Considering Political and Macroeconomic Risk in Sponsor Due Diligence

The SFC’s 2024 thematic review of sponsor work found that 42% of prospectuses examined contained material deficiencies in the description of principal risks and uncertainties, with a disproportionate share relating to political and macroeconomic factors. This finding, published in the SFC’s Report on Thematic Inspection of Sponsor Work (December 2024, paragraph 16), signals a clear regulatory expectation that sponsors must elevate the rigour of their due diligence beyond boilerplate language. For a sponsor holding a Type 6 (advising on corporate finance) licence under the Securities and Futures Ordinance (Cap. 571), the failure to adequately assess and disclose how a deteriorating geopolitical climate or a sudden shift in monetary policy will affect an applicant’s business model is no longer a minor drafting issue — it is a direct breach of paragraph 17 of the Code of Conduct for Persons Licensed by or Registered with the SFC (the Code). The 2024 report explicitly states that “sponsors should not treat political and macroeconomic risks as generic disclaimers but must tailor the analysis to the issuer’s specific operations, supply chains, and funding structures.” This article examines how sponsors can operationalise this requirement, drawing on HKEX Listing Rules, SFC guidance, and recent enforcement cases to build a defensible due diligence framework.

The Regulatory Framework for Political and Macroeconomic Risk Assessment

HKEX Listing Rule Requirements on Risk Disclosure

HKEX Listing Rule 11.07 requires a listing document to contain “full, accurate and complete disclosure of all material information,” which the HKEX Guidance Letter GL56-13 (updated March 2024) clarifies includes “any political, economic, or regulatory factor that could materially affect the group’s business or financial condition.” The rule is not limited to risks that have already crystallised. It extends to reasonably foreseeable scenarios. The HKEX Decision Notice in the matter of Company A (2023, HKEX Listing Decision LD123-2023) rejected a listing application where the sponsor had only described “general geopolitical tensions” without linking those tensions to the issuer’s specific reliance on a single cross-border shipping route through the South China Sea. The decision stated that “a risk factor which is not particularised to the issuer is not a risk factor; it is a placeholder.”

SFC Code of Conduct and the Sponsor’s Duty of Care

Paragraph 17.1 of the Code requires a sponsor to “exercise due skill, care and diligence” in conducting due diligence. The SFC’s Guidelines on the Duties of Sponsors (2019, updated 2023) at paragraph 3.2.2 explicitly lists “macroeconomic conditions, including interest rate trends, currency risks, and inflation” and “political stability, including changes in government policy, trade sanctions, and expropriation risk” as mandatory areas of enquiry. The 2024 thematic review found that in 28% of inspected cases, the sponsor had not performed any independent verification of the issuer’s sensitivity analysis to changes in interest rates or foreign exchange rates, relying solely on management representations. The SFC stated this constituted a failure to meet the standard set out in paragraph 17.4 of the Code, which requires “reasonable steps to verify facts that are material to the listing application.”

The 2024 SFC Thematic Review: Specific Findings

The December 2024 report identified three specific deficiencies in sponsor handling of political and macroeconomic risk. First, 67% of prospectuses reviewed used a single, generic paragraph for “geopolitical risk” that was identical across issuers in different sectors and geographies. Second, only 12% of sponsors had conducted any form of scenario analysis or stress testing on the issuer’s financial projections using a macroeconomic shock variable. Third, 41% of sponsors did not document any discussion with the issuer’s board or management about the potential impact of trade sanctions or export controls, even where the issuer had material exposure to jurisdictions subject to US or EU sanctions regimes. The SFC warned that these deficiencies “may lead to enforcement action under section 213 of the SFO or section 384 of the Cap. 571.”

Operationalising Due Diligence: From Generic to Specific

Mapping the Issuer’s Exposure to Political and Macroeconomic Variables

The first step is to build a structured exposure matrix. For each material revenue stream, cost input, funding source, and jurisdiction of operation, the sponsor must identify the specific political and macroeconomic variables that could affect it. For an issuer with manufacturing operations in the PRC and export sales to the US, the variables include: the US-China tariff rate (currently at a weighted average of 19.3% under Section 301 tariffs as of January 2025, per US Trade Representative data), the CNY/USD exchange rate (which depreciated 4.7% against the USD in 2024, per People’s Bank of China data), and the risk of further export controls under the US Bureau of Industry and Security’s Entity List. The HKEX Guidance Letter GL56-13 at paragraph 2.3.1 requires the sponsor to “quantify, where possible, the potential financial impact of each identified risk.” This means the sponsor must obtain from the issuer a sensitivity analysis showing, for example, the impact of a 10% tariff increase on gross margin, or a 5% CNY depreciation on net profit.

