Chapter 12

Due Diligence Guidelines –


9. Management Discussion & Analysis

9.1 Standards

9.1.1 A sponsor should in conjunction with the management of a listing applicant and its other advisers prepare relevant, adequate and comprehensible MD&A that should:

(a) avoid excessive or irrelevant disclosure that may overwhelm investors and act as an obstacle to identifying and understanding material matters and critical information;

(b) focus on matters that materially impacted upon historical financial performance or condition;

(c) analyse and explain material fluctuations in the financial items and amounts with specific and substantive reasons;

(d) discuss material factors or events that are likely to impact future financial performance or condition; and

(e) identify and discuss from an investor’s perspective any exceptional items or unusual accounting treatments that require further enquiry or disclosure by, amongst other things, making reference to disclosure or treatments adopted by comparable companies. [Paragraph 17.8 of the Code of Conduct]

9.1.2 Reference should be made to the Dual Filing Update issued by the Securities and Futures Commission in July 2012. This draws attention to the SFC’s concern that the management discussion and analysis (MD&A) sections in many listing applications merely recited figures from the financial statements in narrative form with little or no meaningful explanation of the events causing the fluctuations in the applicant’s financial performance. This issue is highlighted by the SFC as a deficiency particularly common in the discussion of changes in gross profit margins and fair value gains.8

9.1.3 The Stock Exchange has issued detailed guidance on MD&A generally, and on the topic of Liquidity Disclosure, each explained below.

9.2 Guidance (General)

9.2.1 The format of the MD&A (which, as indicated above, will be reflected in the detailed agenda for the various management discussions) will vary from one listing applicant to another according to sector and business model.

9.2.2 Sponsors and lawyers engaged in drafting MD&A will typically use peers and competitors as a reference point and comparison, and as a guide for designing the MD&A section.

9.2.3 The processes for capturing content and input relative to the Management Discussion and Analysis section of the listing document have been explained above. See sections 4 and 5 above (“Financial Review Process (Overview)” and “Detailed Financial Review Process”).

9.2.4 It is preferable that the Reporting Accountant should be present at all MD&A meetings and discussions, and it is recommended that they are requested to attend.

9.3 Guidance (Specific to MD&A)

9.3.1 The Stock Exchange has issued guidance on MD&A in Exchange Guidance Letter GL59-13 (July 2013). Reference should always be made to that guidance.

9.3.2 As a general point, Exchange Guidance Letter GL59-13 stipulates that MD&A should:

(a) be concise, easy to read and in plain language; and

(b) provide meaningful discussion and analysis of the listing applicant’s financial information to help investors understand the applicant’s past performance, present position and future prospects.

It is stated that MD&A must be included because the financial statements alone do not provide all the information that investors need to make investment decisions. Listing applicants are expected to disclose not only past events or information, but also an analysis that explains management’s view of the implications to an applicant’s future and the significance of that information.

9.3.3 Certain general principles are stipulated concerning:

(a) clear and straightforward disclosure;

(b) balanced discussion of all major businesses (including both positive and negative circumstances);

(c) provision of integrated information in context suitable to interpret financial position, financial performance and cash flows;

(d) inclusion of cross-references to other relevant sections (to avoid duplication); and

(e) benefits of tables, charts and diagrams.

9.3.4 Further express guidance (on content and principles of disclosure ) is given on certain specific areas of disclosure including:

(a) Key Factors Affecting the Results of Operations

(b) Critical Accounting Policies and Estimates

(c) Review of Historical Financial Information

(d) Liquidity and Capital Resources

9.4 Guidance (Liquidity Disclosure)

9.4.1 In addition to the requirements for an Indebtedness Statement and working capital statement (see section 3 above “Financial Content of the Listing Document”), Paragraph 32(5) of Part A of Appendix 1 to the Listing Rules requires the listing document to include a commentary on (i) the new applicant’s liquidity and financial resources and (ii) its capital structure.

9.4.2 In Exchange Guidance Letter GL37-12, the Stock Exchange refers to the commentary regarding a new applicant’s indebtedness, liquidity, financial resources and capital structure collectively as “Liquidity Disclosure”.

9.4.3 The Stock Exchange considers that the information required under Paragraph 32(5) of Part A of Appendix 1 to the Listing Rules is critical to an assessment of the listing applicant’s future prospects, its ability to generate cash and to meet its existing and known or reasonably likely future cash requirements.

9.4.4 The Stock Exchange considers that the Liquidity Disclosure should offer the management’s qualitative assessment of the various items being discussed (and should not be merely a restatement of financial statement information in a narrative form, or simply a tabulation of financial data without any commentary or analysis).

