Due Diligence Guidelines –
Provision of Information to Analysts
Code of Conduct Paragraph
1. Information Provided to Analysts in New Listings
A sponsor should take reasonable steps to ensure that all material information, including forward-looking information (whether quantitative or qualitative) concerning a listing applicant or listing application disclosed or provided to analysts is contained in the relevant listing document. [Paragraph 17.14 of the Code of Conduct]
1.2.1 During the listing application process, there is often a concern that listing applicants may seek to influence the formulation of analysis and views in the pre-deal research reports by providing research analysts, whether or not to the knowledge of the sponsors, with information about the listing applicant that is not contained or not reasonably expected to be contained in the prospectus (“impermissible information”). A concern has also been expressed that research analysts from firms connected to the listing applicant could be put at an advantage by being provided with impermissible information that is not made available to other research analysts.
1.2.2 In order to ensure equality of the source information and to prevent pre-deal research reports from being used as a vehicle for the listing applicant to disseminate material information relating to an offer without formal prospectus liability, the SFC issued a Consultation Paper on the Regulatory Framework for Pre-deal Research in September 2010 (the “Consultation Paper on the Regulatory Framework for Pre-deal Research”) inviting public comments on, among others, the proposal to codify certain sponsors’ practices and require sponsors to take steps to ensure that all material information, including forward-looking information (whether quantitative or qualitative), disclosed or provided to research analysts in connection with the listing applicant or its securities, is contained in the relevant prospectus or listing document (the “Disclosure Requirement”). The Consultation Paper on the Regulatory Framework for Pre-deal Research suggested that, where material information or forward-looking information (whether qualitative or quantitative) is inadvertently disclosed to research analysts, the sponsor should advise the listing applicant as to what changes are needed to the draft prospectus to ensure the prospectus includes all material information provided to research analysts.
1.2.3 In June 2011, the SFC published the Consultation Conclusions on the Regulatory Framework for Pre-deal Research (the “Consultation Conclusions on the Regulatory Framework for Pre-deal Research”), which codified certain sponsors’ practices through amendments to the Code of Conduct and the CFA Code. As a result of the Consultation Conclusions on the Regulatory Framework for Pre-deal Research, paragraph 5.10 of the CFA Code was amended to give effect to the Disclosure Requirement:
“[W]here a Corporate Finance Adviser acts as a sponsor in relation to a listing of equity securities by a company on the Stock Exchange, the sponsor should take reasonable steps to ensure that all material information, including forward-looking information (whether quantitative or qualitative) disclosed or provided to analysts is contained in the relevant prospectus or where the proposed listing does not involve a prospectus, the relevant listing document, offering circular or similar document.”
1.2.4 In judging whether any information, particularly any forward-looking information, is material, consideration has to be given as to whether, if included in a prospectus, it is likely to significantly influence a reasonable person’s opinion of the listing applicant and its financial condition and profitability.
1.2.5 Since the publication of the Consultation Conclusions on the Regulatory Framework for Pre-deal Research, representatives of certain market participants, including investment banks and other market practitioners (the “industry group”), have discussed possible changes to the market practices relating to the preparation of pre-deal research for Hong Kong IPOs. The industry group has memorialised the proposed changes and developed a set of proposed standard form documentation (the “Recommended Addenda”, the forms of which are set out in Appendix I to this chapter), which includes a standard form research report guidelines, riders for existing forms of documents and additional forms of documentation, all of which are intended to address issues of complying with the SFC’s regulations and to develop consistency across the market. Sponsors may choose to adopt the Recommended Addenda either in part or in full.
1.2.6 On 12 December 2012, the SFC published the Consultation Conclusions on the Regulation of Sponsors. To consolidate all key obligations applicable to sponsors in one code (including the Disclosure Requirement), the Consultation Conclusions on the Regulation of Sponsors transferred the sponsors’ obligation under paragraph 5.10 of the CFA Code to a new Paragraph 17.14 of the Code of Conduct.
