HKIPOGuidefinal

Hong Kong IPO Guide
Herbert Smith HK IPO Guide
Introduction
Going public is a key stage in the growth and development of a company. Obtaining a listing on the Hong Kong Stock Exchange enables a company to improve its standing in the business community and gives it greater access to equity and debt capital raising markets, while at the same time providing shareholders with an internationally recognised stock exchange on which they can freely trade their shares.
The Herbert Smith Hong Kong IPO Guide is intended to provide an overview to capital raising in Hong Kong and in particular to the initial public offering (IPO) process for companies listing on the main board of the Exchange from the pre-IPO strategic investor stage through listing. In 2006 year to date the Exchange has raised more capital through IPOs than any exchange in the world. The global nature of the investment community and capital markets has resulted in more and more companies considering dual listings on other international exchanges, like New York or London, or structuring their offerings as exempt offerings so their shares can be offered to US and other investors. This Guide is a summary only of the more significant legal and regulatory issues encountered in the IPO process as at October 2006 and as such should not be relied upon as legal advice. In particular, this Guide does not consider regulatory issues imposed by jurisdictions other than Hong Kong and the United States. Herbert Smith accepts no responsibility for any errors or omissions this Guide may contain. Reference should be made to the Herbert Smith Compliance Guide for HK Exchange Listed Companies for details of the continuing obligations applicable to companies following listing on the Exchange. This Guide may be updated from time to time. However, we are under no obligation to do so or to forward any revised Guide to any previous recipients. We trust you will find the Herbert Smith Hong Kong IPO Guide a useful reference tool and a helpful introduction to the IPO process in Hong Kong. If you have any questions please feel free to contact any of the people named on the following page.
Ashley Alder Head of Asia
Herbert Smith
Herbert Smith is a leading international legal practice with over 1,100 lawyers based in its offices in Europe and Asia. We are committed to providing high quality and innovative legal services to corporations, governments, financial institutions and all types of commercial organisations. The firm advises its clients on corporate, dispute resolution, banking and finance issues, and energy and projects and offers a full range of specialist services including investment funds, regulatory, construction, insurance, tax and IP/IT. Hong Kong office: 23rd Floor, Gloucester Tower 15 Queens Road Central Hong Kong Beijing office: 1410-1419, China World Tower 1 1 Jianguomenwai Avenue Beijing 100004 Peoples Republic of China Shanghai office: 38th Floor, Bund Center 222 Yan An Road East Shanghai 200002 Peoples Republic of China
Contacts
Corporate Partners Ashley Alder T Tom Chau T Michael Fosh T Gary Lock T Roddy Martin T Tommy Tong T Andrew Tortoishell T Jeremy Xiao T +852 2101 4001 +852 2101 4104 +86 10 6505 6512 +86 21 6335 1144 +852 2101 4183 +852 2101 4151 +852 2101 4012 +86 10 6505 6512 ashley.alder@herbertsmith.com tom.chau@herbertsmith.com michael.fosh@herbertsmith.com gary.lock@herbertsmith.com roddy.martin@herbertsmith.com tommy.tong@herbertsmith.com andrew.tortoishell@herbertsmith.com jeremy.xiao@herbertsmith.com john.moore@herbertsmith.com kevin.roy@herbertsmith.com nicky.cardno@herbertsmith.com tim.wright@herbertsmith.com
US Securities Partners John Moore T +852 2101 4106 Kevin Roy T +852 2101 4102 Practice Support Lawyer Nicky Cardno T +852 2101 4137 Business Development Asia Tim Wright T +852 2101 4665
Defined Terms
CO Exchange INEDs LR or Listing Rules SFC SFO Share Repurchase Code Takeovers Code Companies Ordinance (Cap.32, Laws of Hong Kong) The Stock Exchange of Hong Kong Limited Independent Non-Executive Directors the Main Board Listing Rules of the Exchange Securities and Futures Commission of Hong Kong Securities and Futures Ordinance (Cap.571, Laws of Hong Kong) SFC Code on Share Repurchases SFC Code on Takeovers and Mergers
The information provided in this Guide is general and may not apply in a specific situation. Legal assistance should always be sought before taking any action based on the information provided.
Herbert Smith 2006
Contents
Regulatory background
1. 2. 3. Offers of securities is a prospectus required? Who can offer securities Main Board and GEM key listing criteria 1 4 5
Specific Listing Issues

16. 17. 18. 19. 20. 21. 22. 23. 24. Listing of PRC businesses Continuity of management and ownership Accounts Independence from parent company Competing interests of controlling shareholders and directors Connected transaction waivers PRC property issues Forecasts Share option schemes 50 55 58 58 60 64 65 66 69
Pre-IPO preparation
4. 5. Group reorganisations Strategic investors and pre-IPO placings 6 8
Liability and Due Diligence

6. 7. 8. 9. Prospectus liabilities Due diligence and verification process Comfort letters and US legal opinions Director and Officer liability insurance 13 18 22 25
Underwriting and marketing

25. Structure of the offering 26. Underwriting arrangements 27. Publicity restrictions 28. Research reports 29. Stabilisation and over-allotments 71 73 76 80 85
IPO process
10. The team 11. Listing methods and criteria 12. Listing timetable and Exchange documents 13. Sponsors responsibilities 14. Prospectus content 15. Approval and registration of prospectus 26 29 31 37 45 48
International Offerings
30. Exempt US offerings 31. Hong Kong and US dual listings 32. Hong Kong and Shanghai dual listings 89 92 102
Post- IPO Matters

33. Post IPO restrictions on shareholders and company 104
1. Offers of securities is a prospectus required?

When securities are offered to the public (which includes an IPO) a prospectus must be prepared and registered. The public is defined widely however there are a number of exempt offers (including offers to less than 50 people) which are discussed below. Before a company effects an IPO it will often have already raised equity capital by issuing shares or other securities to investors. In order for these pre-IPO capital raisings to proceed without a registered prospectus it is important to ensure that the offers of these shares fall within one of the categories of exempt offers.
The Hong Kong prospectus legislation is under review and it is expected that proposed legislative amendments, reflecting the September 2006 Consultation Conclusions on the Consultative Paper on Possible Reforms to the Prospectus Regime in the Companies Ordinance (published by the Securities and Futures Commission), will be issued. It is presently not possible to predict when any of the reforms will be effected.
Legislation
Ordinances The primary legislation in Hong Kong governing the offering of securities and other investment arrangements to the public in Hong Kong is the Companies Ordinance and the Securities and Futures Ordinance (SFO). Companies Ordinance Under the Companies Ordinance it is unlawful for a person to issue or distribute in Hong Kong an offer or invitation to the public to subscribe for shares unless a prospectus is prepared, approved by the Securities and Futures Commission (SFC) and filed with the Registrar of Companies. The Companies Ordinance contains guidelines as to certain exempt offers which do not require a prospectus (such as offers to not more than 50 people) and includes detailed provisions on the content requirements for prospectuses. SFO Under Section 103 of the SFO, a person is prohibited from issuing any advertisement, invitation (including any oral invitation), offering memorandum, or document (together an offer document) which to his knowledge is or contains an invitation to the public to subscribe for securities or acquire an interest in a collective investment scheme (such as a unit trust or mutual fund), unless the offer document: relates to an exempt offer under the Companies Ordinance; or is authorised by the SFC; or is issued to professional investors (discussed below).
Exempt offers
The Companies Ordinance requires a prospectus to be prepared where an offer of securities is made to the public. Very little guidance is given as to whom constitutes the public. However, from 3 December 2004 the Companies Ordinance was amended to specifically identify offers which do not require a prospectus. If an offer does not fall within one of these exemptions, the more important of which are noted below, then generally it will be considered as being made to the public and will require a prospectus: offers to professional investors as defined in the SFO (see definition below); offers to not more than 50 people; offers with a maximum offering value of HK$5 million; offers with a minimum subscription value of HK$500,000; offers made in connection with a genuine invitation to enter into an underwriting agreement; offers made under a takeover or merger made in compliance with the Code on Takeover and Mergers; offers where there is no consideration involved (such as bonus issues) or as an alternative to a dividend or other distribution; offers to qualifying persons (including directors and employees) of the company or of any other member of the same group of companies; offers in connection with a collective investment scheme (mutual fund or unit trust) authorised under s104 of the SFO.
All of the above can be used in combination with each other (other than offers with a maximum offering of HK$5 million and offers with a minimum subscription of HK$500,000) so that it is possible to offer shares to an unlimited number of professional investors and up to 50 other investors. The offer document for any of the exempt offers noted above must state that the offer document has not been reviewed by any regulatory authority. Only offers to Hong Kong residents must be considered, thus an offer could be made to 50 Hong Kong residents and additional persons outside Hong Kong provided the offer complies with the rules of the relevant offshore jurisdictions. For the purposes of the above exemptions professional investors include: any individual, either alone or with his spouse or child, having a portfolio of securities and/or currency deposits of not less than HK$8 million; any corporation or partnership having a portfolio of securities and/or currency deposits of not less than HK$8 million or total assets of not less than HK$40 million; any corporation the sole business of which is to hold investments and which is whollyowned by an individual who falls within 2.3.1; or any trust corporation with total assets of not less than HK$40 million.
Offer document content

If the offer of securities is exempt from the prospectus requirements under the Companies Ordinance, the offering memorandum need not be in any prescribed form, other than containing a prescribed statement to the effect that the offer document has not been reviewed by a regulatory authority. If the offer is not exempt then it must comply with the prospectus disclosure requirements of the Companies Ordinance and contain the information required by Section 175 and Schedule 7 of the SFO.
2. Who can offer securities

While a large IPO will generally always be marketed by appropriately qualified persons, where an exempt offer is made (without a prospectus) the company must take care to ensure that any person it engages to assist it with the marketing of the securities is an appropriately qualified person. Permitted persons
The SFO effectively provides that the only persons who can offer securities in Hong Kong (or offer securities from outside Hong Kong but target persons resident in Hong Kong), are: persons licensed by the SFC to carry out Type 1 regulated activities; and the officers of the company whose securities are being offered, or any agent of the company who is not being paid to market such securities, provided that the offer is either an exempt offer under the Companies Ordinance or the issue of the offer document is authorised by the SFC.
Unsolicited calls
A licensed intermediary cannot make unsolicited calls or emails offering to sell securities except: if the call is made to a solicitor, professional accountant, licensed intermediary, authorised financial institution, money lender, professional investor, or an existing client; or if the call is a permissible communication (pursuant to the Securities and Futures (Unsolicited Calls Exclusion) Rules) being any communication other than one made in the course of a visit in person, or by a telephone conversation, or any other interactive dialogue in the course of which statements and responses to them are exchanged immediately.
3. Main Board and GEM key listing criteria

The Exchange operates two listing boards commonly referred to as the Main Board and GEM (Growth Enterprise Market). GEM was primarily established to enable the listing of smaller more speculative companies which did not satisfy the Main Board listing criteria. Both the size of the companies listed on GEM and the volume of shares traded in those companies are generally significantly smaller than those listed on the Main Board. Main Board listing criteria
The principal listing criteria for the Main Board is that the company must have (i) a trading record of not less than three financial years (though limited exemptions are available for companies with a market cap over HK$4 billion, mineral and project companies, and in exceptional circumstances), (ii) management continuity for the last three financial years, (iii) ownership continuity for at least the most recent audited financial year, and (iv) either: profit test a profit in the most recent year of not less than HK$20 million, and in respect of the previous two years, an aggregate profit of not less than HK$30 million (such profits to exclude any income or loss generated by activities outside the ordinary and usual course of the business), although some limited exemptions are available; or market capitalisation/revenue/cash flow test a market capitalisation of at least HK$2 billion, revenue of at least HK$500 million in the most recent financial year, and positive cash flow of at least HK$100 million in aggregate in the last three years; or market capitalisation/revenue test a market capitalisation of at least HK$4 billion and revenue of at least HK$500 million in the most recent financial year, and at least 1,000 shareholders at the time of listing.
More details on the Main Board listing criteria are set out in 'Listing Methods and Criteria'.
GEM listing criteria

The main listing criteria for GEM is that the company must have either: 24 month track record for at least 24 months actively pursued one line of business under substantially the same management and ownership; or 12 month track record for at least 12 months actively pursued one line of business under substantially the same management and ownership, and have turnover of not less than HK$500 million, total assets of not less than HK$500 million or an expected market capitalisation of not less than HK$500 million, and at listing at least HK$150 million of its shares must be held by the public.
4. Group reorganisations
At the early stages of an IPO it is essential to ensure that the group of companies to be listed has the correct group structure and that the group holds all rights necessary to carry on its business operations. For large IPOs this reorganisation process may commence more than a year before the IPO process commences. Below are some of the issues which must be considered. Group structure
As a group develops over time it will often end up with a large number of subsidiaries, some of which may have multiple divisions, while others may no longer be needed. The reorganisation process gives the opportunity to reorganise the overall group structure if desired including addressing issues such as: winding up any redundant companies; shifting companies within the group structure to ensure they are within the correct business groups and reporting lines; splitting up large subsidiaries with multiple divisions to place the divisions within separate subsidiaries; ring-fencing any speculative or high risk business ventures in separate subsidiaries (and where possible excluding these companies from general group funding obligations to avoid triggering cross-defaults).
Regard should also be had to potential competition issues where competing businesses may be excluded from the group, and connected transactions issues where part of the groups operations are held by (see page 8) connected persons following the reorganisation (see page 7). The reorganisation process may also present an opportunity to eliminate minority interests in major subsidiaries, particularly where the minority shareholders are connected persons which may render the subsidiary itself a connected person of the company under the Listing Rules.
Assets and contractual rights

It is important to ensure that all assets and contractual rights needed to operate the group are owned by the group or the contractual rights are granted in favour of a group member. Often during the due diligence process it becomes apparent that certain key assets and contractual rights are held by a parent company outside the group, or by part of the group which is not being listed, or by a shareholder, or are simply held on an informal basis and no formal contracts have ever been prepared. These assets and contractual rights should be identified and transferred into the group as appropriate. Where contractual rights or assets are to be transferred it is important to get all necessary approvals. If the assets being transferred constitute a stand-alone business then you must take into account the provisions of the Transfer of Business (Protection of Creditors) Ordinance.
The consideration paid for any transfer of assets must be carefully considered. Transfers are often simply recorded at book value and where this value is below book value it may trigger deemed distribution and insolvency clawback issues.
Intellectual property rights

As with other assets and contractual rights, it is important to identify all intellectual property rights used by the group and if they are not held by the group ensure they are transferred into the group or at a minimum a group member obtains the rights to use such intellectual property.
Tax
When implementing group reorganisations it is important to liaise with the groups accountants or auditors to ensure that the groups tax position is optimised. Often the use of offshore holding companies may be preferable both for minimising any tax liability and enabling easier distribution of cash from operating subsidiaries up to the parent company. In addition, any inter-group transfers of shares and assets must be reviewed from a tax perspective to consider issues such as the appropriate transfer price, stamp duty and protection of accumulated losses.
Financial assistance
Financial assistance must be considered when transferring shares and assets. The financial assistance provisions of the Companies Ordinance can be quite far reaching.
IPO reorganisation steps

The reorganisation steps undertaken in preparation for the IPO will vary, depending on the existing and intended group structure. One of the key steps is determining the jurisdiction of incorporation of the listing entity. Only companies incorporated in Hong Kong, the Cayman Islands, Bermuda or the PRC may be listed on the Exchange. For listing entities incorporated outside the PRC, the business of the group is generally injected into the listing entity by way of a share swap. For H Share companies, the listing entity will need to be converted into a joint stock limited company or the business operations and assets injected into a newly established listing entity. Such reorganisation will require approvals from relevant PRC governmental authorities and a valuation of the PRC issuers assets by a PRC valuer will need to be carried out. Recently, the PRC has enacted new regulations relating to the reorganisation of PRC entities into offshore vehicles to facilitate listings. At the time of going to press it is too early to give any guidance other than PRC legal advice needs to be obtained on a case by case basis. It is important that the reporting accountants review the reorganisation proposal to ensure that the proposed reorganisation would permit the preparation of the companys accounts on an appropriate basis for inclusion in the prospectus.
5. Strategic investors and pre-IPO placings

When contemplating an IPO, the company will often look for one or more institutional or strategic investors to provide capital to enable the company to proceed to the IPO stage and/or lend credence to the company and its proposed listing. This investment may be made prior to the IPO process commencing, or the investor may simply agree that it will commit to acquiring part of the IPO shares (and thus make its investment at the time of the IPO). The investment may be made in ordinary shares or in other securities such as convertible bonds or preference shares which offer the investor greater downside protection.
Careful consideration is required of the terms of any pre-IPO placing. If these terms are excessively favourable to the investor the Exchange may require that the terms are modified before the listing can proceed. This modification may well require the approval of the investor and thus potentially delay the listing. The following discussion assumes that the placee does not become a connected person of the company as a result of the placing.
Nature of investment
Where the investment is made at the same time as the IPO, the investor will invariably take ordinary shares like the other IPO investors. However, where the investment is made prior to the IPO, the investor may wish to subscribe for securities which offer the investor a greater degree of protection than ordinary shares. Convertible notes or preference shares are commonly used for these pre-IPO investments as they can be converted into ordinary shares on the IPO (or later), but can also be redeemed for cash in certain situations thus providing the investor with downside protection without limiting the upside equity potential.
Offer price and lock-up undertakings

In listing decision 36-1, the Exchange stated that as a general principle a strategic investment made prior to an IPO should be permitted (even where it is at a discount to the IPO price), provided there is full disclosure in the prospectus. However, the placee may be subject to a lock-up of its shares. Whether the shares placed to the placee should be considered part of the public float or subject to a lock-up undertaking to the Exchange is determined by the Exchange on a case by case basis considering factors such as the size of any pricing discount, the length of time between the placing and the listing application, the purpose of the placing, special rights given to the placees and the placees exposure to equity risk. Whether the placing is of existing or new shares and whether the placee is subjected to a voluntary lock-up in favour of the company or the underwriters is of little relevance to the Exchanges consideration. In addition, where the terms of a pre-IPO placing are considered contrary to the principles of LR 2.03 the Exchange may reject the listing application even if a lock-up is provided by the investor. LR 2.03 provides, amongst other things, that the issue and marketing of securities must be conducted in a fair and orderly manner and all holders of listed securities must be treated fairly and evenly.
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In listing decisions 55-1, 55-2 and 55-3, the Exchange rejected pre-IPO placings on the basis that their terms were contrary to LR 2.03. Terms which the Exchange had difficulty with included: the investment would be completed only after approval in-principle of the listing application by the listing committee, combined with a guaranteed discount and the ability of the investor to put its shares back to the controlling shareholders after listing at a premium; payment was deferred until in-principle listing approval, the investor could sell its shares back to the controlling shareholder if final listing approval was not granted, and the shares may be issued at a discount as the agreed price was the mid-point of the intended offer price range in this situation the Exchange noted that given the listing conditions the investor was taking investment risks no different from those of IPO investors; and shares were subscribed for at a discount well before the IPO (which is of itself generally acceptable), but immediately before the listing the parties modified the terms to provide that the investor could sell the shares back to the controlling shareholder after listing at a minimum sales price.
Accordingly, when a pre-IPO placing is undertaken the terms must be carefully considered as the Exchange may require the placee to give a lock-up undertaking (regardless of whether one is already given to the company and/or the underwriters under the terms of the placing) or may require other changes to the terms of the placing to ensure such terms do not breach the intent of LR 2.03. In these situations the consent of the investor will be required to any such changes and this may delay the listing or result in the investor trying to renegotiate the terms of its investment. Where the Exchange imposes a lock-up on the shares placed to the investor, such shares will not count towards the companys public float.
Offer price for IPO investments

In practice, it will not be possible for an investor to invest at a price below the IPO price if the investment is made for shares being offered in the IPO. As the IPO price will not be fixed until the IPO is launched, a strategic investor may agree to invest a specific dollar amount, or may agree to take a specific percentage of shares (and thus the investment amount will not be known until the IPO price is set).
Limitations for PRC companies

For a PRC company, if the strategic investor wishes to invest prior to the IPO, the investor will take legal person shares of the PRC company, not H shares. However, there are PRC legal issues which affect the timing of the IPO following a private placement to such an investor and there are PRC procedural issues if the legal person shares are to be converted into H shares upon listing as part of the company offshore listing approvals process in the PRC.
Size of investment
Often a strategic investor will acquire less than 10% of the shares of the company as once the investor holds 10% or more the investor will be treated as a connected person of the company and as a result, the investor will not constitute part of the public for calculating the minimum public float.
IPO clawback provisions

Where an IPO includes both a placing tranche and a public subscription tranche the minimum allocation of shares to the public subscription tranche will be as follows: an initial allocation of 10% of the shares offered in the IPO; and a clawback mechanism that increases the number of shares available under the public subscription tranche to 30%, 40% and 50% respectively when the total demand for shares in the subscription tranche is at least 15 times, 50 times or 100 times respectively the initial allocation.
As a result of the potential trigger of the clawback rules and given that a strategic investor usually invests as part of the placing tranche of the IPO, strategic investors sometimes negotiate that, as part of the offering, they will be guaranteed a specific allocation of shares which will not be reduced in the event of a clawback due to an over-subscription for the public tranche of the IPO. This is a commercial decision for the company to make, provided that sufficient shares would otherwise be available for reallocation to the public offer tranche pursuant to any clawback.
Disclosure of investment in prospectus

The Exchange usually requires full disclosure in the prospectus of any strategic investment or other pre-IPO investment including: identity of the investor; principal terms of the investment eg offer price, number of shares placed to the investor and timing of issue of the relevant shares and other material terms; reason for the investment eg any long-term commercial benefits and how long the relationship is expected to last; background and the principal businesses of the investor; any contribution which the investor has or is expected to be made to the company; any benefits which the investment is expected to bring to the company and a justification of the placing price; any agreed lock-up period in respect of non-disposal of the relevant shares; any representation of the investor on the board of directors of the Company; whether the shares are subject to clawback; and whether the placing shares are included as part of the shares in the public float.
In addition, if the investment agreement is likely to be a material contract of the company, it has to be disclosed as such in the prospectus and a copy made available for public inspection.
Publicity restrictions
Upon submission of the Form A1 to the Exchange, the company will be bound by LR 9.08 which provides that all publicity material (including an announcement of a possible pre-IPO investment) must be reviewed and cleared by the Exchange before release. In the event of any leakage of information regarding a proposed investment, the Exchange is likely to require
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written submissions on the reasons for the leak and this could result in the timetable for the listing being delayed.
Level of information to investors

It is a general requirement that the level of information provided to all investors should be the same. Therefore, the assumption is that a strategic investor who is investing immediately prior to an IPO or is taking shares in the IPO should be provided with no material information over and above that contained in the prospectus. Any information which is regarded as material information for the purposes of the potential strategic/corporate investor agreeing to invest in the company will have to be included in the prospectus under LR 11.07.
Other jurisdictions
There may be potential securities law issues relating to offers and sales of securities to investors in other jurisdictions (such as the US). If the pre-IPO investor is in the US, the offer and sale of the securities to such pre-IPO investor will be subject to the requirements of the US securities laws, including but not limited to restrictions on publicity, provision of information, the manner of the offer and sale and the status of the investor, which are necessary to comply with exemptions from US securities registration requirements. If restrictions under applicable securities laws of such jurisdictions are such that the investor has to consider using a Hong Kong affiliate to hold the shares, such Hong Kong affiliate should, for purposes of compliance with US law, generally hold the shares for its own account and not for the account of its US affiliate unless certain requirements under the US securities laws are complied with.
US securities law considerations

