Regulation of Sponsors & Independent Financial Advisers HKEx briefings 7, 8 & 13 December 2004

Regulation of Sponsors & Independent Financial Advisers HKEx briefings 7, 8 & 13 December 2004

In October HKEx & SFC announced: Consultation conclusions Rule amendments (commence 1 January 2005 - subject to transitional arrangements)

Agenda: Process Key Objectives Key Aspects 2 Phases Rule Changes • sponsors & CAs • IFAs • transitional • Enforcement • Questions

Process: Conclusions informed by extensive market consultation In conjunction with May 2003 consultation paper Conclusions & rule amendments approved by SEHK & Commission

Key Objectives: Sponsors play an important role in HK. Variance of expectations To address expectation gap: • clear framework for role of sponsors, compliance advisers & IFAs • make it abundantly clear what is expected of them & issuers that appoint them

Key Aspects: Conclusions & amended rules: WILL codify current expectations WILL clearly set out: • when sponsors, CAs & IFAs must be appointed • when sponsors, CAs & IFAs must be independent & what is independence

role of sponsors, CAs & IFAs including due diligence • role of issuers in assisting sponsors & CAs

WILL make it clear that sponsors, CAs & IFAs can only do what is reasonable & appropriate WILL NOT expect sponsors to verify expert reports/ be experts WILL allow engaging of 3rd party professionals (but sponsor must ensure work not substandard) WILL NOT shift obligations from directors/experts to sponsors

2. How? 1 January 2005: most amendments late 2005: new SFC regime & further consequential amendments 2 Phases: 1. Why? Initial & continuing eligibility to be solely in SFC’s licensing regime

Rule Changes: On 1 January, rules amended to: include new chapter re sponsors & CAs (MB Ch.3A; GEM Ch.6A) include new rules re IFAs (MB 13.80 to 13.87; GEM 17.92 to 17.99) include new PN re due diligence by sponsors (MB PN21; GEM PN2) address incidental amendments

New MB & GEM rules largely identical Differences include e.g.: 6A.02 re eligibility (MB: sponsor to be acceptable to SEHK; GEM: sponsor to be admitted to list of acceptable sponsors) 6A.19 re length of appointment of CA (MB: 1+ years; GEM: 2+ years) different incidental amendments

Sponsors & compliance advisers: 1. Appointment • 3 scenarios: • pre-listing (& deemed new listings) • immediately post-listing • other time as directed (3A.20)

Pre-listing & deemed new listings: • sponsor to assist with IPO (3A.02) • no co-sponsorship BUT can engage more than 1 sponsor • if more than 1 (3A.10): • advise primary communication channel • all equally responsible • all must act impartially (3A.06) • only 1 need be independent (come back to independence)

Post-listing: • CA for 1 year+ (3A.19); (GEM - 2 years+) • can be different to sponsor • need not be independent but must act impartially

2. Eligibility • Until 2005: • sponsors: status quo i.e.: MB: acceptable to SEHK GEM: on eligible list • CAs: adopt sponsor regime • After 2005: determined by SFC

3. Independence • all sponsors & CAs must perform duties with impartiality • sponsors must be independent; if more than 1, then only 1 need be • listing document must disclose each sponsor’s independence & if not independent, how

all sponsors must give SEHK statement re independence addressing criteria (3A.08) • independence test: bright line test to be applied by sponsor / issuer (3A.07)

“sponsor group” is defined at 3A.01(9) as: • a sponsor • any holding company of the sponsor • any subsidiary of any holding company of the sponsor (d) any controlling shareholder of: • the sponsor or • any holding company of the sponsor which controlling shareholder is not, itself, a holding company of the sponsor & (e) any associate of any controlling shareholder referred to in paragraph (d) above

This chart does not form part of the Listing Rules Definition of “sponsor group” (: Main Board rule 3A.01 and GEM rule 6A.01) Associates of controlling shareholder (CS) Associates of CS Associates of CS Associates of CS CS of Co A that is not, itself, a holding company of sponsor CS of sponsor that is not, itself, a holding company of sponsor Holding company of sponsor (Co A) Subsidiary of Co A Sponsor

This chart does not form part of the Listing Rules Definition of “sponsor group” (incorporating effect of definition of “holding company” in s2(7) Companies Ordinance) Associates of controlling shareholder (CS) Associates of CS Associates of CS Associates of CS CS of Co A that is not, itself, a holding company of sponsor CS of sponsor that is not, itself, a holding company of sponsor Holding company of sponsor (Co A) Subsidiary of Co A Sponsor Subsidiary of subsidiary of Co A Subsidiary of subsidiary of Co A Subsidiary of sponsor Subsidiary of sponsor Subsidiary of subsidiary of sponsor Subsidiary of subsidiary of sponsor Subsidiary of subsidiary of sponsor Subsidiary of subsidiary of sponsor

3A.07 provides sponsor is not independent if: (1) the sponsor group & any director or associate of a director of the sponsor collectively holds or will hold, • directly or indirectly • more than 5% of the issued share capital of the new applicant • save & except where that holding arises as a result of an underwriting obligation

(2) the fair value of the direct or indirect current or prospective shareholding of the sponsor group in the new applicant • exceeds or will exceed 15% of the net equity shown in the latest consolidated financial statements of • the sponsor’s ultimate holding company or • where there is no ultimate holding company, the sponsor

(3) any member of the sponsor group or any director or associate of a director of the sponsor is • an associate or connected person of the new applicant

