Sponsor Fee Arrangements and Independence Risks: Lessons from Recent SFC Enforcement Cases

The Securities and Futures Commission’s (SFC) enforcement focus on sponsor independence has sharpened materially since the 2024-2025 financial year, with two separate disciplinary actions against licensed sponsors in Q1 2025 alone directly challenging fee structures linked to post-listing performance. These cases signal that the regulator is now scrutinising not only the quality of due diligence but also the commercial terms underpinning sponsor mandates. For licensed corporations holding Type 6 (advising on corporate finance) and Type 6A (sponsoring) regulated activities, the distinction between a standard advisory fee and an arrangement that compromises independence has become a critical compliance boundary. The SFC’s 2024 Annual Report recorded 12 enforcement actions against sponsors and corporate finance advisors, the highest in five years, with three of those cases explicitly citing fee-related independence failures under the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (the SFC Code), paragraph 16.3. This article examines the specific fee structures that triggered regulatory action, the applicable legal framework under the SFC Code and the Hong Kong Stock Exchange (HKEX) Listing Rules, and the structural safeguards sponsors must implement to avoid similar enforcement outcomes.

The Regulatory Framework for Sponsor Independence

Paragraph 16.3 of the SFC Code and the “No Conflict” Principle

The foundational requirement for sponsor independence is codified in paragraph 16.3 of the SFC Code, which mandates that a sponsor must “not be subject to any conflict of interest that would impair its ability to discharge its duties as a sponsor.” The SFC’s 2023 Thematic Inspection Report on Sponsors (the 2023 Thematic Report) clarified that this prohibition extends to fee arrangements that create a financial incentive to overlook material deficiencies in an IPO applicant’s disclosure or business model. Specifically, the report identified three fee structures as presumptively problematic: (i) success fees contingent on the listing occurring at a specific valuation; (ii) deferred fees payable only after a lock-up period expires; and (iii) any fee calculated as a percentage of the total funds raised, where the sponsor also holds a material equity interest in the applicant. The SFC noted in the 2023 Thematic Report that such arrangements could “create a perverse incentive for a sponsor to recommend listing approval despite unresolved due diligence issues.”

The HKEX Listing Rules’ Implicit Independence Requirements

While the HKEX Listing Rules do not contain an explicit “independence fee” provision for sponsors, Rule 3A.06 requires that a sponsor “must be independent of the new applicant.” The Exchange’s Guidance Letter HKEX-GL86-16 (December 2016) elaborates that independence is assessed not only by equity ownership but also by the “nature and structure of any commercial arrangement, including fee arrangements, that could reasonably be perceived to influence the sponsor’s judgment.” In practice, the Listing Division has rejected at least four IPO applications between 2022 and 2024 where the sponsor’s fee structure was deemed to create a conflict of interest, according to publicly available Listing Decision summaries. These decisions underscore that the Exchange’s review extends beyond the sponsor’s legal independence declaration to the economic substance of the engagement.

Case Studies: Fee Structures That Triggered Enforcement

Case 1: The Deferred Success Fee and the Missed Red Flag (SFC Disciplinary Action, March 2025)

In March 2025, the SFC publicly reprimanded Sponsor A and fined it HKD 12.5 million for failures in its sponsor work on the Main Board listing of a PRC-based technology company in 2021. The enforcement notice, SFC v. Sponsor A (2025), detailed a fee arrangement where 40% of the total sponsor fee (HKD 8 million out of HKD 20 million) was deferred and payable only if the company maintained a market capitalisation above HKD 5 billion for six consecutive months post-listing. The SFC found that this structure created a direct financial incentive for Sponsor A to downplay the significance of a related-party transaction that the company’s auditor had flagged as potentially fraudulent. The sponsor’s due diligence team had identified the transaction during the pre-listing review but, in the SFC’s assessment, “failed to escalate the issue to the sponsor’s compliance committee or to seek independent legal advice” because doing so would have delayed the listing and risked triggering the fee deferral condition. The SFC concluded that the fee arrangement violated paragraph 16.3 of the SFC Code and that Sponsor A had also breached paragraph 17.6, which requires a sponsor to “take reasonable steps to ensure that all material information is included in the listing document.”

Case 2: The Valuation-Linked Fee and the Inflated Revenue Recognition (SFC Disciplinary Action, January 2025)

A second case, announced in January 2025, involved Sponsor B, which had agreed to a fee of HKD 15 million, with an additional HKD 5 million bonus payable if the IPO achieved a price-to-earnings (P/E) ratio of 25x or higher. The applicant, a healthcare company incorporated in the Cayman Islands with operating subsidiaries in the PRC, had reported revenue growth of 300% year-on-year in its 2020 financial statements. Sponsor B’s due diligence team accepted management’s explanation for this growth without verifying the underlying contracts with the top five customers, which accounted for 82% of the revenue increase. The SFC’s investigation revealed that three of those customers were shell companies registered at the same address in Shenzhen. The SFC fined Sponsor B HKD 18 million and suspended its Type 6A licence for 18 months, citing a “systemic failure in sponsor due diligence directly attributable to the fee structure.” The SFC’s press release explicitly stated that “a fee arrangement that rewards a sponsor for achieving a higher listing valuation creates an unacceptable risk that the sponsor will cut corners in its verification of financial statements.”

