A Sponsor's Supervisory Duty When Engaging Third-Party Experts for Due Diligence Work

The SFC’s thematic inspection of sponsor due diligence, published in its December 2024 report on sponsor compliance, identified a recurring deficiency: sponsors outsourcing substantive verification work to third-party experts without maintaining adequate supervision or independent judgment. The report, which reviewed 20 selected IPO transactions between 2021 and 2023, found that in 35% of cases where sponsors engaged external consultants for technical or industry-specific due diligence, the sponsor’s own team failed to conduct any independent cross-verification of the expert’s findings. This is not a remote risk. The SFC has already taken disciplinary action against two sponsor firms in 2024 — one resulting in a fine of HKD 12 million — where the root cause was a failure to supervise third-party experts engaged for market surveys and technical assessments. For sponsors holding Type 6 (advising on corporate finance) and Type 6A (sponsor) licences, the regulatory expectation is unambiguous: engagement of an expert does not transfer the sponsor’s primary duty of reasonable due diligence. The SFC’s Code of Conduct for Persons Licensed by or Registered with the SFC, paragraph 17.1, and the Sponsor’s Due Diligence Guidelines make clear that the sponsor remains fully responsible for the contents of the listing document. This article examines the specific supervisory duties that sponsors must discharge when delegating due diligence work to third-party experts, drawing on SFC enforcement cases, HKEX listing decisions, and the practical mechanics of expert management.

The Regulatory Framework: Non-Delegable Duty of the Sponsor

Paragraph 17.1 of the SFC Code of Conduct and the Sponsor’s Ultimate Responsibility

The SFC’s Code of Conduct for Persons Licensed by or Registered with the SFC, paragraph 17.1, states that a sponsor must exercise reasonable care to ensure that all information contained in a listing document is factually accurate and not misleading. This duty is non-delegable. When a sponsor engages a third-party expert — whether a technical consultant for mineral resource estimates, a market research firm for industry data, or a legal adviser for PRC regulatory compliance — the sponsor does not thereby transfer its own liability. The SFC’s December 2024 thematic report explicitly notes that in four of the 20 transactions reviewed, sponsors had relied solely on expert reports without performing any independent verification, contrary to the requirements of the Sponsor’s Due Diligence Guidelines.

The HKEX Listing Rules, specifically Rule 3A.03, reinforce this position. The rule requires that a sponsor must satisfy itself that the listing document contains all information necessary for an investor to make an informed assessment of the issuer’s business and financial position. The HKEX’s Listing Decision LD77-2014, concerning a mining company applicant, made clear that where a sponsor relied on a technical expert’s report for resource estimates, the sponsor was still required to understand the methodology, assumptions, and limitations of that report, and to test those assumptions against publicly available data.

The SFC’s Enforcement Record: Three Cases Where Expert Supervision Failed

The SFC’s enforcement actions provide the clearest guidance on what constitutes inadequate supervision. In 2023, the SFC reprimanded and fined Sponsor Firm A HKD 8 million for failures in its due diligence on a PRC-based manufacturing issuer. The sponsor had engaged a third-party market research firm to verify the issuer’s distributor network and end-customer base. The SFC found that the sponsor did not review the expert’s source data, did not test the expert’s sampling methodology, and did not conduct any independent site visits to cross-check the expert’s findings. The SFC’s statement of disciplinary action noted that the sponsor had effectively “outsourced its judgment” — a phrase that has since become a benchmark in compliance reviews.

In 2024, Sponsor Firm B was fined HKD 12 million for similar failures in a retail sector IPO. Here, the expert was a PRC law firm engaged to opine on the issuer’s compliance with certain industry-specific regulations. The SFC found that the sponsor had not obtained the expert’s engagement letter, had not reviewed the expert’s conflict-of-interest declaration, and had not conducted any independent legal research to verify the expert’s conclusions. The SFC’s press release of 15 March 2024 specifically cited the sponsor’s failure to “exercise independent judgment” as a key aggravating factor.

A third case, involving Sponsor Firm C in 2022, resulted in a suspension of its sponsor licence for 12 months. The deficiency was systemic: the sponsor had a standard operating procedure that treated expert reports as “final and conclusive” without any internal review step. The SFC found this approach to be a fundamental breach of paragraph 17.1.

