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Hong Kong corporate finance regulation 2014 and 2015 – IPO sponsor due diligence regime update

Hong Kong corporate finance regulation  2014 and 2015 – IPO sponsor due diligence regime update

Guidance Letters Updates

Since the new regime came into effect in October 2013, the Exchange has published a number of updates to its disclosure requirements for IPO listing documents in new and updated guidance letters, all of which are available on the Exchange’s website. If the requirements set out in the guidance letters are not complied with, the Exchange may treat an Application Proof as not substantially complete as required by the Listing Rules, and return it to the sponsor. On return, the issuer’s and sponsor’s name and the date of return will be published on the Exchange’s website and a new application cannot be submitted for a further eight weeks.

The principal changes in disclosure requirements since October 2013 are set out below:

  1. GL41-12 (updated) & GL 27-12 (updated)

    The Exchange updated 2 Guidance Letters (GL41-12 and GL27-12) in January to deal with IPO prospectus disclosure of material changes in the group’s financial, operational and/or trading position since the end of the trading record period as required by paragraph 38 of Appendix 1A to the Listing Rules.

    GL41-12 Disclosure Requirements for IPO Cases – Disclosure of Material Changes in Financial, Operational and/or Trading Position after Trading Record Period

    GL41 sets out non-exhaustive examples of adverse changes which would require disclosure if material in relation in the technological, market, economic, legal or operating environment in which an applicant operates.

    The Exchange updated 2 paragraphs of GL41:

    • Paragraph 4.3 now requires inclusion in the “Summary” section of the listing document of either qualitative or quantitative disclosure with commentary on how the adverse changes affect the financial, operational and/ or trading position after the trading record period. Previously there was no indication of where in the listing document that information should be disclosed. Paragraph 4.3 now also specifies that such disclosure must enable investors to have a sense of the materiality of the adverse changes.
    • Paragraph 4.3 already provides that where an applicant discloses quantitative information relating to its financial performance after the track record period other than net profit/loss (e.g. revenue, gross profit, etc.), this non-profit forecast financial information should be reviewed by the reporting accountants, and a statement must be included in the listing document that this information has been reviewed by the reporting accountants.
    • Paragraph 4.3 has been amended to provide that the disclosure of the comparative financial information to the non-profit forecast financial information is not compulsory. However, if an applicant chooses to disclose such information in its listing document, this should at least be reviewed by the applicant’s sponsor.
    • Paragraph 4.4 has been revised to require that any material adverse changes are also highlighted in the “Risk Factors” and “Financial Information” sections of listing documents. These changes must be disclosed notwithstanding any mitigating factors which may reduce the potential impact of financial or operational loss to the applicant.

    GL27-12: Simplification Series – Disclosure in Listing Documents for IPO Cases – the “Summary and Highlights” section

    Attachment 1 to GL27 provides guidance on the information which is typically expected to be included in the “Summary and Highlights” section of listing documents. Attachment 1 has been revised to make it consistent with the new requirements under GL41 in relation to the disclosure of material adverse changes since the end of the track record period in the “Summary and Highlights” section.

    A further change is a requirement to include underwriting commission in the total amount of listing expenses relating to an offer as stated in the “Summary and Highlights” section.

  2. GL65-13 (updated)

    GL65-13 provides guidance on the information to be included in property valuation reports and market reports included in IPO listing documents and was updated in January 2015. The updated guidance requires property valuation reports to make “clear reference to tenure and other specific factors such as title defects and special requirements imposed on the properties by the land grant contracts, and the associated value implications, if material”.

  3. GL32-12 (updated)

    Guidance Letter 32-12 provides guidance on the accounting and disclosure requirements for (A) acquisitions of subsidiaries and businesses conducted during or after the trading record period and (B) stub period comparatives and was revised in October 2014.

    Applicability

    The updated guidance letter clarified the scope of Main Board Listing Rules 4.04(2) & (4) which require a listing applicant to include in its accountants’ the results and balance sheets of any subsidiary or business acquired or proposed to be acquired since the date to which its latest audited accounts have been made up for the three financial years (two financial years for GEM applicants) preceding the issue of the listing document, or since the incorporation of such target entity or the commencement of such business, if this occurred less than three years (or two years for GEM applicants) prior to issue of the listing document.

    The updated Guidance Letter clarified that Main Board Listing Rule 4.05A applies to acquisitions of a material subsidiary or business during an applicant’s trading record period. Rule 4.05A requires listing document disclosure of pre-acquisition financial information on a material subsidiary or business acquired during the trading record period, which would be classified as a major transaction or a very substantial transaction (i.e. 25% or more).