(4) 15% or more of the proceeds raised from the initial public offering of the new applicant • are to be applied directly or indirectly to settle debts due to the sponsor group • save & except where those debts are on account of fees payable to the sponsor group for subject sponsorship services

(5) the aggregate of: • amounts due to the sponsor group from the new applicant & its subsidiaries; & • (b) all guarantees given by the sponsor group on behalf of the new applicant & its subsidiaries exceeds 30% of the total assets of the new applicant

(6) the aggregate of: (a) amounts due to the sponsor group from: (i) the new applicant (ii) the new applicant’s subsidiaries (iii) any controlling shareholder of the new applicant; & (iv) any associates of any controlling shareholder of the new applicant; &

(b) all guarantees given by the sponsor group on behalf of: (i) the new applicant (ii) the new applicant’s subsidiaries (iii) any controlling shareholder of the new applicant; & (iv) any associates of any controlling shareholder of the new applicant exceeds 10% of the total assets shown in the latest consolidated financial statements of the sponsor’s ultimate holding company (or the sponsor)

(7) the fair value of the direct or indirect shareholding of: • (a) a director of the sponsor • (b) a director of any holding company of the sponsor • (c) an associate of a director of the sponsor; or • an associate of a director of any holding company of the sponsor • in the new applicant exceeds HKD 5 million;

(8) an employee or director of the sponsor who is directly engaged in providing the subject sponsorship services to the new applicant, or • an associate of such an employee or director • holds or will hold shares in the new applicant or • has or will have a beneficial interest in shares in the new applicant

(9) any of the following has a current business relationship with the new applicant or • a director, subsidiary, holding company or substantial shareholder of the new applicant • which would be reasonably considered to affect the sponsor’s independence, or • might reasonably give rise to a perception that the sponsor’s independence would be so affected • except where relationship arises pursuant to subject sponsorship services:

(a) any member of the sponsor group • (b) an employee of the sponsor who is directly engaged in providing the subject sponsorship services to the new applicant • an associate of an employee of the sponsor who is directly engaged in providing the subject sponsorship services to the new applicant • (d) a director of any member of the sponsor group; or • (e) an associate of a director of any member of the sponsor group

(10) the sponsor or a member of the sponsor group is the auditor or reporting accountant of the new applicant.

4. Roles sponsors: proactive CAs: reactive

must give undertakings: • sponsors (3A.04): • comply LRs • use reasonable endeavours to ensure info to SEHK is true & complete • promptly advise if that changes • cooperate in Division / Listing Committee investigation • CAs (3A.22): • comply LRs • cooperate in Division / Listing Committee investigation

sponsors’ role set out in 3A.11 • sponsors must: • comply with undertaking • be closely involved in preparation of listing documents • ensure 9.03 & 9.05 to 9.08 complied with • address SEHK questions etc • accompany new applicant to meetings with SEHK • conduct reasonable DD to make declaration in 3A.13

5. Due diligence declaration • will cover due diligence re: • director’s declaration(s) • compliance with basic listing conditions • sufficiency of listing document • new applicant’s systems & controls

directors’ collective experience, qualifications & competence • directors’ individual experience, qualifications & competence • expert sections of listing document including whether:

factual information relied on by expert is true & complete (unless verified by expert) • all bases & assumptions = fair, reasonable & complete • expert appropriately qualified, experienced & resourced • expert scope of work appropriate • expert independent • listing document fairly represents expert views

6. Due diligence by sponsors • in determining what is reasonable DD refer new PN (3A.12) • requirement for DD: • is not new • crystallises existing expectations • is not intended to replace directors’ & experts’ obligations • will not absolve general obligations as CF advisers under SFC administered laws & codes

PN: • applies only to sponsor firms; not CAs, IFAs or individuals • is not a checklist / minimum steps • is SEHK’s expectations of typical DD steps (actual steps may be more or less) • is subject to what is reasonable

PN provides: (at para 2) • sponsor should make inquiries until can reasonably satisfy itself in relation to the disclosure in the listing document • sponsor should examine with professional scepticism the accuracy & completeness of statements & representations made, or other information given, to it • professional scepticism means making a critical assessment with a questioning mind & being alert to information that contradicts or brings into question reliability

(at para 3) • [PN] sets out Exchange’s expectations of DD sponsors will typically perform • PN does not set out actual steps that may be appropriate in any particular case • each new applicant is unique & so will be DD steps necessary • scope & extent of appropriate DD may be different from (& in some cases, considerably more extensive than) the more typical examples in [PN] • sponsor must exercise judgment as to what investigations or steps are appropriate & the extent of each step

(at para 4) • Exchange expects sponsors to document DD planning & significant deviations from plans • includes demonstrating that turned their minds to question of what inquiries are necessary & reasonably practicable in the context & circumstances • Exchange also expects sponsors to document conclusions in respect of new applicant’s compliance with all the conditions in Chapter 8

(at para 5) • may be appropriate for a sponsor to engage 3rd party professionals to assist with tasks related to DD • e.g. assistance in reviewing circumstances of current legal proceedings • in such cases, Exchange expects sponsor to satisfy itself is reasonable to rely on information / advice provided by the 3rd party • Including e.g.:

(a) being satisfied as to: • competence of the professional • scope of work to be undertaken by 3rd party • methodology proposed to be used by 3rd party (b) being satisfied that 3rd party’s report or opinion is consistent with other information known to sponsor about new applicant, its business & its business plans

Regulation of Sponsors & Independent Financial Advisers HKEx briefings 7, 8 & 13 December 2004