Chapter 13

Due Diligence Guidelines –

Internal Controls

6. Steps to be Taken When Material Deficiencies Remain Outstanding

6.1 Standard

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]

6.2 Recommended Steps

6.2.1 Where it is not practicable to remedy material deficiencies in respect of the listing applicant’s internal controls systems and procedures prior to the submission of the listing application, sponsors should disclose details of the relevant material deficiencies as part of the listing application submission, including:

(i) details of the nature of the deficiencies;18

(ii) reasons for the non-rectification of the deficiencies identified prior to the submission of the listing application; and

(iii) the remedial actions to be taken by the listing applicant to address the material deficiencies.

The sponsor may also consider including, where relevant, disclosure of the potential financial and operational impact of the material deficiencies on the listing applicant.

6.2.2 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.19

6.2.3 Where appropriate, the sponsor should seek guidance from the Regulators.20

6.2.4 Sponsors should also refer to Chapter 31 “Due Diligence Guidelines – Dealing with “Material Deficiencies” of the Listing Applicant”.

Endnotes

18. Sponsors should note paragraph 22(iii) of Exchange Listing Decision LD48-2013. 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.

19. Paragraph 99 of the Consultation Conclusions on the Regulation of Sponsors.

20. Paragraph 99 of the Consultation Conclusions on the Regulation of Sponsors.

Depending on the facts and circumstances of each applicant and the seriousness of the non-compliance incidents, the Stock Exchange may request a demonstration period of compliance from the cessation of the non-compliance incidents to demonstrate that the rectification measures and enhanced internal control measures adopted are effective, and there is no financial impact on the applicant. The demonstration period should generally be an audited period (paragraph 3.2 of Exchange Guidance Letter GL63-13). For example, in Exchange Listing Decision LD19-2011, the Stock Exchange required the listing applicant to delay its listing for a period of 12 months from the date it ceased carrying on non-compliant bill financing arrangements. The listing applicant was required to include in its prospectus audited financial statements for that 12 month period to enable investors to fully appraise the company’s performance without reliance on the non-compliant activities. The Stock Exchange additionally required the appointment of an independent consultant with relevant experience to assess the internal controls systems and for such consultant not to have major negative findings about the internal controls at the end of the 12 month period. The prospectus was required to include the independent consultant’s reviews and conclusions on its internal control measures. A footnote to the listing decision provides that where the internal control consultant is the reporting accountants or another accounting firm, the relevant guidelines and practices of the accounting profession may prevent such disclosure in the listing document, save where an assurance engagement is carried out.

Disclaimer

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 Applicants Internal Controls Systems

Disclosure of Material Deficiencies

Sponsors Should Disclose Details of Relevant Material Deficiencies as Part of Listing Application Submission

Steps to be Taken When Material Deficiencies Remain Outstanding

Exchange Listing Decision LD48-2013

Reason for Non-Rectification of Material Deficiencies

Paragraph 17.3(b)(iii) of the Code of Conduct

Remedial Actions Taken by Listing Applicant

Dealing with Material Deficiencies of the Listing Applicant

material deficiencies that cannot be remedied prior to listing

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