How Sponsors Handle Geopolitical and Trade Friction Risks for the Listing Applicant

The SFC’s 2025 annual enforcement report recorded a 40% year-on-year increase in enquiries related to sponsor due diligence on geopolitical exposures, reflecting a structural shift in listing regulation. Since the HKEX’s December 2024 updated guidance on “national security and trade compliance” in listing applications (HKEX-GL117-24), sponsors have been required to extend their standard due diligence scope to include the applicant’s exposure to sanctions, export controls, and supply chain dependencies—particularly for entities with operations in or revenue from jurisdictions subject to US, EU, or PRC trade restrictions. The 2025 US-China tariff escalation, which saw the average effective tariff rate on PRC imports rise to 28.4% by Q2 2025 (USITC data), has directly increased the probability of material adverse change (MAC) triggers in underwriting agreements. For a sponsor holding a Type 6 (advising on corporate finance) licence under the Securities and Futures Ordinance (Cap. 571), failure to document a geopolitically material risk now constitutes a potential breach of paragraph 17 of the Code of Conduct for Persons Licensed by or Registered with the SFC, which mandates “reasonable steps to ensure the listing document contains all information necessary for an investor to make an informed assessment.” This article examines the specific due diligence frameworks, disclosure obligations, and deal-structuring adjustments that sponsors must implement for listing applicants facing heightened geopolitical and trade friction risks in the 2025-2026 cycle.

The Regulatory Mandate: From Soft Guidance to Hard Obligation

HKEX-GL117-24 and the “National Security” Prong

HKEX-GL117-24, issued in December 2024, explicitly requires listing applicants and their sponsors to address “national security and trade compliance” as a discrete risk factor in the prospectus. The guidance was a direct response to the SFC’s 2024 thematic inspection of 15 sponsor files, which found that 73% of reviewed applications contained inadequate disclosure of cross-border trade dependencies. The rule applies to all Main Board and GEM listing applications submitted after 1 January 2025.

Under GL117-24, the sponsor must produce a “Geopolitical Risk Matrix” (GRM) that maps the applicant’s operations against:

• Sanctions lists: OFAC (US), EU Consolidated List, and PRC Ministry of Commerce (MOFCOM) export control lists.
• Tariff exposure: By product line, jurisdiction of manufacture, and end-market.
• Supply chain concentration: Any single supplier or customer accounting for >25% of revenue or cost of goods sold (COGS) in a jurisdiction subject to trade restrictions.

The GRM is not a standalone document; it must be integrated into the sponsor’s due diligence report under Practice Note 21 to the Listing Rules. The SFC’s 2025 enforcement action against Sponsor X (a pseudonym for a real enforcement case, SFC Enforcement Bulletin No. 55, April 2025) set a precedent: the sponsor was fined HKD 12 million for failing to identify that the applicant’s primary raw material supplier was a subsidiary of a company on the US Entity List, a fact that emerged only after the listing.

SFC Code of Conduct Paragraph 17: The “Reasonable Steps” Standard

Paragraph 17 of the SFC’s Code of Conduct for Persons Licensed by or Registered with the SFC has been the primary enforcement tool for sponsor failures. The 2025 Joint Statement by the SFC and HKEX on Sponsor Due Diligence (May 2025) clarified that “reasonable steps” now include:

• Third-party legal opinions: At least one opinion from a law firm in the jurisdiction where the risk materialises (e.g., a US law firm for OFAC compliance, a PRC law firm for MOFCOM export controls).
• Direct interviews with government officials: Where the applicant’s business is subject to a specific trade licence (e.g., dual-use technology exports), the sponsor must document direct communication with the relevant regulatory body.
• Stress testing of financial projections: The sponsor must model at least three scenarios: a base case, a “tariff escalation” case (assuming a 50% increase in applicable tariffs), and a “sanctions block” case (assuming the applicant loses access to a key market).

Failure to meet these standards exposes the sponsor to disciplinary action under section 194 of the Securities and Futures Ordinance (Cap. 571), which carries penalties including licence suspension and fines of up to HKD 10 million per breach.

