A RESPONSE FROM LINKLATERS AND FRESHFIELDS BRUCKHAUS DERINGER ON BEHALF OF 12 FINANCIAL INSTITUTIONS

Dated 31 August 2005 CONSULTATION PAPER ON THE REGULATION OF SPONSORS AND COMPLIANCE ADVISERS A RESPONSE FROM LINKLATERS AND FRESHFIELDS BRUCKHAUS DERINGER ON BEHALF OF 12 FINANCIAL INSTITUTIONS 10th Floor, Alexandra House Chater Road Hong Kong Telephone (852) 2842 4888 Facsimile (852) 2810 8133/2810 1695 Ref Stephen Fletcher/Michelle Carter

1 Introduction 1.1 This is a joint submission by Linklaters and Freshfields Bruckhaus Deringer on behalf of the group of 12 financial institutions listed in paragraph 1.2 below ( Group ) in response to the Consultation Paper on the Regulation of Sponsors and Compliance Advisers ( Consultation Paper ) published by the Securities and Futures Commission ( SFC ) on 29 June 2005. 1.2 The Group comprises: 1.2.1 ABN AMRO Bank N.V.; 1.2.2 Bear Stearns Asia Limited; 1.2.3 BOCI Asia Limited; 1.2.4 Citigroup Global Markets Asia Limited; 1.2.5 Credit Suisse First Boston (Hong Kong) Limited; 1.2.6 Deutsche Bank AG, Hong Kong Branch; 1.2.7 Goldman Sachs (Asia) L.L.C.; 1.2.8 J.P. Morgan Securities (Asia Pacific) Limited; 1.2.9 Merrill Lynch (Asia Pacific) Limited; 1.2.10 Morgan Stanley Dean Witter Asia Limited; 1.2.11 Nomura International (Hong Kong) Limited; 1.2.12 UBS AG. 1.3 Our response is in three parts. Section 2 sets out a summary of our response, and Section 3 sets out our general comments on issues raised by the Consultation Paper and Section 4 our detailed comments on the drafting of the proposed guidance in Annex I to the Consultation Paper. 1.4 If you have any questions in relation to this submission, please contact Stephen Fletcher of Linklaters by telephone at 2901 5350 or by email at stephen.fletcher@linklaters.com, or contact Teresa Ko of Freshfields Bruckhaus Deringer by telephone at 2846 3425 or by email at teresa.ko@freshfields.com. 1

2 Executive Summary 2.1 The Group is generally supportive of the Commission s desire to reinforce the regulatory regime for sponsors and compliance advisers. The Group is grateful for the opportunity to comment on the proposals. 2.2 However, we have a number of concerns: 2.2.1 While the Group agrees that the Hong Kong regime for sponsors needs to be brought up-to-date, the Commission must be very careful to ensure that its standards match but do not exceed international standards. Imposing too great a burden will damage Hong Kong s position as a leading regional financial centre. 2.2.2 We believe that the provisions in the Annex dealing with management responsibility must focus on the particular management who are responsible for a firm s sponsor work, not the all of the management of a firm. 2.2.3 The eligibility criteria for Principals should not be limited to advising Hong Kong listing applicants and listed issuers on Hong Kong requirements; it must expressly take into account relevant experience overseas and general experience in the capital markets. It is not adequate to deal with the latter by saying that the Commission may grant exceptions. 2.2.4 It should not be necessary to have Principals appointed as responsible officers or executive officers of a firm. Doing so confuses and conflicts with the senior management responsibility structures that many of the larger firms adopted to implement the Securities and Futures Ordinance. 2.2.5 We believe that firms should be required to undertake internal assessments of their sponsor systems and controls from time to time, but that this should not be an annual requirement. 2.2.6 The cost of professional indemnity insurance for sponsor work is, we believe, prohibitively high. Requiring firms to take out extensive and expensive cover will damage Hong Kong s competitiveness as a centre for capital-raising. 2.2.7 The Group believes that the eligibility criteria for compliance advisers do not need to be the same as those for sponsors. We would be happy to discuss this with the Commission. 2.3 More generally, we would again note some regret that the Consultation Paper still implicitly suggests that sponsors share an equal amount of responsibility with issuers for listing documentation, disclosures, etc. For example, Paragraphs 5 and 35 of the Consultation Paper suggest that it is sponsors who are responsible for ensuring that the prospectus is accurate and complete. As the Commission knows, we agree that the quality of sponsors work is of great importance to listings and IPOs and therefore to the market and investors. However, as we have previously commented, a sponsor s role is to advise the issuer and to 2

assist it in its listing application and IPO. The role does not and should not extend to taking primary responsibility for inadequate disclosures. 3