For the purposes of US securities law, unless an exemption from registration exists or a transaction is not subject to registration, Section 5 of the Securities Act of 1933 effectively prohibits the use of interstate or international commerce or means of communication (i) to offer a security of any issuer unless a registration statement has been filed with the United States Securities and Exchange Commission (the SEC) or (ii) to sell a security of any issuer unless a registration statement is in effect. As a result, it is important for all offerings of securities which are not being registered with the SEC, including offers and sales outside the United States, pre-IPO offerings, and IPOs, to be crafted such that they are made pursuant to an exemption from registration, or are not subject to registration with the SEC. For the purposes of offerings to strategic investors prior to, or as part of, an IPO, several possible exemptions from registration may be considered: Section 4(2) of the Securities Act of 1933, which clarifies that transactions by an issuer not involving any public offering are not subject to the registration requirement; Regulation D under the Securities Act of 1933, which provides an exemption for sales to accredited investors; Rule 144A under the Securities Act of 1933, which provides for an exemption from registration for re-sales of securities to Qualified Institutional Buyers (or QIBs) in the United States; and
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Regulation S under the Securities Act of 1933, which provides a safe harbour from registration requirements for securities issued outside of the United States.
See International Offerings Exempt US Offerings, for a more detailed discussion of these exemptions from registration. An offering exempt from registration under federal securities laws may still be subject to registration or qualification requirements imposed by state securities laws in the United States. US states are not prevented from imposing filing and fee requirements on issuers. Although the above exemptions provide for exemption from the securities registration requirement of Section 5 of the Securities Act of 1933, they do not provide exemption from the anti-fraud rules of the US securities laws. See Prospectus Liabilities US Securities Law for further information regarding such rules.
Documentation
Where the investment is made prior to the IPO process starting, the documentation may include a subscription agreement, the terms of the securities if the investor wishes to take convertible notes or other quasi-equity securities, and possibly a shareholders agreement. Where the investment is to be made in the IPO shares an investment agreement will generally be entered into and the global coordinator should be a party to this agreement to enjoy the benefit of the subscription undertaking and any lock-up undertakings; at a minimum the investor would give an irrevocable undertaking to subscribe for a certain number, or value, of shares in the IPO.
Timing of disclosure to exchange

Ideally, any discussions with pre-IPO investors should be held as early as possible and the investment decision should be made prior to the Listing Committee hearing. If the final decision has not been made prior to the Listing Committee hearing, the sponsor should, as a matter of good practice, inform the Exchange that a strategic investor has been approached and is considering an investment so that the Exchange will not be surprised if and when the strategic investment subsequently materialises. The Exchange would generally require the companys application to be reported back to the Listing Committee for approval of the pre-IPO investment because the Listing Committee had not been forewarned. Generally the latest practical time for the entry of a strategic or corporate investor is prior to bulkprinting of the red herring prospectus so that the road show may benefit from the investors association with the IPO. Otherwise, issues relating to recirculation of offering documents may arise.
Disclosure of interests under SFO

If a strategic investor subscribes for shares of any class in the company constituting 5% or more of that class post the IPO, it will be subject to a disclosure obligation under the SFO upon listing.
Takeovers Code implications

If the strategic investor and its associates will hold a significant stake in the company, the mandatory takeover thresholds under the Takeovers Code (namely exceeding the 30% or creeping more than 2% in any 12 month period) will apply.
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6. Prospectus liabilities
At the start of the IPO process it is important that the directors of the company are informed of the potential civil and criminal liabilities they face in connection with the issue of the prospectus, in particular liability for any untrue statements or for the omission of any material information. A number of the regulatory provisions are wide enough to impose liability not only on the company and its directors but also on persons who authorised the issue of the prospectus such as the sponsor. Common law
Misrepresentation A prospectus is a document upon which potential investors rely to assess whether they wish to subscribe for shares in the company. As a general principle, where representations are made by one party to induce another party to enter into a contract, and those representations are false, the other party may be entitled to rights of rescission and/or damages if it suffers loss as a result, regardless of whether the misrepresentation was made deliberately, negligently or innocently. Negligent misstatements Directors may also be liable for negligent misstatements in a prospectus if persons whom the directors intend will rely on those statements suffer financial loss as a result of such reliance and it was reasonable for those persons to have relied on those statements. Deceit Directors may be liable under the tort of deceit if it can be shown that they signed or authorised the issue of a prospectus containing a false statement which they did not honestly believe to be true, with the intention that another person would rely upon such statement, and that other person acted upon the statement and suffered a loss as a result. Verification There is no strict legal requirement to prepare verification notes for a prospectus. Verification is carried out for the protection of the company, the directors, sponsors and all those upon whom liability for misstatements in the prospectus may fall. The object of verification is to ensure, as far as practicable, that statements in the prospectus can be independently verified and are made by the directors and other relevant parties based upon a reasonable belief in the truth of the statements. For a number of offences, it is a valid defence to claim that the person had reasonable grounds to believe the accuracy of the statement.
Listing Rules
The Listing Rules require the inclusion in the prospectus of a statement that the directors of the company collectively and individually accept full responsibility for the accuracy of the information contained in the prospectus and confirm, having made all reasonable enquires, that to the best of their knowledge and belief there are no other facts the omission of which would make any statement in the prospectus misleading. This statement can be relied upon by investors.
Companies Ordinance
Sections 38 and 342 These sections, in conjunction with the Third Schedule to the Companies Ordinance, set out the minimum level of information which should be contained in
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a prospectus. If a prospectus does not comply with or contravenes such requirements, any person who is knowingly responsible for the issue, circulation or distribution of the prospectus is liable to a fine. Section 40(1) This section provides that where a prospectus invites persons to subscribe for shares of the company, the following persons will be liable to pay compensation to all persons who subscribe for any shares on the faith of the prospectus for the loss or damage they may have sustained by reason of any untrue statement (which includes the omission of material information) included in such prospectus: directors of the company at the time of the issue of the prospectus; any person who has authorised himself to be named and is named in the prospectus as a director or as having agreed to become a director; every promoter of the company; and every person who has authorised the issue of the prospectus (which we believe includes the sponsor).
A person will not be liable under section 40(1) if he proves that: having consented to become a director, he withdrew his consent before the issue of the prospectus, and that it was issued without his authority or consent; or the prospectus was issued without his knowledge or consent and that on becoming aware of its issue he forthwith gave reasonable public notice that it was issued without his knowledge or consent; or after its issue, but before allotment of the shares, he became aware of an untrue statement in the prospectus, withdrew his consent and gave reasonable public notice of the withdrawal of his consent and the reason for it; or if the untrue statement was not purported to have been made on the authority of an expert or a public official document or statement, he had reasonable grounds to believe, and did until the time of allotment of shares believe, it was true; or if the untrue statement was purported to have been made by an expert or copied or extracted from an experts report and it fairly represented the statement or was a correct and fair copy of or extract from such a report, he had reasonable grounds to believe and did up to the time of the issue of the prospectus believe that the person making the statement was competent to make it and that the person had given his consent to the inclusion of the statement and had not withdrawn the consent prior to delivery of a copy of the prospectus for registration or (to the knowledge of the director) had not withdrawn his consent prior to allotment of the shares pursuant to the prospectus; or if the untrue statement was purported to have been made by an official person or contained what purported to be a copy or extract from a public official document, it was a correct and fair representation of the statement or extract.
Section 40A In addition to the civil liability under section 40(1), section 40A provides that any person who authorised the issue of a prospectus containing any untrue statement (or omits any material information) shall be liable to imprisonment and a fine, unless he proves either that the statement was immaterial or that he had reasonable grounds to believe and did up to the time of issue of the prospectus believe that the statement was true.
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The Hong Kong prospectus legislation is under review and it is expected that proposed legislative amendments, reflecting the September 2006 Consultation Conclusions on the Consultative Paper on Possible Reforms to the Prospectus Regime in the Companies Ordinance (published by the SFC), will be issued. It is presently not possible to predict when any of the reforms will be effected.
Securities and Futures Ordinance

False or misleading information Sections 274 to 278 of the SFO set out certain acts of market misconduct which are prohibited. For prospectuses the main provision is section 277, which covers the situation where a person discloses information likely to induce another person to subscribe for, sell or purchase securities in Hong Kong, where such information is false or misleading in a material way and its disseminator either knows or is reckless as to its being false or misleading. There are exceptions to this rule, for example, a person will not be considered to have disclosed false or misleading information if, at the time of issue of the information, the person did not know the information was false or misleading. A breach of these provisions can result in both civil and criminal liability including a maximum of 10 years imprisonment. Fraudulent or reckless misrepresentations Section 107 of the SFO prohibits certain fraudulent or reckless misrepresentations made in relation to investments, and is wide enough to cover misrepresentations and misstatements in a prospectus. Under this section, a person commits an offence punishable by a fine and/or imprisonment if he induces another person to enter into, or offer to enter into, an agreement to acquire, dispose of, or subscribe for securities, by: any statement which he knows to be false, misleading or deceptive, or which is false, misleading or deceptive and was made recklessly; any promise which he had no intention of fulfilling or which, to his knowledge, was not capable of being fulfilled, or which was made recklessly; any forecast which he knows was not justified on the facts known to him at the time it was made, or which was not justified on the facts known to him at the time he made it and was made recklessly; or any statement or forecast from which he intentionally or recklessly omitted a material fact, with the result that the statement was thereby rendered untrue, misleading or deceptive, or, as the case may be, the forecast was thereby not capable of being justified or was thereby rendered misleading or deceptive.
Besides criminal liability, a person guilty of the acts described above may also incur civil liability under section 108 to compensate persons who have suffered pecuniary loss as a result of having relied on the misrepresentation. Negligent misrepresentation Section 108 also imposes civil liability for negligent misrepresentations inducing another person to enter into or offer to enter into an agreement to acquire, dispose of, or subscribe for securities a negligent misrepresentation being a statement, promise or forecast which is false, misleading or deceptive and was made without reasonable care. However, if a remedy is available under section 40 of the Companies Ordinance, no right of action arises under section 108 of the SFO.
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Misrepresentation Ordinance
Section 3(1) of the Misrepresentation Ordinance provides that a party to a contract who is induced to enter into that contract by a misrepresentation made by the other party, and who suffers loss as a result of the misrepresentation can rescind the contract, or recover damages in lieu of rescission, from the party who made the misrepresentation. The only exception to this is where the misrepresenting party proves that he had reasonable grounds to believe, and did believe up to the time the contract was made, that the facts represented were true.
Theft Ordinance
In addition to any civil liability for making misrepresentations, directors should also be aware of criminal liability under the Theft Ordinance. The Theft Ordinance contains a number of offences relevant to directors and officers of companies regarding the publication of various documents and announcements, such as the prospectus and other information disclosed to the public. In particular, if a director of the company intends to deceive members or creditors about the companys affairs, publish or concur in publishing a written statement or account which he knows is or may be misleading, false or deceptive in a material way, he may be held criminally liable and punishable by a maximum of 10 years imprisonment.
US securities law
Several key provisions under the US securities laws create liability in connection with offering documents. Liability provisions applicable to Rule 144A and other exempt offerings Two liability provisions apply to Rule 144A and other exempt offerings: Section 12(a)(1) Pursuant to Section 12(a)(1) of the Securities Act of 1933, purchasers of any security offered in violation of the registration requirements of the US securities laws may recover the consideration paid for such securities. Strict liability exists thereunder for the seller of the securities. In order to prevail, plaintiffs need show only that the defendant was a seller or broker, the defendant failed to comply with the Section 5 registration requirements, there was use of the means and instrumentalities of interstate commerce, the applicable statute of limitations has not elapsed (ie, the suit was filed within one year of the violation); and adequate tender of the securities is made by a plaintiff seeking rescission. The only practical defence available to a defendant is that the security or the transaction was exempt from the registration requirements of Section 5. Rule 10b-5 Pursuant to Rule 10b-5 under the Securities Exchange Act of 1934, purchasers of a security have a cause of action against any person who makes an untrue statement of a material fact, or omits to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, in connection with the purchase or sale of any security. If successful, private litigants in Rule 10b-5 claims may be awarded damages, or may seek to rescind the transaction and obtain a refund of the original purchase price.
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In addition to establishing materiality, a plaintiff must demonstrate each of the following elements: Reliance The plaintiff must prove that it relied on the misstatement or omission. Under the fraud on the market theory, US courts will presume reliance on a material misstatement or omission if the securities are traded on an established trading market. Under the fraud on the market theory, a material misstatement or omission will be deemed to have affected the market price of the stock, and courts will presume that the plaintiff traded in reliance on the integrity of the price set by the market. Causation A plaintiff also must prove that reliance on the misstatement or omission caused the plaintiffs loss. Scienter The plaintiff must prove that the defendant made the material misstatement or omission with some intent to defraud or manipulate. US courts have held that recklessness may constitute scienter, but mere negligence will not. This is in contrast to claims under Sections 11 or 12(a)(2) of the Securities Act, which principally apply to SECregistered offerings, for which only a failure to show reasonable care is required. Loss US courts have required claimants under Rule 10b-5 to prove that they relied on and suffered loss as a result of the misstatement or omission.
The exercise of reasonable care, in the form of a carefully conducted due diligence investigation, tends to negate the existence of an intent to deceive. As a consequence, underwriter due diligence has become a critical component of a defence to liability in Rule 144A and other exempt transactions.
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7. Due diligence and verification process

As outlined in the previous chapter, directors and other parties involved in the IPO process face potential liability in connection with the issue of the prospectus. However, a large number of the liability provisions provide a defence for statements made where the person had reasonable grounds to believe the statements were true. This defence is sometimes referred to as the due diligence defence the basis being that if adequate due diligence is carried out then the directors and other parties could rely on this and claim that they had reasonable grounds to believe the statements were true. Due diligence and verification
Due diligence for an IPO can be viewed as a two stage process: a set of due diligence questions are prepared (generally comprising legal, financial and business sections and prepared before the prospectus is drafted) to which the company will provide responses; and a set of verification notes are then prepared which endeavour to verify all material statements made in the draft prospectus, where possible by reference to independent written material. These notes are updated throughout the IPO process so that the final set of verification notes will reflect the final form of the prospectus.
Due diligence defence

The due diligence defence has its foundation in that a number of the legislative provisions imposing prospectus liability provide a defence for statements made where the person had reasonable grounds to believe the statements were true. To rely on this defence it is generally accepted that the person must have made all reasonable enquiries to verify the statements. This verification can be undertaken by advisers provided it is reasonable to assume they have the necessary expertise to verify the statements and the director/officer has no reason to believe that any statements are incorrect.
US securities background
Generally, liability will arise under US securities laws in the case of either materially misleading misstatements or an omission of material information that would have been necessary to make statements in the offering document not misleading. Explicitly or implicitly, a due diligence type defence generally exists for underwriters, which provides that liability can be avoided if a defendant can prove it was duly diligent in investigating the business and financial condition of the issuer to ensure that the disclosure in the offering document is adequate. In an SEC registered offering, due diligence allows underwriters, directors and officers to establish that a reasonable investigation of the contents of the registration statement was made, thereby meeting the requirements of the due diligence defence against Section 11 and Section 12 liability available under the Securities Act. In a Rule 144A or other exempt offering, due diligence allows underwriters, directors and officers to refute the scienter element of a Rule 10b-5 claim.
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Due diligence guidelines

While there are no legislative guidelines as to what constitutes adequate due diligence, the Listing Rules include a requirement that a sponsor must conduct reasonable due diligence to enable it to give the required declaration to the Exchange. The Exchange has issued limited guidelines as to the due diligence which should be undertaken by a sponsor in Practice Note 21 to the Listing Rules, these are summarised on pages 39-44. However, such guidelines are not intended to exhaustively set out the relevant due diligence steps sponsors should take and note that sponsors must exercise their judgment in determining what investigations or steps are appropriate for the relevant listing applicant. The following general comments in relation to due diligence standards are worth noting: an officer may not rely exclusively on the companys advisers to verify the prospectus; an officer may not simply rely on assurances from management that the prospectus is accurate; an officer will not be excused from his due diligence obligation simply because he joined the company shortly before the IPO or even after the IPO where he is held out in the prospectus as a person who will be a director of the company upon listing; and an officer should make efforts to investigate matters which he does not understand or which he has reason to believe may not be accurate.
Conducting due diligence

Market practice has developed such that most investment banks routinely request 10b-5 letters for Rule 144A offerings over a certain threshold amount. The due diligence conducted by US counsel will form the basis for its delivery of a 10b-5 letter in connection with the offering. Although the extent of the due diligence review will differ for each transaction depending on the size of the transaction, the type of issuer, and various other matters, any transaction in which a 10b-5 letter is to be delivered merits a thorough and comprehensive due diligence review. This diligence process generally will involve three aspects: (1) documentary due diligence, (2) discussions with management and accountants and other advisers, and (3) participation in the preparation of the offering document. The goal of this process is to gain information relevant to disclosure which a reasonable investor would find helpful in making an investment decision. Although underwriters will rely on 10b-5 letters and an auditor comfort letter in the course of establishing their due diligence defence, underwriters are ultimately responsible for conducting due diligence and must be intimately involved in the due diligence carried out by their attorneys.
Documentary due diligence

Documentary due diligence includes a review of all material documents and information relating to a company, including: minutes of the meetings of the board of directors, board committees and shareholders, governing documents of the issuer, records of company decisions and procedures, material agreements and obligations, information about share capital and public records.
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Underwriters counsel normally prepares a set of due diligence questions (generally comprising legal, financial and business sections and prepared before the prospectus is drafted) to which the company will provide responses. A typical due diligence request list is comprehensive, although tailored to the type of transaction being conducted and the type of business in which the issuer is engaged. The issuer will also make available its corporate books and records, material contracts and other documents, pertaining to the matters identified in the due diligence question list. The primary goal of the attorney in reviewing the documents provided by the issuer is to identify potential issues that may expose those working on the transaction to liability under US securities laws. Generally, the risk of 10b-5 liability can be reduced if any risks or potential problems involving the issuer or the securities being offered are disclosed to potential investors in the offering documentation. Accordingly, the attorney conducting documentary due diligence review should look for any information that could affect the value of the securities to ensure that potential problems identified are rectified prior to the offering and/or disclosed to potential investors in the offering documentation. The review undertaken forms a basis for further questions to be asked of the issuer and its management at face-to-face meetings. The documentary due diligence process also allows the reviewing attorney to identify any obstacles that might prevent the consummation of the transaction (eg debt covenants which may require lender consents, changes in capital structure, such as could be triggered by an IPO).
Discussions with management and accountants

One or more meetings are usually held with senior management and directors of the issuer in the course of the due diligence and offering circular drafting process. Often, the issuer, upon request, will organise a presentation by operating management in each of its divisions in order to give the underwriters and legal counsel a general overview of the business. In addition to this general presentation, the underwriters and legal counsel typically (and should) hold meetings with specific officers or employees of the issuer responsible for particular areas of the issuers business. The underwriters and legal counsel also typically hold at least one meeting with the Chief Executive of the issuer to review strategic aspects of the issuers business and to obtain his or her personal assessment of the issuers strengths and weaknesses. Discussions with management also will include discussion of the issuers business, prospects, plans, internal and disclosure controls and risks. It is also customary to meet with the issuers current and prior auditors for a broad-based discussion of the issuers internal accounting policies, controls and procedures, any signs of illegality, contingent liabilities, any aggressive positions taken vis-a-vis accounting or tax policy, and any disagreements or adjustments regarding the issuers financial statements.
Drafting of offering document

If the transaction involves the registration of securities in the US, US securities laws will provide detailed guidelines as to the type of information that must be included in the offering document. However, even if the securities will be offered in the US under an available exemption from registration, US counsel generally will strive to produce an offering document that contains the disclosure required in registered offerings to protect against 10b-5 liability and in order to be able to deliver a 10b-5 letter.
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Legal counsel generally will begin the drafting process by utilising precedent documentation used in similar offerings by issuers in the same business or industry as the subject issuer. US counsel should ensure that the offering document discloses any material information discovered in the documentary due diligence review and through discussions with management and the accountants. It also is important in the process of drafting to obtain confirmation from the issuers management that the disclosure accurately reflects the reality of the issuers business. This is most important for three key sections of the disclosure document: the description of business, managements discussion and analysis of financial condition and results of operations and risk factors.
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8. Comfort letters and US legal opinions

Auditor comfort letters The due diligence defence that underwriters seek to establish to guard against potential liability depends on a thorough due diligence investigation being conducted in the course of the transaction. Obtaining a comfort letter from the issuers independent auditors is one of the many procedures used by underwriters to establish that they have conducted a reasonable investigation in connection with preparing the offering document.
Comfort letters are delivered to the underwriters by independent auditors and provide comfort on certain financial data contained in an offering document. The purpose of auditor comfort letters, from the underwriters point of view, is two-fold: establishment of a defence to liability under the US federal securities laws and protection of the underwriters professional reputation. Primarily, however, the comfort letter from the accountants to the underwriter is intended to help establish the underwriters due diligence defence regarding the correctness of the financial statements and other financial information included in the offering circular. The actual scope of the comfort letter will vary somewhat and is subject to negotiation between the parties. In the context of a Hong Kong IPO and assuming a Rule 144A tranche, current market practice is generally for the underwriters to request three comfort letters: one for the US tranche (the Rule 144A Comfort Letter), one for the international tranche (the Regulation S Comfort Letter) and one for the Hong Kong public offer (the Hong Kong Comfort Letter). Although practice varies by audit firm and transaction, generally the Rule 144A Comfort Letter and Regulation S Comfort Letter are very similar, if not identical (subject to geographic limitations on reliance), tracking the content of a typical SAS 72 comfort letter described in more detail below. A Hong Kong Comfort Letter, by contrast, may track SAS 72 or track HKSIR 400, a Hong Kong accounting standard which is generally regarded as being more limited in the level and type of comfort provided. Whereas the main condition to delivery of a Rule 144A Comfort Letter is that the underwriters simply represent that they conducted due diligence in a manner substantially consistent with diligence in an SEC-registered offering, market practice with regards to Regulation S Comfort Letters and Hong Kong Comfort Letters is for the auditors to require the underwriters and the Company to enter into arrangement letters with the auditors containing extensive terms and conditions pursuant to which the Regulation S Comfort Letter and Hong Kong Comfort Letter will be delivered. All comfort letters provide auditor comfort on unaudited interim statements and specified financial statement items during the stub period (ie, the period between the end of the audit and the cut-off date for the comfort letter).
SAS 72 comfort letter

In a typical SAS 72 comfort letter (which gets its name from the AICPA's Statement on Accounting Standards 72), the auditors confirm they are independent in accordance with applicable accounting rules and confirm that they have audited the financial statements set out in the offering circular. The auditors will also note that they have performed certain procedures
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with respect to the unaudited interim financial statements and specified financial statement line items during the stub period. Negative assurance refers to the auditors confirmation that, after having carried out the specified procedures, including certain review procedures described below on the unaudited interim financial statements: Nothing has come to their attention that would cause them to believe that any material modifications should be made to the unaudited interim financial information for it to be in conformity with the applicable generally accepted accounting principles (GAAP) and that it complies as to form in all material respects with the applicable GAAP, and Nothing has come to their attention that would cause them to believe that there have been material changes in certain financial statement line items since the date of the latest financial statements included in the offering circular.
The types of financial statement line items included in the negative assurance are subject to negotiation between the underwriters and the accountants but they are usually items which are considered to be important indicators of the issuers financial condition or that directly affect pricing sensitive attributes of the issuer or are good predictors of the issuers future performance. Another important source of auditor comfort letter procedures is SAS 100, which was adopted in October 2002. This standard governs the review of interim financial information and the comfort that is permissible on such information by limiting the situations where auditors are permitted to perform reviews of interim financial statements. SAS 100 provides that auditors may conduct a review of interim financial information of an issuer in preparation for a public offering or listing, if its latest annual financial statements have been or are being audited. The goal of a SAS 100 review is to provide the auditors with a basis for reporting whether material modifications should be made to conform the interim financial statements to the applicable GAAP. Without a SAS 100 review, a comfort letter cannot contain negative assurance comfort as to the interim unaudited financial statements. As a practical matter, comfort letters delivered in connection with Hong Kong IPOs which have Rule 144A/ Regulation S tranches rely on SAS 700, a Hong Kong accounting standard that is similar to SAS 100. Auditors may not give negative assurance on interim financial statements if 135 days or more have passed between the date of the most recent financial statements that have been audited or reviewed and the date of the comfort letter. On negative assurance comfort letters, the auditors also deliver a circle draft as an attachment to their comfort letter, whereby financial information in the offering document is circled and comfort provided by the auditors to the extent of certain procedures identified in the comfort letter, with each specific piece of circled financial information being ticked and tied to a specific procedure identified in the comfort letter.
Agreed-upon procedures comfort letter

Agreed-upon procedures letters offer a lower level of comfort than a SAS 72 comfort letter. In such letters the accountants are limited to reporting procedures performed and the resulting findings. This type of comfort is used where an underwriter is unable to make the required due
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diligence representation or interim financials are issued 135 days or more after the most recent audit or SAS 100 or SAS 700 review.
US legal opinions
A variety of US legal opinions may be requested in connection with an IPO being offered into the United States pursuant to an exemption. Some commonly requested US legal opinions are the following: The no registration opinion An opinion that the sale of the securities to the initial purchasers, and from the initial purchasers to subscribers, does not require registration under the Securities Act. The 1940 Act opinion An opinion that the issuer is not required to register as an investment company under the Investment Company Act of 1940. The 10b-5 disclosure letter A letter from US counsel which states that nothing has come to such counsels attention that leads it to believe that the offering circular contains material misstatements or omissions.
The 10b-5 letter

