Circular to licensed corporations on expected standards for sponsor work

26 Mar 2018



The Securities and Futures Commission (SFC) has identified a number of compliance failures primarily from a recent thematic inspection1. The SFC reminds licensed corporations to comply with the expected standards as set out in this circular in carrying out sponsor work.

Detailed findings are set out in a Report on the Thematic Review of Licensed Corporations Engaged in Sponsor Business, issued today by the SFC, which highlights a number of deficiencies and instances of non-compliance with relevant provisions in the Code of Conduct2, CFA Code3 and the Listing Rules4 (including the practice notes) in respect of due diligence practices and internal systems and controls.

In addition, 44 listing applications were returned or rejected5 as of the date of the report. In a number of cases, the sponsors’ work or the listing application materials were below the expected standard. It is also noteworthy that some individual sponsors handled a relatively large number of the listing applications which were returned or rejected.

Sponsors with a history of returned or rejected listing applications or serious deficiencies and instances of non-compliance may expect more frequent inspection visits and supervisory actions, as these factors may cast doubt on a sponsor’s capability to discharge its responsibilities as well as potential compliance risk. Future listing applications submitted by these sponsors may also be subject to closer scrutiny by the regulators.

Separately, the SFC notes that the sponsor population in Hong Kong grew from 75 as at 31 December 2012 to 107 as at 31 December 2017, with 17 sponsors joining the industry since January 2016. This raises concerns that some sponsors, particularly recent entrants, may not have sufficient experience in resolving difficult issues.

The SFC will not hesitate to take enforcement action against sponsors and their senior executives responsible for failure to comply with the expected standards in sponsor work.

The report also highlights practices observed during the thematic inspection which meet the expected standards.

I.      Due diligence

(a)  Exercising reasonable judgement and applying professional scepticism

Understanding the listing applicant  

-  obtain sales walkthrough documents to verify if the listing applicant’s business operations are accurately described in the listing application. Key issues are often identified in these documents, such as an apparently unrelated third party making payments on behalf of customers, contractual arrangements with customers that are outside the ordinary course of business or goods not being shipped to customers;

-  conduct reasonable due diligence on the listing applicant’s major retail or online customers. This is especially relevant where certain customers account for a materially larger portion of sales than others; and

-  conduct reasonable due diligence on the volume of business at the listing applicant’s major retail stores. This is especially relevant where particular stores account for a materially larger portion of sales than other stores or industry peers.

Due diligence plan and checklist

Relying on third parties

-  why they decided to rely on a particular third party to discharge their due diligence obligations, giving due consideration to the qualification and competence of the third party;

-  whether they communicated to the third party the scope and extent of the due diligence to be conducted;

-  whether the work of the third party provided a sufficient basis to determine that reasonable due diligence had been conducted and whether further due diligence was required, taking into consideration:

Relying on experts

Identifying and following up on red flags

(b)  Interview practices

-  sponsors should, as far as possible, conduct interviews at interviewees’ business premises and conduct further cross-reference checks of more than one type of proof of identity. If this protocol is not adopted, sponsors should ensure any irregularities are adequately explained and resolved.  Sponsors should also take reasonable alternative steps to verify the interviewee’s bona fides; and

-  where interviews are conducted by telephone, sponsors should verify the telephone numbers and identities of the interviewees. In particular, sponsors should not rely solely on telephone numbers provided by the listing applicant to verify an interviewee’s identity. For example, they could call the general line of the interviewee’s company obtained from a reliable public source (such as a telephone directory) to verify the interviewee’s position and confirm that the individual participated in the interview.

-  the criteria for selecting interviewees;

-  if any persons selected refused to attend the interview, what were the reasons and how this was followed up (for example by trying to fix another interview or performing other due diligence); and

-  the name and position of any other person present during the interview (this is especially relevant if representatives of the listing applicant insisted on attending the interview).

II.    Proper records

“The rules and principles of conduct within which sponsors work demand that they maintain records that are sufficiently exact and detailed to enable them, upon request by the SFC, to provide a ‘proper trail of work done’. Such a trail must include documentation of due diligence planning which itself demands a demonstration that sponsors have turned their minds to what enquiries are necessary by way of reasonable due diligence in the context and circumstances of an application. Importantly, sponsors are required to document the conclusions they reach regarding an applicant’s compliance with the listing rules.

