The Stock Exchange of Hong Kong Limited (the Exchange), a wholly-owned subsidiary of Hong Kong Exchanges and Clearing Limited (HKEx) and the Securities and Futures Commission (the SFC) have jointly published a Consultation Paper on Regulation of Sponsors and Independent Financial Advisers (the Consultation Paper).

Summary

The Consultation Paper released today represents a joint proposal by the Exchange and the SFC to introduce measures to tighten the regulation of IPO intermediaries.

The core proposals in the consultation paper will establish a common regime, administered by the Exchange, to establish the acceptability of corporate finance advisers who wish to act as sponsors or Independent Financial Advisers (IFAs) whether to prospective applicants or listed issuers on either the Main Board or GEM. The proposed regime will place emphasis on the experience of individuals but also impose obligations on them to ensure that sponsor and IFA work is performed to acceptable standards. Implementation will also see the introduction of the Code of Conduct for Sponsors and Independent Financial Advisers which provides updated guidance to clarify the responsibilities of sponsors and IFAs.

Other proposals for consideration include a proposed requirement for a declaration in a prospectus by the sponsor and lead underwriter about the due diligence work they have performed in providing the Exchange with assurances on the completeness and accuracy of the prospectus. This proposal, which draws on a well established US requirement, may be regarded as a controversial development. Nevertheless the Exchange and the SFC believe that for improvements to be made in the Hong Kong market it is essential that ideas such as this can be exposed to facilitate consideration and debate by the market. A decision about how to proceed will be made by the Exchange and the SFC in the light of responses to the consultation paper.

The Exchange and the SFC also anticipate that the proposals may have an impact on certain market practitioners and consideration has been given to transitional arrangements which might serve to minimise disruption to market practitioners on implementation.

The Background

The Secretary for Financial Services and the Treasury published the Corporate Governance Action Plan for 2003 on 10 January 2003, a co-ordinated approach by the Administration, the SFC and the Exchange to improve corporate governance. The plan contains measures to tighten the regulation of IPO intermediaries, including a proposal to conduct the present consultation exercise and to make amendments to the Listing Rules (which will follow in due course).

The sponsor's role is of special importance in Hong Kong, due to the unusually large proportion of listed companies and listing applicants whose domicile and main operations are located outside the jurisdiction. In the case of Mainland-based private sector companies, verifying information (including the credentials of promoters and the validity of business ownership, operations and structure under local rules) presents particular challenges. Particular reliance therefore needs to be placed on the judgement and verification work of the sponsors who bring companies to the market.

The latter part of last year was marked by a number of corporate scandals and unheralded failures involving Hong Kong listed companies. Notwithstanding allegations of fraud in some of these cases, press and public attention have focussed on the role and responsibilities of those involved in the process of bringing issuers to the market.

Comments made in response to criticism support the view that an "expectation gap" concerning the responsibilities of sponsors exists between investors, regulators and some sponsors and raise concerns that some sponsors are not properly discharging the responsibilities which are normally associated with this important role in a developed financial market. This in turn creates an uneven playing field for those sponsors who are properly discharging their responsibilities. Both the Exchange and the SFC have therefore decided to put forward proposals to change the Listing Rules to help close the "expectation gap".

Similar concerns have been expressed that some IFAs are not discharging their responsibilities properly.

The summary of the proposals

The Consultation Paper briefly summarises the background to the consultation and then sets out the proposed changes to the Listing Rules. The key proposals are in short:

• a common regime, administered by the Exchange, to establish the acceptability of corporate finance advisers who wish to act as sponsors or IFAs to prospective applicants or listed issuers on either the Main Board or GEM;

   

• enhancements and further guidance to clarify the responsibilities of sponsors and IFAs;

   

• a declaration in a prospectus by the sponsor and lead underwriter about the due diligence work they have performed in providing the Exchange with assurances on the completeness and accuracy of the prospectus;

   

• a declaration in a report by the IFA on the due diligence work it has performed in reaching its recommendation;

   

• a requirement that, in addition to sponsor firms and IFA firms, key individuals within the firm (called "eligible supervisors") give a personal undertaking to the Exchange to comply with the Listing Rules;

   

• further guidance to clarify when a proposed sponsor or an IFA may not be regarded as independent of a new applicant or listed issuer and therefore be unable to act in such capacity; and

   

• a requirement for a sponsor to be appointed with responsibilities equivalent to those applicable at IPO where a listed issuer is otherwise producing a listing document.

   

 

The Code of Conduct for Sponsors and Independent Financial Advisers (the Code of Conduct)

The proposed Listing Rules will require that sponsors and IFA firms and their directors and staff comply with the new Code of Conduct. A failure to comply with the Code of Conduct may result in the Exchange commencing disciplinary action against the sponsor, an eligible supervisor or a director or staff member of a sponsor. The Code of Conduct applicable to sponsors will mirror the SFC Code of Conduct but will contain additional obligations of direct application to sponsors and IFAs.