The most well-known US legal opinion actually is not an opinion at all, but rather a negative assurance letter known as the 10b-5 letter. In most offerings into the United States, the managing underwriter will require a 10b-5 letter from both its own counsel and from the issuers counsel. Although 10b-5 letters typically are sought for public (SEC-registered) offerings, they are also useful and customary in Rule 144A offerings and may even be requested in private placements and Regulation S offerings as well, depending on the number and sophistication of offerees. A 10b-5 letter is a statement by US counsel that upon reviewing the offering memorandum and after having conducted documentary and management due diligence, nothing has come to the attention of counsel suggesting that the offering memorandum contains any untrue statement of material fact or fails to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading. The 10b-5 letter helps establish a due diligence defence for the underwriter to certain potential bases for litigation in the US. As a result of Rule 159 under the Securities Act, part of a recent package of offering reforms promulgated by the SEC, liability under Section 12(a)(2) of the Securities Act for material misstatements or omissions on SEC-registered deals is fixed shortly after the time of pricing at the time of the first sale to any investor. Although Rule 159 is inapplicable to Rule 144A and other exempt offerings, market practice on such transactions is to ensure that due diligence is completed prior to the printing of the preliminary offering circular, which together with any final term sheet or similar written document available at the time of such sale used to convey the final terms, together form the disclosure package used to make such sale. Most banks are therefore requesting that the 10b-5 letter on Rule 144A and other exempt offerings cover such disclosure package at the time of sale, as well as the final offering circular as of its date and the closing date.
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9. Director and Officer liability insurance

When a company goes public the chances of its directors being sued increase significantly. For this reason the directors will wish to ensure that the company has adequate Director and Officer liability insurance (liability insurance). The extent to which a company can insure its directors differs depending on the jurisdiction in which the company is established. For a Hong Kong company, the insurance liability can be of any monetary limit and can extend to liability arising from negligence, default or breach of duty (but not fraud). Indemnifying Directors by company
While liability insurance is permitted (as only the insurance premium is payable by the company) a company cannot indemnify a director or officer for negligence, default or breach of duty, save that a limited indemnity can be granted for any liability incurred in defending proceedings in which the director/officer is found not guilty. Any such indemnity provisions included in directors/officers employment contract will be void.
Liability insurance
A company may purchase liability insurance for any officer which can cover: any liability to any party in respect of any negligence, default, breach of duty or breach of trust (save for fraud) of which he may be guilty in relation to the company or a related company; and any liability incurred by him in defending any proceedings taken against him for any negligence, default, breach of duty or breach of trust (including fraud) of which he may be guilty in relation to the company or a related company.
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10. The team

The parties commonly involved in a listing on the Exchange with a global offering, and their roles, are outlined below. Two or more persons/entities may be appointed to act jointly for some of these roles.
Party Sponsor Roles undertaken in the IPO process Performing the duties of sponsor as prescribed by the Listing Rules, including providing corporate finance advice to the company in relation to its listing, reviewing and supervising the companys other professional advisers and all relevant documentation in relation to the listing application, assisting the company in appointing and coordinating the work of other professional advisers and liaising with the Exchange Forming and coordinating an underwriting syndicate, with overall responsibility and control of the global offering and underwriting process; underwriting part of the offering Underwriting part of the offering Providing legal advice to the company in relation to Hong Kong legal and regulatory requirements pertaining to various matters arising in the course of the IPO and the preparation of relevant documentation Providing legal advice to the company in relation to US legal and regulatory requirements pertaining to various matters arising in the course of the IPO, including providing a Rule 10b-5 letter and no-registration legal opinion if required where the IPO will include an exempt US offering it is generally preferable to engage a law firm, like Herbert Smith, which can handle both the Hong Kong and US legal aspects of the offering Providing legal advice to the company in respect of legal and regulatory issues relevant to that jurisdiction, assisting with local due diligence and providing any legal opinions which may be required
Global coordinator, bookrunner and lead manager (which is usually also a Sponsor) Other underwriters Legal adviser to the company (as to Hong Kong law)
Legal adviser to the company (as to US law)
Legal adviser(s) to the company for any other jurisdiction(s) where the company may have material business interests or otherwise where the company is incorporated, eg, the PRC
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Legal adviser to the sponsors and the underwriters (as to Hong Kong law) Legal adviser to the sponsors and the underwriters (as to US law)
Providing legal advice to the sponsors and the underwriters in relation to Hong Kong legal and regulatory requirements pertaining to various matters arising in the course of the IPO Providing legal advice to sponsors and the other underwriters in relation to US legal and regulatory requirements pertaining to various matters arising in the course of the IPO, including providing a Rule 10b-5 letter and no-registration legal opinion if required Providing legal advice to the sponsors and other underwriters in respect of legal and regulatory issues relevant to that jurisdiction, assisting with local due diligence and providing any legal opinions which may be required Acting as the reporting accountants of the company to prepare, among other things (a) an accountants report; (b) a report on unaudited pro forma financial information; (c) an opinion on profit forecast and (d) appropriate comfort letters Preparing an independent valuation on the property interests held by the group for inclusion in the prospectus Receiving and processing applications under the Hong Kong public offering tranche of the global offering Processing and balloting public offer applications, liaising with the sponsors, Hong Kong Securities Clearing Co. Ltd., and the company for the preparation and dispatch of share certificates to successful applicants; processing of share transfers of the company after listing Providing strategic advice on communications, media relations and event support to the IPO, including developing content of speeches and media materials
Legal adviser(s) to the sponsors and the underwriters for any other relevant jurisdiction(s) Reporting accountants
Independent property valuer Receiving banks Share registrar and transfer office
Public relations consultant
The following persons and committee must also be appointed for the purposes of the companys listing. However, they will not necessarily have an active role in the listing process. Compliance adviser The compliance adviser must be acceptable to the Exchange (and may be the sponsor or someone who has acted as a sponsor). The adviser is appointed until the publication of the issuers accounts for its first full financial year commencing after the date of listing. Under the Listing Rules, the company must seek advice from the compliance adviser if it wishes to undertake certain specific matters such as issuing a regulatory announcement or entering into a notifiable or connected transaction.
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Company secretary
The company secretary must be an individual ordinarily resident in Hong Kong, have the requisite knowledge and experience to discharge the functions of a company secretary and be either (i) a member of the Hong Kong Institute of Chartered Secretaries, (ii) a solicitor, barrister or professional accountant, or (iii) an individual with academic or professional qualifications or relevant experience acceptable to the Exchange. The company must employ a full time individual to oversee financial reporting procedures and internal controls. The individual must be a member of senior management (preferably an executive director) and be a qualified accountant and a member of the Hong Kong Society of Accountants or similar body of accountants recognised by that Society. The qualified accountant can also act as the company secretary provided he satisfies the criteria. The company must appoint two authorised representatives to act as the companys principal channel of communication with the Exchange, being two directors or a director and the company secretary The audit committee must comprise non-executive directors only, have a minimum of three members, the majority of the members and the chairman must be independent nonexecutive directors and they must include at least one independent non-executive director with appropriate professional qualifications or related financial management expertise as set out in LR 3.10
Qualified accountant
Authorised representatives
Audit committee
In addition, the Exchange Corporate Governance Code sets out requirements in relation to the establishment of the following committees. Remuneration committee Under the Corporate Governance Code the company must appoint a remuneration committee to determine, among other things, directors remuneration policy. A majority of the members must be independent non-executive directors. If no such committee is appointed, the company must disclose and explain the reasons for such fact Under the Corporate Governance Code it is a recommended best practice that a nomination committee is established for determining the policy for the appointment of directors, again a majority of the members must be independent non-executive directors
Nomination committee
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11. Listing methods and criteria

It is important that the company and its advisers confirm that all the listing criteria are satisfied at the start of the IPO process before significant legal and accounting costs are incurred the key requirements being a trading record of not less than three financial years, management continuity for the last three financial years, ownership continuity for at least the most recent audited financial year and satisfying at least one of the profit, market capitalisation/revenue/cashflow or market capitalisation/revenue tests. The Exchange will accept a shorter trading record in certain circumstances but otherwise will generally not grant any waivers. Listing methods
A company can seek a listing on the Exchange either by way of an: Initial public offering which may comprise an offer of new shares, the sale of existing shares by a major shareholder(s), or a combination of the two an offering in respect of a listing on the main board of the Exchange will have both a public tranche (which must be underwritten) and a private placement tranche (which is invariably underwritten). Introduction this is possible where the company already has a sufficient spread of public shareholders and it does not wish to raise further capital.
Listing criteria
The qualifications for a primary listing on the main board of the Exchange are detailed in Chapter 8 of the Listing Rules. The principal qualifications are set out below. Currently, the Exchange only accepts listing applications from companies incorporated in Hong Kong, the PRC, Bermuda and the Cayman Islands. For other jurisdictions the applicant must show that the relevant country offers equivalent standards of shareholder protection as are provided in Hong Kong. Suitability for listing (LR 8.04) the company and its business must, in the opinion of the Exchange, be suitable for listing. Sufficient trading record (LR 8.05) the company must have (i) a trading record of not less than three financial years, (ii) management continuity for the last three financial years, and (iii) ownership continuity for at least the most recent audited financial year (although limited exemptions are available for companies relying on the market capitalisation/ revenue/cash flow test or the market capitalisation/revenue test described below and for mineral and project companies), and either: profit test a profit in the most recent year of not less than HK$20 million, and in respect of the previous two years, an aggregate profit of not less than HK$30 million (such profits to exclude any income or loss generated by activities outside the ordinary and usual course of the business or by associated companies or entities whose results are recorded in the companys accounts using the equity method of accounting), although some limited exemptions are available; or
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market capitalisation/revenue/cash flow test a market capitalisation of at least HK$2 billion, revenue of at least HK$500 million in the most recent financial year, and positive cash flow of at least HK$100 million in aggregate in the last three years; or market capitalisation/revenue test a market capitalisation of at least HK$4 billion and revenue of at least HK$500 million in the most recent financial year, and at least 1,000 shareholders at the time of listing.
Latest financial accounts (LR 8.06) the most recent financial period reported on in the prospectus must not have ended more than six months before the date of the prospectus. Sufficient public interest (LR 8.07) the Exchange must be satisfied that there will be sufficient public interest in the company. Minimum public shareholding (LR 8.08) the shares held by the public must constitute at least 25% of the issued shares, although if the market capitalisation of the company is over HK$10 billion, the Exchange may accept a percentage of between 15% and 25%. In addition, there must be a minimum of 300 public shareholders and not more than 50% of the shares in public hands at the time of listing can be beneficially owned by the three largest public shareholders. Minimum market capitalisation (LR 8.09) the expected initial market capitalisation of the company must be at least HK$200 million, with at least HK$50 million held by members of the public. Competing businesses of controlling shareholder (LR 8.10) if the controlling shareholder (being a person, or group of persons, who exercise or control the exercise of 30% or more of the voting power of the company or who is in a position to control the composition of a majority of the board), or any director of the company has an interest in a business which competes or is likely to compete, either directly or indirectly, with the companys business, various disclosures must be made in the listing document. See page 62. Voting power of shares (LR 8.11) the share capital of the company must not include shares which have a voting power which does not bear a reasonable relationship to the equity interest of such shares. Local management presence (LR 8.12) the company must have a sufficient management presence in Hong Kong. This will usually require at least two of the executive directors to be ordinarily resident in Hong Kong. Shares freely transferable (LR 8.13) the shares for which listing is sought must be freely transferable. Director qualifications (LR 8.15) each director must satisfy the requirements of Chapter 3 of the Listing Rules including (i) satisfying the Exchange that he has the necessary character, experience and integrity, and (ii) the board must include at least three independent non-executive directors and at least one of these independent non-executive directors must have appropriate professional qualifications or accounting or related financial management experience.
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12. Listing timetable and Exchange documents

Provided that the listing criteria can be satisfied, the documents submitted with the companys listing application are in good order and the Exchange has no significant issues with the proposed listing, a company can achieve a listing within as little as threefour months from the date it instructs its advisers, although in practice the timeframe for achieving a listing is often longer.
The formal listing application process is initiated by the lodging with the Exchange of the Form A1 (Advance Booking Form for listing), together with other prescribed documents required by the Listing Rules to be submitted with the Form A1. The Form A1 will set out a proposed timetable for the listing, including a proposed date on which the companys listing application will be considered for approval by the Exchange Listing Committee at a hearing held at least 25 business days after the Form A1 is filed. Once the Form A1 is filed, the company is required under the Listing Rules to lodge other relevant documents within a prescribed timeframe before the expected hearing date.
Listing flowchart
Advance booking of an application for listing (Form A1) (at least 25 clear business days before hearing) Further documentary submissions (at least 20/15/10 clear business days before hearing) Formal Application for Listing (Form C1) (at least four business days before hearing) Recommendation/rejection by Listing Division (if rejected can appeal to Listing Committee) Formal hearing by Listing Committee to approve listing application (if rejected may appeal to Listing (Review) Committee) Issue of pre-deal research and commence pre-marketing Issue of red-herring prospectus and road-show HK underwriting documents signed and prospectus registered and issued Public Offer opens and closes IPO price fixed and international underwriting documents signed and final offering circular issued Announcement of results of public offer share applications Dealing in shares commences on the Exchange
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Listing timetable and documents

An indicative listing timetable and list of documents to be filed with the Exchange is set out below the dates are approximate only and business days exclude Saturdays, Sundays and days on which the Exchange is closed for trading. Approximate days before listing 90 + Action required
commence preparation of all listing documents this is an indicative date only and depending on the circumstances the commencement date may need to be significantly earlier Main documents to be submitted when making advance booking of a new listing application at least 25 clear business days before the expected hearing date include: Form A1 Advance Booking Form Listing application fee Draft prospectus (must generally include draft accountants report for three full financial years) Audited accounts for each of the companies comprising the group for at least the first two years of three year track record Waiver applications (eg continuing connected transactions and management presence (if applicable)) Various checklists (eg listing qualifications, prospectus content, accountants report, offering mechanism, property valuation report) Submission on qualification of company secretary (if required) Various prescribed additional information (eg information on top five suppliers and customers, comparison of the groups performance with peer group companies, details of reorganisation and corporate structure) Confirmation from the independent non-executive directors on their understanding of the obligations and duties of an independent nonexecutive director For companies with operations in the PRC, PRC legal opinion on issues including corporate matters and property interests (if applicable) For companies with operations in the PRC, tax confirmation from relevant PRC tax bureaux (if applicable) Sponsors confirmation that a copy of the Standing Request has been passed to each director who has confirmed to the Sponsor that he/she understands his/her obligations under the Standing Request Sponsors undertaking to use reasonable endeavours to ensure all information provided to the Exchange is true and does not omit material information Sponsors statement of independence Specified matters to be brought to the attention of the Exchange which include confirmation on various aspects of the companys operations (eg compliance with relevant laws, litigation or other investigations) Draft share option scheme (if any)
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Documents to be submitted at least 20 clear business days before the expected hearing date include: Advanced draft accounts for each of the companies comprising the group for latest financial year (if not provided previously) Draft statement of adjustments relating to accountants report Memorandum and articles of association, related checklists and confirmation from the companys Hong Kong counsel that the articles of association comply with Listing Rules For PRC issuers, draft service contracts with directors, supervisors and senior management Draft compliance adviser's agreement
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Documents to be submitted at least 15 clear business days before the expected hearing date: Formal declaration by the directors and proposed directors on various matters including any other business activities (Form B or H) Independence confirmation from each of the independent nonexecutive directors Boards draft profit forecast memorandum if the prospectus will include a profit forecast If no profit forecast will be included in the prospectus then an undertaking is required from the sponsor and the underwriters undertaking that no profit forecast or other forward looking statements or financial information of a similar nature will be included in the pre-IPO research reports Sponsors confirmation in relation to the sufficiency of the issuers working capital (usually in draft form) Cash flow forecast for the period ending at least 12 months from the expected prospectus date Summary of new listing particulars Summary of key financial ratios during the track record period
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Documents to be submitted at least 10 clear business days before the expected hearing date include: Copies of material contracts Draft formal notice Draft application forms Draft definitive documents of title For PRC issuers, draft legal opinion from companys Hong Kong legal advisers attaching legal opinion from PRC lawyers on due incorporation and legal person status of the company
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Documents to be submitted at least 4 clear business days before the expected hearing date include: Form C1 Formal application for listing Hearing proof of prospectus Final form of formal notice and application forms Certified copy of various corporate documents (eg certificate of incorporation, articles of association, board and shareholders resolutions, notice of general meetings (if any)) Specimen share certificates Letter from sponsor or auditors as to sufficiency of working capital (usually in draft form) Declaration by corporate shareholder holding over 5% Statutory declaration of promoter which is a company as to identity of those who control it (if applicable) For PRC issuers, certified copy of the approval from the China Securities Regulatory Commission For PRC issuers, confirmation from the companys Hong Kong counsel confirming the accuracy of the summary of material differences between Hong Kong law and PRC law
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Exchange hearing date Documents to be submitted before bulk-printing of the prospectus include: Undertaking from the issuers controlling shareholder as required by LR 10.07 Undertaking from connected persons that they will provide information to auditors for the purpose of reviewing connected transactions Undertaking from directors to exercise share repurchase powers in accordance with Listing Rules (if applicable) Adoption of Standard Transfer Form (STF) Consent to include website hyperlinks(s) on the Exchanges website e-Submission system registration (if applicable) Authorised representatives form
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Documents to be submitted as soon as practicable after Listing Committee hearing but before 11 am on the intended date of registration of the prospectus: Application for authorisation to register the prospectus Signed prospectus Translators certificate certifying accuracy of Chinese translation Sponsors certificate relating to competency of translator Certified copy of each power of attorney pursuant to which prospectus is signed Submission of soft copies of the prospectus and application forms and related confirmations for publication on the Exchange website
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Prospectus registered Documents to be submitted as soon as practicable after Listing Committee hearing but before the date of issue of the prospectus: Formal notice and application forms Certified copies of all documents included or referred to in the prospectus (eg accountants report, property valuation report, board and shareholders resolutions, material contracts) Experts consent letters Notification issued by HKSCC that shares will be eligible securities Sponsors confirmation in relation to publication of the prospectus on the Exchange website together with a copy of the letter from the Companies Registry confirming the registration of the prospectus Sponsors declaration under LR 3A.13 Undertaking from the Company and other persons to the Exchange not previously provided Other signed undertakings, confirmation letters and documents
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Prospectus issued Documents to be submitted after issue of prospectus but before dealing in the securities commence include: Certified copies of board and shareholders resolutions unless previously provided Copy of formal notice, notice of allotment results and final offer price extracted from relevant newspapers List of successful applicants showing the names and addresses Form D Marketing statement and placee lists Form E Sponsors declaration Form F Declaration by issuer Letter from registrar confirming despatch of share certificates Letter from receiving bank confirming receipt of cleared funds Compliance advisers undertaking
Expected Listing Date dealing in securities commences
Selling into the US

Many issuers listing in Hong Kong will decide to sell a portion of the shares to US investors both within and outside the United States pursuant to certain available exemptions under US securities laws. Assuming that US counsel is brought into the Hong Kong IPO process at or close to the kick-off, there should not be any delay to the timetable set out above caused by the addition of an exempt US offering. The absence of regulatory involvement by the SEC means that US counsel can work to the Hong Kong IPO schedule. A decision as to the inclusion of a Rule 144A and/or Reg S tranche in an offering should be made at the outset of the transaction in order to allow US diligence procedures and preparation of disclosure to commence as early as possible. A late decision to include an offering to US investors can substantially delay the completion of the capital-raising.
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If a Rule 144A and/or Reg S tranche is included alongside the Hong Kong listing, an international wrap will be prepared by US counsel containing certain summary terms, risk factors and other disclosures that are specific to US or other international investors and wrapped around the Hong Kong prospectus approximately 7-10 days prior to bulk printing the Hong Kong prospectus to create the preliminary offering circular or red herring. The preliminary offering circular, which generally does not contain pricing information, is primarily used to market the shares to US and other international investors on the international roadshow. Following the finalisation of the share price and just prior to listing, the offering circular will be finalised and circulated to investors who have committed to purchase shares together, where relevant, with a pricing term sheet.
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13. Sponsors responsibilities

The Sponsor plays a key role in the listing process and is the person primarily responsible for liaising with the Exchange. It has specific responsibilities under the Listing Rules and the SFC Code of Conduct for Corporate Finance Advisers. Key responsibilities
Compliance undertaking (LR 3A.04) Each sponsor must give an undertaking to the Exchange in the form set out in Appendix 17 to the Listing Rules confirming that the sponsor will comply with the Listing Rules applicable to sponsors, use all reasonable endeavours to ensure that all information provided to the Exchange is true in all material respects and does not omit any material information, and cooperate in any investigation by the Exchange. Independence statement (LR 3A.08) The sponsor must make a statement to the Exchange in the form set out in Appendix 18 to the Listing Rules. If there are two or more sponsors only one need be independent. The prospectus must disclose whether each sponsor satisfies the independence requirement. Sponsors role (LR 3A.11) LR 3A.11 specifies the sponsors role and in particular provides that the sponsor must be closely involved in the preparation of the listing documents and must conduct reasonable due diligence (in determining what is reasonable due diligence sponsors must have regard to Practice Note 21 of the Listing Rules, discussed below). Sponsors declaration (LR 3A.13) As soon as practicable after the listing hearing, the sponsor must submit to the Exchange a declaration in the form set out in Appendix 19 to the Listing Rules which confirms that all relevant documents have been filed with the Exchange; and that having made reasonable due diligence enquiries, the sponsor reasonably believes that: the directors undertakings to the Exchange in the Form B (or Form H, as appropriate) are true and do not omit material information; the company is in compliance with all the conditions in Chapter 8 of the Listing Rules; the prospectus contains sufficient particulars and information to enable a reasonable person to form as a result thereof a valid and justifiable opinion of the shares and the financial condition and profitability of the Listco at the time of the issue of the listing document; the information in the non-expert sections of the prospectus: contains all information required by relevant legislation and rules; is true in all material respects, or, to the extent it consists of opinions or forward looking statements on the part of the directors of the company or any other person, such opinions or forward looking statements have been made after due and careful consideration and on bases and assumptions that are fair and reasonable; and does not omit material information;
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the company has established procedures, systems and controls (including accounting and management systems) which are adequate having regard to the obligations of the company and its directors to comply with the Listing Rules and other relevant legal and regulatory requirements (in particular Rules 13.09, 13.10, 13.46, 13.48 and 13.49, Chapters 14 and 14A and Appendix 16) and which are sufficient to enable the companys directors to make a proper assessment of the financial position and prospects of the company and its subsidiaries, both before and after listing; the directors of the company collectively have the experience, qualifications and competence to manage the companys business and comply with the Listing Rules, and individually have the experience, qualifications and competence to perform their individual roles, including an understanding of the nature of their obligations and those of the company as an issuer under the Listing Rules and other legal or regulatory requirements relevant to their role; in relation to each expert section in the prospectus, having made reasonable due diligence inquiries the sponsor reasonably believes (to the standard reasonably expected of a sponsor which is not itself expert in the matters dealt with in the relevant expert section) that: where the expert does not conduct its own verification of any material factual information on which the expert is relying for the purposes of any part of the expert section, such factual information is true in all material respects and does not omit any material information, where factual information includes: factual information that the expert states the expert is relying on; factual information the sponsor believes the expert is relying on; and any supporting or supplementary information given by the expert of the company to the Exchange relating to an expert section;
all bases and assumptions on which the expert sections of the prospectus are founded are fair, reasonable and complete; the expert is appropriately qualified, experienced and sufficiently resourced to give the relevant opinion; the experts scope of work is appropriate to the opinion given and the opinion required to be given in the circumstances (where the scope of work is not set by a relevant professional body); the expert is independent from the company and its directors and controlling shareholder(s); and the prospectus fairly represents the views of the expert and contains a fair copy of or extract from the experts report.
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Practice Note 21 due diligence

