Chapter 18

Due Diligence Guidelines –

Interaction with Third Parties including Expert Advisers1

6. Bases and Assumptions

6.1 Standards

…[T]he sponsor should:… assess whether material bases and assumptions (in the case of financial information, critical accounting policies and estimates) on which the expert report is founded are fair, reasonable and complete. [Paragraph 17.7(c) of the Code of Conduct]

6.2 Guidance

6.2.1 The sponsor should assess whether material bases and assumptions on which the expert’s work is founded are fair, reasonable and complete. Such assessment should normally be made by reference to the sponsor’s knowledge of the listing applicant, its business and its business plans.12 The sponsor should also seek to gain an understanding of the market practice on selecting the methodology, bases and assumptions on which the expert’s work is based.

6.2.2 The sponsor’s opinion as to the bases and assumptions should be confined to those that are “material” only (in the case of financial information, it is clarified that the sponsor should only assess critical accounting policies and estimates).13

6.2.3 Given a sponsor’s accumulated knowledge of the listing applicant, its commercial and financial expertise, as well as its role in assessing the listing applicant and its business sector, it is important that a sponsor has an independent view regarding the bases and assumptions on which the expert’s work is founded.

6.2.4 Although the Code of Conduct is silent on the sponsor’s obligation to assess the material bases and assumptions of the work performed by non-expert third parties, it would be good practice for the sponsor to apply Paragraph 17.7(c) of the Code of Conduct to non-expert third parties as well.

6.3 Recommended Steps

6.3.1 The sponsor should discuss with the third party at the outset the methodology, bases and assumptions to be used.

6.3.2 To assess whether the relevant material bases and assumptions are fair, reasonable and complete, the sponsor should apply its own knowledge and experience of the relevant industry which the third party operates in and take into account the general and unique situations of the listing applicant.

6.3.3 The sponsor should critically review the initial draft of the third party’s work when it is ready. If the sponsor has any comment on the material bases and assumptions adopted in the initial draft, the sponsor should make such comment known to the third party and, if appropriate, consider with the third party the use of any alternative methodology, bases or assumptions. In particular, if the sponsor is of the view that the material bases and assumptions on which the third party’s work is based are inconsistent with other information known to itself or established market practice, the sponsor should question the bases and assumptions and make further due diligence enquiries to clarify the issues.14

6.3.4 As regards experts, the sponsor should consider obtaining written confirmation from the expert regarding the content of relevant expert sections in the listing document in advance of the filing of the listing application. The expert should confirm, among other things, that all bases and assumptions on which its expert advice or opinion is founded are fair, reasonable and complete. As regards non-expert third parties, it may not be necessary to seek such written confirmation as non-expert third parties are not seen as being responsible for any particular section in the listing document.15

Endnotes

12. Paragraph 14(e) of Practice Note 21 to the Listing Rules: Typical due diligence enquiries in relation to the expert sections of the listing document include by reference to the sponsor’s knowledge of the listing applicant, its business and its business plans assessing whether the assumptions disclosed by the expert as those on which the expert’s opinion is based, are fair, reasonable and complete.

13. Paragraph 161 of the Consultation Conclusions on the Regulation of Sponsors.

14. Paragraph 52 of the Report on Sponsor Theme Inspection Findings issued by the SFC in March 2011.

15. The SFC clarified in paragraph 171 of the Consultation Conclusions on the Regulation of Sponsors that “expert sections” refer to any part of a listing document that reproduces a self-standing report or opinion made on the authority of, and with a consent issued by, an expert. Examples include the reporting accountant’s report, valuer’s report or competent person’s report. All other parts of the listing document are referred to as “non-expert sections”. Non-expert sections may contain statements made within the general competence of third parties. For example, lawyers may advise on property titles, accountants may review internal controls and consultants may provide market research.