3 General issues 3.1 Annex standalone or appendix The Consultation Paper does not explain whether the Commission will publish the Annex as a standalone document, or whether it will be an appendix to, say, the Commission s Corporate Finance Adviser Code of Conduct. We would be grateful if the Commission could explain its intentions in this regard. As we have discussed with the Commission previously, some market participants remain confused as to which of the SFC s codes and guidelines apply to corporate finance advisers in addition to the Corporate Finance Adviser Code of Conduct. To avoid further confusion, we would suggest that the Annex be, at the least, an annex to the Corporate Finance Adviser Code of Conduct. More importantly, we believe that it would be helpful if the Commission considered setting out all of the conduct of business requirements for corporate finance advisers in the Corporate Finance Adviser Code of Conduct itself, rather than having them in different codes and guidelines, as at the moment. We would ask the Commission to consider doing this sooner rather than later. Similarly, at paragraph 44 of the Consultation Paper, the Commission states that the factors set out in paragraphs 45 to 79 of the Consultation Paper will be taken into account when the Commission determines whether a firm is fit and proper to be a sponsor. We would ask the Commission to clarify what it intends by this. In particular, does this mean that firms should look to these paragraphs as being a (formal) part of the fit and proper test in addition to the guidance in the Annex? If this is the Commission s intention, we would like to discuss this further with the Commission, as we are concerned that these paragraphs appear to impose additional obligations which the market may not appreciate or indeed agree with. 3.2 Commission and Exchange co-operation The Group welcomes the Commission s commitment to co-operating with the Exchange in relation to taking enforcement action against sponsors, and to avoiding duplication of regulatory action. However, we would ask the Commission and the Exchange to set out not only how this co-operation/non-duplication will work in practice, but also their overall regulatory approach to pursuing enforcement action. Investors and market participants need to know which regulator will take what action for what problems. 3.3 Transitional arrangements We welcome the Commission s proposal to implement the new requirements 12 months after the issue of the Commission s conclusions. 4 Comments on draft guidance 4.1 Application of Annex The Annex sets out the list of persons to whom the Guidance applies. However, this list not only includes persons who are licensed/registered for Type 6 activities, but also includes persons who are applying to be so licensed/registered. 4

While the initial eligibility criteria must, of course, apply to applicants, we do not believe that the rest of the Guidance need apply to them: until those persons are licensed or registered for Type 6 activity and are eligible to act as sponsors, etc., they should not be acting as sponsors or compliance advisers. In other words, the remainder of the Guidance will not bite anyway until they are licensed/registered and acting as sponsors/compliance advisors. 4.2 Part I, Paragraph 1.1 Sufficient expertise and resources 4.2.1 Paragraph 1.1 sets out various requirements relating to the competence of firms to carry out their sponsor work: 4.2.2 Paragraph 1.1.2 states that a corporate finance firm that conducts sponsor work must have sufficient expertise and resources to carry out such work, and should not undertake work beyond its capacity and expertise. It goes on to state that it is the responsibility of Management to ensure that the firm has relevant expertise and adequate resources to perform its role as a sponsor properly. 4.2.3 We have several comments on this: Although it is implicit in the above, we believe the Commission should make it clearer by explicitly stating that it is for each firm to assess what staff, resources, etc. it needs for the sponsor work it undertakes. This is primarily the firm s responsibility. Of course, it will be the role of relevant senior management to make that assessment for each firm, i.e., the senior managers of the firm s investment banking business in Hong Kong ( HK IBD Management ). They are best placed to make the assessment as to what staffing, resources, etc. are appropriate and adequate. They know their businesses, they know the Hong Kong markets and they know the capabilities of their staff. However, the Guidance seems to envisage that a wider group of persons should take responsibility for this, since the definition of Management includes the relevant firm s Board of Directors, managing director, Chief Executive Officer, RO or other senior management personnel. We believe that this has some unintended consequences and is not wholly appropriate (a) Where the relevant firm is a branch of a global financial institution (as is often the case), this would suggest that the directors, CEO, etc. of that global institution have to take regulatory responsibility for the resourcing of the Hong Kong business. For a global financial institution, the board of directors and the CEO are typically located overseas and delegate the management of local offices to the respective country heads. While such a firm would have internal controls and reporting systems in place so that its global, senior management can monitor and control the firm s international operations, we trust that the Commission did not intend to lay responsibility for compliance with the detailed 5

