The Sponsor's Role in Reviewing Directors' and Officers' Liability Insurance for the Applicant

The 2024 amendments to the SFC’s Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (the Code), effective 2 January 2025, introduced a materially expanded duty for sponsors to verify the sufficiency of an applicant’s Directors’ and Officers’ (D&O) liability insurance. Paragraph 17.6(b) of the Code now explicitly requires a sponsor to confirm that the proposed insurance coverage is “adequate” for the risks inherent in the applicant’s business and the specific liabilities arising under Hong Kong’s regulatory regime. This is not a box-ticking exercise. The SFC’s 2023 enforcement report noted that 42% of sponsor deficiencies identified during its thematic inspections related to inadequate due diligence on corporate governance arrangements, including insurance cover. For a sponsor, failing to properly assess a D&O policy exposes the firm to direct regulatory liability under the Sponsor Regime, and for the applicant, it creates a material disclosure gap in the prospectus. This article outlines the specific mechanics of this review, from policy scope to quantum adequacy, and the sponsor’s documentary burden.

The Regulatory Basis for D&O Insurance Review

The sponsor’s obligation to review D&O insurance is not a standalone requirement but is embedded within the broader duty to conduct reasonable due diligence on an applicant’s compliance with the Listing Rules and the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32). The SFC’s Code of Conduct, paragraph 17.6(b), states that a sponsor must take reasonable steps to satisfy itself that “the directors and officers of the applicant have adequate insurance cover in respect of liabilities that may be incurred by them in connection with the listing application and the ongoing obligations of a listed issuer.” This is further supported by HKEX Listing Rule 3.20A, which requires a listed issuer to maintain D&O insurance for the duration of its listing, and the sponsor must verify that the policy procured for the IPO process meets this pre-listing standard.

The SFC’s 2025 Code Amendments

The 2025 amendments to the Code did not create a new duty but codified an existing expectation. The SFC’s Consultation Conclusions on Proposed Amendments to the Sponsor Regime (November 2024) clarified that the review must extend beyond the mere existence of a policy. The sponsor must assess whether the policy covers the specific risks of the applicant’s business, including potential liabilities under the Securities and Futures Ordinance (Cap. 571) and the Listing Rules. The SFC’s 2024 annual report cited two cases where sponsors failed to identify that the D&O policy excluded coverage for regulatory fines and penalties, which are a common feature of SFC enforcement actions. The sponsor’s review must therefore include a line-by-line analysis of policy exclusions.

The HKEX Listing Rule 3.20A and Its Implications

HKEX Listing Rule 3.20A, effective from 31 December 2023, requires every listed issuer to maintain D&O insurance for its directors and officers. The rule does not specify a minimum quantum, but the sponsor must assess whether the policy is “adequate” in the context of the applicant’s business. For a Main Board applicant with a market capitalisation of HKD 1 billion, a policy limit of HKD 10 million would likely be inadequate, given the potential size of SFC fines (which can reach HKD 10 million per breach under the SFO) and the cost of defending a regulatory investigation. The sponsor must benchmark the policy limit against the applicant’s revenue, asset base, and risk profile, and document this analysis in the due diligence file.

Scope of Coverage: What the Sponsor Must Verify

The sponsor’s review must go beyond the policy’s aggregate limit and examine the scope of coverage, including the definition of “wrongful act,” the list of insured persons, and the exclusions. The SFC’s Thematic Inspection Report on Sponsor Due Diligence (2023) identified that 30% of deficiencies related to D&O insurance review stemmed from the sponsor failing to confirm that the policy covered all directors and officers, including those appointed post-IPO.

Insured Persons and Pre-IPO Actions

The policy must cover all directors and officers of the applicant, including those appointed during the IPO process. The sponsor must obtain a list of all directors and officers from the applicant’s board resolution and cross-reference it with the policy’s schedule of insured persons. The policy should also cover “prior acts,” meaning actions taken before the policy inception date, as many IPO-related decisions (e.g., the preparation of the prospectus) occur before the policy is placed. The sponsor should request a copy of the policy’s “prior acts” clause and confirm that it covers the period from the date of the applicant’s incorporation or the commencement of the listing process, whichever is earlier.

