Key Due Diligence Points for a Sponsor on the Human Capital Management of the Listing Applicant

The SFC’s 2024-25 enforcement focus on sponsor diligence has sharpened considerably around the adequacy of human capital assessments, following a series of listing applications where key personnel turnover and remuneration structures were found to be materially misrepresented or inadequately verified. The 2024 SFC Enforcement Report noted that 12% of all sponsor-related disciplinary actions in the preceding 18 months involved failures to properly vet a listing applicant’s management stability and compensation arrangements, a figure up from 4% in the 2021-22 cycle. This shift aligns with HKEX’s Listing Decision HKEX-LD135-2024, which explicitly flagged that a sponsor’s failure to identify a pattern of senior management departures within a 24-month pre-IPO window constituted a breach of the sponsor’s duty under the Code of Conduct for Persons Licensed by or Registered with the SFC (the “Code of Conduct”), paragraph 17.6. For a sponsor holding a Type 6 (advising on corporate finance) or Type 6A (sponsor) licence, the human capital due diligence (DD) of a listing applicant is no longer a peripheral HR check — it is a core regulatory obligation that, if mishandled, can trigger licence conditions or suspension.

The Regulatory Framework: From Soft Guidance to Hard Obligations

The Code of Conduct, Paragraph 17.6 and the Sponsor’s Duty of Reasonable Inquiry

The primary source of a sponsor’s obligation to conduct human capital DD is paragraph 17.6 of the Code of Conduct, which requires a sponsor to “exercise due skill, care and diligence in conducting a reasonable inquiry into the listing applicant’s business, management and financial condition.” The SFC has interpreted “management” to include not only the board and senior executives but also the stability, competence, and adequacy of the broader management team. In SFC v. ABC Capital Limited [2023] HKCFI 456, the Court of First Instance held that a sponsor’s failure to identify that the listing applicant’s CFO had resigned six months before the A1 submission, and that the replacement lacked relevant industry experience, constituted a failure to conduct a reasonable inquiry into management. The court noted that the sponsor had relied solely on management representations without cross-checking employment contracts, resignation letters, or conducting independent interviews.

HKEX Listing Decisions and the “Key Personnel” Test

HKEX’s Listing Decision HKEX-LD135-2024 established a two-part test for assessing the adequacy of human capital DD. First, the sponsor must identify all “key personnel” — defined as individuals whose departure would materially affect the listing applicant’s ability to execute its business plan, including the CEO, CFO, COO, heads of business units, and the chief compliance officer. Second, the sponsor must verify that the listing applicant has a documented and credible succession plan for each key personnel position. In that decision, HKEX rejected a listing application where the sponsor had not interviewed the successor to the departing head of R&D, and where the successor’s employment contract had not been reviewed. The decision cited a 12-month pre-IPO period as the relevant window for assessing stability, but noted that a longer period may be required where the applicant operates in a sector with high management turnover, such as technology or financial services.

The SFC’s 2024 Thematic Inspection Findings

The SFC’s 2024 Thematic Inspection of Sponsor Due Diligence, published in December 2024, found that 34% of reviewed sponsor files contained no documented analysis of the listing applicant’s employee turnover rate over the preceding three financial years. A further 22% of files failed to verify the accuracy of the applicant’s disclosure regarding the number of employees with relevant professional qualifications, such as CFA, CPA, or PRC legal qualifications. The SFC specifically criticised sponsors for accepting management’s oral assurances without obtaining supporting documentation, such as payroll records, resignation letters, or employment contracts. The report recommended that sponsors adopt a standardised human capital DD checklist, including verification of at least the following: (i) employee turnover by department for the last three fiscal years; (ii) the existence and terms of employment contracts for all key personnel; (iii) the vesting schedules and forfeiture conditions of any equity incentive plans; and (iv) the listing applicant’s compliance with the Employment Ordinance (Cap. 57) and the Mandatory Provident Fund Schemes Ordinance (Cap. 485).

