Independent Market Research on the Competitive Landscape in Sponsor Due Diligence

The SFC’s 2024-25 enforcement focus on sponsor due diligence has shifted from procedural compliance to the substantive quality of market analysis, directly impacting how sponsors must validate a listing applicant’s competitive position. In its 2024 Annual Enforcement Report, the SFC highlighted that deficiencies in assessing an issuer’s market share, competitive advantages, and industry growth assumptions remain a recurring theme in disciplinary actions against sponsors under the Code of Conduct for Persons Licensed by or Registered with the SFC (the Code). Specifically, paragraph 17.6 of the Code mandates that a sponsor must conduct “reasonable due diligence” to ensure that all material information in a listing document is accurate and complete in all material respects. For sponsors holding a Type 6 (advising on corporate finance) or Type 6A (sponsor) licence, the independent market research supporting a prospectus’s “Competitive Landscape” section is no longer a box-ticking exercise; it is a primary source of regulatory liability. A single misstatement about a competitor’s market share, or a failure to verify a third-party industry report cited in a prospectus, can trigger an SFC investigation and potential disciplinary action under the Securities and Futures Ordinance (SFO). This article examines the specific regulatory expectations, common pitfalls, and best practices for conducting independent market research on the competitive landscape in sponsor due diligence, drawing on SFC circulars, HKEX listing decisions, and industry standards.

The Regulatory Mandate for Independent Market Research

The SFC’s expectation for independent market research is not a recent invention but has been progressively codified through enforcement actions and guidance. The cornerstone remains the SFC’s 2012 Consultation Conclusions on the Regulation of Sponsors and the subsequent 2013 amendments to the Code, which introduced the explicit requirement for sponsors to take reasonable steps to verify the factual basis of an issuer’s competitive claims. The 2024 enforcement report, however, sharpens this focus by noting that the SFC’s inspection team now routinely reviews the sponsor’s working papers for market research, specifically looking for evidence of independent verification against third-party data sources.

The “Reasonable Steps” Standard Under Paragraph 17.6

Paragraph 17.6 of the Code does not prescribe a single methodology for market research, but the SFC’s published decisions create a clear benchmark. In the 2020 disciplinary action against a sponsor (SFC press release, 23 September 2020), the SFC found that the sponsor had failed to take reasonable steps to verify a statement in the prospectus that the issuer was the “largest” in its sector. The sponsor had relied solely on a management representation letter and a single industry report commissioned by the issuer. The SFC’s Statement of Disciplinary Action noted that the sponsor should have cross-checked the issuer’s claim against publicly available data from the Hong Kong Trade Development Council (HKTDC) or the Census and Statistics Department, which showed a different market ranking. This case established that reliance on a single source, particularly one provided by the issuer, does not constitute “reasonable steps.”

The 2024-25 SFC Inspection Focus Areas

The SFC’s 2024 Annual Enforcement Report explicitly states that its inspections of sponsor files in 2024 identified “recurring deficiencies” in the verification of market data. These deficiencies included: (i) failure to obtain the underlying methodology of third-party industry reports; (ii) reliance on outdated or non-publicly verifiable data; and (iii) absence of any reconciliation between the issuer’s internal sales data and external market size estimates. The SFC’s Director of Enforcement, in a February 2025 speech at the Hong Kong Capital Markets Association, emphasised that the regulator now expects sponsors to “triangulate” market data from at least three independent sources: a government or trade association source, a recognised industry research firm, and a publicly available competitor analysis (e.g., annual reports of listed peers). This triangulation requirement is not stated in any single rule but is emerging as an industry standard from enforcement commentary.

Structuring the Independent Market Research Process

A robust independent market research process for the competitive landscape must be documented from the start of the sponsor’s engagement to the finalisation of the prospectus. The SFC’s 2017 “Guidance Note on Sponsor Due Diligence” (a non-binding but influential document) outlines a risk-based approach, and this applies directly to market research. The sponsor should categorise the issuer’s competitive claims by risk level: high-risk claims include market share rankings, revenue growth comparisons, and statements about technological superiority; medium-risk claims include customer concentration and supplier relationships; low-risk claims include general industry descriptions.