1.3 Recommended Steps
1.3.1 The sponsor should educate the listing applicant to ensure that the listing applicant is properly briefed and advised on how to deal with research analysts and what information can and cannot be disclosed to research analysts. In particular, the sponsor should:
(a) explain to the listing applicant the importance of the Disclosure Requirement at the earliest opportunity after receiving the listing applicant’s mandate.
(b) ensure that the listing applicant is aware of important Hong Kong laws and regulations regarding communications between the listing applicant and research analysts during the listing application process.
(c) attend the training of the directors of the listing applicant conducted by the listing applicant’s lawyers (“Directors’ Training”) and ensure that the listing applicant is aware of the restrictions on disclosure of material information to research analysts.
1.3.2 The sponsor should remind its advisers, including intermediaries and lawyers, on the Disclosure Requirement. In particular, the sponsor should:
(a) alert the listing applicant, its directors and senior management members, among other issues, to the implications of providing impermissible information to research analysts.
(b) ensure that the publicity memorandum contains a description of the Disclosure Requirement and the publicity memorandum is circulated to, among others, the listing applicant and other intermediaries.
(c) prepare and distribute the research guidelines which contain a description of the Disclosure Requirement (“Research Guidelines”) to syndicate members.
1.3.3 The sponsor should consider appropriate steps to exercise reasonable control over and understand the content of information passed from the listing applicant to research analysts. For example, the sponsor may instruct the listing applicant to either pass along all information provided or to be provided to research analysts to the listing applicant’s lawyers, or to require the listing applicant to obtain the listing applicant’s lawyers’ consent before passing information along to research analysts.
1.3.4 The sponsor should prepare materials for, and arrange and supervise the analysts’ briefing and presentations by the listing applicant to research analysts. In particular, the sponsor should:
(a) assist the listing applicant to develop the analysts’ presentation and presentation script to ensure they do not contain any impermissible information (e.g., financial projections) and instruct the listing applicant not to answer any questions of research analysts that are not dealt with in the presentation script.
(b) ask the listing applicant’s lawyers and underwriters’ lawyers to review the analysts’ presentation and the presentation script to ensure they do not contain any impermissible information.
(c) adopt measures to ensure that research analysts from the firms involved with the listing application process are only provided with information in the analysts’ briefings and presentations arranged and supervised by the sponsor.
(d) consider requiring research analysts to acknowledge and confirm that they have read and agree to the restrictions and observations set out in the Research Guidelines, and if research analysts have questions prior to the analysts’ presentation, they should submit the questions to the sponsor in writing.
(e) ensure that at the outset of the first meeting between research analysts and the listing applicant, the listing applicant should confirm that it is aware of the Disclosure Requirement.
(f) should the sponsor attend analysts’ briefings and presentations, during such briefings and presentations, be attentive to research analysts’ questions and the listing applicant’s answers to ensure the listing applicant does not communicate impermissible information to research analysts. To the extent that the sponsor is aware of any communication of impermissible information, the sponsor should intervene with the discussion and clarify that such information is impermissible information.
(g) consider requesting the listing applicant’s lawyers and underwriters’ lawyers to chaperone the analysts’ briefings and presentations and to point out to the listing applicant and research analysts whenever they realise impermissible information is being shared with research analysts. In the event of one-on-one communication between the listing applicant and research analysts, the sponsor should consider involving the listing applicant’s lawyers, underwriters’ lawyers and/or its in-house lawyer(s) to the communication.
1.3.5 The sponsor may consider seeking confirmation from the listing applicant and other intermediaries by:
(a) adding a listing applicant’s undertaking to comply with the Disclosure Requirement in the sponsor’s mandate letter.
(b) requiring the listing applicant to confirm that it has not provided research analysts with any impermissible information as part of the listing applicant’s A1 back-to-back confirmation to the sponsor.
(c) requiring each syndicate member to represent, warrant, undertake and confirm its compliance with the Research Guidelines.