PN21 sets out a number of general provisions in respect of the due diligence procedures to be carried out by sponsors. Scope of due diligence Sponsors should make such enquiries as may be necessary until the sponsor can reasonably satisfy itself as to the disclosure in the listing document. In this regard, the sponsor should examine with professional scepticism the accuracy and completeness of statements and representations made, or other information given, to it by the company or its directors. Professional scepticism means making a critical assessment with a questioning mind and being alert to information, including information from experts, that contradicts or brings into question the reliability of such statements, representations or information. Documentation of due diligence The Exchange further expects sponsors to document their due diligence planning and significant deviations from their plans. This includes demonstrating that they have turned their minds to the question of what inquiries are necessary and reasonably practicable in the circumstances of the relevant transaction, and documenting conclusions reached in respect of the companys compliance with the requirements of Chapter 8 of the Listing Rules, taking into account waivers obtained from the Exchange. Engagement of third party professionals It may be appropriate for the sponsor to engage third party professionals to assist it to undertake tasks related to certain due diligence inquiries, though the sponsor is required to satisfy itself that it is reasonable to rely on information or advice provided by the third party professional, including being satisfied as to the competence of the professional, the scope of work and methodology employed by the professional and that the third party professionals report or opinion is consistent with the other information known to the sponsor about the company, its business and its business plans.
In addition, it should be noted that the Exchange expects the sponsor to remain primarily responsible for being satisfied itself as to the overall due diligence conducted and therefore it may not be appropriate to appoint third party professionals to undertake all due diligence inquiries and the sponsor should participate in certain core aspects of due diligence (eg business and financial due diligence).
Suggested due diligence steps

PN21 also sets out a number of specific examples of areas to be covered in respect of due diligence procedures to be carried out by sponsors. It should be note that PN21 only sets out the Exchanges expectations of due diligence that sponsors are expected to typically perform, and is not meant to be exhaustive. In addition, the scope and extent of due diligence to be performed in each case may be different from the specific examples set out in PN21. The sponsor is expected to exercise its judgment as to what investigation or steps are appropriate for a particular company and the extent of such steps.
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Directors typical due diligence inquiries in relation to the collective and individual experience, qualifications and competence and integrity of the directors (including nonexecutive directors) include: reviewing written records that demonstrate each directors past performance as a director of the company including participation in board meetings and decision making relating to the management of the company and its business; assessing individually and collectively the financial literacy, corporate governance experience and competence generally of the directors with a view to determining the extent to which the board of the company as a whole has the depth and breadth of financial literacy and understanding of good corporate governance required; and reviewing the financial and regulatory track record of each publicly listed company (including those listed on other exchanges) of which any of the directors is or was an executive or non-executive director, for example, by reference to company disclosures, media articles and information about these companies on the website of the relevant stock exchange.
Qualifications for listing typical due diligence inquiries in relation to the qualifications for listing and suitability of the company for listing include: searching the company registry in the companys place of incorporation to confirm that the company is duly established in that place and that the company is in compliance with its memorandum and articles of association or equivalent constitutive documents; reviewing material financial information, including: financial statements of the company; financial statements of all subsidiaries of the company and other companies that are material to the groups financial statements; and the internal financial records, tax certificates and supporting documents to the tax certificates for the track record period.
The Exchange expects that in conducting such review, the sponsor should in most cases interview the companys accounting staff and internal and external auditors and reporting accountants and, where relevant, obtain comfort from the companys external auditors or reporting accountants based upon agreed procedures; and assessing the accuracy and completeness of the information submitted by the company in demonstrating that it satisfies the trading record requirement.
Preparation of listing document and supporting information typical due diligence in respect of the preparation of the listing document and supporting information includes: assessing the financial information to be published in the listing document including: obtaining written confirmation from the company and its directors that the financial information (other than that already reported upon by a reporting accountant) has been properly extracted from the relevant underlying accounting records; and being satisfied that the confirmation referred to above has been given after due and careful inquiry by the company and its directors;
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assessing the companys performance and finances, business plan and any profit forecast or estimate, including an assessment of the reasonableness of budgets, projections and assumptions made when compared with past performance, including historical sales, revenue and investment returns, payment terms with suppliers, costs of financing, long-term liabilities and working capital requirements. The Exchange expects that this would normally include interviewing the companys senior management and would often involve interviewing the companys major suppliers and customers, creditors and bankers;
assessing whether there has been any change since the date of the last audited balance sheet included in the listing document that would require disclosure to ensure the listing document is complete and not misleading; assessing whether it is reasonable to conclude that the proceeds of the issue will be used as proposed by the company, taking into account the outcome of the sponsors assessment of, in particular, the companys existing cash and liquid reserves, projected liabilities, working capital requirements and expenditure controls; undertaking a physical inspection of material assets, whether owned or leased, including property, plant, equipment, inventory and biological assets (for example, livestock or crops) used or to be used in connection with the companys business; The Exchange expects the sponsor to visit the site of the asset in order to view the asset and to assess its extent, quality and quantity and the purpose for which it is used. Nevertheless, the Exchange understands that where, in the reasonable opinion of the sponsor, assessment of an asset, including as to its extent, quality, quantity and use, genuinely cannot be achieved without the use of an expert (for example, in undertaking the physical inspection the sponsor becomes suspicious that the asset does not exist as to the extent represented or exists but is not used for the purpose claimed) the company may instruct an appropriately qualified independent expert to conduct all or part of the inspection. In such cases the sponsor should ensure the expert is required to provide a written report in respect of the inspection.
reaching an understanding of the companys production methods; reaching an understanding of the manner in which the company manages its business, including as relevant actual or proposed marketing plans, including distribution channels, pricing policies, after-sales service, maintenance and warranties; reviewing the business (ie non-legal) aspects of all contracts material to the companys business; reviewing legal proceedings and other material disputes that are current or recently resolved (for example, resolved in the previous 12 months) and in which the company is involved, and all proceedings or material disputes the company knows to be contemplated and which may involve the company or one of its subsidiaries; analysing the business aspects of economic, political or legal conditions that may materially affect the companys business;
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considering the industry and target markets in which the companys business has principally operated and is intended to principally operate, including geographical area, market segment and competition within that area and/or segment (including existing and potential principal competitors and their relative size, aggregate market share and profitability); assessing whether there is appropriate documentation in place to confirm that the material assets, whether owned or leased, including property, plant, equipment, inventory and biological assets used or to be used, in connection with the companys business, are appropriately held by the company (for example, reviewing the relevant certificates of title and rights of land use); assessing the existence, validity and business aspects of proprietary interests, intellectual property rights, licensing arrangements and other intangible rights of the company; reaching an understanding of the technical feasibility of each new product, service or technology developed, being developed or proposed to be developed pursuant to the companys business plan that may materially affect the companys business; and assessing the stage of development of the companys business and assessing the companys business plan and any forecasts or estimates, including reaching an understanding of the commercial viability of its product(s), service(s) or technology, including an assessment of the risk of obsolescence as well as market controls, regulation and seasonal variation.
Experts typical due diligence inquiries in relation to the expert sections of the listing document include: interviewing the expert, reviewing the terms of engagement (having particular regard to the scope of work, whether the scope of work is appropriate to the opinion required to be given and any limitations on the scope of work which might adversely impact on the degree of assurance given by the experts report, opinion or statement) and reviewing publicly available information about the expert to assess: the experts qualifications, experience and resources; and whether the expert is competent to undertake the required work;
reviewing the expert sections of the draft listing document in order to form an opinion as to whether the following are disclosed and commented on appropriately: the factual information on which the expert relies; the assumptions on which the expert opinion is based; and the scope of work performed by the expert in arriving at his/her opinion;
verifying factual information where the expert does not conduct its own verification of any material factual information on which the expert is relying for the purposes of any part of the expert section, and ensuring that such factual information is true in all material respects and does not omit any material information;
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where the sponsor is aware that the company has made formal or informal representations to an expert in respect of an expert section or in respect of a report made in connection with the listing application, assessing whether the representations are consistent with the sponsors knowledge of the company, its business and its business plans; by reference to the sponsors knowledge of the company, its business and its business plans assessing whether the assumptions disclosed by the expert as those on which the experts opinion is based, are fair, reasonable and complete; if the experts opinion is qualified, assessing whether the qualification is adequately disclosed in the listing document; and where the standard of independence is not set by a relevant professional body, obtaining written confirmation from the expert that it is independent from the company and its directors and controlling shareholder(s), and being satisfied that there is no cause to inquire further about the truth of such confirmation. This would include confirming that the expert does not have a direct or indirect material interest in the securities or assets of the company, its connected persons, or any associate of the company beyond those allowed by Rule 3A.07 of the Listing Rules.
Accounting and management systems typical due diligence inquiries in relation to the companys accounting and management systems and in relation to the directors appreciation of their and the companys obligations include: assessing the companys accounting and management systems that are relevant: to the obligations of the company and its directors to comply with the Listing Rules and other legal and regulatory requirements, in particular the financial reporting, disclosure of price sensitive information and notifiable and connected transaction requirements; and to the directors ability to make a proper assessment of the financial position and prospects of the company and its subsidiaries, both before and after listing. Such assessment should cover a review of the companys compliance manuals, policies and procedures including corporate governance policies and any letters given by the reporting accountants to the company that commented on the companys accounting and management systems or other internal controls. interviewing all directors and senior managers with key responsibilities for ensuring compliance with the Listing Rules and other legal and regulatory requirements (including the chief financial officer, company secretary, qualified accountant and any compliance officers) to assess: their individual and collective experience, qualifications and competence; and whether they appear to understand relevant obligations under the Listing Rules and other relevant legal and regulatory requirements and the companys policies and procedures in respect of those obligations.
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To the extent that the sponsor finds that the companys procedures or its directors and/or key senior managers are inadequate in any material respect in relation to the issues referred to above, the sponsor should typically discuss the inadequacies with the companys board of directors and make recommendations to the board regarding appropriate remedial steps. The Exchange also expects the sponsor to take such steps prior to listing, which could include training tailored to the needs of individual directors and senior managers.
Code of Conduct on Corporate Finance Advisers

The SFC Code of Conduct on Corporate Finance Advisers sets out requirements and guidelines in respect of the conduct of corporate finance advisers, including IPO sponsors. There are specific requirements in connection with listing applications such as the following: a corporate finance adviser acting as a sponsor to a listing applicant should satisfy all the requirements applicable to sponsors as set out in the Listing Rules. It should ensure that, when giving a view as to whether an issuer is suitable for listing, it is capable of giving impartial advice before accepting the sponsorship role and that such view is given independently; and where information and representations are provided by a client for incorporation in a public document (eg the prospectus) or submission to the regulators, the corporate finance adviser should advise its client to take all reasonable steps to ensure, and obtain confirmation from the client, that the information and representations provided are true, accurate, complete and not misleading, and that no material information or facts have been omitted or withheld.
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14. Prospectus content

The content requirements for a prospectus are set out in the Companies Ordinance and the Listing Rules. The overriding consideration is that the prospectus should contain such particulars and information as are necessary to enable an investor to make an informed assessment of the activities, assets and liabilities, financial position, management and prospects of the company and of its profits and losses and rights attaching to the securities being offered.
The Third Schedule to the Companies Ordinance and Part A of Appendix 1 to the Listing Rules set out the matters required to be included in a prospectus. These matters include (but are not limited to): information about the securities to be listed and the companys capital; industry overview; general information about the groups business and assets; financial information about the group and the prospects of the group including an accountants report; management discussion and analysis of financial condition; property valuation; information about the companys management, directors, securities held by the directors and directors service contracts; details of shareholders holding 5% or more of the share capital; how the IPO proceeds are to be used; and various material contracts and other documents must be made available for public inspection.
US disclosure standards and practice

An offering circular contains substantive disclosures to investors regarding the issuer, the securities being offered, and the manner of distribution. Even if the securities are being offered in the US under an available exemption from registration rather than pursuant to a registration statement filed with the SEC, the underwriters will generally expect US counsel to produce an offering document that contains the disclosure of a standard equivalent to that required in registered offerings in order to protect against Rule 10b-5 liability. To the extent US counsel is expected to issue a Rule 10b-5 letter, it will also insist on complying as closely as possible with the disclosure required in SEC-registered offerings. Rule 10b-5 under the Securities Exchange Act of 1934 establishes the basic disclosure standard for US offerings, by providing that purchasers of a security have a cause of action against any person who makes an untrue statement of a material fact, or omits to state a material fact necessary in order to make the statements made, in the light of the circumstances
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under which they were made, not misleading, in connection with the purchase or sale of any security. As a result, all material information must be provided, and no material information may be omitted or misstated. Offering documents written to US disclosure standards for Hong Kong-listed IPOs will generally include significant disclosure in a so-called international wrap preceding the Hong Kong prospectus, the purpose of which is to provide additional disclosure regarding the issuer and the offering relevant to US and other international investors: Risk factors (specific to international investors); Exchange rate information; Capitalisation and indebtedness; Dilution; Summary of significant differences between the GAAP under which the audited financial statements were prepared and US GAAP; Description of the Exchange; Description of shares; US federal tax considerations; and Plan of distribution
Of the sections in the Hong Kong prospectus, those sections of particular importance to US counsel are the following: Risk factors: The risk factor section in both the international wrap and the Hong Kong prospectus contains a discussion of the principal factors that make an investment in the issuer speculative or of high risk. Business: The business section is a description of the principal business, products and services of the issuer, frequently addressing total sales and revenue by categories of activity and geographic market. Financial information: In a Hong Kong prospectus, the financial information section is the functional equivalent of the management discussion and analysis (MD&A) commonly found in Rule 144A offering circulars. As discussed further below, this section of the offering circular presents a discussion of the historical performance and current financial condition of the issuer and calls for disclosure of information as to trends, uncertainties and other circumstances that may have a material impact in the future on the issuers financial performance.
MD&A
As noted above, the MD&A section is frequently referred to in Hong Kong prospectuses as the Financial Information section. In a Rule 144A offering, the MD&A includes information with respect to results of operations, liquidity, capital resources, and other information necessary to an understanding of a companys financial condition, changes in financial condition and operating results. The purpose of the MD&A is to improve overall financial disclosure and provide the context within
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which financial statements should be analysed, to provide information about the quality of, and potential variability of, a companys earnings and cash flow, and to provide a narrative explanation of the issuers financial statements to enable the investor to see the company through the eyes of management. This is achieved by presenting in the MD&A, on a periodon-period basis, the issuers financial condition, changes in financial condition and results of operations for each year and interim period for which financial statements are included in the offering circular, and explaining causes of material period-to-period changes in key financial statement line items, focusing on the issuers profit and loss statement and statement of cash flows. The MD&A also typically includes a summary of the issuers critical accounting policies (estimates and assumptions involved in the application of GAAP which have a material impact on the issuers reported financial condition and operating performance), principal factors affecting financial performance and a narrative summary of the components of key line items. An issuer must also provide a description of any known trends or uncertainties that have had or that the issuer reasonably expects will have a material impact on the issuers net revenues or income. Where, in the issuers judgement, a discussion of segment information would be appropriate to an understanding of the issuers business, segment discussion and analyses of the issuers financial condition and results of operation should also be included in the MD&A. Segment information would be commonly included in a MD&A if a segment contributes in a materially disproportionate way to revenues, profitability or cash needs, or if failure to discuss a segment would present an incomplete and misleading picture of the enterprise. In the past, extensive US-style MD&A sections were not typical in Exchange listings, but such sections have become increasingly common and expected by the Exchange. SEC-registered offerings must include an MD&A section, and hence it is market practice to include them in Rule 144A offering circulars as well. US-style MD&As are also being included in some Regulation S offerings, as investors and the Exchange have become accustomed to such disclosure.
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15. Approval and registration of prospectus

The Exchange, the SFC and the Registrar of Companies can review a prospectus before it is registered, but in practice the sponsor will liaise solely with the Exchange which will copy the draft prospectus to the SFC and collate its comments and any comments it receives from the SFC. The Registrar of Companies will not see a draft of the prospectus until the date of its registration and will generally rely on a confirmation letter from the Exchange that the Exchange has reviewed the prospectus and authorised it for registration. Approval process
The draft prospectus is filed by the sponsor with the Exchange with the first set of filing documents at the time of filing the Form A1. At the same time the issuer will authorise the Exchange to provide the draft prospectus to the SFC for its review. The SFC will not always provide comments on the prospectus but when it does the general practice is for the Exchange to pass on the SFC comments with its own comments to the sponsor. The SFC will generally make only a limited number of high level comments, whereas the Exchange will generally provide a large number of comments over the entire period of the listing process (at least twenty-five business days to the listing hearing and up to the finalisation of the prospectus).
Registration process
Once the listing application and the prospectus has been approved, the final step before issuing the prospectus to the public is registration of the prospectus with the Registrar of Companies. Registration of the prospectus with the Registrar of Companies is a two stage process involving an application to the Exchange for authorisation of registration followed by an application to the Registrar of Companies for registration. The Exchange must be given at least 14 days advance notice of the intended date of registration of the prospectus (LR 11A.09). Application for authorisation of registration The following documents must be submitted to the Exchange at the time of applying for authorisation of registration: an application for authorisation of registration; the prospectus duly signed by the directors; the application forms; any power of attorney pursuant to which the prospectus is signed; a translation certificate in respect of the Chinese translation of the prospectus and a certificate issued by the sponsor confirming that the translator is competent to give the certificate;
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the consent of any expert named in the prospectus; any statement of adjustments; and certified copies of the material contracts referred to in the prospectus.
Registration of the prospectus At registration various documents will be filed including: a cover letter requesting registration of the prospectus; the prospectus duly signed by the directors; any power of attorney pursuant to which the prospectus was signed; a translation certificate in respect of the Chinese translation of the prospectus and a certificate issued by the sponsor confirming that the translator is competent to give the certificate; the consent of any expert named in the prospectus; any statement of adjustments; certified copies of the material contracts referred to in the prospectus; and a certificate of authorisation of registration from the Exchange.
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16. Listing of PRC businesses

PRC businesses may be listed by way of an H share listing or a red chip listing. An H share listing is the listing on the Exchange of a company incorporated in China. A red chip listing is a listing on the Exchange of a company incorporated outside of China but the company has most of its business in China. These listings are generally more complicated than other listings of Hong Kong businesses as relevant PRC approvals may be required for the reorganisation and listing processes.
A company with its business in China may seek listing by way of an H share listing or by way of a red-chip listing. In each case, approvals may be required from PRC government authorities in connection with any proposed reorganisation and the proposed listing as well as for the conduct of the companys business. Issues relating to the companys title to its real properties located in the PRC are often also an issue (see chapter 22 for a discussion of potential property title issues).
H share listing
Chapter 19A of the Listing Rules Chapter 19A of the Listing Rules deals specifically with the listing on the Exchange of companies incorporated in China setting out additional requirements, modifications and exceptions to the other relevant chapters of the Listing Rules to take account of: The PRC legal system is not a common law legal system; Restrictions on use of foreign exchange in the PRC and its remittance out of the PRC; and Only PRC citizens and legal persons are permitted to own domestic shares and only foreign investors and investors from Hong Kong, Taiwan and Macau may own overseas listed foreign shares the two types of shares therefore operate in separate markets.
Among such requirements: PRC issuers are expected to present their accounts in accordance with Hong Kong or international financial reporting standards; The articles of association of PRC issuers must contain provisions reflecting the different nature of domestic shares and H shares and the different rights of their respective holders; and Disputes involving holders of H shares arising from a PRC issuers articles or from any rights or obligations under the PRC Company Law or other relevant PRC laws and regulations are to be settled by arbitration in Hong Kong or the PRC at the election of the claimant
Additional requirements, modifications and exceptions to the Listing Rules under Chapter 19A Basic Requirements The Exchange will consider an application for listing by a PRC issuer only if (i) the issuer is duly incorporated in the PRC as a joint stock limited company (ii) there are adequate communication and cooperation arrangements in place between the Exchange
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and relevant securities regulatory authorities in the PRC and, where relevant, any other stock exchange on which the PRC issuer is listed and (iii) the Exchange is satisfied that applicable PRC law and the articles of association of the PRC issuer provide a sufficient level of shareholder protection to holders of H shares. Sponsors Sponsors for a listing application by a PRC issuer have a particular responsibility to satisfy themselves that: The PRC issuer is suitable to be listed; and The PRC issuers directors and supervisors appreciate the nature of their responsibilities and can be expected to honour their obligations, and understand what is required of them, under the Listing Rules and applicable PRC laws and regulations.
If the PRC issuer also is or is to be listed on another stock exchange, the sponsor must make a written submission to the Exchange stating whether, in its opinion, the PRC issuers directors appreciate the differences and similarities between H shares and the shares listed on other exchange(s) and between the rights and obligations of holders of such shares and the basis for such opinion. Compliance advisers The PRC issuer should ensure that there are adequate and efficient means of communication between itself, its authorised representatives, directors and officers and the compliance adviser and should keep the compliance adviser fully informed of all communications with the Exchange. The compliance adviser must inform the PRC issuer on a timely basis of any amendment or supplement to the Listing Rules and any applicable new or amended law, regulation or code in Hong Kong. Where the authorised representatives of the PRC issuer are expected to be frequently outside Hong Kong, the compliance adviser must act as the principal channel of communication with the Exchange. Accountants reports Accountants reports must have been audited to a standard comparable to that required in Hong Kong. Reports will normally be required to conform with the requirements of the Hong Kong Financial Reporting Standards or International Financial Reporting Standards. PRC issuers may, in addition, present in a separate part of the report, financial information conforming with applicable PRC accounting rules and regulations provided that the report contains a statement of the financial effect of the material differences with HKFRS or IFRS as appropriate. Qualifications for listing The following modifications and additional requirements apply: Public interest The Exchange has absolute discretion to refuse a listing of securities of a PRC issuer if it believes that it is not in the public interest to list them Agent for service The PRC issuer must appoint and maintain while its shares are listed on the Exchange a person authorised to accept service of process and notices on its behalf in Hong Kong Hong Kong register For registered securities, the PRC issuer must maintain a register of holders in Hong Kong for local registration/transfers of shares. Unless the Exchange otherwise agrees, only securities registered on the Hong Kong register may be traded on the Exchange
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Competing business LR8.10 requires disclosure of any competing business in which a controlling shareholder or directors of the company have any interests. For these purposes, the Exchange will normally not consider a PRC governmental body (including central, provincial or local level governments, but excluding entities under the PRC government carrying out commercial business or operating a commercial entity) as a controlling shareholder of a PRC issuer Management presence the requirement in LR8.12 for sufficient management presence in Hong Kong, ie at least two executive directors to be ordinarily resident in Hong Kong, shall apply except as otherwise permitted by the Exchange. PRC issuers will commonly seek a waiver from the Exchange from the requirements of LR8.12. In considering any such waiver application, the Exchange will have regard to, among others, the PRC issuers arrangements for maintaining regular communication with the Exchange Company secretary the secretary of a PRC issuer need not be ordinarily resident in Hong Kong, provided that they can meet the other requirements of LR 8.17. If the secretary does not meet the qualification requirements of LR8.17(2) (ordinary member of The Hong Kong Institute of Chartered Secretaries, solicitor, barrister or professional accountant) the PRC issuer will have to satisfy the Exchange that the secretary has the relevant experience to be capable of discharging the functions of a company secretary. In assessing relevant experience, the Exchange will have regard to, among others, the period of the persons employment with the PRC issuer, and his familiarity with the Listing Rules. A submission must be made to the Exchange setting out details of the training provided to the person for these purposes. A waiver is commonly sought from LR8.17 providing for the appointment of joint company secretaries for a period of at least three years following listing, one of whom meets the qualification requirements under LR8.17(2) (listing decision 35-1) Independent non-executive directors in addition to the requirements under Chapter 3 of the Listing Rules, the INEDs of a PRC issuer must demonstrate an acceptable standard of competence and adequate commercial or professional experience to ensure that the interests of shareholders will be adequately represented. At least one INED must be ordinarily resident in Hong Kong Supervisors supervisors of a PRC issuer must have the character, experience and integrity and demonstrate a standard of competence commensurate with their position Connected persons connected persons of PRC issuers include its promoters, directors, supervisors, chief executive and substantial shareholders. The Exchange will normally not consider a PRC governmental body (as defined above) as a controlling shareholder of a PRC issuer for these purposes
Application procedures Chapter 19A contains certain modifications to the application procedures, including the documents to be filed with the Exchange. These include the requirement to file a legal opinion from the PRC issuers Hong Kong legal advisers attaching a legal opinion from the PRC issuers PRC lawyers concerning due incorporation and legal person status of the PRC issuer as a joint stock limited company under PRC law. In addition, the PRC issuer will be required to submit a copy of the approval of the China Securities Regulatory Commission approving the PRC issuers listing on the Exchange and the issue of equity securities which, in practice, is required prior to the Listing Committee hearing. A PRC
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issuer will also be required to submit to the Exchange a PRC legal opinion covering a range of PRC legal issues including the obtaining of all requisite PRC approvals for the listing, approvals and permits required by the PRC issuer for the conduct of its business, compliance with applicable legal requirements, and title to properties. Listing Documents Chapter 19A contains modifications to the content requirements for listing documents for PRC issuers, including in particular: Constitutive documents a summary of provisions of its constitutive documents affecting shareholders rights and protection and directors powers Summary of PRC law a summary of relevant PRC law including taxation, taxation of dividends, foreign exchange controls, company law, securities regulations and relevant PRC regulations affecting its industry and major businesses Warning statements and risk factors specified warning statements and risk factors Company law a description of applicable company law including material differences between PRC and Hong Kong laws
Language All documents submitted to the Exchange in a language other than English must be accompanied by a certified English translation. Documents for inspection which are not in English must, unless otherwise provided by the Companies Ordinance, be accompanied by a certified English translation. Offering structure National Social Security Fund Pursuant to applicable PRC regulations, shareholders who hold State-owned shares are required to reduce their shareholdings in an amount of 10% of the entire offering (ie including any additional shares offered upon the exercise of an over-allotment option) in any overseas public offering by remitting the sales proceeds of such shares to the National Social Security Fund (NSSF), transferring such shares to the NSSF for retention or pursuant to other methods that are approved by the competent PRC authorities. Such shares will be converted from domestic shares to H shares upon listing.
Red chip listing

