Jurisdiction - Hong Kong
Hong Kong – New Guidance Letters.

19 Juy, 2012

Use of Proceeds
In April 2012, the Exchange published a guidance letter on the disclosure in prospectuses of the intended use of proceeds by new applicants.
1. Proceeds for general working capital
  • If an applicant has no current or specific plans for the use of a material portion (generally 10% or more) of the proceeds, the prospectus must include a statement to that effect and discuss the principal reasons for the offering.
  • “Working capital” or “general corporate purposes” do not constitute current or specific plans for the proceeds, unless there is a reasonably detailed explanation. 


Case 1: Allocation of all net proceeds as “working capital” was acceptable, as the applicant provided a detailed explanation that the proceeds were to be used to increase its capital base in order to enable it to meet certain statutory capital requirements for business expansion.
Case 2: Allocation of 25% of net proceeds as “working capital” for expansion of sales/operations teams required a clear explanation. 
2. Proceeds for acquisition of properties from connected persons or associates
An applicant must disclose the basis for determining the cost of the acquisitions.
3. Proceeds for acquisition of businesses 
  • An applicant must disclose the identity of the businesses, terms of the proposed acquisition and identity of the parties; or
  • If not yet identified, an applicant must disclose the nature and a brief description of the business types, acquisition strategy and status of negotiations.
4. Proceeds for discharge of indebtedness
  • An applicant must disclose the interest rate and maturity of debt.
  • If debt was incurred within one year before the A1 application, the listing applicant must disclose how the borrowing was used (unless it was for working capital). 
5. Disclosure in prospectus
  • Details of proposed capital expenditures normally would be included in different prospectus sections, e.g., “Financial Information”. 
  • If any material amounts of other funds are necessary for the specified purposes for which the proceeds are to be used, the listing applicant must disclose the amounts of those other funds needed for each specified purpose and the source of funding. 
6. order of priority of the proceeds 
  • An applicant must disclose the intended order of priority of use in the “Use of Proceeds” section if the amount to be raised is variable (e.g., over-allotment option, price range).
7. Change of use of proceeds
  • Any material change of use is generally price sensitive if not previously disclosed in the prospectus. 
  • An applicant may change the use due to contingencies if these are discussed specifically and alternatives clearly described in the prospectus.
For a copy of the Guidance Letter GL33-12, please follow the link: http://www.hkex.com.hk/eng/rulesreg/listrules/listguid/Documents/gl33-12.pdf.
Hard underwriting 
In April 2012, the Exchange published a guidance letter on the disclosure requirements in relation to hard underwriting. (See chart below).
Differences between Soft and Hard underwriting 
Soft underwriting Hard underwriting
• Underwriters are entitled to terminate the underwriting 
agreements with immediate effect if any stipulated events 
occur prior to 8:00 am on the listing date.
• Underwriters are committed to purchase a fixed value of 
shares not taken up on the condition that the offer price is fixed 
at the low end of the price range;
• Extra fees are payable, in addition to the normal soft 
underwriting fees; and
• Usually occurs when the demand for offer shares is expected 
not to be strong.
Disclosure requirements in relation to hard underwriting
Where a hard underwriting agreement is entered into before the issue of the prospectus, disclosure of the salient terms of the agreement should be made in the prospectus applying the principles of Rule 2.13(2) (i.e., disclosure of all material information).  In general, the disclosure should include:
