The Sponsor's Role in Assessing the Rationality of the Use of Proceeds from the Listing

The Hong Kong Stock Exchange (HKEX) published its “Analysis of the Use of Proceeds from IPOs” report in January 2025, revealing that 37% of listed issuers on the Main Board had materially deviated from their stated use of proceeds within the first 24 months of listing. This finding, based on a review of 120 companies that listed between 2021 and 2023, has direct implications for sponsor liability under the SFC’s Code of Conduct. The SFC’s 2024 enforcement report noted that 60% of disciplinary actions against sponsors involved inadequate due diligence on forward-looking statements, including use of proceeds projections. With the HKEX’s new Listing Rule amendments effective 1 January 2025 requiring issuers to provide quarterly updates on fund deployment for the first three years, the sponsor’s role in assessing the rationality of these projections has moved from a procedural box-ticking exercise to a core risk management function. The regulatory shift means sponsors must now verify not just the existence of a business plan, but its economic viability against market conditions.

The Regulatory Framework: From Disclosure to Substantive Review

The SFC’s Code of Conduct and Sponsor Due Diligence Standards

Paragraph 17.6 of the SFC’s Code of Conduct for Persons Licensed by or Registered with the SFC (2015, as amended) establishes the sponsor’s obligation to “take reasonable steps to satisfy itself that each statement of fact or opinion in the listing document is accurate and complete in all material respects.” This standard applies directly to the use of proceeds section, which typically constitutes 5-8 pages of a prospectus. The SFC’s 2023 thematic review of IPO sponsors found that 45% of reviewed prospectuses contained use of proceeds statements that were either generic or lacked specific operational milestones, rendering them unverifiable at the time of listing.

The SFC’s “Guidelines on Sponsor Due Diligence” (2012, updated 2020) require sponsors to obtain and review the issuer’s board-approved business plan, including detailed cash flow projections for the first 12-24 months post-listing. The guidelines specify that sponsors must assess whether the proposed use of funds aligns with the issuer’s historical operational performance, industry benchmarks, and macroeconomic conditions. For example, a sponsor reviewing a biotech issuer’s plan to allocate 40% of proceeds to R&D must verify that the issuer has the laboratory capacity, patent pipeline, and qualified personnel to absorb that capital within the stated timeline.

HKEX Listing Rule Requirements on Use of Proceeds Disclosure

HKEX Main Board Listing Rule 11.07 requires that a prospectus contain “a statement of the purposes for which the proceeds of the issue are to be used and the order of priority in which those purposes are to be satisfied.” The HKEX’s “Guidance Letter HKEX-GL86-16” (updated 2023) further clarifies that this statement must be “specific, quantified, and linked to the issuer’s stated business objectives.” The guidance explicitly warns against generic allocations such as “working capital” or “general corporate purposes” exceeding 20% of total proceeds, a threshold that has been enforced through listing division comments since 2022.

The January 2025 HKEX report cited 14 cases where issuers allocated more than 30% of proceeds to “working capital” without providing any breakdown, and all 14 subsequently redirected those funds to acquisitions or shareholder distributions within 18 months of listing. The HKEX has since amended its vetting procedures to require sponsors to submit a “Use of Proceeds Rationality Assessment” memorandum as part of the A1 filing, which must include sensitivity analysis on the issuer’s ability to execute its stated plan under three scenarios: base case, downside case (20% revenue reduction), and upside case (20% revenue increase).

Practical Assessment Methodology: The Sponsor’s Analytical Toolkit

Financial Modelling and Cash Flow Verification

The sponsor’s assessment must begin with a bottom-up financial model that maps each use of proceeds category to specific operational expenditures. For a manufacturing issuer allocating 35% of proceeds to capacity expansion, the sponsor must verify the existence of signed equipment purchase agreements, factory lease commitments, and contractor bids. The SFC’s 2020 enforcement case against a sponsor (SFC v. [Redacted], HCMP 1234/2020) found that the sponsor failed to confirm that the issuer had actually secured the land use rights for the proposed factory site, resulting in a 24-month delay in fund deployment and a subsequent HK$150 million impairment.

The sponsor should apply a “fund absorption capacity” test, calculating the issuer’s historical capital expenditure run rate and comparing it to the proposed deployment schedule. If an issuer’s historical annual capex was HK$20 million but the prospectus proposes deploying HK$200 million in year one, the sponsor must document the basis for this step-change, whether through pre-existing contracts, acquisition targets, or scaling plans. The HKEX’s 2025 guidance notes that sponsors should obtain third-party verification for any deployment schedule that exceeds 200% of the issuer’s historical annual expenditure.

Industry Benchmarking and Market Context Analysis

Sponsors must benchmark the proposed use of proceeds against comparable listed issuers in the same GICS industry sub-sector. For a technology issuer proposing to allocate 50% of proceeds to sales and marketing, the sponsor should compare this against the industry median of 25-30% for companies at a similar revenue scale (HK$500 million to HK$2 billion). The SFC’s “Thematic Review of IPO Sponsors’ Due Diligence on Financial Projections” (2022) found that 30% of reviewed cases used no industry benchmarks whatsoever, leaving the use of proceeds statements as aspirational targets rather than verifiable plans.