A red chip listing will generally involve a corporate reorganisation resulting in the transfer of the PRC businesses or assets to a company incorporated outside the PRC (eg Bermuda or Cayman Islands) which will form the listing vehicle. While similar regulatory and related issues arise in respect of the business and assets of the company as for H Share issuers, once the relevant business is held outside the PRC, the PRC regulatory process for the reorganisation and listing has historically been simpler than that for H Share applicants. However, following the introduction of new regulations by the China Securities Regulatory Commission and other regulatory authorities in the PRC, the listing process for red chip listing applicants may become increasingly complex. Typically red chip listings also give rise to the following issues in common with the listing of H share issuers: Legal compliance the company will be subject to compliance with applicable PRC legal requirements, including requirements for applicable business permits and licences (particularly where there are restrictions on foreign ownership in the relevant industry)
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Legal opinion the company must submit to the Exchange a PRC legal opinion covering a range of PRC legal issues including the obtaining of all requisite PRC approvals for the listing or a confirmation that no such approvals are required, obtaining of all requisite approvals and permits required for the conduct of its business, compliance with applicable legal requirements, and title to properties Disclosure disclosure of specific risks relating the conduct of business in the PRC.
Where the red chip listing applicant is State-owned, the State-owned shareholder may be subject to a requirement to sell part of its shareholding and remit the sales proceeds to the NSSF or to transfer such shares to the NSSF for retention etc.
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17. Continuity of management and ownership

One of the key listing criteria is that the company must have an adequate trading record under substantially the same management and ownership. The company must demonstrate management continuity for at least the last three financial years and ownership continuity and control for at least the most recent audited financial year. Relevant Listing Rules
The Listing Rules governing the continuity of management and ownership are summarised below: Management continuity LR 8.05(1)(b), 8.05(2)(b), 8.05(3)(b) the company must show management continuity for at least the three preceding financial years. Ownership continuity LR 8.05(1)(c), 8.05(2)(c), 8.05(3)(c) the company must show ownership continuity and control for at least the most recent audited financial year. Pursuant to Rule 8.05A, where a company applies for listing under the market capitalisation/revenue test, the Exchange may accept a shorter trading record under substantially the same management under the circumstances specified in that Rule. In such circumstances, the company must demonstrate management continuity for the most recent audited financial year. See page 29. Practice Note 3 trading record the trading record period (last three financial years) of the company must enable the Exchange and investors to make an informed assessment of the managements ability to manage the companys business and the likely performance of that business in the future. In order to make this assessment the company must be able to satisfy the Exchange that its main business or businesses, as at the time of listing, have normally been managed by substantially the same persons throughout the trading record period and that such persons are the management of the company. The management continuity requirement is primarily aimed at preventing listing for a company which has only recently purchased or established its current main line of business and thus management have not been able to establish that they can successfully manage this specific type of business. The Exchange encourages potential listing applicants who have made acquisitions during the track record period or who intend to make an acquisition prior to listing, or where there has been a material change in management or ownership of the company during the track record period, to contact the Exchange for confidential advice before submitting a formal listing application. While a company is free to dispose of assets at any time, it may be difficult to satisfy the Exchange that the company meets the management and ownership continuity requirements where it has acquired new businesses during the track record period or where the companies
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comprising the group to be listed have been recently organised into a group. Paragraph 4 of PN3 sets out the factors the Exchange will take into account where the company has acquired new businesses during the track record period: whether the new business forms a material part of the companys business at the time of listing; whether the new business is forecast to make a material contribution to the companys profit forecast; whether the new business is in a similar line to that of the companys previous business activities and is part of the logical growth trend of the business; whether the company has retained the management of the new business and whether it can be demonstrated to the Exchange that necessary continuity and synergy of the management is provided; the period of time which has elapsed since completion of the acquisition; and whether the new group has been formed solely for the purpose of satisfying the listing requirements or to enhance the apparent attractiveness of the group as a new applicant for listing.
The issue of materiality and compliance generally with the requirements of LR 8.05 will be determined by the Exchange, in its sole discretion.
Listing decisions/guidelines
The Exchange has issued a number of rulings on management and ownership continuity, each addressing slightly different factual situations. Management continuity An Exchange Consultation issued in July 2002 states that the Exchange has interpreted the management continuity requirement to mean that applicants must demonstrate that there has been no change in the majority of the applicants board of directors and senior management of its principal operating subsidiaries during the three financial year track record period. In listing decision 45-1 the Exchange noted that management continuity was a question of fact and clarified that it would focus on the substance of management of the business when examining management continuity particularly considering whether: (a) an identifiable group of individuals most relevant and responsible for the track record results of a listing applicant remained in positions of responsibility with the enterprise under review throughout the relevant track record period; and (b) such group of individuals would form the core management of the applicant at the time of listing and thereafter. When assessing the relevance of individual members of a management team to the track record results of Company A and its predecessor, the Exchange followed the practice of ordinarily attributing proportionately greater responsibility to officers with more senior positions and those with responsibility at the group level. Provided that the company demonstrates management continuity within the core management group responsible for the track record results of the company, the management continuity requirement may be satisfied
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notwithstanding that such core management may constitute a minority in number on the board of directors. Ownership continuity The Exchange defines ownership continuity and control as the continuous ownership and control of the voting rights attaching to the shares by a controlling shareholder, or where there is no controlling shareholder, the single largest shareholder (Exchange Frequently Asked Questions). In listing decision 44-4, the Exchange confirmed that the requirement for ownership continuity and control under Rule 8.05(1)(c) could be satisfied by aggregating the shareholding interests and control of a group of individual shareholders, where such shareholders could, on the facts, be regarded as a controlling group for the purposes of the Listing Rules.
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18. Accounts
A prospectus must contain an accountants report which reports on the last three audited financial years results and, if the latest financial year ended more than six months before the date of the prospectus, then an audited interim (or stub) set of accounts is required for part of the current financial year. Relevant Listing Rules
The main Listing Rules dealing with the accountants reports to be included in a prospectus are: LR 4.01 (1) a listing document must contain an accountants report. The accountants report must be prepared by independent, qualified professional accountants. LR 4.04 and 4.05 these set out the content requirements for an accountants report, which includes income statements, balance sheets and cashflow statements for the last three year financial years or such shorter period as may be acceptable to the Exchange. LR 4.05(A) if the company has acquired any material subsidiary or business during the three year trading record period then certain pre-acquisition financial information must be included. LR 4.09 The reporting accountants must report on the consolidated or combined results and balance sheet of the company and its subsidiaries. LR 4.11 Such results and balance sheet must normally be drawn up in conformity with Hong Kong Financial Reporting Standards or International Financial Reporting Standards. LR 4.14 Where adjustments are made by the reporting accountants in preparing the accountants report, a statement of adjustments must be prepared, which is made available for public inspection. LR 4.18 Where the reporting accountants qualify or modify their report, they must refer to all material matters about which they have reservations, and give all reasons for the modification or qualification and its effect qualified if relevant and practical. A qualified or modified accountants report may not be acceptable where the modification or qualification relates to a matter of significance to investors. LR 4.28 Where the company has acquired or proposed to acquire a major subsidiary since the date to which its latest audited accounts have been made up, it must include specified pro forma financial information in respect of the enlarged group in the prospectus. LR 4.29 Where pro forma financial information is included in the prospectus, such information must comply with the requirements of Rule 4.29 and must be reported on by the reporting accountants. LR 8.06 the latest financial period reported on by the reporting accountants must not be more than six months before the date of the prospectus and must include a comparison with the corresponding interim period for the previous financial year. Thus where the prospectus will be dated more than six months after the end of the latest financial year a set of interim (or
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stub) accounts must be prepared (with the financial information for the previous financial period being subject to a review).
Waivers from the Exchange and the SFC

Pursuant to LR 4.04 and paragraphs 27 and 32 of the Third Schedule to the Companies Ordinance, the prospectus must include the companys results for each of the three financial years immediately preceding the date of the prospectus. Companies seeking to issue their prospectus shortly after the expiration of its financial year may apply to the Exchange and the SFC for waivers from the requirements of LR 4.04 and paragraphs 27 and 31 respectively. In listing decision 31-2, the Exchange ruled that such a waiver would not be granted where the proposed listing date is more than three months after the latest financial year end.
Filing the accounts with the Exchange

Pursuant to LR 9.11, the prospectus filed with the Form A1 should include financial statements with audited figures for the first two years of the track record period and audited or advanced draft figures for the latest financial year. The Exchange has recently clarified its position in separate listing decision 43-4, the effect of which is: the listing application should be accompanied by the last three full years audited accounts and audited or advanced drafts of the stub accounts if required; if advanced drafts of the most recent financial years accounts are not ready at the time the listing application is filed then they may be filed after the application provided that (i) financial statements for the three financial years preceding the most recent audited balance sheet date are included in the prospectus filed with the Form A1, (ii) in addition, financial statements as of a date within 230 days of the filing of Form A1 are included in the materials submitted to the Exchange, (iii) the Exchange has, prior to the filing of the companys Form A1, accepted the sponsors written request to delay filing of the most recent financial years accounts, and (iv) the listing hearing date will not be earlier than 20 business days after the most recent financial years accounts are filed.
Listing decision 46-4 applied the same approach to the filing of accounts for any stub period. These decisions enable the Exchange to start reviewing the prospectus earlier without having to wait for the interim accounts to be finalised.
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19. Independence from parent company

The Exchange must be satisfied that the company can carry on its business independently of its controlling shareholders once it is listed. Where the degree of dependence on the controlling shareholder is excessive, this may give rise to concern as to suitability for listing. Relevant Listing Rules
LRs Appendix I Part A para 27A the prospectus must include a statement explaining how the company is satisfied it is capable of carrying on its business independently of controlling shareholder(s) (including its associates, as defined in the Listing Rules) after listing and particulars of the matters that it relied on in making such statements.
The Exchange has issued a number of rulings on the requirement for independence, each addressing different aspects of the independence requirement. In listing decision 42-1 the Exchange stated that when considering independence issues, it will generally require the company to take into account the following: financial independence; independent access to sources of supplies/raw materials for production; independence of production/operation capability; independence of access to customers and independent management.
Where the degree of dependence on the controlling or substantial shareholders is excessive, this may give rise to concern as to the suitability of the company for listing under Rule 8.04. When reviewing the reliance issue, the Exchange ordinarily would consider the particular facts and circumstances of the applicant. In listing decision 46-1 the Exchange noted that the issue of reliance on controlling shareholders can usually be dealt with by disclosure in the prospectus but where the degree of reliance could not be addressed by disclosure alone the company must take concrete steps to address the reliance rather than simply demonstrate that it has the ability to operate independently. Financial independence In listing decision 42-1, the Exchange referred to its established practice that prior to listing, a listing applicant will ordinarily be required, barring exceptional circumstances, to repay all outstanding loans due to, and release all guarantees provided by, the controlling/substantial shareholders (even though such loans may constitute exempt financial assistance allowed under the connected transactions requirements of the Listing Rules).
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Operational independence In listing decision 46-1, the Exchange noted that reliance which the listing applicant placed on its controlling shareholder for provision of sales and procurement functions gave rise to concerns including conflicts of interests, substantial reliance on the protection mechanisms offered by the connected transaction requirements under the Listing Rules and how performance of the listed company may be independently evaluated. Reliance on a controlling shareholder for supply of raw materials may, in certain circumstances, be dealt with by disclosure including a description of the associated risks provided that adequate mechanisms are put in place to protect minority shareholders (listing decision 46-2).
Independence of management In assessing the level of independence of management of the company, the Exchange will consider the level of overlap between the management of the company and its controlling shareholder. In listing decision 52-2, the Exchange considered factors including the number of common directors between the company and its controlling shareholder, the role of the common directors in the management of the companys business and daily operation, the extent of delineation of the business of the company and its controlling shareholder and the amount of connected transactions between the company and its controlling shareholder.
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20. Competing interests of controlling shareholders and directors

Where a controlling shareholder or director of the company has an interest in a business which is likely to directly or indirectly compete with the company this interest must be disclosed in the prospectus (and its annual issued report post listing). However, if there are inadequate arrangements to manage conflicts of interest and delineation of businesses between the company and other businesses under common control, the Exchange may consider the impact on the companys suitability for listing. Relevant Listing Rules
LR 8.10 (1) (2) Where a controlling shareholder or director of the company has an interest in a business which competes or is likely to compete, either directly or indirectly, with the company then certain disclosures must be made in the prospectus, including: reasons for the exclusion of the excluded business; a description of the excluded business and its management, including its nature, scope and size and an explanation of how such business may compete with the companys business; facts demonstrating that the company is capable of carrying on its business independently of and at arms length from the excluded business; and any intention of the controlling shareholder to inject the excluded business into the company.
Non-competition undertakings
Although not specifically required under the Listing Rules, it is common market practice for the controlling shareholder of a new listing applicant to enter into a non-competition agreement with the listing applicant to delineate their businesses following listing and to eliminate future competition. Such undertakings may include provisions for referral of future business opportunities to the listing applicant, approval procedures prior to the controlling shareholder entering into future competing businesses and rights of first refusal for the listing applicant to acquire any excluded business retained by the controlling shareholder.
The Exchange has issued a number of rulings on this issue of competing interests, each addressing slightly different factual situations. In listing decisions 51-2 and 51-3 the Exchange stated that it normally requires the company to take into account factors relating to the conduct of the applicants business independently from its controlling shareholder, in areas including financial independence, operational independence and management independence. An applicant may be dependent on its controlling shareholders in one or more of these areas. Where the degree of independence is excessive, this may translate into a concern about the suitability of an applicant for listing.
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Competition is normally regarded by the Exchange as a disclosure issue. However, in extreme cases where in the view of the Exchange, there are inadequate arrangements to manage conflicts of interest and delineation of businesses between the applicant and other businesses under common control, the Exchange would consider the impact on the applicants suitability for listing. A review of whether the applicant is or is not capable of carrying on its business independently of its controlling shareholder in the light of competing businesses operated by the controlling shareholder therefore involves careful balancing of all the relevant factors in the applicants case. The giving of non-competition undertakings by the controlling shareholder on a voluntary basis is a relevant factor but is not decisive. Non-competition undertakings may or may not effectively contain competition within acceptable boundaries. Enforceability of noncompetition undertakings, in turn, is often dependent on a number of other factors, including but not limited to (a) the effect of exemption clauses on non-competition undertakings, (b) how independently a listing applicant can exercise its right to enforce the non-competition undertakings in light of its own corporate governance and (c) the degree to which the management of the listing applicant and its controlling shareholders are closely connected. If there are indications that a non-competition agreement may not function effectively in light of the facts and circumstances of an individual case, the Exchange may disregard the agreement when determining whether the requirements of the Listing Rules have been satisfied.
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21. Connected transaction waivers

Connected transactions are transactions between the company (or any of its subsidiaries) and any connected persons of the company. At the time the listing application is filed any ongoing connected transactions must be identified and appropriate waivers sought from the Exchange. Identification of connected transactions
The first step is to identify all continuing transactions or arrangements between the company (and its subsidiaries) and any connected persons (being its directors, CEO, substantial shareholders and their associates and in the case of listing applicants established in the PRC, also includes its promoters and supervisors and their associates) and the historic and expected future amounts of such transactions. Once the continuing transactions have been identified it is then necessary to determine which of them are exempt under the Listing Rules. The main exemptions are noted below. The first three are exemptions from disclosure, reporting and shareholders approval, while the last point is solely an exemption from shareholders approval: the provision of consumer goods or services on normal commercial terms; the sharing of administrative services on a fair and equitable cost basis; the consideration under the transaction calculated using the five size tests is either (i) less than 0.1%, or (ii) between 0.1% and 2.5% and does not exceed HK$1 million; and the consideration under the transaction calculated using the five size tests is either (i) less than 2.5%, or (ii) between 2.5% and 25% and does not exceed HK$10 million.
The company must enter into written agreements with relevant parties in respect of its connected transactions not falling under the final three exemptions as set out above. The period for the agreement must be fixed and not exceed three years.
Waiver submission
If shareholder approval would usually be required for any of the continuing connected transactions then a waiver must be sought from the Exchange. Waivers will also generally be sought for transactions subject to the announcement requirements. The waiver will normally be sought subject to certain conditions, including: the agreements must be in the ordinary course of business, on normal commercial terms and in the interests of the company and its shareholders as a whole; details of the transactions shall be disclosed in each annual report; the aggregate value of each transaction will be made subject to an annual cap; and the independent non-executive directors and the auditors shall review the transactions annually to ensure they comply with the waiver conditions.
The sponsor is required to opine in the prospectus whether the continuing connected transactions for which waivers are sought are in the ordinary and usual course of business of the company, on normal commercial terms, are fair and reasonable and in the interests of the shareholders as a whole.
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22. PRC property issues

Every prospectus must contain a property valuation report. Where the company has PRC property a number of issues commonly arise in respect of the title and ownership rights to its PRC properties. Valuation report requirement
Chapter 5 of the Listing Rules provides that every prospectus must include a property valuation report. This chapter also sets out the content requirements for the report. Where a property is simply leased, or where the company has incomplete documents evidencing ownership of the land or the building on the land, or if the properties are not freely transferable then the land or building as appropriate is generally given a nil valuation. The valuer will also rely on a legal opinion given by a firm of PRC lawyers which is responsible to check the title documents for all relevant land and buildings.
Land use rights and building ownership

Ownership of PRC property is evidenced by land use rights certificates and building ownership certificates (or in certain areas of the PRC, a combined real estate ownership certificate). Practice Note 12 of the Listing Rules provides that where the issue of a land use right certificate is pending, a properly approved land grant or land transfer contract in writing accompanied by a PRC legal opinion as to the validity of the approval may be acceptable as evidence of a transferees pending title to the land to be granted or transferred. In March 1998 the Exchange issued an announcement to clarify the requirements for land use title to properties in the PRC. For companies other than infrastructure project and property companies (for whom relevant title certificates are a pre-requisite for listing approval), where a PRC property is crucial to the companys activities in the opinion of the Exchange, the company would be expected to have the relevant title certificate, unless otherwise permitted by the Exchange.
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23. Forecasts
Profit forecasts are not required to be included in a prospectus. However, where a forecast is included, or any language is used which implies a forecast (eg the companys profit should increase next year) then various rules must be followed, assumptions must be prepared, the accounting policies and calculations must be checked by the reporting accountant and the sponsor must be satisfied that the directors have made due and careful enquiries in making their forecast. The inclusion of a profit forecast in the prospectus will also determine whether profit forecasts or other forward looking financial information may be included in analysts research reports. Relevant Listing Rules
Listing Rules 11.16 to 11.19 set out the rules relating to profit forecasts, these include: LR 11.16 the prospectus must not contain any general or particular reference to future profits or contain dividend forecasts based on an assumed level of profits unless supported by a formal profit forecast. The term profit forecast is defined very widely in LR 11.17 to include any profit or loss forecast however worded and includes any estimate for a period which has already past but for which results have not yet been audited or published. In addition any valuations (other than for land and buildings) for assets or businesses purchased by the company based on discounted cashflows, or projections of profits, earnings or cashflows will be treated as profit forecasts. LR 11.17 the company may elect to include a profit forecast if it wishes to, however if one is included it must be clear and unambiguous, the principal assumptions must be stated, consistent accounting policies must be used, the reporting accountants must report on the accounting policies and calculations, and the financial adviser or sponsor must report that they have satisfied themselves that the forecast has been made by the directors after due and careful enquiry. LR 11.18 a profit forecast should normally cover a period which ends on the financial year-end. If it is only prepared to the half year-end then the relevant interim accounts will need to be audited in due course. A profit forecast cannot cover a period not ending on the financial year end or the half year-end. LR 11.19 the assumptions must provide useful information to investors to help them form a view of the reasonableness and reliability of the forecast, be quantified where possible, and be specific and definite rather than vague and general. It will not normally be acceptable for assumptions to relate to matters which the directors are best able to take a view on or are able to exercise control over since such matters should be directly reflected in the profit forecast.
Profit forecast
Where the company intends to include a profit forecast in its prospectus, it must prepare a profit forecast memorandum, which is submitted to the Exchange for review together with the 15 day documents. Such memorandum will be reviewed by and discussed with the reporting
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accountants and sponsor prior to submission, to ensure that such forecast is prepared in accordance with the accounting policies used in the preparation of the companys audited accounts contained in the prospectus and to check the calculations and by the sponsor to ensure that the forecast has been prepared by the directors after due and careful enquiry. Reports from the reporting accountants and the sponsor are then included in the prospectus. A listed issuer must consult with and seek advice from its compliance adviser if its results deviate from any profit forecast or estimate contained in its prospectus. In such circumstances, the company will be required to issue an announcement and include an explanation of the difference in its annual report.
Listing decisions
In listing decisions 35-2 and 50-4, the Exchange determined that it was inappropriate to include a risk factor or disclaimer in respect of the profit forecast in the prospectus.
Profit forecasts in analysts research reports

Pursuant to LR 8.21B, pre-deal research issued by the sponsor, each of the underwriters or their associates must not incorporate any profit forecast or other forward looking statements unless such statements are included, in substantially the same form, in the applicants listing document. Where a profit forecast is included in the prospectus, a practice has developed to request a confirmation from the Exchange that it would not have any comment on the inclusion of independently prepared profit forecasts covering a limited period (of an additional one to two years) beyond that covered in the prospectus. Where no profit forecast is included in the prospectus, the sponsor is required to provide an undertaking to the Exchange that it will not include profit forecasts or other forward looking statements or financial information of a similar nature in any analysts report or other report or document of a similar nature.
US considerations
The inclusion of forecasts and projections in offering documents is generally disfavored in the context of offerings to be sold in the United States. Even where forecasts and projections are qualified, the risk of liability in the United States may exist with regard to such forecasts and projections. In general, projections, forecasts and other forward-looking statements are considered inherently unreliable, involving known and unknown uncertainties which may cause actual results to be materially different from any projected or forecasted results. The international wrap prepared by US counsel in connection with Hong Kong-listed IPOs typically contains one or more risk factors stating that forecasts and projections provided in the base prospectus pursuant to local legal requirements should be disregarded as unreliable. Many offering circulars set forth detailed assumptions made in providing forecasts and projections, the incorrectness of any of which may cause the forecast or projection to be inaccurate.
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The US Private Securities Litigation Reform Act, as amended, contains a safe harbour from anti-fraud liability in private securities litigation for certain forward-looking information under certain conditions. As a result, market practice on Rule 144A transactions is to comply with the requirements of the safe harbour. These include accompanying the forward-looking information with meaningful cautionary language identifying important factors that could cause results to differ. It is common to exclude from the international offering circular copies of the letters from the reporting accountants and the sponsor in respect of the profit forecast.
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24. Share option schemes