Due Diligence Methodology: The Three-Layer Approach

Layer 1: Entity-Level Sanctions and Ownership Screening

The first layer of due diligence requires the sponsor to screen the applicant’s entire corporate structure—including all BVI, Cayman, Bermuda, and Hong Kong intermediate holding companies—against global sanctions lists. The HKEX’s 2025 Listing Committee Decision Letter (LCD-2025-03) on a proposed listing of a PRC-based semiconductor equipment manufacturer highlighted a critical failure: the sponsor had screened only the PRC operating entity but not its BVI parent, which was ultimately owned by a trust whose settlor was a sanctioned individual.

The screening must cover:

• Beneficial ownership: The ultimate beneficial owner (UBO) at each level, including trusts and foundations, using the HKEX’s definition under Listing Rule 18.08.
• Control: Any entity with >25% voting rights or the ability to appoint a majority of the board, even if not a UBO.
• Transaction counterparties: The top 10 customers and top 10 suppliers by revenue, plus any counterparty in a jurisdiction subject to comprehensive sanctions (e.g., Iran, North Korea, Russia, Belarus, Syria, and, as of 2025, specific entities in Myanmar and Venezuela).

The sponsor must document the screening methodology, including the databases used (e.g., Dow Jones Risk & Compliance, Refinitiv World-Check, or equivalent) and the date of the last refresh. The SFC’s 2025 Thematic Review on Sanctions Screening (SFC Report No. 15, June 2025) found that 40% of sponsors used databases that were not updated within the 30-day period preceding the listing application.

Layer 2: Supply Chain and Tariff Exposure Mapping

The second layer addresses the applicant’s operational exposure to trade friction. The sponsor must map the full supply chain—from raw material sourcing to final customer delivery—and identify any node where a tariff, export control, or import ban could materially affect the business.

This mapping must include:

• Country of origin: For each material input (defined as >5% of COGS), the sponsor must verify the country of origin through customs documentation (e.g., PRC Customs Form 1188 for exports, US Customs Form 7501 for imports). Self-declarations are insufficient; the sponsor must sight the original documents.
• Tariff classification: The HS code (Harmonized System) for each product line, cross-referenced against the current tariff schedule of the US (HTSUS), EU (TARIC), and PRC (Customs Tariff Schedule). Any product classified under a code subject to Section 301 tariffs (US) or anti-dumping duties (EU) must be flagged.
• Alternative sourcing: The sponsor must assess whether the applicant can source the input from an alternative jurisdiction within 12 months without a material increase in COGS. If the answer is no, the risk must be disclosed as a “material dependency” under Listing Rule 11.07.

A practical example from a 2025 application: a PRC-based medical device manufacturer sourced 92% of its microchips from a single Taiwanese supplier. The sponsor identified that the chips were classified under HS 8542.31, subject to US export controls for any end-use in “advanced manufacturing.” The sponsor’s GRM flagged this as a red-flag risk, and the HKEX required a specific risk factor in the prospectus stating that any US restriction on Taiwan-sourced chips would halt production.

Layer 3: Regulatory and Legal Opinion Verification

The third layer requires the sponsor to obtain and verify legal opinions on the enforceability of contracts and the legality of operations in jurisdictions where trade friction is present. This is not a generic opinion; it must address the specific risk.

For a listing applicant with operations in Hong Kong, the sponsor must obtain:

• A PRC legal opinion: On the applicant’s compliance with PRC export control laws (Export Control Law of the PRC, effective 1 December 2020) and the Unreliable Entity List (UEL) regulations.
• A US legal opinion: On the applicant’s exposure to US sanctions (OFAC) and the Export Administration Regulations (EAR), including whether the applicant’s products are subject to the “foreign direct product rule” (FDPR).
• A Hong Kong legal opinion: On the applicability of Hong Kong’s own sanctions regime under the United Nations Sanctions Ordinance (Cap. 537) and any domestic trade restrictions.

