidance Letter GL37-12).
3.4.11 The Indebtedness Statement has been a formal requirement of the Listing Rules for many years. More recently, the Stock Exchange has emphasised that it is now viewed as part of a broader thematic disclosure topic known as “Liquidity Disclosure”.
3.4.12 Because of the practical logistics involved in verifying outstandings and commitments (see further below, “Guidance on Indebtedness Statement, and Recommended Steps”), the information relevant to the Indebtedness Statement is necessarily compiled as of a date (known as the “latest practicable date”) ahead of publication of the listing document.
3.4.13 Under current practice (as revised from October 2013), the Liquidity Disclosure (including the Indebtedness Statement) must ordinarily be made as of a date no more than two calendar months before the issue of the listing document. (Similarly, in relation to the Application Proof, the Liquidity Disclosure must ordinarily be made as of a date no more than two calendar monthss before the date of the Application Proof). See Exchange Guidance Letters GL37-12 and GL38-12.
3.4.14 The Stock Exchange has issued detailed guidance on the topic of Liquidity Disclosure, and this is explained in section 9 below.
“No Material Change” Statement
3.4.15 Paragraph 38 of Part A of Appendix 1 to the Listing Rules requires disclosure in the listing document by the directors of (i) 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 (ii) an appropriate negative statement.
Pro Forma Financial Statistics
3.4.16 Some of the statistical data commonly included in listing documents constitutes pro forma information for technical accounting and regulatory purposes.
3.4.17 In particular, this commonly includes figures for adjusted net tangible assets and earnings per share.
3.5 Guidance on Core Historical Financial Content, and Recommended Steps
3.5.1 Paragraph 3 of Part I of the Third Schedule to the Companies (Winding Up and Miscellaneous Provision) Ordinance requires a listing document which is a prospectus to contain sufficient particulars and information to enable a reasonable person to form a valid and justifiable opinion of the shares and the financial condition and profitability of the company at the time of the issue of the prospectus, taking into account the nature of the shares being offered and the nature of the company and the nature of the persons likely to be consider acquiring them.
3.5.2 Listing Rule 11.07 sets out an overriding general duty of disclosure for the content of a listing document, stipulating that a listing document must, as an overriding principle, contain such particulars and information which, according to the particular nature of the listing applicant and the securities for which listing is sought, is necessary to enable an investor to make an informed assessment of the activities, assets and liabilities, financial position, management and prospects of the listing applicant and of its profits and losses and of the rights attaching to such securities.
3.5.3 Listing Rule 2.03(2) prescribes the general principle that potential investors must be given sufficient information to enable them to make a properly informed assessment of the listing applicant and of the securities for which listing is sought.
3.5.4 Listing Rule 2.13 stipulates that the information contained in any announcement or corporate communication of the listing applicant must (among other things) be accurate and complete in all material respects and not be misleading or deceptive.
3.5.5 Application of the rules on core content is generally straightforward, so in the majority of cases there will be no meaningful question as to the basic financial content of the accountants’ report.
3.5.6 This is particularly the case if the accountants’ report will be based substantially on (or may be a reproduction of) pre-existing audited combined / consolidated accounts of an existing entity (or group) having continuity of structure and accounting policy.
3.5.7 However, it is not uncommon in IPOs that the financial statements in the accountants’ report are a newly created combination of underlying financial information. This may entail:
(a) new consolidation;
(b) adoption of new accounting standards for some or all of the combined / consolidated entities; and/or
(c) presentation in a new/different currency.
3.5.8 Other situations which may require significant judgement in financial presentation would include cases involving:
(a) recent acquisitions;
(b) recent disposals;
(c) carve-outs / reorganisations;
(d) pre-IPO financing structures which are complex or otherwise impact upon the financial statements.
3.5.9 Occasionally (and particularly in cases involving overseas applicants for secondary listing) financial information will be presented under overseas financial reporting standards other than HKFRS/IFRS/CASBE. In such cases:
(a) the fundamental nature of the financial information (and related due diligence considerations) is essentially no different; but
(b) additional disclosure is normally required in the form of narrative and (sometimes) quantified disclosure of the differences and financial effects of the departures (i.e., reconciliation).
3.5.10 Additionally, where there has been any change of financial year-end during the reported track record period, it will be necessary to understand the reasons underlying (and impact of) such change.
3.5.11 Decisions on overall financial presentation usually need to be made early in the process.
3.5.12 In practice, even in unusual circumstances there is usually only a finite and relatively small range of possible approaches having regard to applicable accounting standards, principles and practices.