    In calculating the relevant ratios, the total assets, profits and revenue for the most recent financial year of the trading record period of the subsidiary or business being acquired should be compared to those of the applicant for the same financial year. If the financial year of the subsidiary or business to be acquired is not coterminous with that of the applicant, the total assets, profit or revenue for the most recent financial year of the subsidiary or business being acquired should be compared to those of the applicant for the most recent financial year of its trading record period.

    Main Board Listing Rule 4.28 requires listing document disclosure of pro forma financial information in relation to a business or company which is acquired or proposed to be acquired after the trading record period (including those where an applicant has entered into an acquisition agreement after the trading record period which will not be completed at listing and where there is an intention to acquire a specific subsidiary or business, even where there is no binding agreement) which would be classified as a major subsidiary at the date of the listing application or any later day of acquisition before listing. New Paragraph 4.6A of GL32-12 requires that all acquisitions or proposed acquisitions of businesses or companies since the end of the trading record period should be aggregated. If the aggregate total assets, profits or revenue exceeds 5% under any of the percentage ratios, such acquisitions will be regarded as an acquisition of a major subsidiary and require disclosure of pro forma financial information in respect of the enlarged group. The entire amount of the major subsidiary’s total assets, profits and revenue for the most recent financial year should be compared to those for the applicant’s latest financial year of its trading record period.

    Accounting / Disclosure Requirements

    Requirements under paragraphs 32 and 33 of the Third Schedule to the Companies
    (Winding Up and Miscellaneous Provisions) Ordinance (C(WUMP)O) apply to an acquisition subject to Rules 4.04(2) and (4) if part of the listing proceeds is to be applied directly or indirectly to purchase any business or subsidiary. In this case, the Financial Information for the acquisition must be disclosed in a separate accountants’ report.

    The Guidance Letter amendments additionally require that pro forma financial information required to be disclosed under Rule 4.28 must be disclosed as an appendix to the listing document, which must be covered by an accountants’ report as required by Main Board Rule 4.29 (GEM Rule 7.31).

    Conditions for waiver

    The updated Letter specifies the conditions for granting waivers under Rules 4.04(2) and (4):

    1. Acquisitions of equity securities in the ordinary and usual course of business of the applicant

      The Exchange will ordinarily grant a waiver of Rules 4.04(2) and (4) provided that:

      1. the percentage ratios of each acquisition are less than 5% by reference to the most recent financial year of the applicant’s trading record period;
      2. the applicant cannot exercise any control or significant influence over the underlying company or business; and
      3. the listing document includes the reasons for the acquisitions and confirmation that the counterparties and their ultimate beneficial owners are independent third parties of the applicant and its connected persons.
    2. Acquisitions of a business or subsidiary

      The Exchange will ordinarily grant a waiver of Rules 4.04(2) and (4) provided that:

      1. the percentage ratios of the acquired or to be acquired business or subsidiary are all less than 5% by reference to the most recent financial year of the applicant’s trading record period;
      2. the historical financial information of the acquired or to be acquired business or subsidiary is not available or would be unduly burdensome to obtain or prepare; and
      3. the listing document includes at least the information required for a discloseable transaction under Chapter 14 of the Main Board Rules (Chapter 19 of the GEM Rules).

      The Exchange may modify these conditions if it considers it necessary.

      In cases where the requirements of the Third Schedule to the Companies (Winding Up and Miscellaneous Provisions) Ordinance apply, an exemption of the relevant requirements is granted by the SFC.

  4. GL6-09A (updated)

    This guidance letter sets out the financial information required to be included for the trading record period in the Application Proof. It was last updated in May 2014 to make it consistent with GL32(12) (which I’ve just talked about) regarding the financial information required to be disclosed under Main Board Listing Rules 4.04(2) & (4) and 4.28 in respect of companies or businesses acquired or to be acquired after the latest audited financial year / period end (the Acquisition).

    Accordingly GL-09A requires that where an Applicant has acquired or intends to acquire a company or business since the latest audited (or advanced draft) accounts were made up, the Application Proof must include:

    1. financial information of the company or business as required by Rules 4.04(2) & (4)(a); and
    2. where the Acquisition falls under Main Board Rule 4.28 (GEM Rule 7.30), pro forma financial information of the enlarged group under Main Board Rule 4.29 (GEM Rule 7.31).

    The May amendments to the guidance letter provide that such information needs not be included in the Application Proof if the applicant’s financial information in its subsequent draft listing document will be updated to cover a later period which includes the Acquisition. However, pre-acquisition financial information for acquisitions made during the trading record period and any stub period must be included in the Application Proof.