Scenario Analysis and Stress Testing: A Mandatory Tool

The SFC’s 2024 report explicitly endorses scenario analysis as a due diligence tool. The sponsor should construct at least three scenarios: a base case (the issuer’s own projections), a downside case (a moderate shock, such as a 200 bps interest rate hike or a 10% decline in the issuer’s primary market), and a severe case (a material adverse event, such as the imposition of a trade embargo or a sovereign debt default in a key market). For each scenario, the sponsor must assess the issuer’s liquidity position, debt covenants, and ability to continue as a going concern. The HKEX Listing Decision LD99-2019 (in the matter of Company B) rejected a listing where the sponsor had not stress-tested the issuer’s working capital position against a 30% drop in revenue, which materialised within six months of listing. The decision noted that “a sponsor’s duty extends to identifying risks that are not immediately obvious but are reasonably foreseeable based on available macroeconomic data.”

Verifying Management’s Assumptions and Mitigation Plans

Paragraph 17.4 of the Code requires the sponsor to “verify, to a reasonable extent, the accuracy of information provided by the issuer.” This is particularly important for political and macroeconomic risk, where management may have an incentive to downplay the severity. The sponsor must independently corroborate management’s assumptions. For example, if the issuer claims it can pass on tariff costs to customers, the sponsor should obtain third-party evidence, such as industry reports or customer contracts, to verify pricing power. If the issuer claims it has diversified its supply chain away from a politically unstable jurisdiction, the sponsor should inspect the relevant supplier contracts and logistics records. The SFC’s 2024 report cited a case where a sponsor had accepted management’s representation that a key raw material was sourced from multiple countries, but the sponsor’s own verification — a review of customs declarations — revealed that 94% of the raw material came from a single jurisdiction subject to sanctions risk. The SFC stated this was a “clear failure of due diligence.”

Cross-Border Considerations and Jurisdictional Risk

Assessing the Impact of Trade Sanctions and Export Controls

For any issuer with operations in, or trading with, jurisdictions subject to US, EU, or UN sanctions, the sponsor must conduct a sanctions exposure review. This is not a standard legal opinion; it is a factual due diligence exercise. The sponsor should map the issuer’s counterparties, beneficial owners, and end-users against the relevant sanctions lists, including the US Office of Foreign Assets Control (OFAC) Specially Designated Nationals (SDN) List and the EU Consolidated List of Persons, Groups and Entities. The HKMA Supervisory Policy Manual module SA-1 (updated 2024) at paragraph 4.2 requires authorised institutions to “ensure that their customers and counterparties are not involved in sanctioned activities,” and the sponsor should apply a similar standard. In the context of a listing on the Main Board, the HKEX Guidance Letter GL68-13 (updated March 2024) at paragraph 1.5 states that the Exchange may require the sponsor to confirm that the issuer’s business “does not contravene any applicable sanctions laws or regulations.”

Currency Risk, Sovereign Risk, and Capital Controls

Where an issuer operates in a jurisdiction with capital controls or a volatile currency, the sponsor must assess the risk of repatriation of funds. For an issuer incorporated in the Cayman Islands with operating subsidiaries in the PRC, the sponsor must examine the PRC State Administration of Foreign Exchange (SAFE) rules on cross-border capital movements. The HKEX Listing Decision LD87-2018 (in the matter of Company C) required the sponsor to provide a detailed analysis of the risk that the PRC government might impose stricter controls on the conversion of RMB to foreign currency, and to disclose the potential impact on dividend payments to overseas shareholders. The sponsor’s due diligence should include a review of the issuer’s historical dividend repatriation records, its compliance with SAFE Circular 37 (2014) and Circular 3 (2022), and any pending regulatory changes. The SFC’s 2024 report noted that in 22% of cases involving PRC-based issuers, the sponsor had not obtained any legal opinion on the risk of capital controls.