When contemplating an IPO there are two types of schemes, pre-IPO schemes and post-IPO schemes. For the post-IPO schemes there are a number of rules to be followed which are set out in the Listing Rules. For preIPO schemes these do not need to comply with all aspects of the Listing Rules (such as the minimum strike price for the shares) but generally they are structured to comply with the rules to the extent possible. Post-IPO share option schemes
Any share option scheme under which options will be issued after listing must comply with the requirements of Chapter 17 of the Listing Rules, the key requirements being: eligible grantees eligible grantees generally include directors and employees of the group and other persons who have or will contribute to the group. maximum number of shares the maximum number of shares which can be issued under the scheme and all other schemes must not exceed 30% of the issued capital in issue immediately following the IPO, provided that once options equivalent to 10% of the capital have been issued, further shareholder approval is required for each subsequent 10% up to the 30% limit. maximum number of shares per grantee unless approved by shareholders, the maximum number of shares issued and to be issued on exercise of the options granted to any grantee cannot exceed 1% of the issued shares in any 12 month period. issue of options to connected persons where an option is to be granted to a connected person (or their associate), such grant must be approved by the independent non-executive directors (excluding the grantee). issue of options to substantial shareholder or INED shareholder approval is required if an option is to be granted to a substantial shareholder or an independent non-executive director (or their associates) and will result in that person holding options for more than 0.1% of the issued shares with an aggregate value of greater than HK$5 million. minimum subscription price the subscription price must not be less than the lower of the share price on the date of offer of the options and the average closing price for the last five business days prior to the date of offer of the options (or the IPO price where the company has been listed for less than five days). period of scheme no options can be granted under the scheme after the 10th anniversary of the adoption of the scheme. price sensitive events options cannot be granted after a price sensitive event has occurred until that event is disclosed, nor can they be granted in the period one month preceding the board approval of any annual or interim financial results until the results are announced.
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The Exchange also issued a directive to all listed companies in 2005 clarifying the application of LR 17.03(13) which deals with adjustments to option exercise prices on the issue of new shares by the company. While this clarification did not expressly amend the Listing Rules (and is arguably inconsistent with the Listing Rules) regard to this ruling should be had when preparing the option scheme and when issuing new shares while there are options outstanding.
Pre-IPO share option schemes

Where a company wishes to issue options to employees prior to an IPO then it is free to do so. Where the scheme does not comply with the provisions of Chapter 17 of the Listing Rules, options granted before listing remain valid after listing (subject to approval of listing of the underlying shares) but no further options may be granted following listing. The company is required to disclose in the prospectus full details of outstanding options, the grantees (subject to obtaining relevant waivers from the SFC and the Exchange) and their dilution effect and impact on earnings per share upon exercise. Such pre-IPO option schemes often provide that the exercise price of options will represent a limited discount to the IPO price.
Share appreciation rights

Due to the restrictions under PRC law on PRC nationals holding H shares, H share companies do not generally adopt share option schemes upon listing. Some H share issuers adopt phantom share option schemes or share appreciation rights schemes upon listing.
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25 Structure of the offering

The Listing Rules provide for an initial allocation of 10% of the offer shares to the public offer tranche with clawback arrangements where the public offer is significantly over-subscribed. In addition, the Listing Rules provide for the grant of an over-allotment option to the underwriters in respect of additional shares representing up to 15% of the shares initially offered under the IPO. Initial allocation to public offer and placing tranches
Pursuant to Practice Note 18, the minimum allocation to the public offer tranche of the IPO shall generally be 10% of the total number of shares offered in the IPO. As a result, the initial allocation of shares to the placing tranche is generally 90% of the shares initially offered in the IPO.
Clawback arrangements
Practice Note 18 provides for a reallocation of shares from the placing tranche to the public offer tranche where the public offer tranche is significantly over-subscribed, as follows: a clawback mechanism that increases the number of shares under the public offer to 30% of the shares initially available under the IPO when total demand in the public offer tranche is 15 times, but less than 50 times, the initial allocation; a clawback mechanism that increases the number of shares under the public offer to 40% when total demand in the public offer tranche is 50 times, but less than 100 times, the initial allocation; and a clawback mechanism that increases the number of shares under the public offer to 50% when total demand in the public offer tranche is 100 times or more the initial allocation.
Shares may be transferred from the public offer tranche to the placing tranche where there is insufficient demand in the public offer tranche to take up the initial allocation. In addition, underwriting agreements may provide an additional discretion to the underwriters to reallocate shares from the placing tranche to the public offer tranche to satisfy excess applications in the public offer tranche, to cater for the position where the level of over-subscription in the public offer is insufficient to trigger the clawback provisions of PN18. Waivers from the requirements of Practice Note 18 In respect of large offerings where the number of shares available to the public in Hong Kong would be very large if the requirements of PN18 were applied in full, the Exchange may be willing to grant waivers from the above allocation ratios to reduce the percentage of the offering allocated initially and upon triggering of the clawback arrangements to the public offer. In practice, such waivers are only available where the total offer size exceeds HK$10 billion. Over-allotment option It is common for companies and selling shareholders to grant an option to the underwriters to require the company to issue and the selling shareholder to sell additional shares representing up to 15% of the number of shares initially available under the IPO for the purpose of covering over-allocations in the placing tranche. Such additional shares will generally be allocated to the placing tranche. Please refer to Chapter 29.
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Allocation of shares within the public offer tranche The total number of shares available for subscription in the public offer tranche is to be divided equally into two pools, Pool A and Pool B. Shares in Pool A should be allocated to investors who have applied for shares with an aggregate price (representing the price initially payable on application rather than the price as finally determined, and excluding brokerage of 1%, Exchange trading fee of 0.005% and SFC transaction levy of 0.005% of the offer price) of HK$5 million or less. Shares allocated to Pool B should be allocated to investors who have applied for shares with an aggregate price of more than HK$5 million and up to the total value of Pool B. Where one of the pools is under-subscribed, surplus shares should first be reallocated to the other pool to satisfy excess applications. Multiple applications The company, its directors, the sponsor and the underwriters should take reasonable steps to ensure that multiple or suspected multiple applications are identified and rejected. For these purposes multiple applications means circumstances where (i) more than one application is made under the public offer by the same person; (ii) an application under the public offer is made for more than 100% of the total number of shares originally allocated to each pool; or (iii) an application is made under the public offer by an investor who has also applied for or been placed shares in the placing tranche. Pricing of the IPO shares Although shares may be offered under the IPO at a fixed price, it is more common that shares will be offered under the public offering at a price range, with applicants under the public offer required to pay the maximum offer price on application together with relevant brokerage, fees and levies, subject to refund. Where the offer price is expressed as a range, the prospectus will generally provide for a reduction in the price range and/or the number of shares offered under the IPO, at any time up to the morning of the last day for filing applications under the public offer. The company is required to issue an announcement in the event of a reduction in the offer price range and/or number of IPO shares with such announcement to be issued no later than the morning of the last day for filing applications under the public offer. Such announcement is required to include updates of any financial information set out in the prospectus which is impacted. In the event of an announcement, the final offer price range, if agreed, must be set within the reduced range. Applications filed prior to any such announcement may not be withdrawn. Where no such announcement is made the final offer price may not be set outside the range stated in the prospectus. The offer price will generally be determined through a book-building process based on the orders placed by professional and institutional investors in the placing tranche. The final offer price will be fixed by agreement between the global coordinator of the IPO and the company. Where no such agreement is reached the IPO will lapse. The offer price will generally be determined on the day following the close of the placing tranche and in any event, not later than the day on which the results announcement is published, and, in practice by 5:00pm on the preceding day, to allow clearance of the relevant announcement by the Exchange. The offer price as finally determined will be the same in both the public offer and placing tranches.
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26 Underwriting arrangements
Pursuant to LR7.02, the public offer tranche of an IPO must be fully underwritten. In practice, the placing tranche is also underwritten. The company and any selling shareholder will enter into underwriting agreements with the underwriters of the public offer and placing tranches setting out their respective rights and obligations. Hong Kong underwriting arrangements
LR7.02 requires that the public offer tranche of an IPO is fully underwritten. In this regard, the company and potentially other parties including major shareholders and executive directors of the company, will enter into an underwriting agreement with the underwriters setting out the underwriting arrangements for the public offer. The Hong Kong underwriting agreement is generally signed on the morning of the day of registration of the prospectus and is a material contract which will be registered with the prospectus and made available for public inspection. Pursuant to the Hong Kong underwriting agreement, the Hong Kong underwriters will agree to procure subscribers for, or failing which to subscribe for, the shares offered under the public offer tranche in return for the payment of an underwriting commission. The obligations of the underwriters under the Hong Kong underwriting agreement are several, with each Hong Kong underwriter agreeing to take up a fixed proportion of the shares available under the public offer. The Hong Kong underwriting agreement will also set out the mechanics of the public offer including the determination of the allotment of the offer shares available under the public offer, clawback and reallocation provisions and arrangements for the delivery of shares and payment of the proceeds of the public offer to the company, subject to the deduction of fees incurred in connection with the IPO. In addition to setting out the underwriters underwriting obligations, the underwriting agreement sets out other provisions in respect of the public offer, including the following: Conditions precedent the conditions precedent to the Hong Kong underwriting agreement will generally include the registration of the prospectus, the agreement of the final offer price, the signing of the international purchase agreement and that agreement becoming unconditional, the Exchange granting admission for listing of the companys shares and the delivery of specified documents to the underwriters; Representations and warranties the company and other warrantors under the underwriting agreement will give extensive representations, warranties and undertakings to the Hong Kong underwriters covering the accuracy and completeness of prospectus disclosure, the financial information, due incorporation, title to assets, legal compliance, approvals required for the offering and other matters. The undertakings will generally cover issues including maintenance of listing status, using the proceeds of the offering in accordance with the prospectus and the issue of announcements; Indemnity the company and other warrantors will also provide the Hong Kong underwriters with an indemnity from liabilities arising from misstatements or omissions in the prospectus, breaches of laws and breaches of the terms of the underwriting agreements, including the representations and warranties;
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Termination provisions the Hong Kong underwriting agreement will also set out comprehensive events of termination, including force majeure events, material restrictions on trading on major securities markets, adverse changes in the business of the company, breaches of warranties, litigation being brought or threatened against the company and material omissions or misstatements in the prospectus, on the occurrence of which prior to a specified time (generally 8:00am on the morning of listing) the underwriters have the right to terminate their obligations under the underwriting agreement; and Lock-up provisions the company and controlling shareholders will give undertakings not to issue shares (in the case of the company) or dispose of their interests in the shares of the company for a specified period of time following the listing of the company's shares on the Exchange.
Agreement among Hong Kong underwriters At the same time as entering into the Hong Kong underwriting agreement with the company, the underwriters of the public offer tranche will enter into an agreement among Hong Kong underwriters, setting out their respective rights and obligations in respect of the public offer. The agreement will include provisions in respect of any default by any Hong Kong underwriter of its underwriting obligation, allocation of the underwriting commissions among the underwriters and authorising the global coordinator to exercise the underwriters discretions under the Hong Kong underwriting agreement on their behalf. Price determination agreement As the offer price will generally be expressed in terms of a range at the time the Hong Kong underwriting agreement is entered into, upon agreement of the final offer price between the global coordinator (on behalf of the underwriters) and the company, the global coordinator and company will enter into a simple price determination agreement setting out the offer price as finally agreed. Receiving bankers agreement In connection with the public offering, the company and the global coordinator will enter into a receiving bankers agreement with a commercial bank, in respect of the distribution of prospectuses and application forms and collection and processing of applications and application monies. The agreement will also provide for the payment of interest on application monies, which on major and popular IPOs can be a significant amount.
International underwriting arrangements

International underwriting agreements are entered into for Regulation S and Rule 144A tranches to be offered outside of Hong Kong. International underwriting agreements should contain US-specific representations and warranties, and US-specific covenants, depending on the exemption(s) from registration being relied upon in connection with the offering. US-Specific Representations, Warranties and Covenants Representations, warranties and covenants requested by the underwriter from the issuer and selling or controlling shareholders in an international underwriting agreement are similar to those requested in the Hong Kong underwriting agreement, except that US-specific representations, warranties and covenants are also obtained in order to establish exemptions from registration.
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These include, in the case of Regulation S offerings, that no directed selling efforts have been made in the United States by the issuer, a distributor, any of their respective affiliates or any person acting on behalf of the foregoing, that applicable offering restrictions have been complied with and that there is no substantial US market interest in the securities offered. Where Rule 144A is relied upon, typical representations, warranties and covenants include that no general solicitation or general advertising has been made in the United States by the issuer, a distributor, any of their respective affiliates or any person acting on behalf of the foregoing, and that no securities of the same class are listed in the United States. Agreement Among Managers A separate agreement, referred to as an Agreement Among Managers, will specify the underwriters obligations to each other in relation to an international offering. This agreement will generally establish a several commitment of the underwriters and is similar in effect to the Agreement among Hong Kong underwriters. The global coordinator will be authorised but not obliged to arrange for subscription by others of any defaulting underwriters's shares. It will also provide terms as to commissions and expenses. The Agreement Among Managers will also establish the authority of the global coordinator to exercise, on behalf of all underwriters, rights under the underwriting agreement on their behalf, such as extending deadlines and waiving conditions precedent to closing under the underwriting agreement, terminating the underwriting agreement, reallocation among the public offer and the international offering, determining pricing, exercising any over-allotment option, making payment to the issuer in accordance with the underwriting agreement and engaging in stabilising activities. Intersyndicate Agreement A separate agreement, referred to as the Intersyndicate Agreement, is an agreement among the underwriters of the Hong Kong offering and the underwriters of the international offering, and will govern reallocation between the offerings, commissions and expenses and agreed selling restrictions.
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27 Publicity restrictions
There are a number of regulations governing the release of information by the company or any of its advisers in connection with an IPO. It is important that appropriate guidelines are put in place to ensure that any releases of information do not breach the regulations as this may result in potential liability, delays to the timetable and possibly prevent the IPO from being marketed in certain jurisdictions. We have dealt with the rules relating to the release of research reports in Chapter 28. Principal regulations
The regulations governing the release of information in connection with an IPO are contained in the Companies Ordinance, the SFO, guidelines issued by the SFC, and the Listing Rules. The regulations are complex, very restrictive and arguably inconsistent with each other which makes their interpretation very difficult. In this chapter we have endeavoured to simplify these regulations and outline what we consider to be accepted market practice. In broad terms, the regulations provide that before registration of the prospectus the company (and its advisers) cannot issue any press announcements or make any public statements which contain any reference to the IPO or the offer of the shares or the current or future trading prospects of the company, other than a very limited offer awareness statement made not earlier than 14 days before registration of the prospectus and which is approved by the Exchange. Under LR9.08, any publicity material issued by the company relating to the IPO must be approved by the Exchange before release and must not be released until the Exchange has confirmed that it has no further comments thereon. For these purposes, publicity material does not relate to an issue of securities if its purpose is the promotion of the company or its products and not the securities to be issued. Where any material relating to the proposed IPO is released before the Listing Committee hearing without prior review by the Exchange, the Exchange may delay the timetable for the Listing Committee hearing by up to one month. In practice it is rare for authorised publicity material to be issued. If the company and its advisers hold meetings with financial advisers and major investors before registration of the prospectus this may involve a breach of the regulations and thus any information released at these meetings should be limited to that contained in the draft prospectus and the attendees should agree not to publicly release this information until the prospectus is registered.
Publicity guidelines
Guidelines It is recommended that a set of publicity guidelines is prepared and distributed to directors, senior management and all other parties involved in the IPO. Approval by Authorised Person An internal Authorised Person should be appointed by the company to approve all written publicity material (including any oral presentations) relating to the IPO, current or future trading prospects, or the operations of the group other than material issued in the ordinary course of business. Where the Authorised Person is in doubt as to whether the information may breach the regulations he should consult with the companys legal advisers. All approved information should be copied to the legal advisers.
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Enquiries by press or public Before registration of the prospectus, if the company is asked to respond to any enquiry from the press or any member of the public relating to the IPO, or to the current or future trading prospects of the group, then the company should decline to comment. If the enquiry relates only to the general business of the group (excluding trading prospects) or relates to publicly available information then the company can respond to the enquiry, but caution is required. After registration of the prospectus the directors or employees can respond to enquiries provided that they do not provide more information than is contained in the prospectus. Press releases and other materials Prior to registration of the prospectus the company should not issue any press releases or other written material relating to the IPO, except for the very limited statement as permitted by the SFC Offer Awareness Guidelines discussed below. After registration of the prospectus all press releases and other written material relating to the IPO or the operations of the group must be approved by the Authorised Person and, if such release refers to the IPO, it must comply with the SFC Offer Awareness Guidelines and be approved by the Exchange. SFC offer awareness guidelines The SFC guidelines permit offer awareness materials to be issued not earlier than 14 days before registration of the prospectus provided this contains only very limited information (as specified in the guidelines) of the fact of the forthcoming IPO and does not contain any information promoting the company or the offer of shares under the IPO. Such materials need not be approved by the SFC or the Exchange. Such materials should not be used after the close of the offer period. After registration of the prospectus the guidelines also permit the company to issue summary disclosure materials which are materials that do not contain any substantive information that is not contained in the prospectus and also contain certain warning statements as prescribed in the guidelines. Summary disclosure materials must be approved by the Exchange, but are rare in practice. Unsolicited communications No director, officer or employee of the group should make any unsolicited communications to any analyst, potential investor or other person regarding the IPO or the business of the group. Company website The companys website should not refer to the IPO or include any material which is not usually placed on its website, as this information may be viewed as conditioning the market to the IPO. In addition, prior to submission of the Form A1, the companys website should be screened for any information which is inconsistent with the draft prospectus. Press conferences No press conferences regarding the IPO should be held until the prospectus is registered. Once registered, a press conference is often called the same day at which the prospectus can be made available and the company can respond to questions provided that no material should be released which goes beyond that contained in the prospectus. If a press conference is held prior to registration of the prospectus on matters not related to the IPO, the company should decline to answer any questions concerning the IPO or its trading prospects. Underwriter marketing and roadshow Before the Listing Committee hearing, the sponsor and underwriters should not discuss the IPO with the press or any potential investors other than any strategic or anchor investor(s) who should be required to provide a confidentiality undertaking.
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Following the Listing Committee hearing, the sponsor and underwriters will commence the pre-marketing process. Roadshow meetings with potential investors will generally commence after the Listing Committee hearing and pre-marketing process but before the prospectus is registered. At these meetings the practice is to release the red-herring draft of the prospectus to institutional investors and give presentations supported with slides and answer questions. The presentation and any answers should not include any substantive material which goes beyond that included in the prospectus. Those attending these meetings should be required to keep the information confidential until the prospectus is registered.
US considerations as to publicity guidelines

The distribution of publicity in the United States immediately before or during an offer of an issuers securities is subject to restrictions under US federal securities laws. The term offer is construed broadly under the US securities laws, such that any documents in which a contemporaneous or contemplated offering of securities by an issuer is discussed including publicity or marketing materials could be interpreted as offering materials, and their dissemination in the United States as an offer of securities. It is illegal under the Securities Act to make an offer of securities in the United States without either (i) registering such securities under the Securities Act by filing a registration statement with the SEC or (ii) relying on an exemption from such registration requirement. Where a Regulation S is the exemption relied upon, Regulation S bars all directed selling efforts made in the United States by the issuer or a distributor, any of their respective affiliates or any person acting on behalf of the foregoing. Where Rule 144A is the exemption relied upon, general solicitation or general advertising is prohibited in connection with an offering. Directed selling efforts, as defined in Regulation S, include any activity undertaken for the purpose of, or that reasonably could be expected to have the effect of, conditioning the market in the United States for securities being offered in reliance on Regulation S. General solicitation or general advertising includes, but is not limited to: publishing any advertisement, article or notice in any US newspaper, magazine or similar media in the United States or broadcasting such over US television or radio; or any seminar or meeting in the United States whose attendees have been invited by any general solicitation or general advertising.
Examples of marketing activities or publicity that could be deemed to be directed selling efforts, general solicitation or general advertising include: the promotion of feature articles about the issuer or management interviews in US publications by representatives of the issuer; advertisements for the offering in any US publication; and meetings between representatives of the issuer and research analysts or brokers in which the offering is discussed, if such analysts or brokers then distribute such information in the United States.
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Any distribution of publicity by any offering participant in the United States that was found to be directed selling efforts or a general solicitation or general advertising could (i) result in a loss of the exemption from the registration requirements of the Securities Act for either the US or the non-US portions of the offering, (ii) create a risk that the SEC could prevent or delay the US portion of any such offering and (iii) subject offering participants to liability to US investors under US laws for statements made in such publicity.
Protective measures
As a result of these considerations, in general, underwriters should ensure that no press conferences are held in the United States and no press releases or other announcements relating to the IPO are issued or disseminated in the United States by any person involved with the IPO or the company. Press conferences may be held outside the United States in accordance with local market practices and US journalists may be invited provided that access to the conference is provided to both US and non-US journalists. One-on-one interviews may be held with US journalists provided similar opportunities are given to non-US journalists. The issuer should not solicit media coverage in US media or non-US media commonly disseminated in the United States (such as The Financial Times or the Economist). Any written press-related materials must contain an appropriate legend. The legend should state that the written press-related materials are not an offer of securities for sale in the United States, that securities may not be offered or sold in the United States absent registration or an exemption from registration, that any public offering of securities to be made in the United States will be made by means of a prospectus that may be obtained from the issuer or the selling security holder and that will contain detailed information about the company and management, as well as financial statements. Since materials posted on a website are generally available to persons located in the United States, any offering materials posted on the issuers websites could be construed as an offer of securities into the United States, as directed selling efforts in violation of the Regulation S safe harbour and/or as a general solicitation or general advertising, rendering Rule 144A unavailable. Other restrictions on publicity on offerings sold into the United States are similar to those referred to above in relation to offerings generally.
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28. Research reports

The IPO publicity restrictions also apply to the release of information by analysts who are connected with the sponsors and underwriters. Generally a separate set of guidelines in relation to pre-IPO research reports is put in place for each IPO and circulated to the relevant parties to ensure that reports do not breach relevant laws and regulations. The sample guidelines assume the IPO will include an exempt US offering.
This area of law is complex, and relevant legislation is open to conflicting interpretations resulting in uncertainty as to how it should be applied. To address this uncertainty the legislation is presently under review by the regulators.
Research report guidelines