  5. GL72-14 (new)

    In January 2014, the Exchange published new guidance letter 72-14 setting out guidance on disclosure in the “Applicable Laws and Regulations” section of listing documents. The primary requirement is that the description of the rules and regulations that are material to the applicant’s current and/ or future business should be succinct and easy to read.
    While current practice is generally to include this information in a standalone section of the listing document, the guidance letter suggests that including the information elsewhere in the listing document instead of in a standalone section might assist investors’ understanding.

    The following guidance is provided:

    1. Avoid Use of Legalistic Language

      Legalistic language and long complex descriptions should not be used. Applicants are recommended to give concise definitions of titles of laws and regulations to make the section easy to read.

    2. Key Laws and Regulations of Relevant Jurisdictions

      Disclosure should be made of laws and regulations that are specific to, and have a material impact on an applicant’s business (e.g. rules and regulations governing the applicant’s key licences for operations). Boiler plate disclosure of laws and regulations that do not materially impact the applicant’s business should be avoided.

      Where an applicant has or plans to have material businesses (in terms of its operations and sales) in a number of jurisdictions, disclosure should be made of the laws and regulations that have a material impact on the applicant’s businesses in each such jurisdiction. Such description should be proportionate to their importance to the applicant.

    3. Key Changes in the Laws and Regulations

      Listing documents should disclose changes in laws or regulations that are expected to have a material impact on the applicant’s business. Cross references should be included to the “Business” and “Risk Factor” sections to describe the impact of the laws and regulations on the applicant and its plans and procedures implemented or to be implemented to deal with them.

      Where changes in laws and regulations occur during or prior to the track record period, these do not need to be disclosed unless:

      1. the applicant is subject to grandfathering provisions; or
      2. the changes in laws and regulations have had a material impact on the business, which may be disclosed elsewhere in the listing document (e.g. in the “Business” or “Financial Information” section which should be cross-referenced within the “Applicable Laws and Regulations” section.
    4. Relevance to the Applicant

      As opposed to abstract summaries, this section should disclose clearly how each law and regulation is relevant to the applicant, unless it would be obvious to an average investor. If there is a risk that the applicant’s business may breach a law or regulation, the steps that the applicant has taken and plans to take to ensure compliance should be disclosed in either the “Applicable Laws and Regulations” or the “Business” section, and it may be appropriate to include a legal opinion as to the likelihood of breach and the maximum liability of the applicant.

    5. Highly Regulated Industries

      Applicants engaged in highly regulated industries (including but not limited to banking, insurance and gambling) should ensure that the “Applicable Laws and Regulations” section focuses not only on local statutory laws governing the industries (e.g. banking laws, laws governing insurance companies and gambling laws), but also other internationally implemented industry specific rules and regulations (e.g. anti-money laundering).

    6. Laws of the Issuer’s Jurisdiction of Incorporation

      The Guidance Letter refers to the Joint Policy Statement released on 27 September 2013 regarding the listing of overseas companies. The disclosure of regulatory provisions (as required by Main Board Rules 19.10(2) and (3) and specific disclosure items in paragraphs 63-66 of the Joint Policy Statement) in relation to an applicant’s jurisdiction of incorporation should be set out in a section of the listing document separate from the “Applicable Laws and Regulations” section.

  6. GL68-13 (new)

    The Exchange published new Guidance Letter 68-13 in December 2013 setting out a non-exhaustive list of factors that may affect suitability of a listing applicant.

    1. Suitability of director and controlling shareholders

      There may be concern over the applicant’s suitability if a person likely to exercise substantial influence on the applicant after listing has a past non-compliance or conviction record that raises serious concern as to the person’s integrity.

    2. Non-compliance

      Systematic, intentional, and/or repeated breaches of laws and regulations may affect an applicant’s suitability for listing. The Exchange will take into account the nature, extent and seriousness of the breaches, the reasons for them (i.e. whether they were intentional, fraudulent or negligent), their impact on the applicant’s business and financial performance, the rectification measures adopted and precautionary measures to avoid future breaches.

    3. Deteriorating financial performance

      Even where an applicant satisfies the relevant requirements of Rule 8.05 during the track record period, any deteriorating financial performance after the track record period may be indicative of a fundamental deterioration of commercial or operational viability, which raises serious concerns as to its sustainability and suitability.