Accordingly, a ‘bare bones’ outline setting out only broad and entirely expected areas of due diligence is insufficient.” 

-  the listing applicant’s major customers, suppliers, bankers and creditors as well as its directors and senior management;

-  material assets used or to be used in connection with the business;

-  contracts material to the business;

-  legal proceedings and other material disputes the listing applicant or its subsidiaries are involved or may be involved in; and

-  the existence, validity and business aspects of proprietary interests, intellectual property rights, licensing arrangements and other intangible rights.

III.   Resources, systems and controls

(a)  Corporate governance  

(b)  Other aspects

(c)  Annual assessment of systems and controls    

Sponsors should pay regard to the areas of concern discussed in this circular and the Report on the Thematic Review of Licensed Corporations Engaged in Sponsor Business, and critically review and enhance their systems and controls as needed to ensure that their conduct standards and control procedures meet the relevant regulatory and legal requirements. The SFC will continue to monitor market and regulatory developments and may take further measures where appropriate.

Should you have any queries regarding the contents of this circular, please contact Ms Seine Luk at 2231 1696.

Intermediaries Supervision Department
Intermediaries Division
Securities and Futures Commission

End

SFO/IS/018/2018

1 The inspection primarily reviewed the work undertaken by 31 sponsors from October 2013, when the new sponsor regulatory regime was introduced, to 31 December 2017.
2 This refers to the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission, with specific reference to Paragraph 17 on sponsors.
3
Corporate Finance Adviser Code of Conduct. 
4 Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited (SEHK) (Main Board Listing Rules) and Rules Governing the Listing of Securities on GEM of the SEHK (GEM Listing Rules) (collectively, Listing Rules).
This refers to listing applications (excluding those relating to transfers of listings from GEM to the Main Board) returned by the SEHK or rejected by the SEHK or the SFC based on publicly available information.
6 As required under Paragraph 17.3(a) of the Code of Conduct.
7 As required under Paragraph 17.10(c)(ii)(A) of the Code of Conduct.
8 As required under Paragraphs 17.10(c)(ii)(C) and (D) of the Code of Conduct which states that "In respect of each listing assignment, a sponsor should keep records, including relevant supporting documents and correspondence, within its control relating to… the nature, timing and extent of due diligence procedures; and… the results of due diligence performed together with its assessment of these results".
9 As defined under Paragraph 17.15(s) of the Code of Conduct.
10 As required under Paragraph 17.6(g) of the Code of Conduct which states that "A third party’s work, in itself, would not be sufficient evidence that a sponsor has discharged its obligation to conduct reasonable due diligence."
11
As required under Paragraph 17.7(d) of the Code of Conduct.
12 As required under Note 1 to Paragraph 17.7(b) of the Code of Conduct.
13 As required under Paragraph 13(b) of Practice Note 21 of the Main Board Listing Rules or Practice Note 2 of the GEM Listing Rules.
14 For the avoidance of doubt, where an entity is assisting in connection with due diligence tasks as well as being responsible for an expert report for a particular listing application, footnote 5 to Paragraph 17.6(g) of the Code of Conduct states that guidance for sponsors in Paragraph 17.6(g) applies to the due diligence tasks and the guidance in Paragraph 17.7 to the work as an expert. As a result, where an expert is assisting with due diligence tasks, it functions as a third party when undertaking those due diligence tasks and the above guidance to sponsors on relying on third parties will apply.
15 Paragraphs 17.6(a), (b) and (c) of the Code of Conduct.
16 Paragraph 17.6(f)(iii) of the Code of Conduct.
17 Please refer to Paragraphs 236 and 241 in its Reasons for Determination dated 27 January 2014 in SFAT No 3/2013.
18
As defined under Paragraph 17.15(i) of the Code of Conduct.
19
As defined under Paragraph 17.15(l) of the Code of Conduct, “Principal” means an individual who meets the criteria stipulated under the Sponsor Guidelines appointed by a sponsor to act as a Principal; in respect of a listing assignment, a Principal means an individual appointed by a sponsor to supervise the Transaction Team.


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Page last updated : 26 Mar 2018