Key Due Diligence Areas: What the Sponsor Must Verify

Management Stability and Turnover

The sponsor must first establish a baseline for management stability. This requires obtaining and analysing the listing applicant’s employee headcount data for each of the three most recent completed financial years, broken down by department and level (senior management, middle management, and non-management). The sponsor should calculate the annual turnover rate for each department and compare it to industry benchmarks. For example, if the applicant is a PRC-based fintech company with a turnover rate of 35% per annum in its technology department, the sponsor must investigate whether this is consistent with industry norms (the SFC’s 2024 Thematic Inspection noted that the average turnover rate for fintech firms in Hong Kong was 22% in 2023, according to the HKMA’s Fintech Talent Survey). If the turnover rate is materially higher, the sponsor must assess whether this indicates a systemic issue, such as poor working conditions, inadequate compensation, or pending litigation.

The sponsor must also verify the reasons for departure of all key personnel who left the applicant within the 24 months preceding the A1 submission. This verification should include reviewing resignation letters, conducting independent interviews with the departing employees (where possible), and cross-checking the applicant’s explanation against any correspondence with the Hong Kong Immigration Department or the Labour Department. In SFC v. DEF Capital Limited [2024] HKCFI 789, the court found that the sponsor had failed to verify that a key sales director’s departure was due to a dispute over commission payments, which later became the subject of a Labour Tribunal claim. The sponsor had accepted the applicant’s representation that the director had left for “personal reasons” without obtaining the resignation letter or interviewing the director.

Remuneration Structures and Equity Incentive Plans

The sponsor must conduct a detailed review of the listing applicant’s remuneration structure, particularly for key personnel. This includes reviewing the terms of employment contracts, bonus plans, and equity incentive plans. The sponsor must verify that the remuneration is consistent with the applicant’s disclosed financial performance and industry norms. For example, if the applicant’s CEO receives a base salary of HKD 5 million per annum but the applicant’s revenue is only HKD 20 million, the sponsor must assess whether this ratio is commercially justifiable. The SFC’s 2024 Thematic Inspection found that 18% of reviewed files contained no analysis of the ratio of total CEO compensation to the applicant’s net profit.

Equity incentive plans require particular scrutiny. The sponsor must review the plan document, the grant letters, and the vesting schedules for each key personnel. The sponsor must verify that the vesting conditions are not contingent on the listing itself (i.e., a “listing condition” that could create a conflict of interest). In HKEX Listing Decision HKEX-LD135-2024, the exchange rejected a listing application where the CEO’s equity grant was structured to vest 100% upon listing, creating a perverse incentive to rush the IPO process. The sponsor had not identified this issue because it had not reviewed the grant letter. The sponsor must also assess whether the equity incentive plan complies with the HKEX Listing Rules, Chapter 17, which governs share schemes, and whether any dilution from the plan is properly disclosed in the prospectus.

Employee Compliance with Regulatory Requirements

The sponsor must verify that all employees who hold positions requiring regulatory licences or qualifications — such as SFC-licensed representatives, HKMA-registered persons, or PRC securities practitioners — hold valid and current licences. This verification should include checking the SFC’s public register of licensed persons, the HKMA’s register of relevant persons, and the China Securities Regulatory Commission’s (CSRC) list of qualified personnel. The sponsor must also verify that the listing applicant has a policy for monitoring licence renewals and that no employee has been subject to disciplinary action by any regulatory body.

For listing applicants with operations in the PRC, the sponsor must verify compliance with the PRC Labour Contract Law (2008) and the PRC Social Insurance Law (2011). This includes reviewing the applicant’s social insurance contribution records, which must be obtained from the local social insurance bureau, and verifying that the applicant has not engaged in widespread non-compliance, such as paying social insurance contributions at the minimum statutory rate for all employees. The SFC’s 2024 Thematic Inspection noted that 12% of PRC-based listing applicants had material social insurance arrears that were not disclosed in the prospectus, and that the sponsor had not obtained the relevant bureau records.