requirements in the Annex on them. Further, for the reasons set out in (b) below, we do not believe that it would even be appropriate to lay such responsibility on the senior management of the local Hong Kong branch (e.g. the Hong Kong country head). (b) Within a multi-service firm, we believe that regulatory responsibility for the resourcing of each business unit has to be borne by the senior management of that business unit in Hong Kong: as noted above, they are the persons best placed to make the assessment as to what resources are appropriate and adequate, and they should take responsibility accordingly. In the current circumstances, this means that the HK IBD Management should take responsibility. For example, we do not believe it fair to impose potential regulatory liability on, say, the senior managers of a firm s research department for the resourcing failures made by their colleagues responsible for sponsor work. Unlike the HK IBD Management, the managers of the research department are unlikely to be well placed to make decisions as to what resources would be appropriate and adequate for the firm s sponsor activities - they are not actively engaged in those activities. Moreover, they will rarely be in a position to make decisions about or even to influence decisions about resourcing. Indeed, in some cases, there may be regulatory limitations on their involvement, e.g. to avoid allegations of conflicts of interest as between a firm s investment banking and research divisions. We do not believe that the Commission intended this unfairness either and indeed the Commission s own Code of Conduct suggests that it would not (see paragraph 1.3). Accordingly, we submit that it is the HK IBD Management who should take primary management responsibility under, and be the relevant Management for the purposes of, the Annex. (c) (d) The points made in paragraph (b) above apply regardless of (i) whether the relevant managers are company directors, ROs, the CEO, etc. or not, and (ii) whether the investment banking business unit is housed within a Hong Kong branch of a global financial institution (as referred to in paragraph (a) above), or is (part of) a Hong Kong incorporated entity (as referred to in paragraph (d) below). We do recognise that the position of the directors of a Hong Kong incorporated company is perhaps slightly more complicated. As the Commission is aware, international firms which operate their businesses in Hong Kong through a 6

locally incorporated entity, often (but not always) appoint the senior managers/heads of each of the local business units to the local company s board of directors. The board then effectively delegates responsibility for the day-to-day management of the different business units to the respective directors (not in their capacity as directors, but in their capacity as heads, etc. of their respective units). Of course, this delegation may also be to non-directors. While the board would, of course, legally retain control, it would generally defer to the judgement of the relevant business unit management as to resourcing issues for the same reasons as stated in paragraph (b) above. Please note that we are not suggesting that the board should not take responsibility for its role but its role is essentially as part of the firm s corporate governance structure, not one of day-to-day oversight and supervision of the running of particular business units. In this regard, the role of the board is similar to the role of the local senior management of a Hong Kong branch of a global institution. We strongly believe that there should be clarity about which individuals are and are not responsible for resourcing sponsor work. This focuses the attention of those who are responsible and is fair to those who are not. Accordingly, in the first place, we would suggest that responsibility for proper resourcing of a firm s sponsor activities be given to HK IBD Management. Accordingly, we suggest that footnote 3 to Paragraph 1.1.2 be amended to read: Management means the firm s management personnel who are directly responsible for the supervision of the firm s day-to-day sponsor activities. To the extent that there are other more senior local management or a local board of directors, we would suggest that their responsibility should be for ensuring that the delegation of the running of the sponsor activities to HK IBD Management is and continues to be proper. Clearly, such senior management should be responsible for oversight and monitoring of this, but not for the day-to-day role of managing the resourcing of teams. 4.2.4 The comments above also apply in relation to the responsibilities imposed on Management in paragraphs 1.1.3, 1.1.4(i) and 1.1.5. Paragraph 1.1.3 requires Management to appoint a transaction team when the firm is appointed as a sponsor. Under Paragraph 1.1.4(i), both Management and Principals need to be satisfied that the staff working in one transaction team can also work as part of another transaction team on another transaction. Paragraph 1.1.5 imposes on Management the responsibility to ensure the firm has sufficient staff for the entire period that a firm acts as sponsor. 7

