Due Diligence Guidelines –
4. Physical Existence, Condition/Development Status, Quantity and Valuation
4.1.1 A sponsor should conduct the following independent due diligence steps: … conduct inspection of key physical assets including where appropriate production facilities. [Paragraph 17.6(e)(ii) of the Code of Conduct]
4.1.2 The sponsor and independent valuer should be satisfied with the physical existence and the condition/development status (e.g. age and health) of the biological assets by their independent verification (including the extent of reliance on data and information provided by the applicant and details of independent fieldwork/physical inspections conducted) and with the disclosure in the listing document on the quantity and valuation of the biological assets. [Paragraph 4.8(c) of Exchange Guidance Letter GL46-12]
4.1.3 Typical due diligence inquiries in respect of each new applicant and the preparation of its listing document and supporting information include: … undertaking a physical inspection of material assets, whether owned or leased, including property, plant, equipment, inventory and biological assets (for example, livestock or crops) used or to be used in connection with the new applicant’s business. [Paragraph 13(e) of Practice Note 21 to the Listing Rules]
4.2.1 The sponsor should undertake a physical inspection of material assets (including biological assets) used or to be used in connection with the new listing applicant’s business by visiting the main sites of the assets to view and assess the extent, quality and quantity of the asset and the purpose for which it is used. Where, in the reasonable opinion of the sponsor, assessment of an asset, including as to its extent, quality, quantity and use, cannot be achieved without the use of an expert (for example, the scale of the assets are such that it would be unreasonable for the sponsor to carry out a physical inspection of all material assets itself, or in undertaking the physical inspection the sponsor becomes suspicious that the asset does not exist to the extent represented or exists but is not used for the purpose claimed), the sponsor should ensure that the listing applicant instructs an appropriate qualified independent expert to conduct all or part of the inspection. In such cases the sponsor should ensure the expert is required to provide a written report in respect of the inspection.6
4.2.2 Where a valuer is involved in the examination of the biological assets, the sponsor should still consider if the valuer is an appropriate expert to provide an opinion on the condition/development status of the biological assets. There may be instances where the sponsor and the valuer have to engage another expert on the specific biological asset such as university professors or scientific researchers to help issue a report on the condition/development status of the biological assets. If another expert is engaged, the sponsor should follow the guidance set out in Chapter 18 “Due Diligence Guidelines – Interaction with Third Parties including Expert Advisers” as to the due diligence work it should perform on the expert.
4.2.3 The sponsor should assess whether there is appropriate documentation in place to confirm that the material assets (including biological assets) used or to be used in connection with the listing applicant’s business are appropriately held by the listing applicant (for example, reviewing the relevant certificates of title and rights of land use).7
4.2.4 The sponsor should also follow the guidance set out in Chapter 21 “Due Diligence Guidelines – Inspection of Assets and Property Valuers’ Reports”.
4.2.5 For forestry biological assets, the sponsor should also refer to the specific guidance issued by the International Valuation Standards Council.8
4.3 Recommended Steps
4.3.1 The sponsor should consider the specific industry and risk factors applicable to such industry to compile a list of factors to consider in assessing the extent/quantity of the assets as well as the quality of the assets prior to the site visit. The list of factors will depend on the specific nature of each type of biological asset and should be customised accordingly. The sponsor should also follow the guidance in relation to understanding the relevant industry set out in Chapter 8 “Due Diligence Guidelines – Business Model”.
4.3.2 In addition to where the sponsor becomes suspicious that the asset does not exist to the extent represented or exists but is not used for the purpose claimed, the sponsor should also consider appointing an independent industry expert to assist it in due diligence where it is unfamiliar with the specific industry or business. The sponsor should follow the guidance set out in Chapter 18 “Due Diligence Guidelines – Interaction with Third Parties including Expert Advisers” where using such an expert.
4.3.3 As an initial step, the sponsor should obtain details of the assets and discuss with the listing applicant’s management, the auditors and valuer (where involved) the different types of interests involved. The sponsor should also discuss with lawyers in relevant jurisdictions how to establish evidence of ownership of the biological assets.
4.3.4 The sponsor should keep records of site visits and material information received in relation to the assets.
4.3.5 The sponsor should obtain details of how the listing applicant performs its stock-take on biological assets, and review internal controls over physical existence of biological assets and the relevant record keeping, and compare these to industry practice wherever possible.
4.3.6 Where the biological assets of the listing applicant are extensive, the sponsor should ensure that physical inspections are conducted as soon as possible to allow for sufficient time to substantially verify the existence and quality of the assets. The sponsor should customise a physical site visit and inspection work plan to ensure that appropriate members of its team are able to be fully involved in all physical inspections. Where sampling is used, the sponsor should assess the suitability of the sample size and be satisfied that the reviewed samples are randomly selected and statistically valid.
4.3.7 The sponsor should also examine and assess the listing applicant’s internal controls for inventory checking and management. For example, if sampling is used by the listing applicant to monitor the status, development or condition of the assets, there should be periodic random sampling of different batches of the assets. The listing applicant should have internal controls to ensure that its biological assets exist and are in good condition. Different experts (such as the accountants, valuers and other experts) should also avoid conducting checking and sampling exercises of the same assets at the same time to avoid overlap and thereby increase the integrity of the sampling results.
6. Paragraph 13(e) of Practice Note 21 to the Listing Rules.
7. Paragraph 13(l) of Practice Note 21 to the Listing Rules.
8. The International Valuation Standards Council published The Valuation of Forests (Exposure Draft) and the comment period closed in mid-February 2013. Given the diversity of responses received, further research is being undertaken to obtain broader feedback on some of the issues that the Exposure Draft sought to address with a view to developing a further Exposure Draft.
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.