  • the date of the hard underwriting agreement;
  • the amount underwritten;
  • any conditions;
  • the grounds for termination; and
  • the fees.
If the hard underwriting agreement is entered into after the issue of the 
prospectus, the issuer is required to issue a supplemental prospectus to disclose the above information to the public. 
For a copy of the Guidance Letter GL34-12, please follow the link:
Profit Forecasts
In May 2012, the Exchange published a guidance letter to clarify the following:
  1. the difference between a profit forecast and a profit estimate; 
  2.  when applicants need to include a profit forecast or a profit estimate in a listing document; and 
  3. the need to submit a profit forecast memorandum despite the repeal of Rule 8.21B. 
Difference between profit forecast andprofit estimate
  • A profit forecast means any forecast of profits or losses, whereas a profit estimate is an estimate of profits or losses for a financial period which has ended but for which the results have not yet been audited or published. 
  • Rule 11.07 requires the principal assumptions on which a profit forecast is based to be stated in a listing document. However, the requirement to state assumptions is not applicable to a profit estimate as a profit estimate is related to a financial period which has already ended. 
When to include a profit forecast or a profit estimate in a listing document
  • Inclusion of a profit forecost or profit estimate in a listing document is purely voluntary. 
  • However, where a Rule 4.04(1) waiver is applied for, a profit estimate is required (see GL25-11).
Requirement to submit profit and cash flow forecast memorandum
  • Rule 9.11(10) requires the submission of the profit and cash flow forecast memorandum to the Exchange to demonstrate an applicant’s sustainability. This remains a requirement despite the repeal of Rule 8.21B. 
Differences between Rules 9.11(10)(a) and 9.11(10)(b) 
Rule 9.11(10)(a): prospectus contains a profit forecast
  • The profit forecast memorandum should cover the same period of the profit forecast, and the cash flow forecast memorandum should cover at least 12 months from the expected date of publication of the listing.document with principal assumptions, accounting policies and calculations.
Rule 9.11(10)(b): prospectus does not contain a profit forecast
  • The profit forecast memorandum should cover the period up to the forthcoming financial year-end date after the date of listing, and the cash flow forecast memorandum should cover at least 12 months from the expected date of publication of the listing document with principal assumptions, accounting policies and calculations.
For a copy of the Guidance Letter GL35-12, please follow the link:
Distributorship business Model
In May 2012, the Exchange issued a guidance letter on the distributorship business model, setting out various areas of concern and how disclosure should be 
made in the prospectus.
1. Inventory risk remains with applicant
A sharp increase in sales during the track record period may indicate a risk that these are artificially pumped-up sales unsustainable by an actual rise in demand from ultimate end-users. Similarly, a minimum purchase condition in the applicant’s distribution agreement with its distributors may be translated into a risk of inventory accumulation.
The presence of one or more of features may require delay in revenue recognition: 
  • the applicant retains significant risks of ownership, although legal title has been passed to the distributors;
  • sales to distributors on a “right of return” basis and payment is delayed or otherwise different from typical sales agreements;
  • the applicant is required to repurchase the product at a price with adjustment that covers the distributor’s cost of holding the product, including financing cost; and 
  • the applicant guarantees a minimum resale value.