In the case of Paragraphs 1.1.3 and 1.1.4(i), we believe that responsibility need only be imposed on the relevant Principals. In relation to Paragraph 1.1.5, responsibility should be borne by the HK IBD Management. 4.2.5 We would also ask the Commission to clarify that the transaction team s responsibility under Paragraph 1.1.3 is to have adequate legal/regulatory support to ensure that it has sufficient Hong Kong regulatory knowledge. 4.3 Part I, Paragraph 1.2 Management s responsibility 4.3.1 Paragraph 1.2 continues the focus on management responsibility for sponsor work. 4.3.2 Our comments in Section 4.2 above also apply in relation to Paragraphs 1.2.4 and 1.2.5. 4.3.3 We would also suggest that Paragraph 1.2.5 be merged with Paragraph 1.1.3 which seems to cover exactly the same issue, i.e., the appointment of a transaction team for each sponsor engagement. 4.4 Part I, Paragraph 1.3 Principals 4.4.1 Paragraph 1.3 sets out the basic requirements for the appointment of Principals. 4.4.2 Again, our comments in Section 4.2 above also apply in relation to the obligations imposed on Management in Paragraphs 1.3.1 and 1.3.2. 4.4.3 We would suggest a slight re-working of the order of Paragraph 1.3. In particular, we believe that the requirement for Management to ensure that sufficient Principals are appointed (currently at the end of Paragraph 1.3.2) logically should come at the start of paragraph 1.3. The current Paragraph 1.3.1 would then follow on from there. 4.4.4 We welcome the Commission s decision to require a minimum of two Principals. 4.4.5 In relation to the requirement that Management endorse a Principal s competence to act as a Principal, we would appreciate the Commission making clear what form this would take. In particular, we are not clear whether this endorsement is to be made by Management in their capacity as individuals (i.e., so that they can be held to account for endorsing a person who is not competent to be a Principal) or whether this is an endorsement to be made by Management on behalf of the firm. It is also unclear whether the endorsement is a certification that the relevant person qualifies as a Principal as at the time of the endorsement or whether the endorsement is continuing in nature. 4.4.6 We would like further information on what the application process for Principals will be. 4.4.7 The first sentence of what is currently paragraph 1.3.2 can be deleted as this issue is already covered (more appropriately) in paragraph 1.4.1(1) which deals with the eligibility of persons to be Principals. 8

4.4.8 Paragraph 1.3.3 states that a Principal s responsibility as a supervisor cannot be delegated. We assume that what the Commission means by this is that a Principal will always face regulatory challenge if there are, say, compliance failings attributable (in part or whole) to a lack of proper supervision of the members of a transaction team. However, if the Commission actually means that a Principal cannot appoint others to help in supervising a transaction team, we strongly disagree with this. Generally, a large IPO requires a large transaction team, and different parts of that team will be responsible for different aspects of the IPO. While one Principal may lead the entire team, he may have to appoint others to lead the sub-teams addressing each of those different aspects. This should be permitted. 4.4.9 The Note to Paragraph 1.3.3 states that a Principal is expected to be the decision maker on all key issues, e.g. as to the breadth and depth of the due diligence undertaken and the resourcing of that due diligence. We would appreciate discussing this further with the Commission. We appreciate that the Commission wants to ensure that the Principal (i.e., a senior manager with requisite corporate finance experience) gets involved in and takes responsibility for the important decisions on particular transactions. However, the Commission should be aware that this does not reflect international best practice with respect to managing transactions. The Group considers that the better approach would be that the Principal should take responsibility for making sure that key issues are appropriately addressed rather than that the Principal should necessarily be the decision maker. For example, key decisions on issues arising out of the due diligence often will not be made by the team leaders on their own the legal, regulatory and commercial risks are often too important to be left to one or two individuals to decide on. Accordingly, such matters are often referred to one of the firm s (global) risk management committees for discussion and decision. This is a better way of trying to ensure that issues are fully and properly debated and considered by a wider range of senior staff with (overall) greater experience. This is especially true for transactions with listings or offerings in multiple jurisdictions. The Hong Kong team leaders and HK IBD Management will be involved in this, but they will not always be the decision makers. Accordingly, we believe that the Note should be amended as follows: The firm is expected to ensure that Management and/or the Principal is involved in the making of the key decisions relating to the work carried out by the transaction team. For example, in respect of conducting due diligence in relation to a listing applicant, the firm should ensure that Management and/or the Principal is involved in determining the breadth and depth of the review and the amount of resources to be deployed for carrying out such work. The Principal is expected to be fully conversant with the key issues in each sponsorship appointment and to be able to respond promptly to requests from the Regulators on such issues. 9