Source Selection and Verification

The first step is to identify the universe of potential data sources. For a Main Board listing applicant in the manufacturing sector, for example, the sponsor should identify: (i) official government statistics (e.g., Hong Kong’s Census and Statistics Department or the PRC’s National Bureau of Statistics); (ii) industry-specific trade associations (e.g., the Hong Kong Apparel Association); (iii) recognised third-party market research firms (e.g., Frost & Sullivan, Euromonitor, IDC); and (iv) public filings of listed competitors (e.g., annual reports, stock exchange filings in Hong Kong, Shanghai, or Shenzhen). The sponsor must then verify each source’s credibility. For a third-party report, the sponsor should obtain the full methodology, including sample size, geographic coverage, and the definition of the market being measured. If the report does not disclose its methodology, the SFC’s expectation is that the sponsor cannot rely on it as a primary source. In a 2022 HKEX listing decision (HKEX-LD-2022-001), the Exchange questioned the sponsor’s reliance on a market report that lacked a clear audit trail for its market size estimates, leading to a request for supplemental due diligence.

Data Reconciliation and Gap Analysis

Once sources are collected, the sponsor must reconcile the data. If the issuer claims a 25% market share in a specific segment, the sponsor should compare this figure against: (i) the total addressable market (TAM) from a government source; (ii) the revenue of the top three competitors from their annual reports; and (iii) any independent industry survey data. A gap of more than 10% between the issuer’s claim and the sponsor’s independent calculation should trigger a red flag and require additional verification. The sponsor’s working papers must document this reconciliation process, including the specific arithmetic used. The SFC’s 2023 disciplinary action against a sponsor for inadequate market share verification (SFC press release, 15 March 2023) cited the sponsor’s failure to perform any arithmetic reconciliation as a key deficiency.

Documenting the Research and Conclusions

The sponsor’s due diligence memorandum on the competitive landscape must include a clear section titled “Independent Market Research.” This section should list every source consulted, the date of access, the specific data points extracted, and the sponsor’s conclusion on reliability. For each material claim in the prospectus, the memorandum should cross-reference the supporting source. The SFC’s inspection team in 2024 specifically looked for “negative evidence” – that is, whether the sponsor had actively sought information that could contradict the issuer’s claims. A sponsor that only collected favourable data without searching for contradictory evidence is at risk. The memorandum should therefore include a “Contradictory Evidence Search” subsection, documenting searches of competitor websites, news archives, and regulatory filings for information that might undermine the issuer’s competitive position.

Common Pitfalls in Competitive Landscape Analysis

Despite the clear regulatory guidance, sponsors continue to make recurring errors in their competitive landscape analysis. These pitfalls are well-documented in SFC enforcement actions and HKEX listing decisions from 2022 to 2025.

Over-Reliance on the Issuer’s Commissioned Report

The most common pitfall is treating a third-party report commissioned by the issuer as an independent source. While such reports can be useful, the SFC’s position is clear: a report paid for by the issuer is not “independent” for due diligence purposes. In a 2024 SFC enforcement case (SFC press release, 12 June 2024), the sponsor relied on a Frost & Sullivan report commissioned by the issuer to support a claim of “leading market position.” The SFC found that the sponsor had not verified the report’s underlying assumptions, such as the definition of the product category or the geographic scope. The sponsor was fined HKD 12 million. The lesson is that any commissioned report must be treated as a starting point, not a conclusion. The sponsor must independently verify the report’s key assumptions against public data.

Ignoring Competitor Public Filings

Another recurring deficiency is the failure to use competitor public filings to cross-check the issuer’s claims. For example, if the issuer claims to have a 30% market share, the sponsor should calculate the implied market size and compare it against the revenue of the largest listed competitor. If the competitor’s revenue suggests a different market size, the sponsor must investigate the discrepancy. In a 2023 HKEX listing decision (HKEX-LD-2023-005), the Exchange required the sponsor to provide a detailed reconciliation between the issuer’s market share claim and the financial statements of the top three competitors. The sponsor had not performed this reconciliation, and the listing was delayed by three months.