Structural Risks in Common Fee Models

The Percentage-of-Proceeds Model

The most prevalent fee structure in Hong Kong IPOs is the percentage-of-proceeds model, where the sponsor’s fee is calculated as a fixed percentage of the total funds raised, typically between 2.5% and 4.0% for Main Board listings. While this model is not prohibited per se, the SFC’s 2023 Thematic Report warned that it becomes problematic when the sponsor also holds a material equity interest in the applicant, as the sponsor then has a dual incentive to maximise the offering size and the valuation. The SFC recommended that sponsors in such situations implement a “fee cap” mechanism, where the maximum fee is fixed in absolute terms, and that the sponsor’s compliance officer certify in writing that the fee does not create an independence risk. The 2023 Thematic Report noted that only 34% of the 50 sponsors surveyed had such a mechanism in place as of December 2022.

Milestone-Based Fees and the Timing Trap

Milestone-based fees, where the sponsor receives payments at specific stages of the IPO process (e.g., submission of A1 filing, passing of listing hearing, and listing date), are standard in the market. However, the SFC’s enforcement actions have highlighted the risk when the final milestone payment is disproportionately large relative to the earlier payments. In Sponsor A’s case, the final payment represented 60% of the total fee. The SFC’s 2023 Thematic Report recommended that no single milestone payment exceed 40% of the total fee and that the final payment be capped at 30% to reduce the incentive to rush the listing process. The report also suggested that sponsors include a “clawback” provision in their engagement letters, allowing the sponsor to reduce or cancel the final payment if material issues emerge after the listing hearing.

The Emerging Risk of Equity-Linked Fees

A more recent development is the use of equity-linked fees, where the sponsor accepts a portion of its fee in the form of warrants or shares in the listed entity. While the SFC has not yet taken formal enforcement action on this model, the 2023 Thematic Report flagged it as a “high-risk” arrangement that requires enhanced disclosure and independent compliance review. The report noted that such fees could create a conflict of interest that persists beyond the listing date, as the sponsor may be incentivised to support the company’s stock price through positive research coverage or favourable analyst reports. The SFC recommended that sponsors who accept equity-linked fees must (i) disclose the arrangement in the prospectus; (ii) implement a Chinese wall between the sponsor team and the research department; and (iii) obtain a legal opinion confirming that the arrangement does not violate paragraph 16.3 of the SFC Code.

Practical Safeguards for Sponsor Compliance

Pre-Engagement Independence Assessment

Every sponsor should conduct a formal independence assessment before accepting a mandate, documented in a written memorandum that addresses the specific fee structure. The assessment should consider: (i) whether the fee is contingent on any event other than the successful completion of the sponsor’s duties; (ii) whether the fee creates a financial incentive to overlook material deficiencies; and (iii) whether the structure could reasonably be perceived by a third party as compromising independence. The assessment should be reviewed by the sponsor’s compliance officer and, where the fee is novel or complex, by external legal counsel with experience in SFC enforcement cases.

Fee Structure Documentation and Disclosure

The engagement letter should clearly separate the sponsor’s fee from any success-based or valuation-linked components. The SFC’s 2023 Thematic Report recommended that sponsors include a clause stating that the fee is payable regardless of whether the listing is completed, and that no additional payment is contingent on the listing price, valuation, or post-listing performance. The sponsor should also disclose the fee structure in the prospectus under the “Sponsor’s Interests” section, as required by the Listing Rules Appendix 1A, paragraph 53(2). Failure to make such disclosure could itself constitute a breach of the Securities and Futures Ordinance (Cap. 571), section 384, which requires that all material information be included in the listing document.

Internal Compliance Controls for Fee Monitoring

The sponsor’s compliance department should maintain a register of all fee arrangements, with a specific flag for any structure that deviates from the standard fixed-fee model. The register should be reviewed quarterly by the sponsor’s board of directors, or by the designated compliance committee where one exists. The SFC’s 2023 Thematic Report recommended that sponsors conduct an annual “fee independence audit,” where an independent internal or external auditor reviews a sample of fee arrangements to assess compliance with paragraph 16.3 of the SFC Code. The audit findings should be reported to the SFC as part of the sponsor’s annual compliance return.

Conclusion: Three Actionable Takeaways for Sponsor Compliance

First, sponsors must treat any fee arrangement that is contingent on the listing price, valuation, or post-listing performance as a presumptive conflict of interest under paragraph 16.3 of the SFC Code, requiring full documentation and independent legal review. Second, the engagement letter must contain a clear statement that the fee is payable irrespective of the listing outcome, and that no additional payment is linked to the company’s market performance or any other factor that could impair the sponsor’s objectivity. Third, the sponsor’s compliance officer should maintain a centralised register of all fee structures, with quarterly board-level review and an annual independent audit, to ensure that the sponsor can demonstrate to the SFC that it has implemented adequate controls to identify and mitigate independence risks.