We note that the Commission states at paragraph 7 of the Consultation Paper that a Principal should take full responsibility for the work of the team. We assume that this should be read as meaning that the Principal will be responsible for his personal (i.e., supervisory) failings, not for failings by members of the team for which the Principal cannot be blamed (e.g. where a member of the team fails to tell the Principal about a due diligence issue that has arisen). We would like the Commission s confirmation of this. 4.5 Part I, Paragraph 1.4 Eligibility Criteria for Principals 4.5.1 Paragraph 1.4 sets out the criteria that a person must fulfil to be eligible to be appointed as a Principal. 4.5.2 Paragraph 1.4.1(1) requires that in order to qualify as a Principal, an individual must be a responsible officer (or, in the case of banks, executive officer ) ( RO ) of the relevant firm. As noted above, we appreciate that the Commission s reason for requiring this is to ensure that the Principal is senior staff member and that, as a result, management is actively engaged in the firm s sponsor activities. We strongly disagree with this requirement as it applies to the larger financial institutions. In the Group s view, requiring Principals to be ROs confuses and conflicts with the senior management structures these firms adopted to implement the Securities and Futures Ordinance. To promote management/regulatory responsibility at the highest level within their Hong Kong management teams, the larger financial institutions have typically decided to register only their most senior managers as ROs (i.e., usually between 2 and 4 managers per regulated activity). For example, the ROs for advising on corporate finance will normally be the head executives of the firm s Hong Kong investment banking business unit(s). We understand that this reflects the Commission s own view that the most senior managers within a firm should be the ROs. However, such senior staff do not normally take part in the day-to-day management of particular transactions, especially given the number of transactions in which the larger firms are normally engaged - the Group estimates that a large financial institution will normally be working on over 10 IPOs at any one time. These ROs are (part of) HK IBD Management, and should be regarded as Management for the purposes of the Annex accordingly, they will remain ultimately responsible for the Hong Kong IPO business - but they do not need to be Principals (although, of course, they may choose to be if they wish). It is normally the staff who report to these senior managers who lead the transaction teams and run transactions. These team leaders are senior investment bankers who have been involved in capital markets transactions and corporate finance work, typically for much longer than 5 years. While they may not have been registered as ROs, they have proven themselves to be experienced, capable and competent in fulfilling firms sponsor duties in the past. They are the staff who should be appointed as Principals under the Annex, but they should not need to be ROs. Making them ROs 10

