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Hong Kong Securities and Futures Commission Adds a Continual Monitoring Requirement for Due Diligence of Initial Public Offerings

With this expected growth of public offerings, regulators have offered new due diligence guidance for IPO listings. In March of this year the Hong Kong Securities and Futures Commission (“SFC”) updated the due diligence requirements for IPOs to highlight a sponsor’s regulatory obligations in the listing process. In addition, the new requirement will act as another layer of security due to a series of recent compliance failures. For example, several large financial institutions have been cited for failing to conduct adequate inquiries, and generally producing “careless work” for IPO diligence.

For current and future offering sponsors in Hong Kong, these types of failures can lead to significant delays in the listing timetable or increased scrutiny of IPO applications and, ultimately, returned or rejected applications. It can also cause a suspension from sponsoring future IPOs for periods of up to 18 months, costing sponsors their current offerings and the chance at future listings. Additionally, the SFC noted that it “will not hesitate to take enforcement action against sponsors and their senior executives responsible for failure to comply with the expected standards in sponsor work.” Given the recent increase in the sponsor population in Hong Kong, which grew from 75

to 107 by the end of 2017, the SFC is concerned that it may see more of these failures from inexperienced sponsors.

Why is Continuous Monitoring Important?

With respect to background and reputational due diligence, the SFC guide notes that sponsors will need to run regular due diligence reports between the completion of initial diligence until the offering is listed. Information changes during this period and it can be caused by various factors: a shift in market conditions, unfavorable performance by a similar listing in the interim, a favorable buyout offer for the listing company, newly filed litigation, or a new regulatory probe. Diligence conducted and reported

Hong Kong is home to one of the world’s largest initial public offering (“IPO”) markets. IPOs have played a crucial role in establishing the city as a leading international financial center, and analysts are expecting a record

number of IPOs this year from companies in mainland China. Ernst and Young has estimated that HK$200 billion ($25.5 billion) in IPO funds to be raised in 2018. This is due to a recent groundbreaking announcement from the Hong Kong Stock Exchange, stating that companies with dual-shareholding structures are now permitted go public in Hong Kong.

1. https://www.cnbc.com/2018/06/20/hong-kong-rising-as-hot-ipo-market.html

2. https://www.cnbc.com/2018/06/26/hong-kong-ipo-markets-to-raise-hk200-billion-this-year-ey.html

3. https://www.bloomberg.com/news/articles/2018-04-24/hong-kong-approves-dual-class-shares-paving-way-for-tech-titans

4. https://www.finews.asia/finance/26586-ubs-hong-kong-ipos-fined-ban

5. http://www.sfc.hk/edistributionWeb/gateway/EN/circular/doc?refNo=18EC23

6. http://www.sfc.hk/edistributionWeb/gateway/EN/circular/doc?refNo=18EC23

Using automated due diligence technology will help [IPO’s] find key items that may occur during

the period between the initial due diligence report and when the offering is filed, keeping all

stakeholders informed of evolving situations on a timely basis.

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1 | Hong Kong's Securities and Futures Commissions

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would naturally be missed by the sponsor if continuous monitoring is not in place after the initial due diligence is completed.

The risk during this period is in an adverse event regarding the company and its stakeholders occurring after the initial vetting. Simple sanctions monitoring will not pick up materially adverse events such as newly filed litigation, negative media regarding the company’s operations, or newly uncovered indications of political exposure. These changes are material in nature and could affect a public listing by requiring new officers, board members, or business considerations. Furthermore, if the SFC determines that these risk items should have reasonably been reported by the issuer prior to the listing, then the threat of shareholder litigation and regulatory fines becomes real. Thus, re-assessing the adequacy of current due diligence practices and carrying out proper due diligence is a fundamental safeguard in the listing process.

Technology is the Key to Monitoring While Maintaining Efficiencies and Robust Audit Trails

Conducting continuous monitoring is challenging due to the burdens involved for all stakeholders. For due diligence and compliance firms, compiling this type of information on an indefinite timeline incurs personnel and monetary costs that will ultimately

be passed onto the sponsor or issuer, which in turn will increase the overall cost for filing IPOs. However, technology- enabled research can drastically reduce the overall costs associated with ongoing monitoring, providing increased coverage while keeping costs manageable. By pairing manual due diligence research with an automated tool, individuals and companies can then be monitored on a daily, weekly, or monthly basis for a fraction of the initial cost.

New technology platforms have been able to effectively automate monitoring, searching for changes in not only sanctions status for entities and individuals, but in a wide array of public records in numerous languages. Additionally, continuous monitoring platforms automatically create audit trails for all due diligence conducted, allowing sponsors to denote what type of monitoring occurred and when it was carried out. Without the most recent technological interventions, clear and comprehensive audit trails are both labor and time intensive, yet absolutely necessary for issuers when faced with regulatory inquiries. Technology platforms can automatically generate audit information by displaying the types of searches conducted and the parameters used, providing diligence professionals, sponsors, and regulators clarity and accurate sources for any new information found.

This type of IPO due diligence approach provides the most comprehensive data for sponsors to make the most informed decisions while complying with the SFC’s guidelines and recommendations. At the same time, using automated due diligence technology will help find key items that may occur during the period between the initial due diligence report and when the offering is filed, keeping all stakeholders informed of evolving situations on a timely basis.

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For more information, contact:

New York City | Silver Spring (DC Metro) | Toronto | Vancouver | London | Hong Kong | Singapore

www.exiger.com

Rahul RaviAssociate Research Directorrravi@exiger.com

Margaret LorDirector, Business Developmentmlor@exiger.com

ABOUT EXIGERExiger is a global regulatory and financial crime, risk and compliance company. Exiger arms financial institutions, multinational corporations and governmental agencies with the practical advice and technology solutions they need to prevent compliance breaches, respond to risk, remediate major issues and monitor ongoing business activities. Exiger works with clients worldwide to assist them in effectively managing their critical challenges while developing and implementing the policies, procedures and programs needed to create a sustainable compliance environment. A global authority on regulatory compliance, the company also oversees some of the world's most complex court-appointed and voluntary monitorships. Exiger has four principal business units being: Exiger Advisory; Exiger Diligence; Exiger Government Services; and Exiger Tech, including AI-based automated due diligence solutions DDIQ and Insight 3PM. Exiger operates through offices in London, New York City, Silver Spring (DC Metro), Toronto, Vancouver, Hong Kong, and Singapore.