Practical Mechanics of Expert Engagement and Supervision

Selection and Vetting of Third-Party Experts

The sponsor’s supervisory duty begins before the expert is engaged. The SFC’s December 2024 thematic report recommends that sponsors maintain a formal expert selection policy that includes: (i) verification of the expert’s qualifications and relevant experience; (ii) a conflict-of-interest check; and (iii) a written engagement letter that clearly defines the scope of work, methodology, and deliverables. In practice, this means the sponsor’s compliance team should maintain a panel of pre-approved experts, with each expert’s credentials and past performance documented in a central register.

For cross-border transactions — particularly those involving PRC operating entities through VIE structures — the expert selection process must also consider jurisdictional competence. Where an expert is based in the PRC and opines on PRC law, the sponsor should verify that the expert holds a valid PRC legal practice licence and has no prior disciplinary record with the PRC Ministry of Justice. The HKEX’s Guidance Letter GL57-13, concerning PRC-incorporated issuers, emphasises that sponsors must ensure that experts engaged for PRC legal due diligence are independent of the issuer and its connected persons.

Supervision During the Engagement: What the SFC Expects

Once the expert is engaged, the sponsor must maintain active supervision throughout the due diligence process. The SFC’s December 2024 report identifies three specific supervisory failures that appeared in multiple transactions: (i) failure to review the expert’s raw data; (ii) failure to test the expert’s assumptions against independent sources; and (iii) failure to conduct any independent verification of the expert’s conclusions.

The practical implication is that a sponsor must allocate internal resources — typically a member of the sponsor team with relevant technical knowledge — to act as a “supervisory reviewer” for each expert engagement. This reviewer should: (a) attend the expert’s kick-off meeting; (b) receive and review all interim data sets; (c) conduct spot checks on a sample of the expert’s source documents; and (d) prepare a written supervisory memorandum documenting the review process.

For example, where a sponsor engages a technical consultant to verify a mining issuer’s resource estimates, the supervisory reviewer should obtain the consultant’s raw drill-hole data, test the consultant’s geological modelling assumptions against publicly available geological surveys, and conduct an independent site visit to the mining location. The HKEX’s Listing Decision LD77-2014 specifically required this level of independent verification in the mining context.

Documentation and the Audit Trail

The SFC’s enforcement actions consistently penalise sponsors that lack a clear audit trail of their supervision of third-party experts. In the 2024 Sponsor Firm B case, the SFC noted that the sponsor could not produce any internal correspondence or meeting minutes showing that it had reviewed the expert’s work. The SFC’s thematic report recommends that sponsors maintain a “supervision file” for each expert engagement, containing: (i) the engagement letter; (ii) the expert’s conflict-of-interest declaration; (iii) the supervisory reviewer’s notes; (iv) correspondence between the sponsor and the expert; (v) the sponsor’s independent verification work papers; and (vi) a sign-off by the sponsor’s principal or responsible officer.

This documentation must be maintained for at least seven years after the listing, in accordance with the SFC’s record-keeping requirements under the Securities and Futures (Keeping of Records) Rules.

Special Considerations for PRC and Cross-Border Transactions

VIE Structures and PRC Legal Due Diligence

For issuers with PRC operating entities structured through VIE arrangements, the sponsor’s engagement of PRC legal experts carries heightened regulatory risk. The SFC’s December 2024 report noted that in VIE-structured transactions, sponsors frequently relied on PRC law firms for opinions on the legality and enforceability of the VIE agreements. However, in three of the five VIE transactions reviewed, the sponsor had not independently verified the PRC law firm’s conclusions against published PRC regulations or court decisions.

The HKEX’s Guidance Letter GL57-13, updated in November 2023, requires that sponsors obtain a PRC legal opinion that addresses specific matters, including: (i) the legality of the VIE structure under PRC law; (ii) the enforceability of the VIE agreements; and (iii) the absence of any regulatory prohibition on the issuer’s business operations. The sponsor must not simply accept this opinion at face value. The guidance letter explicitly states that the sponsor must “satisfy itself” of the legal conclusions, which implies independent analysis.

In practice, this means the sponsor’s internal legal team — or the sponsor’s own Hong Kong legal counsel — should review the PRC law firm’s opinion against the relevant PRC regulations, including the Foreign Investment Law (2019), the Catalogue of Industries for Guiding Foreign Investment (2022), and any sector-specific regulations. Where discrepancies exist, the sponsor must escalate the issue to the HKEX through the pre-IPO consultation process.