The sponsors and the reporting accountants must reasonably believe that the revenue recognition is appropriate in the applicant’s case. When making the assessment, the returned goods policy and the amount of returned goods must be examined.

2. Cannibalization
Profits arising from royalty payments from distributors may not be sustainable if there are too many distributors in the market.
Accordingly, the sponsors must reasonably believe that the applicant’s revenue is not the result of cannibalization among distributors (which is often associated with a high turnover of distributors, each of which makes a royalty payment on establishment). The turnover of distributors during the track record period, including the reasons for their termination or replacement, must be carefully assessed and stated in the listing document to enable investors to appreciate the sustainability of the business.
3. Recoverability of accounts receivable
If there has been a persistent increase in accounts receivable and debtors’ turnover days in the track record period, the directors and the sponsors are required to provide their views on whether the applicant’s credit management policy is appropriate and the provisions for trade receivables are adequate. 
Disclosure in the prospectus should include:
  • a commentary on the recoverability of accounts receivable and the subsequent settlement of the balance as at the latest practicable date; and
  • the impact of the increase in accounts receivable and debtors’ turnover days on liquidity and cash flow. 
4. Independence of distributors 
Goods may be sold to (i) distributors or sales representatives who were previously employees of the applicant or (ii) sales partners who trade under the applicant’s name. This gives rise to uncertainty as to the independence of customers and the authenticity of sales. 
In one case, the applicant distributed its products either directly through its own sales representatives who were part-time employees or indirectly through its sales partners that were corporate entities using the applicant’s name in their trading. Some of the applicant’s sales representatives or their associates also held equity interests in the sales partners.  The Exchange suggested that the applicant should clearly delineate its sales between the sales representatives and the sales partners. 
Additional disclosures were required, including:
  • the terms of the agreement with the sales partners, including conditions of use of the applicant’s name;
  • measures to address the potential conflict of interests between the sales representatives and the sales partners; 
  • internal controls and corporate governance measures to monitor the applicant’s sales activities to detect potential abuses; and management of the sales partners using the applicant’s trading name and the associated risks to the applicant’s overall business from improper use of the applicant’s name by the sales partners.
5. general disclosure in prospectus
The Exchange expects sponsors to have performed sufficient due diligence work in relation to the fairness and reasonableness of sales to distributors recorded during the track record period and to disclose the following in the prospectus:
  • distribution channels and their total revenue contribution;
  • the degree of control over distributors (especially pricing policy, sales and avoidance of competition between different levels of distributors);
  • the benefits of using the particular distributorship model and whether it is an industry norm;
  • the nature of the relationship with the distributors (seller/buyer or principal/agent);
  • the turnover rate of distributors and movements in the number of distributors and reasons for the major changes; 
  • the amounts of sales to and goods returned from distributors;
  • a discussion of revenue recognition and unsold goods return policies; and
  • the principal terms of the distribution/consignment/franchise agreements. 
For a copy of the Guidance Letter GL36-12, please follow the link:
Indebtedness, Liquidity, Financial Resources and Capital Structure Disclosure
In June 2012, the Exchange issued a guidance letter to assist new applicants and their advisers to prepare certain liquidity disclosures, such as the statement of sufficiency of working capital and certain information, including a commentary regarding a new applicant’s indebtedness, liquidity, financial resources and capital structure. This supersedes previous guidance letters and has taken into account the current practices adopted by the Exchange. 


A new listing applicant is ordinarily expected to disclose the following in its 
listing document:
  • net current assets (liabilities) position of the applicant stating the composite assets and liabilities as at the most recent practicable date, and a management discussion on the position; 
  • an analysis and explanation of the sources and uses of cash and an analysis of the material changes in the underlying drivers; 
  • an analysis and information on factors that would have a material impact on the new listing applicant’s liquidity; 
  • a discussion and an analysis of any external financing plans (or a negative statement) and their impact on the new listing applicant’s cash position and liquidity; 
  • a discussion and an analysis of material covenants (or a negative statement)related to outstanding debt and the impact of debt covenants on the new listing applicant’s ability to undertake additional debt or equity financing; and 
  • any other information on the new listing applicant’s indebtedness, liquidity, financial resources and capital structure that would be material to an investor to make a properly informed assessment of the financial position and prospects of the new listing applicant. 
For a copy of the Guidance Letter GL37-12, please follow the link: http://www.hkex.com.hk/eng/rulesreg/listrules/listguid/Documents/gl37-12.pdf.
Latest Practicable Date and Latest Date for Liquidity Disclosure
(Paragraph 32 of Part A of Appendix 1 requires the listing document to include a statement as at the most recent practicable date (which must be stated) of the new applicant’s indebtedness (or an appropriate negative statement), liquidity, financial resources and capital structure, if material (Liquidity Disclosure).
In June 2012, the Exchange published a guidance letter on the latest practicable date for ascertaining information in a prospectus and the latest date for liquidity disclosure in a prospectus. (Please see the chart below.)
Latest practicable date No more than 10 days before the prospectus date
Latest date for the Liquidity Disclosure No more than two months before the  prospectus date
Confirmation of no adverse change in the “Summary” and “Financial Information” 
Up to the date of the prospectus (previously, up to latest practicable date)
For a copy of the Guidance Letter GL38-12, please follow the link:



For further information, please contact:
Venantius Tan, Partner, Morrison & Foerster


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