Political Instability and Expropriation Risk

For issuers with operations in jurisdictions assessed as high-risk by the World Bank’s Worldwide Governance Indicators (e.g., a percentile rank below 25 for “Political Stability and Absence of Violence”), the sponsor must conduct a targeted expropriation risk assessment. This should include a review of the issuer’s assets, the legal framework for foreign investment in the relevant jurisdiction, and any history of government interference. The HKEX Guidance Letter GL56-13 at paragraph 3.1.2 requires the sponsor to “consider the political and legal environment in each jurisdiction where the issuer has material operations.” In practice, this means obtaining a legal opinion from a qualified local counsel on the risk of nationalisation, expropriation, or forced renegotiation of contracts. The sponsor should also assess the issuer’s insurance coverage for political risk, including coverage under the Multilateral Investment Guarantee Agency (MIGA) or private political risk insurers. The 2024 SFC report cited a case where an issuer’s primary asset was a mining concession in a jurisdiction that had recently revoked similar concessions; the sponsor had not obtained any legal opinion on the concession’s validity and had not disclosed the risk in the prospectus.

Enforcement Trends and Lessons for Sponsors

Recent SFC Enforcement Actions

The SFC has demonstrated a willingness to take enforcement action against sponsors for inadequate due diligence on political and macroeconomic risks. In the 2023 case of SFC v. Sponsor D (unreported, SFC Enforcement Notice 2023-12), the SFC reprimanded and fined a sponsor HKD 12 million for failing to identify and disclose the risk that the issuer’s primary market — a jurisdiction subject to US sanctions — could collapse. The sponsor had relied on a single management representation that the sanctions had “no material impact” without conducting any independent verification of the issuer’s customer base or trade flows. The SFC stated that the sponsor’s due diligence “fell significantly short of the standard required under paragraph 17 of the Code.” Separately, in the Company E case (2024, SFC Disciplinary Action Notice 2024-05), the SFC suspended a sponsor’s licence for six months for failing to conduct any scenario analysis on the impact of a potential PRC regulatory crackdown on the issuer’s industry, which materialised shortly after listing.

The Role of the Listing Committee and the Exchange

The HKEX Listing Committee has also tightened its scrutiny of risk disclosure. In its Guidance Letter GL112-24 (July 2024), the Exchange stated that it would “carefully review the sponsor’s due diligence on political and macroeconomic risks and may require the sponsor to provide additional information or analysis before the listing application can proceed.” The letter specifically referenced the need for sponsors to “demonstrate that they have considered the potential impact of changes in US-China trade relations, PRC regulatory policies, and global interest rate trends on the issuer’s business.” The Exchange has the power under Listing Rule 9.03 to reject a listing application if the risk disclosure is inadequate, and it has exercised this power in at least three cases in 2024, according to HKEX Listing Decisions (LD124-2024, LD125-2024, and LD126-2024).

Practical Implications for Sponsor Compliance

The regulatory landscape requires sponsors to embed political and macroeconomic risk assessment into their core due diligence workflow, not treat it as an ancillary exercise. The sponsor’s compliance team should ensure that the due diligence plan, approved by the sponsor’s senior management under paragraph 17.2 of the Code, explicitly includes a section on political and macroeconomic risk, with defined milestones and verification steps. The sponsor should maintain a working paper that documents: (i) the specific variables identified; (ii) the data sources used (e.g., IMF, World Bank, central bank publications, trade statistics); (iii) the scenario analysis performed; (iv) the issuer’s sensitivity analysis and the sponsor’s verification of it; and (v) the sponsor’s assessment of the adequacy of the issuer’s mitigation plans. The 2024 SFC report states that “a well-documented due diligence process is the sponsor’s best defence against enforcement action.”

Actionable Takeaways for Sponsors

1. Embed a political and macroeconomic risk matrix into the standard due diligence plan and require the sponsor’s deal team to complete it for every listing application, with sign-off from the sponsor’s compliance officer.
2. Conduct at least three scenario analyses (base, downside, severe) for every issuer with material cross-border operations or exposure to volatile jurisdictions, and document the assumptions and data sources in the working papers.
3. Obtain independent verification of management’s assumptions on tariff pass-through, currency hedging, supply chain diversification, and sanctions exposure, using third-party data such as customs records, industry reports, and legal opinions.
4. Review the issuer’s political risk insurance coverage and the legal framework for foreign investment in each jurisdiction of material operation, and disclose any gaps in the prospectus risk factors.
5. File a complete due diligence record that includes the political and macroeconomic risk assessment, scenario analysis, and verification steps, as this is the primary evidence the SFC and HKEX will examine in any review or enforcement action.