3.5.13 If dispensations are required (for example, in cases where there have been acquisitions by the listing applicant during or subsequent to the trading record period and prior to the listing date), this should normally be the subject of early discussions with the Exchange, and applications to the Exchange made ahead of filing Form A1.
3.5.14 It is sometimes necessary or appropriate to make adjustments to the listing applicant’s historical financial information for the purpose of the accountants’ report. For example, (i) if uncertainties affecting the underlying financial statements for an earlier period have been resolved, (ii) following a change in accounting policies, (iii) following a reorganisation involving the acquisition or disposal of a subsidiary or (iv) generally to ensure that the financial information in the accountants’ report is presented on a consistent and properly comparable basis according to the listing applicant’s current accounting policies.
3.5.15 In any case where such adjustments are made, it will be important that the sponsor (i) understands the reason for each adjustment made (as itemised in the formal Statement of Adjustments) and (ii) considers the appropriate scope of related disclosure.
3.5.16 The sponsor should usually discuss the question of overall financial presentation with the listing applicant’s management and the Reporting Accountant at an early stage and keep a record of those discussions.
3.5.17 Even if a decision has already been reached as between the Reporting Accountant and the listing applicant’s management, the sponsor should always seek to understand (and should ask the Reporting Accountant) what alternative approaches to presentation were discussed with management.
3.5.18 In cases where the choice of overall financial presentation involves Pre-A1 submissions (or other dispensations or rulings from the Stock Exchange), the Reporting Accountant should be closely involved to review the financial content of submissions and provide any confirmations required by the Stock Exchange.
3.5.19 Wherever financial information is presented under an overseas financial reporting standard other than HKFRS/IFRS/CASBE it will be important to discuss with the Reporting Accountant at an early stage the disclosure proposed (narrative and quantitative) to demonstrate the differences compared to one of the conventional Hong Kong standards (normally HKFRS or IFRS).
3.5.20 It will also be necessary to approach the Stock Exchange to agree (again at as early a stage as possible) on the appropriate nature of such disclosure. While the Listing Rules (and related Listing Decisions) indicate a requirement for quantitative reconciliation, in practice this is not a common result, and it is often the case that quantitative reconciliation is:
• unnecessary in cases where differences are insignificant; or
• impracticable (and potentially inappropriate / misleading by virtue of its inherently selective nature) in cases where the differences are more extensive.
There are also examples where dispensations have been given from the requirement to include comparative disclosure at all (including where the listing applicant has reported under US GAAP).
3.5.21 Wherever disclosure is to be included, it is imperative that the Reporting Accountant is closely involved in management’s preparation of this disclosure (irrespective of whether the disclosure is contained within the accountants’ report or in the body of the listing document). By its nature, this form of disclosure is based entirely on technicalities of accounting in which the sponsor is not expected to be expert. It is best wherever possible that this information be contained within the accountants’ report (normally by way of special note). The Stock Exchange will usually expect this to be the case.
3.5.22 Where the disclosure is contained within the accountants’ report (including by way of note), the sponsor is not normally expected to carry out any further due diligence on this information.
3.5.23 If (unusually) for any reason it is not possible for the disclosure to be contained within the accountants’ report, it is important that the Reporting Accountant is closely involved in its preparation, and the sponsor should discuss with the Reporting Accountant the degree of comfort (if any) which may be available.
3.5.24 Because adjustments are only made where amounts are considered to be material, in any case where a Statement of Adjustments is made, the sponsor should:
(a) review the Statement of Adjustments to ensure that the sponsor understands the nature of and reason for each adjustment;
(b) discuss the adjustments with the Reporting Accountant (and keep a record of those discussions); and
(c) consider whether and if so how the adjustments (or the factors giving rise to each adjustment) should be disclosed.
3.6 Guidance on Pro Forma Financial Content, and Recommended Steps
3.6.1 Under Listing Rule 4.29, any pro forma financial information must be reported on in the listing document by the Reporting Accountant, who must report that, in its opinion:
(a) the pro forma financial information has been properly compiled on the basis stated;
(b) such basis is consistent with the accounting policies of the listing applicant; and
(c) the adjustments are appropriate for the purposes of the pro forma financial information as disclosed.
3.6.2 In addition to the applicable provisions of the Listing Rules, the Reporting Accountant’s reporting work will normally be governed by a professional reporting standard, usually Hong Kong Standard on Assurance Engagements 3420 “Assurance Engagements to Report on the Compilation of Pro Forma Financial Information Included in a Prospectus” issued by the Hong Kong Institute of Certified Public Accountants (the “Pro Forma Standard”).