would suggest that they are in the same position, from a regulatory perspective, as the most senior staff currently registered as ROs. This is plainly not the case. Moreover, the Group estimates that a larger firm will need at least 5 to 6 Principals to ensure proper coverage of the 10 IPOs that it is normally working on. Requiring all of these staff to be ROs would impose additional administrative burdens for no apparent benefit. For example, some firms require (under their global corporate governance procedures) that ROs are also appointed as directors of the relevant entity, again to promote good corporate governance and regulatory responsibility at the highest levels. This would be weakened if an additional 5 to 6 investment banking staff were appointed to the board to meet one eligibility criterion in the Annex. Accordingly, the Group considers that it is not necessary for Principals to be ROs, and that this requirement should be deleted. We believe that the Commission s objective of ensuring that the Principal is a senior member of the firm s staff can be met by replacing Paragraph 1.4.1(1) with: be sufficiently senior within the firm to be able to fulfil his supervisory responsibilities as a Principal appropriately;. 4.5.3 Paragraphs 1.4.1(2) and (3) set out initial experience requirements. A Principal must have a minimum of 5 years of relevant corporate finance experience in respect of companies listed on the Hong Kong Stock Exchange. The Note to paragraph 1.4.1(2) provides that this includes providing advice on IPOs, notifiable transactions, rights issues and open offers, and takeovers and share repurchases under the Takeovers Code. 4.5.4 The Note to paragraph 1.4.1 states that these requirements may be varied where a firm can demonstrate that there are valid and justifiable grounds for this, which will not prejudice the protection of investors interests. 4.5.5 As we have discussed with the Commission previously, we wholly support the Commission s desire to ensure that the supervisors of sponsors are properly qualified for such role in terms of their prior experience. However, we are concerned at the stress on Hong Kong experience, which can only be varied with the Commission s consent. We believe that international experience is just as valuable and relevant to what the Commission is trying to achieve in strengthening the Hong Kong regime, and we know that the Commission agrees with this. 4.5.6 However, we do not believe that a waiver process would deal with this adequately. Unfortunately and based on experience with the equivalent requirements in relation to ROs supervising work governed by the Takeovers Code, the front line staff at the Commission dealing with the applications frequently fail to recognise that international experience is as valid as Hong Kong experience. Despite what some may think, Hong Kong is not unique in the commercial and regulatory issues that it has to face: other international markets face the same issues, and individuals who have experience in dealing with those issues are just as competent to be Principals as those who have only worked in Hong Kong. Indeed, in bringing international best-practices and standards to Hong Kong, they may 11

be better qualified to help raise the standards of sponsors in Hong Kong. The Commission should encourage this. 4.5.7 Of course, we are not suggesting that corporate finance/ipo experience gained in any and every overseas market automatically qualifies an individual to be a Principal in Hong Kong, as there are many markets whose standards fail to meet the standards that Hong Kong already meets. However, experience gained in any of the leading international markets, e.g. the U.S., London, Europe, Australia, Japan and Singapore, should be adequate, and the Commission should expressly recognise this. 4.5.8 Some may object that individuals from overseas markets do not have the same sort of in-depth knowledge of, say, the Hong Kong listing rules as those staff who have never worked elsewhere, and that this should therefore mean that they are less qualified. We do not agree with this. They are not at any real disadvantage given the substantial changes in the Hong Kong regulatory framework that have taken place over the last few years, and the changes that are still due to take place, to bring Hong Kong into line with international standards. Provided that the firm and the transaction team has the requisite compliance knowledge, we do not believe that the Principal has to be an expert in Hong Kong compliance matters. As we have already suggested: Hong Kong is not unique in the regulatory issues that have to be addressed. 4.5.9 We would also note that the Commission has recently recognised the value of non-hong Kong financial markets experience in relation to the appointment of ROs of the management company of a real estate investment trust. Paragraph 5.4 of the Commission s Code on Real Estate Investment Trusts specifies that the ROs must have 5 years experience in investment management or property portfolio management this recognises that what is important is that the relevant managers have the right experience to do their job, regardless of where that experience was gained. 4.5.10 Accordingly, we would suggest that: Paragraph 1.4.1(2) be amended so that it require a minimum of 5 years of relevant corporate finance experience. The Note should then be amended to read: Relevant corporate finance experience includes providing advice, for example, on the following matters: (i) (ii) (iii) IPOs involving listings of securities in any jurisdiction having listing requirements which aim to achieve a level of disclosure to investors which is comparable to or higher than that in Hong Kong; debt financings or other types of capital-raising in the international capital markets; transactions for issuers admitted to listing in any jurisdiction mentioned in (i) above (including, without limit, securities repurchases, connected transactions, and corporate and 12