    4. Excessive reliance on parent group / connected persons / major customer

      If an applicant demonstrates heavy reliance on certain parties or model, the Exchange may have concerns as to its suitability for listing. Examples of reliance causing concern as to suitability for listing are:

      1. Reliance on a parent group for important functions such as sales and procurement functions or financial and operational reliance on the applicant’s parent;
      2. Reliance on a parent where there are overlapping directors, the applicant and parent are in the same industry sector, and the arrangements for managing potential conflicts of interest and delineation of businesses are inadequate;
      3. Where a significant portion of the applicant’s turnover and net profit is derived from transactions with connected persons and other closely related parties;
      4. Extreme reliance on a single major customer may cause concern as to the applicant’s suitability for listing. The Exchange will take into account the applicant’s ability to find replacement customers, likelihood of reduced reliance in the future, the industry landscape, whether the reliance is mutual and complimentary, the existence of long-term contractual arrangements and the applicant’s ability to sustain its revenue and profitability in the long-term.
      5. A captive business model (meaning the sourcing of the listing applicant’s principal raw materials and its principal customer channel are dominated by the same party) – If the applicant cannot operate independently of such party, this will raise concerns as to its listing suitability.
    5. Gambling

      Listing applicants are not suitable for listing unless they satisfy the requirements stated in the Exchange’s announcement entitled “Gambling Activities Undertaken by Listing Applicants and/or Listed Issuers” and Listing Committee Report 2006.

    6. Contractual Arrangements (VIEs)

      Applicants that are VIEs must satisfy the conditions specified in Listing Decision “HKEx-LD43-3” to establish their suitability for listing.

    7. Reliance on unrealized fair value gains to meet profit requirement

      If the applicant cannot satisfy the profit requirement after excluding unrealised fair value gains of its investment properties and it did not have a substantive business during its track record period, it must demonstrate that it has a sustainable business in order for the Exchange to consider it suitable for listing. A sustainable business may be demonstrated by the existence of property projects under development or significant recurring income).

  7. GL63-13 (updated)

    Guidance Letter 63-13 which deals with disclosure of material non-compliance incidents was updated in May 2014 to put incidents into three categories:

    1. Material Impact Non-compliance Incidents

      Non-compliance incidents which, individually or in aggregate, have had or may have a material financial or operational impact on the listing document (e.g. those giving rise to significant financial penalties or which may result in the closure of material operating facilities;

    2. Systemic Non-compliance Incidents

      Non-compliance incidents which are not Material Impact Non-compliance Incidents, but which reflect negatively on the applicant’s or its directors’/senior management’s ability to operate in a compliant manner, such as repeated and/or continuous breaches of laws;

    3. Immaterial Non-compliance Incidents

      Non-compliance incidents not within the above two categories.

      The guidance letter provides that where there are serious non-compliance incidents (e.g. involving director fraud, systemic failure of an applicant’s internal controls and/or matters having a significant financial impact on the applicant), this may raise questions as to the suitability of the applicant’s directors and/or the applicant’s suitability for listing. The May amendment added that such serious non-compliance incidents may result in:

      1. the application being rejected; or
      2. the Exchange requesting a demonstration period of compliance from the cessation of the non-compliance incident(s) to show that rectification measures and enhanced internal controls put in place are effective and that there is no financial impact on the applicant. The demonstration period would normally be an audited period.

      Where non-compliance incidents do not cause the applicant to be considered to be unsuitable for listing, the Exchange requires that:

      • Material Impact Non-compliance Incidents should be highlighted in the “Summary and Highlights” section of listing documents and disclosure of the information set out in paragraph 3.4 of the guidance letter.
      • Systemic Non-compliance Incidents should also be highlighted in the “Summary and Highlights” section of listing documents and the listing document disclosure should include the views of the directors and the sponsor(s) on the adequacy and effectiveness of the applicant’s internal controls, the suitability of its directors and the applicant’s suitability for listing the information.

      Disclosure of major customers’ identities

      The Securities and Futures Commission’s (the SFC’s) latest Corporate Regulation Newsletter (Issue No. 2 of April 2015) sets out its recommendation that listing applicants should disclose the identities of their major customers in their listing documents, especially if a few customers only are responsible for a large part of the company’s revenues. If a listing applicant does not disclose customer identities in its listing document, the listing applicant and its sponsor must take reasonable steps to ensure that this information is not included in any marketing communication provided to analysts or investors.

May 2015

This note is provided for information purposes only and does not constitute legal advice. Specific advice should be sought in relation to any particular situation. This note has been prepared based on the laws and regulations in force at the date of this note which may be subsequently amended, modified, re-enacted, restated or replaced.

Hong Kong Corporate Finance Regulation

Hong Kong Stock Exchange’s weighted voting rights concept paper

Shenzhen-Hong Kong Stock Connect

Shanghai Hong Kong Stock Connect

China-Hong Kong Mutual Recognition of Funds

Hong Kong Mandatory Reporting Obligations for OTC Derivatives

open-ended investment funds in corporate form in Hong Kong

Hong Kong sponsors’ due diligence obligations

Corporate Laws

Laws and Regulations for Businesses

Shanghai HK Connect
IPO Stocks


Skills

Posted on

2015-01-28