Failure to Define the Market Correctly

The definition of the “market” in which the issuer competes is critical and often contested. The sponsor must ensure that the market definition used in the prospectus is consistent with industry practice and is not artificially narrow to inflate the issuer’s share. The SFC’s 2022 “Report on the Quality of Listing Applications” noted that some sponsors defined the market by a single product feature or a specific customer segment, which was not supported by independent industry reports. The sponsor should justify the market definition in the due diligence memorandum, citing industry standards or trade association definitions. If the market definition is novel, the sponsor should include a sensitivity analysis showing how the issuer’s market share would change under alternative definitions.

Best Practices for Independent Market Research in 2025-2026

Given the evolving regulatory landscape, sponsors should adopt a proactive and structured approach to independent market research. The following best practices are drawn from SFC guidance, industry standards, and the experiences of leading sponsor firms.

Establish a Dedicated Market Research Protocol

Every sponsor firm should have a written internal protocol for conducting independent market research on the competitive landscape. This protocol should specify the minimum number of independent sources required for each risk category, the acceptable types of sources, and the documentation standards. The protocol should be reviewed annually and updated to reflect new SFC circulars and enforcement actions. For example, following the 2024 enforcement case on commissioned reports, many firms have added a requirement that any commissioned report must be accompanied by a written methodology from the research firm and a reconciliation statement from the sponsor.

Engage External Specialists for Complex Industries

For listing applicants in highly specialised or emerging industries (e.g., biotechnology, clean energy, AI software), sponsors should consider engaging an independent external specialist to validate the competitive landscape. The specialist should be a recognised firm with no prior relationship with the issuer. The engagement letter should specify that the specialist’s work will be used for regulatory due diligence and that the specialist must provide full access to their methodology and underlying data. The sponsor should then incorporate the specialist’s report into its own due diligence memorandum, with a clear explanation of how the specialist’s conclusions were verified.

Conduct a “Red Team” Review

A “red team” review involves assigning a separate team within the sponsor firm (or an external consultant) to challenge the issuer’s competitive claims from a sceptical perspective. This team should attempt to find evidence that contradicts the issuer’s market share, growth rate, or competitive advantage claims. The red team’s findings should be documented and addressed in the due diligence memorandum. This practice is not yet mandated by the SFC, but it is increasingly seen as a best practice by leading Hong Kong sponsors. In a 2025 industry roundtable hosted by the Hong Kong Securities and Investment Institute, several senior compliance officers stated that their firms now conduct red team reviews on all Main Board applications.

Use a Standardised Verification Checklist

A standardised verification checklist for the competitive landscape section can help ensure consistency and completeness. The checklist should include items such as: (i) Has the market definition been verified against at least two independent sources? (ii) Have the issuer’s top three competitors been identified and their public filings reviewed? (iii) Has the issuer’s market share been reconciled against the implied market size from competitor data? (iv) Have any third-party reports been verified for methodology and independence? (v) Has a search for contradictory evidence been conducted? The completed checklist should be signed off by the sponsor’s principal and the compliance officer, and filed in the working papers.

Actionable Takeaways

1. The SFC’s 2024-25 enforcement focus requires sponsors to triangulate all material competitive landscape claims from at least three independent sources, with documented methodology and reconciliation.
2. Any third-party industry report commissioned by the issuer must be treated as a starting point only; the sponsor must independently verify its key assumptions against public data from government sources or competitor filings.
3. The sponsor’s due diligence memorandum must include a dedicated “Contradictory Evidence Search” subsection, documenting efforts to find information that could undermine the issuer’s competitive position.
4. For listing applicants in complex or emerging industries, engaging an independent external specialist with no prior relationship to the issuer is now a recommended practice to meet the “reasonable steps” standard under paragraph 17.6 of the Code.
5. A standardised verification checklist, signed off by the sponsor principal and compliance officer, should be filed in the working papers for every prospectus competitive landscape section to demonstrate a systematic and defensible due diligence process.