debt restructurings), where such transactions require public disclosure and/or the consent of one or more holders of the issuer s listed securities pursuant to the listing or other regulatory requirements of that jurisdiction; or (iv) takeovers or other M&A transactions involving issuers admitted to listing in any jurisdiction mentioned in (i) above. In order to tie the eligibility criteria back to the requirement in Paragraph 1.3.1 that Management endorse the competence of Principals, we would suggest that Paragraph 1.4.1(3) be amended to require as follows: be determined by Management as having sufficient relevant corporate finance experience in the five years immediately preceding his appointment to be able to directly supervise a transaction team appropriately. 4.5.11 If the Commission intends to leave Paragraph 1.4.1(3) as it is, the Group would appreciate clarification on the meaning of substantial role, i.e., whether it means (a) involvement in the key decisions relating to a transaction (such as structuring, evaluation of due diligence issues and assessment of the applicant s eligibility for listing) or (b) participating in all aspects of the day-to-day work (e.g. the verification process, due diligence reviews, prospectus drafting, preparation of responses to the Exchange s queries and liaison work between intermediaries). The Commission should be aware that the tasks in (b) are generally delegated to the middle/juniorranking investment bankers who report to and are under the supervision of the senior investment bankers leading the transaction. Given that Commission expects Principals to be senior investment bankers who have corporate finance supervisory experience, we submit that the meaning of substantial role should be limited to (a). 4.6 Part I, Paragraph 1.5 Systems and Controls and Internal Assessment 4.6.1 Paragraph 1.5 requires sponsors to have effective systems and controls in place. 4.6.2 Paragraph 1.5.1 sets out the core requirements for sponsors systems and controls. We would suggest a small but important change to this. At the moment, the Guidance states that sponsors must have effective systems and controls in place to ensure its compliance with applicable laws, etc. (paragraph 1.5.1(3)). As the Commission is aware, it is practically impossible for a firm to implement systems and controls that ensure compliance in all respects in many areas, firms must depend on their staff to comply with applicable requirements. We know that the Commission recognises this, given its emphasis on the competence of individuals, both Principals and individual representatives. Accordingly, we would suggest that Paragraph 1.5.1 require firms to take reasonable steps to implement and maintain systems and controls which are designed to assist the firm to comply in all material respects with applicable law, etc. 4.6.3 The Note to Paragraph 1.5.1 suggests that Management must ensure that they are kept abreast of any material development and key issues relating to a firm s sponsor work. We would be grateful for the Commission s 13

clarification on what it expects in this regard. If the Commission is concerned about key issues arising on each transaction, we believe that this is primarily a matter for Principals. Please see our comments in Section 4.2 above. 4.6.4 Sponsors are required to keep a record of the members of their transaction teams (including any changes) (paragraph 1.5.2). We assume that this is only a list of staff in Hong Kong who are providing corporate finance advice, and does not include, say, a record of the secretaries, IT and other support staff involved on any transaction. Requiring the latter would soon become unmanageable from a practical perspective. 4.6.5 Paragraph 1.5.3 requires sponsors to undertake an annual assessment to ensure that it has the required systems and controls. We do not agree with this for the reasons below. Please note that we are only objecting to a requirement to undertake an annual review we wholeheartedly agree that sponsors should be subject to internal compliance reviews/audits. Internal compliance reviews/audits should be carried out according to a firm s own assessment of compliance risk both as between different business lines, and as between front, middle and backoffice functions. This determines which business units are reviewed, in what order and when. Business units engaged in sponsor work are not inherently riskier than other business units. And just as other business units are not necessarily reviewed annually, we do not see the need to impose such a requirement for sponsor business units. Requiring annual reviews will inevitably lead to increased costs, as firms will need to hire additional compliance and audit staff to undertake this work. Unless there is a demonstrable benefit to investor protection to be gained from this, we do not see the need to impose this cost. We are aware that the new UK regulatory regime for sponsors states that sponsors should undertake an annual compliance review. However, please note that this is not a mandatory requirement but guidance (signified by the G in the FSA s Handbook reference - LR 8.6.14G) in relation to sponsors obligation to maintain appropriate systems and controls. In any event, we would note that the UK is a substantially bigger market, where firms have substantially greater internal compliance/audit resources who can undertake this review without material, additional cost. Please also see our related comments below in relation to Paragraph 4. Accordingly, we would suggest that Paragraph 1.5.3 be amended to require a sponsor to carry out the assessment from time to time (i.e., as and when it deems appropriate). 14