(d) requiring the listing applicant to represent, warrant, undertake and confirm its compliance with the Disclosure Requirements.
1.3.6 The sponsor should take steps to ensure that pre-deal research reports do not contain (i) any factual inaccuracies, or (ii) any material information that could have been sourced from the listing applicant that cannot reasonably be expected to be included in the listing document or is not publicly available. For example, the sponsor may consider:
(a) reminding the underwriters’ lawyers regarding the review of pre-deal research reports.
(b) requiring research analysts to confirm prior to printing and distribution of pre-deal research reports that they have not sought nor received any impermissible information.
1.3.7 The sponsor should ensure the listing document disclosure is revised to contain all material information, including forward-looking statements (whether quantitative or qualitative), concerning the listing applicant or listing application that it knows has been disclosed or provided to the research analysts during the process of conducting any preventive measures outlined in the foregoing paragraphs. To the extent that the sponsor is aware of any material information or forward-looking information (whether qualitative or quantitative) being disclosed to research analysts (whether inadvertently or otherwise), the sponsor should advise the listing applicant as to what changes are needed to the draft listing document. The sponsor should also work with the drafting lawyers to ensure that any such proposed changes are disclosed in the listing document. The sponsor and the listing applicant may also consider including a risk factor in the listing document, stating that the investors should not place any reliance on any media or research reports regarding the listing applicant, and that the investors should make their investment decisions on the basis of the information contained in the listing document only.
SFC Publishes Consultation Paper On The Regulatory Framework For Pre-IPO Research Reports
The Securities and Futures Commission ("SFC") has published a Consultation Paper on possible amendments to the regulatory framework governing investment research reports issued before a first listing of equity securities on the Hong Kong Stock Exchange ("Pre-deal Research"). The central proposal is to extend analysts' existing obligations as detailed in paragraph 16 of the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission ("Code of Conduct") to the preparation of Pre-deal Research. These proposals involve amendments to:
The Code of Conduct; and
The Corporate Finance Adviser Code of Conduct ("CFA Code")
Ensuring the independence and objectivity of Pre-deal Research reports are key goals for the SFC. The following is a summary of the principal proposals included in the Consultation Paper, a copy of which is available on the SFC website at here.
Background to the proposed reform
The Consultation Paper recognises that analysts play a vital role in the Hong Kong capital market, acting as gatekeepers between companies and investors and providing investors with expert research and advice on the quality of the securities of public companies.
Difficulties arise however when analysts face a conflict of interest. This can occur where an analyst or his/her employer has a financial interest in an issuer, the value of whose securities the analyst is tasked with assessing impartially on behalf of third party investors. That interest has the potential to affect the analyst's ability to objectively present the issuer's financial position.
Paragraph 16 of the Code of Conduct addresses conflicts of interest by regulating the conduct of analysts and their employers with regard to investment research on securities traded in Hong Kong or research which has an effect on such securities. Processes designed to address conflicts of interest, for instance between a firm's trading and financial interests, are mandated as are procedures to prevent undue influence being placed on analysts by outsiders. Disclosure of any potential or actual conflicts and the analyst's ethical behaviour is required.
The Scope of the Reform
The issues in relation to conflict of interest outlined above apply also to analysts examining a company or SFC authorised real estate investment trust ("REIT") which is preparing to list on the Exchange, and also to listed REITS. The SFC therefore proposes to extend the scope of paragraph 16 of the Code of Conduct beyond analysts covering companies listed in Hong Kong to:
Companies that are about to list their securities on the Exchange for the first time and which are obliged to issue a prospectus; and
Listings of and listed REITs
As retail investors typically do not have access to Pre-deal Research reports, the SFC aims to prevent such reports by analysts who are employed by a sponsor, manager, placing agent or underwriter to the offering (or by a related company) ("Connected Analysts") from being used as a means to disclose material information not disclosed in the prospectus solely to professional investors. This is to be achieved by preventing Pre-deal Research reports from containing or being based on information which is not in the public domain or the prospectus. In order to ensure compliance, the SFC intends to amend the CFA Code so as to place an obligation upon sponsors 1 in relation to a new listing of equity securities. This is discussed in more detail below.