3.6.3 In practice, the combination of (i) the restrictions and prescriptions within Listing Rules 4.29(2) to 4.29(6), (ii) the requirement for the Reporting Accountant to report formally in prescribed format, and (iii) the terms and constraints within the applicable professional Pro Forma Standard mean that there is usually limited or no scope for discretion in presentation.
3.6.4 However, the sponsor should always discuss with the Reporting Accountant as part of the discussion on overall financial presentation (see above “Guidance on Core Historical Financial Content, and Recommended Steps”), and should ask what alternative approaches to presentation have been discussed with management? The sponsor should keep a record of those discussions.
3.6.5 In any case where pro forma information results from or relates to the acquisition of a new business, the sponsor should discuss with the Reporting Accountant the adjustments which have been made within or for the purposes of the pro forma.
3.6.6 Subject to that, preparation of pro forma content is primarily a technical accounting exercise in which the sponsor does not have any direct involvement.
3.7 Guidance on Profit Forecast and Working Capital Statement, and Recommended Steps
3.7.1 To support the working capital statement and any profit forecast, the listing applicant will prepare a formal combined profit forecast and cash-flow memorandum.
3.7.2 Listing Rule 9.11(10) requires and governs the filing of a draft form of memorandum with the Stock Exchange (as to which see further section 3.7.3 below) together with the Application Proof and Form A1. A finalised form of memorandum (as to which again see further section 3.7.3 below) is required under Listing Rule 9.11(28a) to be filed before bulk print of the Listing Document.
3.7.3 The memorandum prepared by the listing applicant is typically based on, and contains projections extracted from, a projective model normally containing cash-flow projections covering a period of some 15 to 18 months beyond the listing document date. As a matter of general prudence, the cash-flow model invariably extends for a period (commonly up to six months) beyond the tenor of the formal working capital statement in the listing document (though the extended period is not required for, and not normally covered in, the form of memorandum submitted to the Stock Exchange). The memorandum should set out the principal assumptions and bases on which the projections have been made, and would normally include a sensitivity analysis. The memorandum (incorporating the underlying projections from which the numbers derive) is formally adopted by the listing applicant immediately prior to launch.
3.7.4 The requirements in Listing Rule 11.17 for a published sponsor’s report on any profit forecast have been noted at paragraph 3.2.28 above, and the requirements in Listing Rule 8.21A(1) for a formal sponsor’s confirmation to the Stock Exchange with respect to the working capital statement are described at paragraph 3.4.5 above. As noted in paragraph 3.4.5, the sponsor’s confirmation on the working capital statement must be based upon (among other things) written confirmations from the listing applicant and the Reporting Accountant.
3.7.5 Although it is alisting applicant-prepared output / document (and the sole responsibility of the listing applicant’s directors), it is important for the reasons in paragraphs 3.4.5 and 3.7.4 above (and generally) that the listing applicant’s profit forecast and cash-flow memorandum is carefully considered by the Reporting Accountant.
3.7.6 The Reporting Accountant plays a key role in ensuring that the projections are prepared on a basis that is consistent with the accounting policies adopted in the listing applicant’s audited financial statements.
3.7.7 In connection with any profit forecast, the Reporting Accountant is required to report formally (in a letter from the Reporting Accountant which is published within the listing document) on the accounting policies adopted and calculations made in arriving at the profit forecast. See further section 14 below (“Forecasts and Projections”).
3.7.8 In addition to the published report on any profit forecast, the Reporting Accountant should also be engaged by the listing applicant to report privately with respect to the working capital statement, and on the basis that this report will be filed with the Stock Exchange as indicated in paragraphs 3.4.5 and 3.7.4 above.
3.7.9 In practice, even though the Reporting Accountant’s report(s) may be restricted to matters of accounting policies and compilation, (i) the Reporting Accountant will not be prepared to issue such a report (without express comment in the report) unless it has also considered the underlying assumptions and satisfied itself that there are no unrealistic assumptions or important omissions and (ii) careful consideration of the directors’ projections is required for the Reporting Accountant’s private report in relation to the working capital statement (see immediately below).
