A significant part of the responsibilities of a sponsor is the due diligence work that it undertakes with respect to a listing applicant. This due diligence exercise is crucial to enable the sponsor to gain knowledge and understanding of the applicant and satisfy itself that the applicant complies with the Hong Kong Stock Exchange (HKEX) Listing Rules (HKEX Listing Rules), and that the prospectus contains sufficient disclosure for investors.
Due diligence requirements are prescribed by both the HKEX Listing Rules (in particular, Practice Notice 21) and the Securities and Futures Commission’s (SFC’s) Code of Conduct for Persons Licensed by or Registered with the SFC (Code of Conduct).
Due diligence steps, scope and materiality
The Code of Conduct requires a sponsor to take reasonable due diligence steps in respect of a listing application which must be completed (except in relation to matters that by their nature can only be dealt with at a later date) before submitting a listing application. It sets out a number of independent due diligence steps that a sponsor should carry out including inquiring directly of directors, key management staff, consultants and controlling shareholder(s), inspecting key physical assets (which includes production facilities where appropriate), and interviewing major business stakeholders (such as customers, suppliers, creditors and bankers).
The HKEX’s Practice Note 21 also sets out typical due diligence inquiries a sponsor would be expected to take in respect of directors’ qualifications, competence and integrity, compliance with qualifications for listing, expert sections and other matters. A copy of Practice Note 21 can be accessed here.
Due diligence procedures cannot be a comprehensive check of every aspect of a listing applicant’s affairs. An assessment of materiality will be needed when formulating a due diligence plan for a particular applicant. A selective or sampling approach may be used where appropriate when a listing applicant has many like operations, assets or processes.
A sponsor should exercise reasonable judgement on the nature and extent of due diligence work needed in a particular case. The nature and extent of due diligence will vary from case to case depending on the facts and circumstances and there is no exhaustive list of due diligence steps that would apply in all circumstances.
Due diligence cannot be a forensic process, and cannot be expected to guarantee an absence of fraud, forgery or deliberate non-disclosure.
Professional scepticism and verification
A sponsor should not merely accept statements and representations made and documents produced by a listing applicant or its directors at face value. Under Practice Note 21 and the Code of Conduct, a sponsor is expected to examine with “professional scepticism” the accuracy and completeness of such statements, representations or other information. This entails making a critical assessment with a questioning mind and being alert to information that contradicts or brings into question the reliability of such statements, representations and information.
The sponsor is also expected to perform appropriate verification procedures, such as reviewing source documents, inquiring of knowledgeable persons or obtaining independently sourced information.
Where appropriate and practicable, a sponsor should seek direct confirmation of information from major business stakeholders, such as major suppliers, customers, licensors and bankers. However, such parties will normally have no obligation to cooperate with the due diligence process and their participation is voluntary. Certain third parties, such as bankers or joint venture partners, may be prevented by privacy or confidentially requirements from cooperating fully.
Where a sponsor becomes aware of circumstances that may cast doubt on information provided to it or otherwise indicates a potential problem or risk, the sponsor should undertake additional due diligence to ascertain the truth or completeness of the matter and information concerned.
For more information on verifying the contents of the prospectus, please click here.
Reasonable reliance on experts and other third parties
A sponsor is permitted to assign specific due diligence tasks to third parties, such as lawyers, accountants, valuers and internal control consultants. However, the sponsor cannot rely blindly on the work of experts and other third parties. While a sponsor is not expected to re-perform the work of an expert or other third party adviser, it is still required to perform certain due diligence tasks in respect of the third party and its work product.
Due diligence to be completed by time of listing application
Sponsors must complete all reasonable due diligence before submitting a listing application, except for matters that by their nature can only be dealt with later. This includes advising and resolving issues concerning eligibility criteria, internal controls and directors’ credentials, which are fundamental to the suitability of a listing applicant.
Documenting due diligence planning
Sponsors must document their due diligence planning and significant deviations from their plans. The due diligence plan will serve to map out key details of the intended due diligence steps and procedures that the sponsor intends to conduct on the listing assignment. The plan can also contain the expected timeline required to conduct each step and procedure, and the key parties (including the sponsor, the listing applicant and third parties from whom that the sponsor expects to seek assistance) that should be involved in each step. The due diligence plan should then operate as a tool to guide and direct the sponsor in the commencement of its due diligence work.
Throughout the conduct of the sponsor’s due diligence work, findings and results of each of the material due diligence steps and procedures performed should be noted in the due diligence plan or referenced to relevant supporting documents and correspondence as appropriate.
After the due diligence plan and the detailed due diligence steps and procedures have been developed, the sponsor should regularly review the plan at regular transaction team meetings to review the status and progress of the due diligence work, to consider and discuss material issues identified to date, to consider whether changes should be made to the plan (including in terms of due diligence steps and timeline) and / or whether further due diligence steps and procedures should be added by reference to the facts and circumstances known to the sponsor throughout the due diligence process.
A complete set of sponsor’s records in connection with a listing assignment should be retained in Hong Kong for at least seven years after completion or termination.