Generally underwriters counsel will prepare guidelines in relation to the distribution of research reports which are circulated to members of the underwriting syndicate. Research report guidelines typically include the following terms: Research reports These include any analysts report, brokers circular, opinion, recommendation or other research material concerning the company or any of its subsidiaries, whether newly issued or previously issued and whether prepared as a separate report or included in a report dealing with other companies (eg a sector report). Application to all syndicate members All syndicate members, being the sponsors, underwriters and their related group companies, must adhere to the guidelines in relation to any reports issued by them. Key expected dates The following is a summary of certain key dates in relation to the distribution of research reports: Deadline for submission of research reports for review Latest time for publication and distribution of research reports Start of Global Blackout Period Usually at least three days before publication of the report Usually the day before the Global Blackout Period Usually 14 days prior to the printing of the preliminary prospectus and commencement of the IPO roadshow Usually 40 days after the date of listing Immediately upon commencing planning of offering Usually 40 days after the closing date of the offering or the completion of the distribution of the securities if later
End of Global Blackout Period Start of US Blackout Period End of US Blackout Period
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Own research Each research report should be the syndicate members own research. Internal compliance procedures All research reports should be reviewed by the syndicate members research compliance officer (or internal legal compliance officer) before publication to ensure that the report is in accordance with internal guidelines. In addition, research reports should also be cleared with the syndicate members corporate finance director in charge of the client relationship with the company before publication. This is to enable the director to check that there are no factual errors in the research report, and no material inconsistencies with the draft prospectus. Compliance with regulatory requirements Each syndicate member issuing a research report is responsible for ensuring that all applicable regulatory requirements and standards of professional conduct in relation to the preparation, publication and distribution of the research report are complied with in all relevant jurisdictions. Chinese Walls Appropriate information barriers should be maintained between the analyst(s) preparing the research and those other divisions of the financial organisation advising the company or involved in the IPO. Such analysts should not attend due diligence meetings in relation to the offering or have other contact with the company, save that they will often attend formal analysts presentations; their reports should be prepared by reference only to draft offering materials provided by bankers advising on the IPO on the other side of the Chinese Wall. Date and disclaimer All research reports should be dated and must include a disclaimer of liability and an indication statement in the form recommended by the underwriters legal advisers. The disclaimer should appear prominently at the front of the research report and the indication should appear on each page. The disclaimer is of assistance in avoiding liability but is not conclusive. To the extent disclosure of an underwriters participation in the Offer is required in its research report due to regulatory or liability considerations, such disclosure must not be given greater prominence than any other disclaimers, legends and qualifying statements in the research report. Basis of preparation Each research report must be produced using a high standard of care. This requires that: the research report should be, and present itself as, an outsiders view of the company which has been independently produced; qualifications, explanations and caveats should be clearly stated; it should be clear what information is a matter of fact and what is a matter of the authors judgement; to the extent that information is based on published or historic information, and particularly if this has not been updated, this should be made clear; the facts should where possible be checked against authoritative sources (and the relevant source should be stated in the research report); where this is not possible, this should be made clear and appropriate qualifications should be included; the research report makes clear that the research report does not, and does not attempt to, contain everything material about the company;
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research reports must be accurate and not misleading by omission; and where there is a reference to the authors belief, there must be a reasonable basis for that belief.
No reference to the IPO The research report should not contain any reference to the IPO or suggest in any way that it is being issued in connection with or because of the IPO. Forecasts, projections and valuations Subject to the restrictions set forth below, research reports may include forecasts, projections and valuations prepared independently of the company. Inclusion of forecasts, projections or valuations in the research report may lead to increased liability with respect to such research report and great care should be taken. If forecasts, projections or valuations are to be included, in order to minimise the potential risk: they must comply with the requirements of local law; they must be fairly based; there must be no price target or fair value per share. Comments on valuation should be restricted to general remarks about the methods that the market generally uses to value comparable companies. It should be made clear that any suggested valuation framework is based upon long-term analysis and is not linked to a short-term assessment of the likely performance of the securities; it must be made clear that they represent the opinion of the authors alone and not of anyone responsible for the preparation of the prospectus or in possession of confidential information regarding the company or any of the subsidiaries and must be accompanied by appropriate cautionary language indicating that such forecasts, projections or valuations may or may not occur, as well as any other applicable risk factors; and detailed assumptions on which they are based must be clearly stated, the sources used must be identified and the sensitivity of the projections to any exogenous factors must be estimated.
The Listing Rules provide that pre-deal research issued by the sponsor, each of the underwriters or their associates must not incorporate any profit forecast or other forward looking statements unless such statements are included, in substantially the same form, in the applicants listing document. Where a profit forecast is included in the prospectus, a practice has developed to request a confirmation from the Exchange that it would not have any comment on the inclusion of independently prepared profit forecasts covering a limited period (of an additional one to two years) beyond that covered in the prospectus. Where relevant contents of a research report prepared by a syndicate member are published in the press (possibly following a leak), the Exchange may withdraw any such confirmation given. Where no profit forecast is included in the prospectus, the sponsor is required to provide an undertaking to the Exchange that it will not include profit forecasts or other forward looking statements or financial information of a similar nature in any analysts report or other report or document of a similar nature. No recommendations The research report must not include any investment recommendation or any wording that implies such a recommendation.
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Independent production Except as referred to in the disclaimer, nothing in the research report should suggest that the report is definitive or authoritative or that any part of the research report is based on information provided by, represents the views of, or has been written, verified or approved by, the company, the sponsor or any other syndicate member or any of their directors. Submission of final draft for review At least three days prior to the publication of the research report and after review by the syndicate members legal and research compliance departments, a final draft of the research report must be provided to the sponsor and the sponsors lawyers. Any drafts submitted to the company should have any sections covering forecasts or projections, the research summary and assumptions removed. Basis of review The sponsor may review the research reports for factual accuracy and consistency with the prospectus. The sponsors legal advisers will review the research reports for compliance with the research report guidelines. Global Blackout Period No research report may be published or distributed anywhere in the world during the Global Blackout Period. US Blackout Period No research report may be published or distributed in, or transmitted to, the United States or to US persons during the US Blackout Period which commences immediately upon preparation of the offering and which is expected to end 40 days after the closing date of the offering or the completion of the distribution of the securities if later (the US Blackout Period). During the US Blackout Period, syndicate members should: screen potential recipients of research reports to ensure that only persons who are outside the US and institutional investors on the relevant analysts current research mailing list with addresses outside the United States receive research reports. A list should be kept of all recipients; adopt procedures to ensure that all personnel responsible for the preparation, storage or distribution of research reports and the recipients of the research reports understand that the research reports are not to be distributed in the United States; and if any reasonable doubt exists regarding a persons US status, the syndicate member should refrain from sending research reports to such person.
Distribution of research reports in Hong Kong Research reports may not be issued, circulated, or distributed in Hong Kong other than to persons whose ordinary business is to buy or sell shares or debentures, whether as principal or agent (except in circumstances which do not constitute an offer to the public within the meaning of the Companies Ordinance), and either (i) such persons fall within the meaning of professional investors as defined in the Securities and Futures Ordinance and the Securities and Futures (Professional Investor) Rules or (ii) the issue of this document to such persons is exempt from the Securities and Futures Ordinance. No research reports should be distributed before the formal hearing by the Listing Committee of the Exchange. Distribution of research reports outside Hong Kong Reports should only be distributed to potential investors in jurisdictions outside Hong Kong in compliance with local laws. The distribution of research reports in certain jurisdictions including Canada, Japan and the PRC is prohibited.
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Hard copy distribution only Research reports must be delivered in physical form in one mail shot only and must not be published on the internet, sent by email or other electronic form or put on an electronic retrieval system. Each individual research report should be numbered and records kept of the recipient to whom such report was sent. Any such records are subject to review at any time by the sponsor. No distribution at roadshows, to press or public Research reports must not be distributed, discussed or reviewed at large meetings, such as roadshow presentations, or given to the press (including information vendors and wire services) or any other media organisation, private investors or members of the public anywhere in the world. Distribution consistent with past practice All syndicate members who distribute research reports should issue only such number of research reports as is consistent with their past practice on similar transactions and should maintain records of the names and addresses of all recipients of research reports. Distribution of final reports only Research reports should not be sent to clients until they are in final form. If a draft research report is circulated internally, it should be stamped or marked for internal use only. The company should in any event be provided with a final copy of each research report as soon as it is disseminated to clients. Distribution of prospectus Each syndicate member should ensure that any person to whom a research report has been sent also receives a copy of the preliminary prospectus and, to the extent such recipient is an investor in the offering, any final prospectus when published.
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29 Stabilisation and over-allotments

A stabilising manager may be appointed to stabilise the price of shares after listing by undertaking primary stabilising actions (such as purchasing shares in the secondary market to minimise any reduction in the share price) and also ancillary stabilising actions (such as exercising any over-allotment option). Price Stabilisation Rules
Stabilisation seeks to maintain or support the price of securities at levels different to those which might otherwise prevail. As such, stabilisation activities may be considered market misconduct under the SFO as being false trading and stock market manipulation. The Securities and Futures (Price Stabilising) Rules (PS Rules) provide a safe harbour from the market misconduct provisions under the SFO. The PS Rules apply to offers of equity securities, debt securities and depositary receipts of equity or debt securities (Relevant Securities) provided the total value of the shares offered under the IPO (excluding shares offered pursuant to any over-allocation) is not less than HK$100 million.
Who can carry out stabilising actions

Only a stabilising manager or its agents can carry out stabilising actions. The stabilising manager is a single intermediary appointed by or on behalf of the issuer to take stabilising action under the PS Rules. The consultation paper which led to the implementation of the PS Rules envisaged that only lead managers and underwriters of the public offering may conduct stabilising actions and be appointed as the stabilising manager. In particular, the consultation paper stated that the issuer of securities should not be involved in the stabilisation of its own securities.
Primary and ancillary stabilising actions

Under the PS Rules, a stabilising manager may stabilise the price of securities by effecting transactions prescribed in the PS Rules in the same type of security. Stabilising actions under the PS Rules are divided into primary stabilising actions and ancillary stabilising actions. Purchases of securities (or offers for or attempts to purchase securities) by a stabilising manager in the secondary market for the sole purpose of preventing or minimising any reduction in the market price of those securities are categorised in the PS Rules as primary stabilising actions. A stabilising manager may also, in connection with any primary stabilisation, carry out ancillary stabilising actions which include: over-allocation (up to the number of shares as may be issued on a full exercise of an overallotment option), for the purpose of preventing or minimising any reduction in the market price of those securities and borrowing shares for the purpose of such over-allocation; subscribing for shares on an exercise of an over-allotment option; or selling shares so as to liquidate any long position created as a result of primary stabilising actions.
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Even if there is no over-allocation in relation to the share offer, under the PS Rules, the stabilising manager may still engage in market purchases of the shares in order to stabilise the market price of the shares so as to create a net long position in the shares.
Restrictions applicable to stabilising actions

In order to qualify for the safe harbour under the PS Rules, primary stabilising actions are subject to pricing restrictions, and may only be carried out for a limited period of time. Pricing Restrictions Under the PS Rules only upward stabilisation is permitted and various restrictions apply to the price at which primary stabilising actions may be carried out: a. No stabilising actions may be taken at a price greater than the offer price excluding brokerage and fees (Offer Price). b. The stabilising manager is allowed to make a stabilising bid (Price B) which is at or below the Offer Price. Once an initial stabilising bid has been made the stabilising manager may subsequently make further stabilising bids at or below Price B. c. If a deal is done on the Exchange by a party other than the stabilising manager for the shares at a price (Price C) which is higher than Price B but below the Offer Price, the stabilising manager will then have a new maximum Price C, so that it may stabilise at or below Price C. d. The pricing restrictions under Section 11 of the PS Rules only apply to primary stabilising actions and do not apply to ancillary stabilising actions. Stabilising period Primary stabilising actions must be carried out during the period from the date of commencement of trading in the shares on the Exchange until the 30th day after the date on which the application lists under the public offer closed. Provided ancillary stabilising actions are carried out in connection with primary stabilising actions, they need not be carried out within the stabilising period. However, the SFC indicated in the consultation paper and related consultation conclusions that it expected such actions to be carried out as soon as possible after the end of the stabilising period and did not expect any net long position to be held for an unduly long period of time, which it considered would affect market liquidity. The SFC has acknowledged that the stabilising manager should be given the discretion to determine when to unwind any net long position created as a result of primary stabilising actions, so long as the liquidation is executed in a way that minimises market impact. As a result, where the stabilising manager holds a net long position in the shares as a result of purchasing shares in the secondary market in order to stabilise the market price of the shares, it has a discretion to determine when market conditions are sufficiently favourable to dispose of such shares. However, the stabilising manager would not be expected to hold onto such shares for an unduly long period. Prohibition on principal transactions between the stabilising manager and its agent(s) The stabilising manager shall not, as principal, enter into any dealing with any agent appointed pursuant to the PS Rules to act on its behalf. The PS Rules will not prevent proprietary trading activities of the stabilising manager and its agent as long as their transactions are executed through the normal order matching mechanism in the open market and neither the stabilising manager nor the agent concerned know, or ought reasonably to have known, the identity of the counterparty. The PS Rules will not prohibit client transactions for which the stabilising manager is merely an agent of its clients.
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Other restrictions under the PS Rules The stabilising manager is prohibited from taking any stabilising action in relation to the Relevant Securities where the market price of the Relevant Securities was or could reasonably be expected to be an artificial price and the stabilising manager knew or ought reasonably to have known that the artificiality in the market price was attributable in whole or in part to any conduct which constitutes market misconduct or an offence under Part XIV of the SFO. No restrictions on the size of any net long position created as a result of primary stabilising actions The PS Rules do not impose any limit on the size of any net long position which may be created as a result of primary stabilising actions. The number of shares which may be purchased pursuant to primary stabilising actions can thus exceed the number of shares under the over-allotment option. However, in practice, other regulatory requirements, such as the public float requirement under the Listing Rules and the disclosure of interests requirements under the SFO, would limit the size of the net long position.
Disclosure obligations
The PS Rules impose prior, interim and post-stabilisation disclosure obligations. Prior disclosure requirement The stabilising manager may not take any stabilisation actions in relation to the Relevant Securities unless, from the date of the first announcement indicating that a public offer of the Relevant Securities is intended to be made, adequate disclosure is made in relevant documents, including any announcement, invitation or prospectus, that stabilising action may take place in relation to the offer. Interim disclosure requirement As soon as reasonably practicable after any exercise or partial exercise of an over-allotment option, the stabilising manager is required to ensure that a public announcement is made by or on behalf of the issuer or the stabilising manager stating (i) the number of the Relevant Securities subscribed for on such exercise or partial exercise; and (ii) the number of Relevant Securities remaining available thereafter under any unexercised portion of the option. Other than in relation to an exercise of the over-allotment option, the PS Rules do not impose any other obligation on a stabilising manager to flag any stabilisation bid in the market in the course of its stabilising actions by way of simultaneous public announcement. Post stabilisation disclosure Within seven days after the end of the stabilising period the stabilising manager is obliged to ensure that a public announcement is made (whether by or on behalf of the offeror company or the stabilising manager) setting out the following: the date of the end of the stabilising period; whether or not stabilisation was undertaken; the price range between which stabilising purchases were undertaken; the date and price of the last stabilising purchase; and where applicable, the extent to which any over-allotment option was exercised.
There is no obligation under the PS Rules to disclose the volume of stabilising purchases undertaken.
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Role of the stabilising manager

The stabilising manager is responsible for overseeing compliance with the PS Rules and, in particular, the disclosure requirements referred to above and the record keeping requirements referred to below. The stabilising manager may appoint agents, local and overseas, to undertake stabilising actions, but remains ultimately responsible to the issuer and for compliance, including by its agents, with the PS Rules.
Record keeping requirements

The stabilising manager is obliged to establish and keep a register in respect of each offer of Relevant Securities to which the PS Rules apply, which should be kept for seven years from the end of the stabilisation period and made available for inspection by the SFC upon notice. Certain information in the register (the items under the first bullet point below) should be made available for inspection by the issuer upon notice at any time within three months after the end of the stabilising period. The register (which should be kept in Hong Kong) should include the information set out in section 13 of the PS Rules, summarised below, and should be updated immediately or on a daily basis: details of each transaction effected in the course of the stabilising action in question including: the type of the Relevant Securities; the unit price of the Relevant Securities; the quantity or total value of the Relevant Securities in the transaction; the date and time of the transaction; and details of the counterparty to the transaction;
details of the allocation of the Relevant Securities (name of offeree and amount allotted); details (so far as is known to the stabilising manager) of transactions other than those which are effected by or in accordance with the instructions of the stabilising manager at a price above the current stabilising price for the purposes of determining the maximum stabilising price (referred to as Price C in the section Pricing restrictions above).
In addition details of any agents appointed by the stabilising manager must be included in such register. The SFC expects the stabilising manager to properly separate its activities as stabilising manager and its other trading activities, including proprietary trading, to avoid committing market misconduct not covered by the safe harbour under the PS Rules. All stabilising actions should be recorded in the register in order to be eligible for the safe harbour under the PS Rules.
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30. Exempt US offerings

Exemptions from the registration requirements The basic premise of the US federal securities laws is that disclosure of all facts that are material to an investment decision is the best way to protect investors. To that end, the laws provide that public offers and sales of securities in the US or to US persons outside the US must either be registered with the SEC (which must declare the registration statement effective before sales proceed) or exempt from the registration requirements.
Exemptions generally restrict publicity about the offering and limit the class of permitted offerees to those meeting certain sophistication thresholds in order to allow issuers to avoid registering capital raising transactions with the SEC. If an issuer sells securities in violation of this registration requirement, a buyer of the issuers securities will have the right to rescind its purchase and recover from the issuer the consideration paid for the securities, even if the buyer is unaffected by the issuers failure to register. As a result, it is important for all offerings of securities not being registered with the SEC, including offers and sales outside the United States, pre-IPO offerings, and IPOs, to be crafted such that they are made subject to an exemption from registration, or are not subject to registration with the SEC. US counsel should be consulted to confirm the availability of an exemption from registration. A US legal opinion, termed a no registration opinion, may be requested from US counsel expressing the opinion of such counsel that the subject securities are sold in a manner exempt from the registration requirements of the Securities Act of 1933. For purposes of offerings to strategic investors prior to, or as part of, an IPO, several possible exemptions from registration may be considered: Section 4(2) offerings Section 4(2) of the Securities Act exempts from registration requirements transactions by an issuer not involving any public offering. Although the term public offering is not defined in the Securities Act, the SEC and US courts have interpreted the exemption to be available for offerings conducted in a non-public manner. Generally, the number of persons offered the securities, the sophistication of both offerees and purchasers of the securities and the type of disclosure provided to offerees will be considered in determining whether the issuer has engaged in a public offering. Because of the uncertainty in determining whether a public offering has occurred, the SEC has adopted Regulation D as a safe harbour for offerings made under Section 4(2), as discussed further below. Failure to comply with Regulation D does not preclude issuers from relying on the exemption under Section 4(2). Regulation D private placements Regulation D allows sales to an unlimited number of accredited investors. Accredited investors include banks, insurance companies, registered and small business investment companies, certain business development companies, certain employer benefit plans, organisations with total assets in excess of $5 million and certain wealthy individuals.
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In connection with a Regulation D private placement, general solicitation and general advertising may not be undertaken. General solicitation and general advertising include, with respect to the offering: publishing any advertisement, article or notice in any US newspaper, magazine or similar media in the United States or broadcasting such over US television or radio; or any seminar or meeting whose attendees have been invited by any general solicitation or general advertising.
An issuer offering securities under Regulation D must file with the SEC five copies of a notice on Form D no later than 15 days after the first sale of securities in the Regulation D offering (typically considered to be the receipt of the first subscription agreement or acceptance of subscription funds). The Form D, a fairly short form requiring only general information about the issuer and the offering, is a notice filing only; it does not subject the offering to review by the SEC. In practice, however, most issuers do not file the Form D in connection with their private placements on the theory that compliance with all other requirements of Regulation D would suffice to ensure that the exemption under Section 4(2) would be available. However, a Form D may nonetheless need to be filed in certain states to meet state exemption requirements. Rule 144A offerings In Rule 144A offerings, the securities offered must be sold only to QIBs, or those whom the seller reasonably believes are QIBs. Generally, QIBs are entities that in the aggregate own and invest on a discretionary basis at least $100 million in securities of non-affiliated issuers. Rule 144A securities are considered restricted securities and cannot be sold to non-QIBs (unless resold outside of the US under Reg S). In connection with a Rule 144A offering, similar to a Regulation D private placement, general solicitation and general advertising may not be undertaken. Regulation S offerings In a Regulation S offering, two general conditions must be satisfied: (i) any offer/sale must have occurred in an offshore transaction, and (ii) there must have been no directed selling efforts into the United States by the issuer, any distributor or any of their respective affiliates. Directed Selling Efforts are activities undertaken to, or that reasonably could be expected to, condition the US market for the securities. Additional restrictions apply if US holdings (for debt securities) or trading volumes (for equity securities) indicate the presence of substantial US market interest, or SUSMI. In such cases, additional restrictions are required: sales may not be made to US persons, as defined for purposes of Regulation S; offering restrictions must be complied with (ie, distributors must agree that offers and sales during a distribution compliance period will be made under Regulation S); and notice requirements applicable to inter-dealer sales will apply during a 40-day distribution compliance period.
State law (Blue Sky) requirements An offering exempt from registration under federal securities laws may still be subject to registration or qualification requirements imposed by state securities laws in the United States. US states are not prevented from imposing filing and fee requirements on issuers.
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Liability on disclosure Although the above exemptions provide for exemption from the securities registration requirement of Section 5 of the Securities Act of 1933, they do not provide exemption from anti-fraud rules.
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31. Hong Kong and US dual listings

Some issuers will seek to simultaneously list their securities both in the US and Hong Kong. Perceived benefits of dual listings in the US and Hong Kong include a positive pricing impact, an increased investor base, greater liquidity and enhanced disclosure, greater transparency for investors and increased prestige and coverage in the US markets. Such dual listings may also appeal in particular to technology-related issuers, as NASDAQ offers such issuers listings alongside many other technology-related companies.
Timing and coordination issues may arise in connection with submitting draft offering documentation to multiple regulators in connection with such offerings. Among other things, securities regulators in Hong Kong and the United States may provide inconsistent comments, or may impose potentially conflicting requirements on issuers. Perceived drawbacks associated with listing securities in the United States include enhanced potential legal liability and disclosure and diligence in connection with the offering, a potentially lengthened timetable for the capital raising exercise, on-going reporting obligations in the United States under the Securities Exchange Act of 1934, and various on-going compliance obligations in the United States under the Sarbanes-Oxley Act of 2002. US and Hong Kong dual listings In order to complete an IPO with a dual listing on the Exchange and a US exchange, such as the New York Stock Exchange (the NYSE) or NASDAQ, the securities to be listed in the United States must be registered with the SEC pursuant to a registration statement and declared effective by the SEC. Registration statements must be signed by the issuer, its principal executive officer, its principal financial officer, its principal accounting officer, at least a majority of its board of directors and a duly authorised representative in the US. This section discusses the procedure for, and several consequences arising from, listing securities in the United States. SEC comment and review In order to register securities with the SEC, a registration statement must be filed with the SEC and be declared effective by the SEC. A prospectus forms the bulk of the registration statement under the Securities Act and contains substantive disclosures to investors regarding the issuer, the securities being offered, and the manner of distribution. Registered offerings are usually marketed to investors using a preliminary or red herring prospectus, which omits certain pricing information. The prospectus is subject to extensive review and comment by the SEC, as are the accompanying financial statements of the issuer. SEC rules require issuers, and their legal counsel, to present information in certain sections of prospectuses in a clear, concise and understandable manner. These rules, which must be observed by all issuers filing registration statements under the Securities Act, encourage the use of short sentences, bullet lists and descriptive headers and sub-headers, wherever possible. In addition, the rules discourage excessive reliance on glossaries and defined terms and the use of legalistic, overly complex presentations, vague boilerplate language, excerpts from legal documents and repetitive concepts. Failure to follow these plain English rules can lead to delays in the approval of the prospectus and registration statement by the SEC.
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Financial statements Disclosure documents for SEC registered offers require the issuer to provide five years of selected financial data, three years of audited income statements and two years of audited balance sheets. Furthermore, issuers making an initial public offering generally must use audited financial statements (which may cover a period of less than a full year) not older than 12 months at the time the registration statement is filed. If the registration statement is dated more than nine months after the end of the last audited financial year, it should contain consolidated interim financial statements (which may be unaudited) covering at least the first six months of the financial year and comparative statements for the same period in the prior financial year. Moreover, if at the date of the registration statement the issuer has published interim financial information that is more current than required under this standard, the more current information must be included in the document. An additional consideration that may influence the parties decision regarding the financial statements to be included is the unavailability of negative assurance comfort from the auditors with respect to subsequent changes in financial statement items as of a date more than 135 days after the most recent period for which the accountants have performed an audit or interim review. Generally financial statements of non-US private issuers must contain reconciliations of key items to US GAAP and a discussion of material variations between home country and US GAAP. First time non-US registrants are permitted to reconcile financial statements and selected financial data for only the two most recently completed fiscal years. In subsequent reports and registration statements, an additional year is required until eventually the reconciliation covers five years. Audit reports for the financials must provide that the audit was conducted according to US generally accepted auditing standards.
Timetable for a registered offering