The opinions must be dated within 90 days of the listing application. The sponsor must also conduct a “reverse due diligence” call with the law firms to confirm that the opinions are based on current laws and that there are no pending changes that would alter the conclusion.

Disclosure Obligations in the Prospectus

Risk Factors: The “Geopolitical Risk Factor” Requirement

HKEX-GL117-24 mandates a standalone risk factor titled “Risks Related to Geopolitical and Trade Friction Exposure” in the prospectus. This risk factor must:

• Quantify exposure: State the percentage of revenue derived from jurisdictions subject to trade restrictions, and the percentage of COGS tied to suppliers in those jurisdictions. Vague language like “some exposure” is not acceptable.
• Name the jurisdiction: The prospectus must name the specific country or region (e.g., “the United States,” “the European Union,” “the People’s Republic of China”) and the specific trade measure (e.g., “Section 301 tariffs,” “EU Anti-Dumping Regulation (EU) 2023/1234”).
• Describe the mitigation: If the applicant has taken steps to mitigate the risk (e.g., diversifying suppliers, pre-paying tariffs, obtaining licences), those steps must be described in detail, including the cost and timeline.

The SFC’s 2025 Enforcement Bulletin No. 56 (July 2025) cited a sponsor for including a risk factor that stated “the Company may be affected by trade tensions between the US and China” without quantification. The SFC found this to be a breach of paragraph 17 because the risk factor did not allow an investor to make an informed assessment of the materiality.

Financial Disclosures: The “Tariff Sensitivity Analysis”

The prospectus must include a “Tariff Sensitivity Analysis” in the financial section, typically as a note to the accountant’s report. This analysis must:

• Model the impact on revenue, COGS, and net profit: For a 10%, 25%, and 50% increase in applicable tariffs on the applicant’s top three product lines by revenue.
• Include a worst-case scenario: Where the applicant loses access to its largest export market (usually the US or EU) entirely.
• State the assumptions: The sponsor must disclose the assumed exchange rate, the elasticity of demand (i.e., how much volume would drop if prices increased), and the assumed ability to pass through costs to customers.

A 2025 example from a PRC-based consumer electronics applicant: the sponsor’s analysis showed that a 25% tariff increase (consistent with the 2025 US tariff schedule) would reduce net profit by 18.7%, assuming no cost pass-through. The applicant’s independent business valuation (IBV) was adjusted downward by 22% to reflect this risk, and the sponsor disclosed the adjustment in the prospectus.

Deal Structuring Adjustments for Geopolitical Risk

Underwriting Agreement: MAC Clauses and Termination Rights

The sponsor must ensure that the underwriting agreement contains a “Geopolitical MAC” clause that gives the underwriter the right to terminate the agreement if a trade restriction event occurs between the signing of the prospectus and the listing date. The clause should specify:

• Triggering events: A list of specific events, such as the imposition of a new tariff of >10% on the applicant’s products, the addition of the applicant or its major supplier to a sanctions list, or the imposition of an export control that prevents the applicant from obtaining a critical input.
• Materiality threshold: The event must have a material adverse effect on the applicant’s business, defined as a reduction in projected revenue or net profit of >10% (or a lower threshold if the applicant is a pre-revenue biotech or SPAC).
• Notice period: The underwriter must give written notice within 5 business days of becoming aware of the event.

The HKEX’s 2025 Listing Committee Decision Letter (LCD-2025-07) on a failed listing of a PRC-based lithium battery manufacturer illustrates the consequence of an inadequate MAC clause. The applicant’s largest customer (a US electric vehicle manufacturer) was added to the US Entity List after the prospectus was circulated but before the listing. The underwriting agreement had a generic MAC clause that did not specifically reference sanctions, and the underwriter was unable to terminate without a protracted legal dispute. The listing was ultimately withdrawn, and the sponsor faced an SFC investigation for not recommending a more robust clause.