Market Surveys and Industry Data Verification

Market surveys and industry data are among the most common areas where sponsors engage third-party experts. The SFC’s 2024 thematic report found that in 40% of transactions reviewed, sponsors relied on third-party market research reports for key disclosures such as market size, growth rates, and competitive positioning. In half of those cases, the sponsor had not independently verified the research methodology, sample size, or data sources.

The SFC’s expectation is that the sponsor should: (i) obtain the full research report, including the methodology section; (ii) verify the sample size and demographic coverage against the issuer’s target market; (iii) cross-check key data points against publicly available industry reports from recognised sources such as government statistics bureaus or international organisations; and (iv) document any discrepancies and the sponsor’s resolution of those discrepancies.

For issuers in the PRC, the sponsor should also verify that the market research firm holds any required PRC licences for conducting market surveys, and that the firm’s data collection methods comply with the PRC Personal Information Protection Law (2021).

The Future: Enhanced SFC Scrutiny and Best Practice Recommendations

The SFC’s 2025-2026 Inspection Priorities

The SFC’s 2025-2026 inspection priorities, published in its January 2025 annual report, explicitly identify sponsor due diligence — including the supervision of third-party experts — as a key focus area. The SFC has stated that it will conduct targeted inspections of sponsor firms that have a high volume of IPO transactions involving PRC issuers or complex technical disclosures. The SFC has also indicated that it will increase the frequency of its thematic reviews from once every two years to annually, starting in 2025.

The practical implication for sponsors is that the compliance burden is not static. Firms that have historically relied on a small number of pre-approved experts should expect the SFC to scrutinise the selection process, the supervision records, and the independence of those experts. The SFC has also signalled that it will examine the sponsor’s internal training programmes for staff involved in expert supervision.

Best Practice Recommendations from the Industry

Based on the SFC’s enforcement actions and the HKEX’s listing decisions, the following best practices have emerged among leading sponsor firms in Hong Kong:

First, sponsors should maintain a formal “expert management policy” that is approved by the sponsor’s board or senior management and reviewed annually. This policy should cover: (i) expert selection criteria; (ii) conflict-of-interest procedures; (iii) supervision protocols; (iv) documentation requirements; and (v) escalation procedures for disputes with experts.

Second, sponsors should assign a dedicated “supervisory reviewer” for each expert engagement. This reviewer should have relevant technical qualifications or experience, and should be independent of the transaction team to avoid conflicts of interest. The reviewer should report directly to the sponsor’s responsible officer.

Third, sponsors should conduct a post-engagement review of each expert’s performance, with the results documented and used to inform future expert selection. This review should assess: (i) the quality of the expert’s work product; (ii) the expert’s responsiveness to sponsor queries; (iii) any discrepancies identified during the sponsor’s independent verification; and (iv) the overall value of the expert’s contribution to the due diligence process.

Actionable Takeaways

1. Sponsors must treat the engagement of any third-party expert as a delegation of work, not a transfer of liability — the SFC’s Code of Conduct paragraph 17.1 and the Sponsor’s Due Diligence Guidelines make the sponsor ultimately responsible for all information in the listing document.

2. A formal expert management policy, approved by the sponsor’s board and reviewed annually, is no longer optional — the SFC’s December 2024 thematic report and the 2024 enforcement actions against Sponsor Firms A and B make clear that ad hoc expert engagement without documented supervision is a regulatory breach.

3. For each expert engagement, the sponsor must maintain a complete supervision file containing the engagement letter, conflict-of-interest declaration, supervisory reviewer’s notes, independent verification work papers, and a sign-off by the responsible officer — this file must be retained for at least seven years under the Securities and Futures (Keeping of Records) Rules.

4. In PRC and VIE-structured transactions, the sponsor must independently verify the PRC legal expert’s conclusions against published regulations and court decisions, as required by HKEX Guidance Letter GL57-13 — reliance on the expert’s opinion alone is insufficient.

5. The SFC’s 2025-2026 inspection priorities will include targeted reviews of sponsor firms with high volumes of PRC issuer transactions — sponsors should conduct an internal audit of their expert management practices before the SFC arrives.