Regulatory Framework for Pre-deal Research
At present, Hong Kong securities regulation does not deal specifically with Pre-deal Research. In a 2005 Consultation Paper 2, the SFC considered banning the issue of Pre-deal Research reports written by Connected Analysts imposing an obligation to publish leaked Pre-deal Research reports by Connected Analysts and imposingalso imposing an obligation to publish leaked Pre-deal Research reports by Connected Analysts, and commentary on such leaked research reports, in the prospectus of the relevant listing applicant. However, following the consultation, it was determined that such a ban would be disruptive to the Initial Public Offer ("IPO") process and of little value to investors. Such research can, for instance, play an important role in the price discovery process. The focus shifted therefore to confronting the problems of unequal distribution of information and inaccurate information contained in Pre-deal Research reports.
IPO Current Market Practice
The current practice is that the "pre-marketing" or "investor education" activities of Connected Analysts normally take place after the applicant for listing ("Applicant") receives from the Exchange a letter setting out the Listing Committee's comments and any conditions attached to the listing approval sought. In the case of REIT listing applicants, this process ordinarily commences after the REIT listing applicants and their listing agents receive the SFC's approval-in-principle letter.
The "pre-marketing" or "investor education" process is ordinarily preceded by the Connected Analysts distributing Pre-deal Research to professional and institutional investors under the placing tranche.
After the "pre-marketing" or "investor education" process, the underwriters commence the "book-building" procedure, where the underwriters approach potential institutional investors to gauge their interest in purchasing securities in the offering at various prices. This book-building process is usually conducted contemporaneously with a management road show and normally starts approximately two to three weeks before the start of the public offer period. Applicants will usually issue and distribute a "red herring" to assist in the book-building and management road show process.
Since January 2008, Applicants have posted a near complete prospectus (or near complete offering circular in the case of a public offering of SFC authorised Collective Investment Schemes, including REITs) on the HKEx Website at around the same time as the "red herring" is made available to institutional investors. This ensures public access to substantially the same information as that provided to institutional investors by the Applicant. The prospectus, which contains all relevant information relating to the offering and the accompanying share application form is issued later, upon registration with the Registrar of Companies in Hong Kong or authorisation by the SFC in the case of a REIT. A large majority of IPOs allow an offer period of three and a half days between the issue of the prospectus and the close of the offer.
It is already common practice for sponsors to use a detailed internal compliance system in order to ensure the independence and integrity of Pre-deal Research reports and to ensure that they are disseminated only to professional investors, and that there is no leakage of their contents whereby reports run the risk of technically constituting a prospectus. The SFC considers that as a result of these private initiatives, the implementation of a new regime regarding Pre-deal Research, with the principles underlying existing compliance procedures codified as a minimum expected standard, should pose no great practical difficulties.
Proposed Amendments: Extend the Requirements under Paragraph 16 of the Code of Conduct to Pre-deal Research
The SFC notes that the risk of conflict of interest for Connected Analysts writing Pre-deal Research papers is the same as it is for Connected Analysts writing reports on listed companies. Accordingly it proposes extending the existing conflict of interest requirements for analysts writing research reports on listed corporations in paragraph 16 of the Code of Conduct to Pre-deal Research reports. This is to ensure analysts' independence and objectivity in relation to Pre-deal Research reports. This extension would also apply to proposed listings of and listed SFC-authorised REITs in Hong Kong.
Proposed Amendments: The integrity of information provided to research analysts
The SFC identifies three key concerns relating to the integrity of information provided to research analysts:
Devising a means of preventing the leakage to the public of non prospectus information during or prior to the offer period.