3.7.10 Under applicable professional reporting standards (usually Auditing Guideline 3.340 “Prospectuses and the Reporting Accountant” issued by the Hong Kong Institute of Certified Public Accountants), the Reporting Accountant is required to satisfy itself for the purposes of its private working capital report that (among other things) the directors’ have considered all relevant information with due care. Under conventional practice (reflecting the applicable professional reporting standards), the Reporting Accountant’s report with respect to the working capital statement will normally confirm that, in its opinion, the directors’ cash flow projections have been properly compiled on the basis of the assumptions made. Additionally, it will often (though not always) also make express reference to the Reporting Accountant’s conclusion that the directors’ working capital statement has been made after due and careful enquiry.
3.7.11 Part of the work performed by the Reporting Accountant in evaluating the projections is to obtain evidence and satisfy itself that the persons or institutions providing finance have stated in writing that the relevant financing facilities exist. (See also below, “Guidance on Indebtedness Statement, and Recommended Steps”).
3.7.12 The sponsor together with its legal advisers should ensure that the Reporting Accountant’s terms of engagement follow conventional practice.
3.7.13 It is also common practice for the sponsor to review and comment on the listing applicant’s profit forecast and cash-flow memorandum as it is developed.
3.7.14 Familiarity with the memorandum (and, in particular, the bases and assumptions on which it has been prepared), and reviewing and commenting, is an important part of the sponsor’s financial due diligence.
3.7.15 The sponsor should always obtain a written confirmation from the listing applicant and its directors in support of the working capital statement in the form stipulated in Listing Rule 8.21A(1)(a). The Reporting Accountant’s finalised private report should also be issued and obtained, and filed with the Stock Exchange, contemporaneously with the sponsor’s confirmation to the Stock Exchange.
3.7.16 In cases where the listing applicant’s working capital is significantly dependent on financing facilities, the sponsor should arrange interviews with the relevant banks or other finance providers. (See section 14.4.9 below).
3.7.17 For further guidance on working capital and profit forecast diligence, see section 14 below (“Forecasts and Projections”).
3.8 Guidance on Indebtedness Statement, and Recommended Steps
3.8.1 In connection with the Indebtedness Statement, the Reporting Accountant should be engaged to conduct conventional enquiries and to report results.
3.8.2 This involves obtaining evidence to satisfy itself that the persons or institutions providing finance have stated in writing that the relevant financing facilities exist.
3.8.3 This exercise should be memorialised in a private report (which may or may not be addressed to the sponsor as well as the listing applicant) with respect to the Indebtedness Statement. The report should accord with conventional practice according to applicable professional reporting standards, usually Auditing Guideline 3.340 “Prospectuses and the Reporting Accountant” issued by the Hong Kong Institute of Certified Public Accountants. Consistent with such standards and practices, the report will commonly confirm (based on the procedures performed) that nothing came to the attention of the Reporting Accountant to indicate that the Indebtedness Statement requires adjustment.
3.8.4 The sponsor together with its legal advisers should ensure that the Reporting Accountant’s terms of engagement follow conventional practice.
3.8.5 The scope of enquiries should extend to any committed but undrawn facilities.
3.8.6 Notwithstanding that the Reporting Accountant’s procedures do not constitute an audit, the sponsor will not normally carry out any further investigative due diligence itself in this area (subject to general considerations noted in section 12 below (“Red Flags and Similar Irregularities”).
3.8.7 As at the time of publication of this guidance, the Stock Exchange does not insist or expect that written confirmations from financiers must be obtained at the time of (or in preparation for) the A1 filing.
3.9 Guidance on “No Material Change” Statement, and Recommended Steps
3.9.1 For guidance on diligence relative to the period subsequent to the latest balance sheet date, see section 11 below (“Changes Subsequent to Latest Balance Sheet Date”).
3.9.2 The directors’ confirmation of no material change (and/or related disclosure) is required to be made up to and as of the date of publication of the listing document. (There is no permissible “buffer” based on latest practicable date or similar concept). (See Exchange Guidance Letter GL38-12)
3.10 Technical Pro Forma Financial Content
3.10.1 Preparation and substantiation of technical pro forma content (in particular, figures for adjusted net tangible assets and earnings per share) is normally a technical accounting exercise.
3.10.2 This exercise is normally memorialised by formal reports from the Reporting Accountant which are published within the listing document.
3.10.3 The sponsor is not required to undertake any direct involvement in this exercise, though the sponsor should ensure that it understands (through discussion with the Reporting Accountant) the nature of the calculations made.
7. See Exchange Listing Decisions LD85-1 regarding an applicant seeking secondary listing and LD78-1 regarding immaterial acquisitions.
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.