The sponsor must also assess macroeconomic conditions at the time of listing. If an issuer proposes expanding into a specific geographic market that is experiencing currency controls, trade restrictions, or regulatory uncertainty, the sponsor must document how these risks are addressed. For example, a consumer goods issuer listing in 2024 that proposed allocating 25% of proceeds to mainland China retail expansion would require the sponsor to assess the impact of the PRC’s 2023 “Regulation on the Administration of Foreign Investment in Domestic Enterprises” (Decree No. 745) on the issuer’s ability to repatriate profits or deploy capital in RMB-denominated accounts.

Regulatory Enforcement and Case Studies: Consequences of Inadequate Assessment

The SFC’s Disciplinary Track Record on Use of Proceeds Failures

The SFC has taken disciplinary action against three sponsors since 2020 specifically for failures related to use of proceeds due diligence. In 2022, the SFC reprimanded and fined a sponsor HK$12 million for failing to verify that an issuer’s stated plan to allocate 40% of proceeds to “strategic acquisitions” was supported by any signed term sheets, letters of intent, or valuation reports (SFC Statement of Disciplinary Action, 15 March 2022). The issuer subsequently used 80% of the proceeds to repay related-party loans, which the sponsor had not identified as a prohibited use under the listing agreement.

The SFC’s 2024 enforcement report highlighted that 25% of all sponsor-related disciplinary actions involved misrepresentations in the use of proceeds section. The most common failure patterns were: (1) no independent verification of third-party contracts supporting the deployment plan (40% of cases), (2) failure to update the use of proceeds analysis when material changes occurred between the A1 filing and listing (30% of cases), and (3) reliance on management representations without cross-checking against audited financial statements (25% of cases).

The HKEX’s Listing Decision Review Process

The HKEX’s Listing Committee has the power to refuse listing applications where the use of proceeds statement is deemed “not supported by reasonable commercial rationale” (Listing Decision LD-2022-01). In LD-2023-03, the committee rejected an application from a mining company that proposed allocating 60% of proceeds to exploration activities in a jurisdiction where the issuer did not hold valid exploration licenses. The sponsor had accepted management’s representation that the licenses were “in the final approval stage” but had not obtained written confirmation from the relevant government ministry.

The HKEX’s 2025 policy update introduced a “Use of Proceeds Compliance Certificate” requirement for all Main Board listings, which must be signed by the sponsor’s principal and the issuer’s CFO. This certificate confirms that the issuer has a board-approved capital allocation policy, that the use of proceeds statement has been reviewed by an independent financial advisor, and that the issuer has established internal controls to monitor fund deployment. Failure to submit this certificate within 30 days of the listing date can result in the HKEX suspending trading in the issuer’s shares under Rule 6.01.

Practical Implementation: Building the Sponsor’s Internal Framework

The Rationality Assessment Memorandum

The sponsor should prepare a “Use of Proceeds Rationality Assessment Memorandum” (UPRAM) as a standalone due diligence workpaper. This document should contain: (1) a mapping of each use category to specific line items in the issuer’s board-approved budget, (2) a comparison against three comparable listed issuers selected based on market capitalization (±20%), revenue (±15%), and industry classification, (3) a sensitivity analysis showing the impact of a 10% and 20% deviation in revenue on the issuer’s ability to execute the stated plan, and (4) a risk matrix identifying the top three execution risks for each use category, with mitigation measures documented.

The UPRAM should be updated at each material milestone: (a) at the A1 filing, (b) upon any material change in the issuer’s financial position (defined as a 15% deviation from forecast revenue or EBITDA), and (c) at the time of the listing hearing. The SFC’s 2024 guidance suggests that sponsors should retain all versions of the UPRAM for at least seven years post-listing, consistent with the record-keeping requirements under the Securities and Futures (Records) Rules (Cap. 571AA).

Coordination with Other Due Diligence Workstreams

The use of proceeds assessment cannot be conducted in isolation. It must be integrated with the sponsor’s business due diligence, financial due diligence, and legal due diligence workstreams. The business due diligence team should confirm that the issuer’s operational capacity matches the deployment plan. The financial due diligence team should verify that the cash flow projections supporting the use of proceeds are consistent with the audited financial statements for the track record period (typically three years for Main Board listings under Rule 8.05). The legal due diligence team should confirm that all regulatory approvals required for the proposed use of funds have been obtained or are reasonably expected to be obtained within the stated timeline.

The sponsor should also coordinate with the reporting accountant on the “Proceeds from the Listing” section of the accountants’ report, which typically appears as a note to the pro forma financial information. The HKEX’s “Guidance Letter HKEX-GL57-13” (updated 2024) requires that this note include a reconciliation between the stated use of proceeds and the issuer’s working capital forecast for the 12 months post-listing. Any discrepancy exceeding 10% must be explained in the prospectus.

Closing: Three Actionable Takeaways for Sponsors

1. Sponsors must implement a “fund absorption capacity” test as a mandatory workpaper in every IPO engagement, comparing the proposed deployment schedule against the issuer’s historical capital expenditure run rate and documenting any step-change exceeding 200% with third-party verification. 2. The Use of Proceeds Rationality Assessment Memorandum should be treated as a living document updated at the A1 filing, upon any material financial deviation, and at the listing hearing, with all versions retained for seven years under the Securities and Futures (Records) Rules. 3. Sponsors should establish a dedicated cross-functional review committee comprising the lead sponsor principal, the financial due diligence lead, and the legal due diligence lead to approve the use of proceeds section before submission to the HKEX, ensuring alignment with the SFC’s Code of Conduct paragraph 17.6 standards and HKEX Listing Rule 11.07 requirements.