Ensuring that Applicants and their representatives do not influence the content of Pre-deal Research reports by releasing information to the analyst which is not contained in the prospectus. This can be used as a means of circumventing the strict prospectus rules regarding the publication of information about the Applicant.
Preventing Connected Analysts from enjoying an advantage over other analysts due to their ability to obtain additional information by virtue of their links with the issuer.
These areas are being addressed by the SFC in three ways:
1. The Codification of Control Procedures regarding the kind of information to which analysts have access
It is current market practice that firms employing research analysts preparing Pre-deal Research reports on an Applicant should be required to establish, maintain and enforce a set of written policies and control procedures to ensure that firms do not provide these analysts with any material or forward looking information (whether qualitative or quantitative) concerning the Applicant that is not reasonably expected to be included in the prospectus or publicly available.
Sponsors assist in this regard as they generally prepare the necessary data for analysts' briefings and also coordinate and manage the meetings between analysts and the Applicant's representatives. They will have control procedures in place to ensure that the Applicant's representatives do not communicate to the analysts any material information that is not contained in the prospectus or which analysts from other firms do not have access to.
To ensure the integrity of these control measures, the SFC proposes to amend paragraph 16.7 of the Code of Conduct in order to make firms responsible for ensuring that they do not pass any material or forward looking information (whether qualitative or quantitative), not reasonably expected to be included in the prospectus or otherwise publicly available, to any analyst charged with preparing a Pre-deal Research report on an Applicant.
2. The Codification of the rule that analysts should not seek non prospectus information
The SFC also proposes amending paragraph 16.11 of the Code of Conduct to require that research analysts preparing Pre-deal Research reports on an Applicant should not seek from the Applicant or its advisers, either directly or indirectly, any material or forward looking information (whether qualitative or quantitative) concerning the Applicant that is not reasonably expected to be included in the prospectus or publicly available.
The SFC states that this proposal is not designed to prevent analysts from undertaking their own due diligence exercises, including for example site visits organised by the Applicant. Nor is it intended to disallow the inclusion of forward looking material prepared by the analysts themselves in Pre-deal Research reports. However the material cannot be formulated or prepared by the Applicant.
Paragraph 5.3 (a) of the CFA Code contains the principle that sponsors are the primary guide and manager of the Applicant throughout the IPO process. As noted above, one of their key responsibilities is the control of meetings between analysts and Applicant representatives in order to ensure that no material information which is not reasonably expected to be contained in the prospectus or otherwise publicly available is disclosed to the analysts. This does not mean they must be present at every meeting, but they certainly must be present at the main analyst briefings.
The SFC proposes to amend the CFA Code to create an obligation on sponsors, in relation to a new listing of equity securities, to take steps to ensure that all material or forward looking information (whether qualitative or quantitative) disclosed to analysts is contained in the relevant prospectus, offering circular or similar document. If adopted, this obligation would apply equally to listing agents in the case of REITs.
Applicant Responsibility for Disclosure of Information
The SFC also discusses and dismisses the suggestion, put forward by market practitioners, that sole responsibility for the disclosure to analysts of material or forward looking information should fall upon the Applicant and its directors. The argument advanced by the market participants was that as the directors and the Applicant are responsible for the content of the prospectus, the sponsor should have no duties in this area.
However the SFC notes that sponsors have a responsibility, under paragraph 5.3 of the CFA Code of Conduct, for the overall management of the public offer and putting in place sufficient arrangements and resources to ensure that the public offer is conducted in a fair, timely and orderly manner. This includes ensuring that Applicants are properly informed about what information may or may not be disclosed to analysts. The SFC suggests that of the three groups, analysts, sponsors and Applicants, the latter are usually the least informed as regards the intricacies of the IPO process and as a result, the responsibilities in this specific area should not lie with them.
This note contains a summary only of the principal proposals contained in the SFC's Consultation Paper on the Regulatory Framework for Pre-deal Research. Specific advice should be sought in relation to any particular situation.