It is proposed that the Main Board and GEM Listing Rules be amended to require sponsors to conduct reasonable investigations to satisfy themselves that:

• the new applicant is suitable for listing, the new applicant's directors appreciate the nature of their responsibilities and the new applicant and its directors can be expected to honour their obligations under the Listing Rules and the Listing Agreement;

   

• "non-expert sections" contained in the new applicant's listing application and prospectus are true and that they do not omit to state a material fact required to be stated or necessary to avoid the statements being misleading; and

   

• there are no reasonable grounds to believe that the "expert sections" contained in the new applicant's listing application and prospectus are not true or omit to state a material fact required to be stated or necessary to avoid the statements being misleading. For this purpose, it is proposed that any part of a prospectus purporting to be made on the authority of an expert or purporting to be a copy of or an extract from a report, opinion or statement of an expert, shall be called the "expert sections". Other parts of the prospectus are the "non expert sections".

   

 

It is also proposed that the Main Board and GEM Listing Rules be amended to require IFAs:

• to take all reasonable steps to satisfy themselves that the terms and conditions of the transaction are fair and reasonable and that there are no grounds to believe that any expert advice or opinion relied on in relation to the transaction are not true or omit a material fact; and

   

• to make a declaration in their report of the due diligence they have performed in order to reach a conclusion that the terms of the relevant connected transaction are fair and reasonable.

   

• The Code of Conduct will illustrate the general obligations of due diligence proposed by reference to non-exhaustive descriptions of the subject matter and extent of due diligence. In particular the Code will clarify that:

   

• sponsors must make site visits and other appropriate enquiries;

   

• in relation to the "non-expert sections" of a disclosure document or listing application the sponsor cannot simply rely on the statements of directors and senior management but must conduct its own investigations; <

   

• in relation to the "expert sections" of a disclosure document or listing application the sponsor must determine whether, in light of its knowledge of the application/issuer and the scope of work, methodology and assumptions employed, it can reasonably rely on the truth and completeness of the statements contained therein; and

   

• in the event that problems are or should reasonably have been identified in relation to statements contained in either the "expert sections" or "non-expert sections" of the disclosure document or listing application, the sponsor will be under an obligation to conduct more detailed, extensive and intrusive investigations to ensure the accuracy and completeness of the statements in question.

   

 

Other professional advisers

The Exchange and the SFC have also considered the role of other professional advisers and steps being taken to ensure that the regulatory framework applicable to such firms and individuals promote high standards of conduct and incorporates effective disciplinary measures as a deterrent to poor performance.

General

We have set out above only our principal proposals on the regulation of Sponsors and IFAs. Members of the public are requested to refer to the Consultation Paper for details of our proposals.

We anticipate that there will be divergent views on our proposals. The Exchange and the SFC welcome views and suggestions of viable alternatives.

As the issues involved are important to the future development of the Hong Kong securities market, we urge members of the public to consider the discussion and suggestions set out in the Consultation Paper in detail and submit detailed responses, including reasons for their views.

It is our objective to receive comments on the Consultation Paper from a wide spectrum of respondents. The Exchange and the SFC will provide a hotline service during the consultation period on 2840 3800 and 2840 3400 for HKEx and on 2283 6815 for the SFC to respond to any queries that respondents may have relating to the Consultation Paper. In addition, we will hold seminars for issuers and market practitioners to discuss the proposals set out in the Consultation Paper.

Copies of the Consultation Paper and questionnaire will be despatched to issuers and market practitioners on 30 May 2003. Copies are available for collection at the office of HKEx at 11/F, One International Finance Centre, 1 Harbour View Street, Central, Hong Kong and the office of the SFC (on or before 30 June 2003) at 12/F, Edinburgh Tower, The Landmark, 15 Queen's Road Central, Hong Kong and (after 30 June 2003) at 8th Floor, Chater House, 8 Connaught Road, Central, Hong Kong. The Consultation Paper can also be viewed at or downloaded from the HKEx website at www.hkex.com.hk and the SFC website at www.sfc.hk.

Interested parties are invited to submit to either HKEx or the SFC their comments on the Consultation Paper by completing and returning the questionnaire set out in Annex 3 of the Consultation Paper. If the use of the questionnaire alone is not adequate to fully communicate comments on the Consultation Paper, respondents are welcome to supplement their comments and views by attaching additional sheets to the questionnaire. They may also complete and submit the electronic questionnaire available at www.hkex.com.hk. They may also download a soft copy of the questionnaire from the HKEx website and the SFC website and submit the completed copy via email to cvw@hkex.com.hk for the HKEx or cfdconsult@hksfc.org.hk for the SFC. Responses should arrive no later than the close of business on 31 July 2003.