Due Diligence The due diligence process is meant to facilitate the drafting process and to provide protection from both Sections 11 and 12 and Rule 10b-5 liability, as described above. The due diligence process is a wide-ranging investigation of the business and legal affairs of the issuer of securities in connection with the sale of such securities. The process generally consists of presentations by the issuers management about its business to the bankers and lawyers, document review by lawyers of the issuers material documents (such as board minutes, contracts, loan agreements, governmental authorisations, and litigation records), and interviews with outside accountants, customers and suppliers. Another part of the process is the production by the lawyers of the 10b-5 letter and the comfort letter (see above) by the accountants. To reduce the risk of potential criminal or civil liability, therefore, each person responsible for the prospectus should satisfy himself, on all reasonable grounds, (and) having made such enquiries as were reasonable prior to the publication of the prospectus: that each material statement of fact or of opinion in the offering memorandum is not only accurate but is not misleading in its context; that nothing has been omitted which would affect the import of the information in the offering memorandum;
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that, taken as a whole, the document gives, so far as possible, a true and fair impression of the history, business and prospects of the issuer (as part of this exercise the offering memorandum must clearly cover the risks as well as the attractions of the investment); and, that nothing has been omitted so as to make the document misleading.
Pre filing period In connection with an IPO by a foreign private issuer, during the period before the registration statement is filed no one may offer, either orally or in writing, to sell the securities to be registered in the US. In this context, the term offer is broadly construed to include acts that may stimulate market interest in the issuer even if the securities are not mentioned. Rule 135 under the Securities Act allows the publication of very limited information about the offering before the registration statement is filed (provided it does not contain any of the underwriters names). Improper communications during this period are called gun-jumping violations. The penalty for such violations is a SEC imposed cooling off period which is meant to reduce the effect on the market of the improper communication. The cooling off period may last anywhere from a few weeks to several months. The SEC may also require the issuer to include the information that was improperly communicated in its prospectus, thus increasing the potential liability of all parties to the offering. Gun-jumping is also considered to be a violation of Section 5s registration requirement which allows the purchaser to rescind his purchase for up to one year following the sale. Filing the registration statement Filing fees must be paid to the SEC in connection with filing a registration statement. As of November 2002, non-US issuers are required to file registration statements electronically with the SEC by means of its EDGAR (Electronic Data Gathering and Retrieval System) system. A non-US issuer may request a confidentiality review of its registration statement prior to making a formal public filing. This confidential treatment is only available for first-time filers. A formal public filing is usually made after responding to the SECs comments on the confidential filing. The comment (waiting) period The initial public filing with the SEC marks the beginning of a waiting period, during which time the SEC staff may issue comments on the registration statement, and the issuer and the managing underwriter conduct preliminary marketing efforts in order to ascertain the level of interest in the transaction within the investment community. Review by the SEC staff for legal and accounting compliance during this period may take from 30 to 60 days (or longer if novel issues are present or staff workload is intense), although a shorter period is possible if the issuer has submitted a draft registration statement for confidential review and the issues raised by the SEC staff have been substantially resolved prior to the public filing. The managing underwriter should receive some word from the National Association of Securities Dealers (the NASD) and the Blue Sky administrators within four to five weeks following the filing. The SEC will contact the issuer with comments, orally or in writing, and may then schedule meetings to discuss necessary revisions. The SEC may require an interim amendment to the registration statement prior to declaring it effective. During this period oral selling efforts, such as a road show, are permitted.
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In connection with an IPO by a foreign private issuer, preliminary prospectuses are the only permitted written offering materials during this period and no sales may be made or confirmed during this period. The road show In order to market the securities to be sold, the issuer and bankers will visit potential investors during the SEC comment period, making presentations to them about the issuer and the securities, as part of a so-called road show. The road show typically covers several cities over a relatively short time frame (one three weeks). The presentation is prepared in advance with information drawn from the offering memorandum and is often followed by a question and answer section. For public offerings, no written materials may be distributed at a road show other than the preliminary or red herring prospectus. Interim amendment Depending on the extent to which SEC staff concerns can be resolved in any confidential review process, an issuer making its initial filing may be required to file amendments to its registration statement with the SEC before the registration statement becomes effective. If an amendment reflects material changes that ought to be known by public investors before they receive their sale confirmations after the effective date, a full re-circulation of the revised preliminary prospectus must be made to all persons to whom the underwriters expect to send confirmation not less than 48 hours prior to the mailing of such confirmations. If the changes are not of the type that would require re-circulation, but the SEC staff still wishes to review the revised language, the staff may accept a printers proof of the final pricing amendment, or a letter containing the proposed language. On some occasions, insignificant changes can be discussed over the telephone with the examiner, and included in the pricing amendment without formal review by the SEC staff. Pricing On the day prior to the effective date of the registration statement, the issuer and the managing underwriter will conduct a pricing meeting to determine the IPO price, based on demand for the securities. Once the price is decided upon, the final underwriting agreement is signed. Effective date Once the SEC receives the amended registration statement and approves the disclosure, the staff will declare the registration statement effective, and public trading may commence. Closing Within three days of commencement of public trading, the closing will generally take place. This is the point at which the underwriters receive the securities and required documents, comfort letters, and opinions set forth in the underwriting agreement in exchange for remitting the proceeds of the offering to the issuer and any selling shareholders. DTC trading The Depository Trust Company (DTC) is a clearing agency which holds securities for its participants and facilitates the clearance and settlement of securities transactions between participants through electronic book-entry changes in the accounts of its participants, thereby eliminating the physical movement of certificates. Securities which are registered with the SEC are eligible to clear through the facilities of DTC. Investors hold the beneficial interests in securities directly through DTC if they are participants, or through their accounts with participants such as securities firms, banks and other institutions. The European clearing agencies Euroclear and Clearstream also participate in DTC through their nominees.
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Consequences of registration
As a result of registering securities in the United States, issuers will become subject to a number of requirements under US law. Sarbanes-Oxley Act of 2002 The Sarbanes-Oxley Act of 2002 imposes significant requirements on US-listed issuers relating to corporate governance, composition of board and audit committees, internal financial control reviews and financial statement certification requirements. The Act also creates specific ethics-based requirements for issuers, including a prohibition on personal loans from the issuer to executives. Under the Sarbanes-Oxley Act, an issuer that has a class of securities registered under Section 12 of the Exchange Act must maintain controls and procedures that are designed to ensure that information required to be disclosed by the issuer under the Exchange Act is recorded, processed, summarised and reported within the time periods specified in the SECs rules and forms. The required controls and procedures include procedures designed to ensure that such information is accumulated and communicated to the issuers management as appropriate to allow timely decisions regarding required disclosure. The SEC encourages creation of a disclosure committee to ensure that methods of gathering, analysing and disclosing all information about the issuer are as comprehensive as the methods used for disclosing financial information. Pursuant to Section 404 of the Sarbanes-Oxley Act, the principal executive officer and principal financial officer of an issuer are required to publish information in their annual periodic reports to the SEC concerning the scope and adequacy of the internal financial control structure and procedures for financial reporting. This management report is also required to assess the effectiveness of such internal financial controls and procedures. Section 404 further requires a registered accounting firm provide an auditors attestation to and report on the assessment on the effectiveness of the internal financial control structure and procedures for financial reporting of the company. This financial controls auditor attestation requirement has imposed significant compliance costs upon issuers listing on US securities exchanges. The SEC recognised non-US issuers resistance to these compliance costs by announcing on August 9, 2006 that it had approved extending the Sarbanes-Oxley Section 404 auditor attestation compliance deadline for certain foreign private issuers by one year, and that it proposed extending the Section 404 management report and auditor attestation for certain other foreign private issuers, in terms of the fiscal years to which they first relate. The Section 404 auditor attestation and management report compliance deadlines for foreign private issuers that are large accelerated filers (ie, seasoned issuers with a public float of at least US$700 million) was proposed to remain unchanged (first applying to fiscal years ending on or after July 15, 2006). However, the SEC approved extending the Section 404 auditor attestation compliance deadline for foreign private issuer accelerated filers that are not large accelerated filers from fiscal years ending on or after July 15, 2006 to fiscal years ending on or after July 15, 2007. The SEC also proposed extending (subject to public comment) the Section 404 auditor attestation compliance deadline for foreign private issuers that are not accelerated filers from fiscal years ending on or after July 15, 2007 to fiscal years ending on or after July 15, 2008 and the Section 404 management report deadline for such filers from July 15, 2007 to December 15, 2007.
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Periodic Reporting under the Securities Exchange Act of 1934 Section 12 of the Securities Exchange Act of 1934 (the Exchange Act) requires any non-US private issuer with more than $10 million in assets worldwide and more than 500 global securities holders (of which 300 or more are US residents) to register as a reporting company under the Exchange Act, or seek an exemption from registration. Registration under the Exchange Act is also required before a class of debt or equity security can be listed on any US stock exchange. Registration under the Exchange Act invokes its periodic reporting requirements, which for foreign issuers include the filing of an annual report with the SEC, known as a Form 20-F, which is roughly similar to the initial registration statement in content. The Exchange Acts periodic reporting requirements apply to all non-US private issuers that have either registered securities under the Exchange Act or registered a public offering under the Securities Act. A non-US private issuer subject to these requirements must submit an annual report on Form 20-F and interim reports on Form 6-K. Form 20-F Form 20-F must be filed annually, within six months of the end of the reporting companys fiscal year. The information required to be disclosed is similar to that provided in the registration statement and is intended to provide the SEC and the public with annual updates of the information that was provided during the initial offering. The Sarbanes-Oxley Act requires that Form 20-F be accompanied by two written statements, each signed by the chief executive officer and the chief financial officer certifying that the CEO or CFO has reviewed the disclosure, and that in the view of the officer the information is not misleading, that it fairly presents the condition of the issuer in all material respects, and that the report complies with the Exchange Act. The certification must also include statements with respect to the quality and the effectiveness of an issuers disclosure controls and procedures. A CEO or CFO who knowingly or wilfully certifies a report that does not meet the requirements of the Exchange Act faces fines and/or imprisonment. Form 6-K Form 6-K requires information to be filed with the SEC and any stock exchange on which the issuers securities are listed if such information is (i) required to be made public pursuant to the law of the issuers country of domicile or incorporation, (ii) filed with a non-US stock exchange and made public by such exchange, or (iii) distributed to the security holders of the issuer. Information meeting one of the above tests is only required to be disclosed on Form 6-K if it is material to the issuers business. Ownership reporting requirements under the Securities Exchange Act of 1934 Sections 13(d) and 13(g) require persons acquiring more than 5% of any class of voting securities registered under Section 12 of the Exchange Act to file reports with the SEC. Schedule 13D, if applicable, must be filed within 10 days of a person crossing the 5% threshold. The acquirer must disclose, among other things, its identity, the source of the funds used to acquire the securities and the purpose of the acquisition (including any plans for future purchases). A prompt amendment of the schedule must be filed if there is a material change to the information disclosed on the form. Persons that acquired their securities prior to the issuer becoming a reporting company and certain institutional investors that acquire securities in the ordinary course of business and do not change or influence control of the issuer may qualify to file a short form report on Schedule
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13G. Schedule 13G must be filed within 45 days of the end of the calendar year in which the acquisition occurred. If the acquirers level of ownership falls below 5% prior to the deadline, no filing is necessary. In addition to the more favourable filing deadlines of Schedule 13G, less information is required to be disclosed. National Exchanges and Automated Quotation Services Rules US National Exchanges, such as the NYSE and the American Stock Exchange (the Amex) and NASDAQ (to date the only automated quotation service in the US) impose certain notice and reporting obligations as well as certain listing standards which are discussed in greater detail below. NASD Rules The rules of the NASD will apply to the underwriters involved in a registered offering. Primarily, the rules focus on the fairness of the underwriting compensation. The SEC will not declare a registration statement effective until it receives from the NASD a letter which states that it does not object to the compensation arrangements. Offerings of investment grade debt securities are exempt from the NASD fair compensation rules. The Foreign Corrupt Practices Act The Foreign Corrupt Practices Act contains two important requirements for issuers that have registered securities under the Exchange Act or the Securities Act. The first prohibits the bribery of foreign officials. Issuers may not use means or instrumentality of interstate commerce corruptly in furtherance of improper payments to foreign political parties or officials for the purpose of influencing any act or decision in order to obtain business. The second requirement is that issuers maintain their accounts in a way that will deter bribery. Issuers must (i) keep books, records, and accounts that accurately reflect the transactions and assets of the issuer and (ii) maintain an adequate system of internal accounting controls. Violations of either requirement of the Foreign Corrupt Practices Act can result in criminal fines and/or imprisonment. Also, the SEC may bring civil suit against issuers or individuals that can result in additional fines. If civil or criminal fines are imposed on individuals, they may not be paid by the issuer directly or indirectly. Regulation M: anti-manipulation rules With regards to US-listed securities, the rules under Regulation M generally prohibit participants in the offering from purchasing, or attempting to induce any person to purchase, the securities offered in the market for a certain period. There are exceptions to these rules for ordinary course transactions, actively traded securities and certain stabilisation activities by the underwriters. NYSE and NASDAQ requirements The ongoing requirements of NASDAQ and NYSE are similar to those of the Exchange Act but are in some ways more demanding. In addition, new SEC rules formulated under the Sarbanes-Oxley Act reforms direct national securities exchanges and associations such as NASDAQ to prohibit the listing of any security of an issuer that does not have an audit committee composed entirely of independent directors. Moreover, issuers with an audit committee must disclose whether or not their audit committee has at least one member who fits the SECs criteria of a financial expert and, if not, why. The audit committee is responsible for the appointment, compensation, and oversight of the auditor, for establishing complaint procedures, and for resolving disagreements between the auditor and management.
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NYSE requirements The NYSE requires issuers to provide security holders annual reports within three months of the close of their fiscal year and at least 15 days in advance of their annual meeting. Quarterly reports must be provided as soon as they become available. Non-US issuers may be able to obtain waivers of these requirements. Issuers are also required to promptly release information that could materially affect the market for their securities. Material negotiations do not need to be disclosed so long as discussions are limited to members of top management and their confidential advisors. Once it becomes necessary to involve outsiders, however, public disclosure must be made. Issuers must provide prompt written notice to the NYSE upon the occurrence of certain events. These events include changes to the charter or by-laws, a change of auditors, changes in directors or officers, increases in the outstanding amount of securities and other changes affecting the issuers securities. NASDAQ requirements The disclosure requirements are similar to those of NYSE. Issuers must (i) file annual reports, (ii) provide NASDAQ with any information filed with the SEC on Form 6-K, and (iii) disclose any information that could materially affect the value of their securities.
Liability issues
Various potential legal liabilities exist for issuers failing to comply with the registration requirement under the US securities laws. Section 12(a)(1) In terms of the consequences of a failure to register, Section 12(a)(1) of the Securities Act creates a private cause of action for purchasers of securities that were required to be registered under the registration requirement of Section 5 of the Securities Act but were not registered by the seller. Purchasers may bring civil suits against the seller to have the sale rescinded. Recovery is limited to the purchase price plus interest (less any income received on the security) but this may be a significant amount for purchasers if the share value has fallen from its initial offering price. Section 20 Section 20 of the Securities Act empowers the SEC to bring an action in a United States district court when it discovers a violation of the registration requirements. The SEC may seek the disgorgement of any profits resulting from the prohibited acts and the imposition of a fine. If the violation was wilful, criminal proceedings may be instituted. Section 10(b) and Rule 10(b)(5) The antifraud provisions of the Exchange Act are contained in Section 10(b) and its accompanying Rule 10b-5, both for the SEC and for private litigants. Section 10(b) and Rule 10b-5 are broadly written: Section 10(b) proscribes the use of any manipulative or deceptive device or contrivance in connection with the purchase or sale of any security, and Rule 10b-5 specifies three categories of conduct that qualify as violations. These are (i) employing any device, scheme, or artifice to defraud, (ii) making any untrue statement of material fact or failing to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, and (iii) engaging in any act, practice, or course of business which operates as a fraud or deceit. US courts have
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long held that buyers or sellers of securities have an implied right to recover damages based on violations of Section 10(b) and Rule 10b-5. Information is deemed material for these purposes if there is a substantial likelihood that a reasonable investor would consider it important in deciding whether to purchase or sell securities. In a private right of action the plaintiff must show that the defendant acted with scienter, that is, some intent to defraud or manipulate. Courts have ruled that recklessness also constitutes scienter, but mere negligence will not suffice. The remedies for violations of Rule 10b-5 differ depending on whether the action was initiated by the SEC or by a private litigant (or group of private litigants). The SEC has a number of remedies under Section 10(b) and Rule 10b-5, including: injunctive relief, prohibiting (permanently or temporarily) any person who has violated these provisions from acting as an officer or director of any public company, civil penalties and referral to the Department of Justice, which may seek criminal sanctions for wilful violations of the anti-fraud provisions of the Exchange Act. A private person can recover their out-of-pocket loss, which is generally the difference between the price paid for the security and the true value of the securities, which will normally be deemed to be the market price of the security at the time of the suit. The plaintiff may also seek to rescind the transaction and return the securities to the defendant in exchange for the money originally paid by the plaintiff. Section 11 Section 11 of the Securities Act applies when a registration statement contains a material misstatement or omission. Purchasers, whether they bought the security in the initial offering or the secondary market, may bring civil suits to recover monetary damages. The issuer, underwriters, signers of the registration statement, directors, accountants and others are all potential defendants. Section 12(a)(2) Under the civil liability provisions of Section 12(a)(2) of the Securities Act, liability attaches to any person who offers or sells a security, by the use of any means or instruments of transportation or communications in [US] interstate commerce or of the [US] mails, by means of a prospectus or oral communication, which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements, in the light of the circumstances under which they were made, not misleading...and who shall not sustain the burden of proof that he did not know and in the exercise of reasonable care could not have known, of such untruth or omission. Section 15 Under Section 15 of the Securities Act, liability may be extended to any person who controls any person liable under Sections 11 or 12, as described above. Under the Securities Act control is defined in terms of the power to, directly or indirectly, direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise. There is an exception for controlling persons if the person had no knowledge of or reasonable ground to believe in the existence of the facts by reason of which the liability of the controlled person is alleged to exist. Section 20(a) of the Exchange
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Act imposes similar liability on persons who directly or indirectly control any person who has violated any provision of the Exchange Act. An exception is available to a controlling person who can demonstrate good faith and a lack of positive action to encourage the violation. Section 18 Under Section 18 of the Exchange Act, filers of Exchange Act reports (such as Form 20-F) are potentially liable for material misstatements and omissions contained in their filings. A purchaser or seller of securities who acted in reliance on the misstatement or omission may bring suit against any person responsible for the misleading statements. Plaintiffs must demonstrate that they actually relied on the misleading information. The defendant can avoid liability by showing that he acted in good faith and had no knowledge of the misstatement or omission.
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32. Hong Kong and Shanghai dual listings

Whilst there are now a significant number of companies with dual Hong Kong (H share) and Shanghai (A share) listings, simultaneous H and A share offerings are a recent phenomenon.
A consequence of current regulatory restrictions in the PRC on the investment by PRC persons in H shares and by non-PRC persons in A shares (with certain exceptions such as the PRC Social Security Fund and Qualified Domestic Institutional Investors for H shares and PRC Qualified Foreign Institutional Investors for A shares) is that H and A shares are not fungible. For so long as A and H shares are not fungible it is likely that simultaneous H and A share offerings will be conducted as independent offerings. However, even if they are structured as independent and not mutually conditional offerings, the conduct of A and H share offerings simultaneously by the same issuer will almost certainly result in their being mutually material to the other. This will impact upon the disclosure in the respective offering documents as well as the regulator vetting and offering timetables.
Relevant listing rules

LR 8.08(1)(a) requires companies to have a public float of at least 25% of their issued share capital. LR 8.08(1)(b) recognises that, where an issuer has more than one class of shares, other than the class for which listing is sought, the public float on all regulated markets, including the Exchange, should be not less than 25%, provided that those listed on the Exchange (the H shares) should not be less than 15%. LR 8.08(1)(d) states the Exchange may, at its discretion allow a public float of between 15% to 25%, where the market capitalisation of the issuer is expected to be over HK$10 billion at the time of listing. For dual A and H offerings, this means that for issuers with a total market capitalisation of less than HK$10 billion, if the H shares in public hands represent less than 25%, in the absence of a waiver from the Exchange (which may be very difficult to procure) a 25% public float will need to be satisfied by a combination of A and H shares, provided that H shares representing at least 15% are held in public hands, and the H share offering will effectively be conditional upon the A share offering. Where the issuer is expected to have a capitalisation in excess of HK$10 billion upon listing, the exercise of the Exchanges discretion may be sought under LR 8.08(1)(d) if it is intended that the number of H shares to be issued would result in a public float of less than 25% in Hong Kong. In any event, the public float should not be less than 15%. LR 19A.42 where a PRC issuers share issue plan approved in an inaugural meeting of its shareholders includes an initial placing or issue of securities other than the H shares, simultaneously with the H shares for which listing is sought on the Exchange, LR 19A.42 supplements the information to be disclosed in the H share prospectus under Part A of Appendix 1 of the Listing Rules. The supplemental information required to be disclosed includes information concerning the securities other than the H shares, the issue timetable and intended use of proceeds of such other issue and the exchange on which listing is sought for the securities to be issued. In addition a statement is required as to whether or not the H share issue is conditional on the other issue of securities and, among other things, the description of the effect on the PRC issuers future plans, prospects and financial condition if such other issue does not proceed as described.
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Offering timing and disclosure

Other than as prescribed by LR 19A.42, given that the offering documents for each of the H and A share offerings will relate to the same issuer with the same underlying assets, each prospectus should contain the same material information. However, differences may arise through disclosure arising from regulatory requirements that are specific to a particular market or regulatory regime and not otherwise material to investors as a whole. This may mean, for example, that the A share and H share prospectuses may differ in the description of connected transactions owing to different definitions of connected person under relevant A share and H share listing regimes. As well as the likely materiality of one offering on the other with regard to disclosure, the coordination of the vetting and offering timetables are important so that pre-marketing and marketing and the actual public offerings can be conducted not only in a manner that is mutually complimentary but also that does not infringe upon the securities laws and regulations of the other jurisdiction. For example, the practice in A share offerings of the early publication by way of posting on the CSRC website of an advanced (pre-disclosure) proof of the A share prospectus before the A share listing hearing and the final prospectus shortly afterwards as well as prescribed A share announcements is alien to the Hong Kong practice which does not typically see any publication of the H share offering document, either in advanced or in final form in the absence of registration. This practice is likely to change with further A and H simultaneous offerings in future and if the proposal of the SFC to require a red-herring prospectus to be made available becomes a regulatory requirement.
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33. Post IPO restrictions on shareholders and company

Controlling shareholders (being persons who together control 30% or more of the shares of the issuer) must not dispose of any interest in their shares in the six months after listing nor dispose of any shares in the subsequent six months if it would result in the person ceasing to be a controlling shareholder. In addition, the issuer cannot issue any new shares in the six months after its listing. Controlling shareholders
LR 10.07 provides that in the six months following listing the controlling shareholders cannot dispose of or enter into any agreement to dispose of, or otherwise create any options, rights, interests or encumbrances in respect of its shares. Furthermore, in the period from six months to twelve months after listing commences, the controlling shareholders shall not dispose of any shares or any interest therein if as a result thereof that person would cease to be a controlling shareholder.
No issues of new shares for six months

LR 10.08 provides that an issuer may not issue, or enter into any agreement to issue, any shares or securities convertible into shares within six months of listing except for: issues under an approved share option scheme; conversion of warrants offered as part of the IPO; any capitalisation issue, capital reduction, consolidation of sub-division of shares; or the issue of shares under an agreement entered into before listing and disclosed in the prospectus.
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Hong Kong IPO Guide

Herbert Smith HK IPO Guide

Ashley Alder Head of Asia

Herbert Smith HK IPO Guide

Herbert Smith 2006

Herbert Smith HK IPO Guide

Specific Listing Issues

Liability and Due Diligence

Underwriting and marketing

Post- IPO Matters

Herbert Smith HK IPO Guide

1. Offers of securities is a prospectus required?

Herbert Smith HK IPO Guide

Herbert Smith HK IPO Guide

Offer document content

Herbert Smith HK IPO Guide

2. Who can offer securities

Herbert Smith HK IPO Guide

3. Main Board and GEM key listing criteria

GEM listing criteria

Herbert Smith HK IPO Guide

Assets and contractual rights

Herbert Smith HK IPO Guide

Intellectual property rights

IPO reorganisation steps

Herbert Smith HK IPO Guide

5. Strategic investors and pre-IPO placings

Offer price and lock-up undertakings

Herbert Smith HK IPO Guide

Offer price for IPO investments

Limitations for PRC companies

Herbert Smith HK IPO Guide

IPO clawback provisions

Disclosure of investment in prospectus

Herbert Smith HK IPO Guide

Level of information to investors

US securities law considerations

Herbert Smith HK IPO Guide

Timing of disclosure to exchange

Disclosure of interests under SFO

Takeovers Code implications

Herbert Smith HK IPO Guide

Herbert Smith HK IPO Guide

Herbert Smith HK IPO Guide

Securities and Futures Ordinance

Herbert Smith HK IPO Guide

Herbert Smith HK IPO Guide

Herbert Smith HK IPO Guide

7. Due diligence and verification process

Due diligence defence

Herbert Smith HK IPO Guide

Due diligence guidelines

Conducting due diligence

Documentary due diligence

Herbert Smith HK IPO Guide

Discussions with management and accountants

Drafting of offering document

Herbert Smith HK IPO Guide

Herbert Smith HK IPO Guide

8. Comfort letters and US legal opinions

SAS 72 comfort letter

Herbert Smith HK IPO Guide

Agreed-upon procedures comfort letter