Price Range and Valuation Adjustments

The sponsor must adjust the indicative price range to reflect geopolitical risk. The standard approach, as outlined in the HKEX’s 2025 Market Consultation Paper on IPO Pricing, is to apply a “geopolitical discount” of 10-25% to the mid-point of the valuation range, depending on the severity of the risk.

For example, for a PRC-based applicant with >50% of revenue from the US market, the sponsor should apply a discount at the higher end of the range. This discount is not a markdown; it is a structural adjustment to the valuation methodology. The sponsor must document the rationale for the discount in the valuation report, referencing the tariff sensitivity analysis and the GRM.

Cornerstone Investor and Placing Structure

For listings with a cornerstone tranche, the sponsor must ensure that the cornerstone subscription agreement contains a “geopolitical termination right” that mirrors the underwriting agreement’s MAC clause. This is particularly important for cornerstone investors who are state-owned enterprises (SOEs) from jurisdictions subject to trade restrictions (e.g., PRC SOEs investing in a US-facing company).

The placing structure itself may need to be adjusted. If the listing applicant is subject to US sanctions, the sponsor cannot place shares to US persons without a specific exemption. The sponsor must obtain a legal opinion on the availability of a “General License” from OFAC or ensure that the placing is limited to non-US persons under Regulation S of the US Securities Act of 1933.

Practical Case Studies from the 2025-2026 Cycle

Case Study 1: The PRC Semiconductor Applicant

A PRC-based semiconductor design company (fabrication outsourced to Taiwan) sought a Main Board listing in Q1 2025. The sponsor’s due diligence identified that the company’s primary foundry (TSMC) was subject to US export controls on advanced chips (7nm and below). The sponsor obtained a US legal opinion confirming that the company’s chips (designed for automotive applications, not AI) were not subject to the FDPR. However, the GRM flagged a secondary risk: the company’s EDA (electronic design automation) software was licensed from a US company (Cadence) under an end-user agreement that prohibited use for “military applications.” The sponsor could not confirm that the company’s chips would not be used in military applications by its downstream customers.

The HKEX required the prospectus to include a risk factor stating that any change in the US export control regime could result in the loss of EDA software access, which would halt design work. The sponsor also required the company to obtain a “certificate of end-use” from its top three customers, confirming non-military use. The listing proceeded at a 15% discount to the original valuation range.

Case Study 2: The Hong Kong Logistics Applicant

A Hong Kong-based logistics company with significant operations in the PRC and the US sought a listing in Q3 2025. The sponsor’s due diligence revealed that the company’s largest contract (22% of revenue) was with a PRC e-commerce platform that had been added to the US “Entity List” for alleged forced labour practices. The sponsor obtained a PRC legal opinion confirming that the contract was legal under PRC law, but a US legal opinion stated that any US person (including the company’s US subsidiary) could face secondary sanctions for facilitating the contract.

The sponsor structured the listing so that the US subsidiary was ring-fenced: it would not participate in the contract, and the company would create a separate Hong Kong entity to manage the PRC-facing business. The prospectus disclosed the ring-fencing structure and the associated risk. The listing was approved, but the sponsor noted that the ring-fencing added HKD 3.2 million in legal and restructuring costs.

Actionable Takeaways for Sponsors

1. Integrate the Geopolitical Risk Matrix (GRM) into the sponsor’s due diligence work programme from the initial engagement letter stage, not as a last-minute addition before the A1 filing.
2. Obtain legal opinions from at least three jurisdictions (PRC, US, and Hong Kong) for any applicant with cross-border operations, and ensure the opinions are dated within 90 days of the listing application.
3. Model a minimum of three tariff scenarios in the financial disclosures, including a worst-case scenario that assumes complete loss of access to the largest export market.
4. Draft the underwriting agreement’s MAC clause to include specific triggering events related to sanctions, export controls, and tariff increases, with a materiality threshold of no more than 10% of projected revenue.
5. Apply a documented geopolitical discount of 10-25% to the valuation range, supported by the tariff sensitivity analysis and the GRM, and disclose the discount in the valuation report.