9.4.5 Exchange Guidance Letter GL37-12 was published to assist new applicants and their advisers to prepare the Liquidity Disclosure, and sponsors should always refer to that letter as a guide to considering the appropriate disclosure for the particular listing applicant.

9.4.6 The guidance in Exchange Guidance Letter GL37-12 is generic but makes express reference to certain examples of detailed disclosure normally expected, including:

(a) discussion of net current asset (liabilities) position as at the most recent practicable date;

(b) an analysis and explanation of the sources and uses of cash, and an analysis of the material changes in the underlying drivers;

(c) an analysis of and information on factors that would have a material impact on the new listing applicant’s liquidity, potentially including:

(i) funds necessary to meet contractual obligations and operations and projects in progress or planned;

(ii) commitments for (or anticipated) significant capital expenditures;

(iii) the likelihood of future cash requirements associated with known trends and uncertainties; and

(iv) relevant legal/ regulatory requirements and/or restrictions;

(d) any plans to raise material external debt;

(e) a discussion and analysis of material covenants related to outstanding debt (or covenants applicable to third parties in respect of guarantees or other contingent obligations), and the impact of debt covenants;

(f) material extrinsic factors such as deterioration of the credit markets and / or tightened monetary policies.

9.4.7 Express negative confirmations are required in any case where:

(a) the listing applicant has no external financing plans; or

(b) there are no material covenants relating to the new listing applicant’s outstanding debts.

9.4.8 Exchange Guidance Letter GL37-12 also contains express guidance on disclosure requirements for listing applicants having net current liabilities, negative operating cash flows for most of the track record period, significant capital commitments, high gearing ratios and/or significant reclassification of long-term debt to short term. Such requirements include:

(a) the basis on which the directors form their view on working capital sufficiency (and the basis on which the sponsor shares that view), including stress tests on key assumptions where material; and

(b) Directors’ confirmation on whether the listing applicant had any material defaults during the track record period.

9.4.9 For the above purposes, Liquidity Disclosure is ordinarily required to be made as of (and the “most recent practicable date” should normally be) a date not more than two calendar months before the issuance 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 months before the date of the Application Proof). See Exchange Guidance Letters GL37-12 and GL38-12.


8. Examples include:

Changes in gross profit margins

In one extreme case, the initial draft listing document merely stated that the decrease in the applicant’s gross profit margin was because “[the] rate of increase in cost of sales was faster than the rate of increase in revenue.” In another case, the initial draft listing document only stated that a decrease in the gross profit margin of one principal business segment was due to “differences in product varieties caused by changes in customer preferences”. The specific reasons for the changes in product varieties and customer preferences were disclosed only after the regulators’ enquiries.

Significant fair value gains

For some businesses, fair value gains may contribute a significant part of the profits. The initial draft listing documents in a number of cases failed to provide sufficient information for investors to understand the reasons for the significant fair value gains during the track record period and the bases and assumptions used in the estimation of the gains.

In a case involving a property developer outside Hong Kong, the estimated fair value of the applicant’s investment properties was said to have more than doubled over the track record period although the applicant failed to lease out a substantial portion of the units and an industry report suggested that there was a severe over-supply of similar units in the market. However, the initial draft listing document failed to provide any meaningful explanation for the significant appreciation in the estimated capital value of the applicant’s properties notwithstanding the unfavourable market conditions.

In one case, the applicant recorded a gain on certain biological assets acquired in the latest financial year. The initial draft listing document was silent on the fact that some of the biological assets had been infected with disease and that the fair value was estimated based on a “constant yield” assumption, contrary to the decreasing yield of the biological assets in reality. Upon regulators’ further enquiries, the assumption was revised to take into account the expected decrease in yield over time, resulting in a reduction in the fair value gain.

In another case, the initial draft listing document disclosed that the fair value of the applicant’s biological assets was estimated by an independent expert. Only upon the regulators’ enquiries was it revealed that the expert had not conducted any physical count to ascertain the condition or quantity of an entire class of biological assets, which accounted for over 30% of the total fair value of the applicant’s biological assets. The case did not proceed after the regulators enquired further into the bases of the valuation.


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.

Dual Filing Update

Management Discussion and Analysis MD&A

Stock Exchange Guidance on MD&A

Format of the MD&A

Sponsors and Lawyers Engaged in Drafting MD&A

Liquidity Disclosure guidance

Guidance on MD&A

Listing Application Management Discussion and Analysis section

guidance on MD&A Exchange Guidance Letter GL59-13

Table of contents