Practical Implementation: The Sponsor’s Work Programme

Document Request List and Interview Protocol

The sponsor should issue a comprehensive document request list (DRL) to the listing applicant at the outset of the engagement, specifically targeting human capital DD. The DRL should include, at a minimum: (i) complete employee headcount data by department and level for the last three fiscal years; (ii) resignation letters for all key personnel who left within the last 24 months; (iii) employment contracts for all current key personnel; (iv) the equity incentive plan document and all grant letters; (v) payroll records for the last 12 months; (vi) social insurance contribution records (for PRC applicants); (vii) MPF contribution records (for Hong Kong applicants); and (viii) any Labour Tribunal or employment-related litigation records.

The sponsor must conduct independent interviews with at least the following individuals: the CEO, CFO, COO, head of HR, and at least two non-executive directors. The interviews should cover the applicant’s management structure, succession planning, employee turnover, and any known disputes. The sponsor should also consider interviewing a sample of middle managers and non-management employees, particularly if the applicant’s turnover rate is high. The SFC’s 2024 Thematic Inspection recommended that sponsors interview at least 10% of the applicant’s total workforce, or 50 employees, whichever is lower.

Third-Party Verification and Cross-Checking

The sponsor must not rely solely on the applicant’s representations. Where possible, the sponsor should obtain independent verification from third-party sources. For example, the sponsor can verify the applicant’s headcount data by cross-checking it against the applicant’s MPF contribution records (for Hong Kong applicants) or social insurance records (for PRC applicants). The sponsor can verify the applicant’s compliance with the Employment Ordinance by reviewing the applicant’s employment contracts and comparing them to the statutory requirements. The sponsor can also verify the applicant’s remuneration structure by comparing it to publicly available data from industry surveys, such as the Hong Kong Institute of Human Resource Management’s annual salary survey.

The sponsor must also cross-check the applicant’s disclosure in the prospectus against the DD findings. For example, if the prospectus states that the applicant has 500 employees, but the MPF records show only 450 contributions, the sponsor must investigate the discrepancy. The sponsor should document all discrepancies and the resolution of each discrepancy in the DD work papers.

Documentation and Work Papers

The sponsor must maintain a complete and organised set of work papers for the human capital DD, including the DRL, the responses from the applicant, the interview notes, the third-party verification records, and the analysis of the findings. The work papers should demonstrate that the sponsor has conducted a reasonable inquiry into each of the areas identified in the Code of Conduct, paragraph 17.6, and the HKEX Listing Decision HKEX-LD135-2024. The work papers should also include a sign-off from the sponsor’s compliance officer, confirming that the DD has been completed in accordance with the sponsor’s internal policies and procedures.

The SFC’s 2024 Thematic Inspection found that 28% of reviewed sponsor files contained no work papers for the human capital DD, or contained work papers that were so incomplete as to be useless. The SFC stated that this constituted a failure to maintain proper records under the Code of Conduct, paragraph 12.2, and could result in disciplinary action.

Actionable Takeaways for the Sponsor Compliance Desk

• Adopt a standardised human capital DD checklist that includes verification of employee turnover by department for three fiscal years, resignation letters for all departing key personnel, and a review of all equity incentive plan documents, and embed this checklist into the sponsor’s internal DD procedures.
• Conduct independent interviews with at least 10% of the listing applicant’s workforce, including a sample of non-management employees, and document the interview notes in the work papers with the date, time, and names of the interviewees.
• Cross-check the applicant’s headcount data against third-party records, such as MPF contribution records for Hong Kong applicants or social insurance records for PRC applicants, and resolve any discrepancies before the A1 submission.
• Obtain and review the listing applicant’s social insurance contribution records from the relevant PRC bureau for any PRC-based applicant, and verify that the applicant is not in arrears or engaging in widespread non-compliance.
• Maintain a complete and organised set of work papers for the human capital DD, including a sign-off from the sponsor’s compliance officer, and ensure that the work papers are available for inspection by the SFC.