4.7 Part I, Paragraph 2 Minimum capital requirements/professional Indemnity Insurance 4.7.1 Paragraph 75 of the Consultation Paper seeks the views of the market in relation to the requirement for sponsors to maintain professional indemnity insurance coverage for possible liabilities arising out of sponsor work. 4.7.2 It is not clear from the Consultation Paper what liabilities the Commission would expect such insurance to cover. In terms of possible liabilities arising out of its sponsor work (see paragraph 75 of the Consultation Paper), if the Commission is referring primarily to prospectus liabilities, the Group does not consider that the requirement to obtain professional indemnity insurance should be used as a mechanism through which sponsors are implicitly made liable for the contents of the disclosures made by the issuer to the Exchange and the public in the issuer s listing documentation. 4.7.3 We do not support this proposal. Members of the Group have previously investigated the availability of such insurance such insurance is not generally available in the insurance market, and, according to estimates provided by the very few insurance companies that would be prepared to offer such insurance, the cost would be commercially prohibitive. Indeed, it would appear that it would sometimes be higher than the investment bank s own fees charged on the transaction. As this cost would ultimately be borne by issuers, the Group strongly believes that it would make Hong Kong increasingly unattractive for capital raising and uncompetitive when compared with other regional financial centres. 4.7.4 In any event, we submit that there should not be a mandatory minimum for any professional indemnity insurance. This should be left to the management of each firm to decide on given its size, the transactions it engages in, etc. 4.7.5 For completeness and as the Commission is aware from our discussions about the master policy system for Exchange business, we would firmly resist any suggestion that a master policy structure be adopted in this context. 4.8 Part I, Paragraph 3 Continuing professional education 4.8.1 We wholeheartedly agree with the Commission s focus on training and education. We believe that it is appropriate to require staff to devote 50% or more of their five CPT hours (in relation to their Type 6 licences) to sponsor-related topics. 4.9 Part I, Paragraph 4 Annual return 4.9.1 The Group would appreciate clarification on the form of confirmation which a sponsor would be required to provide to the SFC under Paragraph 4. In particular, we would be grateful to know whether the confirmation will be in a form of a prescribed checklist (e.g. forming part of the Commission s Business Risk Management Questionnaire) or a general statement by a firm s management that, in their view, the firm has conducted the required internal assessment on the firm s controls and systems, having taken into 15

account the activities of the transaction teams, their members and the Principals (see paragraph 62 of the Consultation Paper). We would like to discuss this with you. 4.9.2 The scope of the confirmation is important, as it drives the scope and extent of any annual review to be performed under Paragraph 1.5.3. Consequently, the market needs to understand this as soon as possible, in order to be able to comment properly on Paragraph 1.5.3. 4.9.3 We believe that the scope of any internal assessment, as well as the timing of that assessment, should be a matter left to the management of each firm as the businesses, size, structure, risk profile and policy of each investment bank will be different, as will their respective internal control systems. 4.10 Part II Compliance Advisers 4.10.1 Part II of the Annex sets out the requirements for compliance advisers. Paragraph 1 sets out the basic eligibility criteria, while Paragraph 2 requires firms to appoint qualified staff and to carry out all due diligence with due care and skill. 4.10.2 The Group does not agree with the Commission s requirement that in order to be a compliance adviser, a firm should first meet the criteria to be a sponsor. This is because we do not agree that the role of compliance advisers is necessarily an extension of the corporate finance advisory work conducted by a sponsor during the listing application (see paragraph 78 of the Consultation Paper). The two roles can be and often are quite separate. The requirement in Paragraph 1 would restrict some boutique firms from providing compliance advisory services. In practice, small boutique firms are often engaged by listed issuers to provide corporate finance advice on, for example, notifiable transactions and, together with the listed issuer s legal advisers, to provide general advice on transaction-related compliance matters. Where these smaller boutique firms have the relevant expertise and allocate proper resources to focus on this compliance advisory work and so are able to fulfil the duties of compliance adviser under the Listing Rules, they should not be ruled out from delivering such services, just because they could not meet the higher requirements to be a sponsor under the Annex. The capital, human resource and management requirements/commitments for the provision of sponsor services and compliance advisory services are different. 4.10.3 Accordingly, the Group urges the Commission to remove this requirement, and to revisit the issue as to what the eligibility criteria for compliance advisers should be. We would be pleased to discuss this with the Commission. 16