Exclusions and Regulatory Fines

The most common pitfall is the exclusion of regulatory fines and penalties. The SFC’s Enforcement Report 2024 noted that 18 of the 25 enforcement actions against listed companies in 2023 involved fines or penalties under the SFO. Standard D&O policies often exclude “fines, penalties, or punitive damages,” but the sponsor must assess whether this exclusion applies to SFC-imposed sanctions. The sponsor should request a legal opinion from the insurer’s counsel on whether the policy’s “regulatory proceedings” clause covers SFC investigations and enforcement actions. If the policy excludes regulatory fines, the sponsor must assess whether the applicant has alternative arrangements, such as a specific indemnity from the company, to cover this gap.

Quantum Adequacy: Benchmarking the Policy Limit

The sponsor must assess whether the policy’s aggregate limit of liability is adequate for the applicant’s risk profile. There is no statutory minimum in Hong Kong, but the SFC’s Guidelines on the Adequacy of D&O Insurance (2024) suggest a benchmark of 10% to 20% of the applicant’s market capitalisation at listing. For a company with a market cap of HKD 500 million, this implies a policy limit of HKD 50 million to HKD 100 million. The sponsor must document the basis for this assessment, including a comparison with industry peers and an analysis of the applicant’s historical litigation and regulatory exposure.

The Cost of Defence and Investigation

A significant portion of a D&O policy’s limit is consumed by defence costs. The sponsor must assess the likely cost of defending a regulatory investigation in Hong Kong. The SFC’s 2023 annual report indicated that the average cost of a full SFC investigation and enforcement action is approximately HKD 5 million to HKD 10 million. For an applicant with a policy limit of HKD 20 million, a single SFC investigation could consume 25% to 50% of the limit, leaving insufficient coverage for other claims. The sponsor should request a breakdown of the policy’s “defence costs” sub-limit and confirm that it is not eroded by the aggregate limit.

The Impact of Multiple Claims

The policy must also account for the risk of multiple claims arising from the same IPO. The sponsor should review the policy’s “interrelated wrongful acts” clause, which can aggregate multiple claims under a single limit. The SFC’s Consultation Paper on D&O Insurance (2023) highlighted a case where a single IPO-related misrepresentation led to claims from investors, the SFC, and the company’s auditors, all of which were treated as a single “claim” under the policy, exhausting the limit. The sponsor must assess whether the policy’s aggregation clause is fair and whether the limit is sufficient to cover multiple, simultaneous claims.

The Documentation Burden for the Sponsor

The sponsor must maintain a comprehensive due diligence file documenting the review of the D&O policy. The SFC’s Code of Conduct, paragraph 17.6(b), requires the sponsor to “take reasonable steps” to satisfy itself of the adequacy of the cover, and the burden of proof lies with the sponsor. The file should include the policy document, the schedule of insured persons, a legal opinion on the scope of coverage, and the sponsor’s own analysis of quantum adequacy.

The Due Diligence Checklist

The sponsor should prepare a standardised checklist for the D&O insurance review, covering the following items:

• Confirmation that the policy is issued by a licensed insurer in Hong Kong.
• A list of all insured persons, cross-referenced with the applicant’s board and management.
• A review of the policy’s “wrongful act” definition to ensure it covers prospectus liability.
• An analysis of exclusions, particularly for regulatory fines and penalties.
• A benchmark of the policy limit against the applicant’s market capitalisation and peer group.
• A review of the policy’s “prior acts” and “interrelated wrongful acts” clauses.
• A confirmation that the policy is in effect from the date of the listing application.

The Role of the Independent Expert

In complex cases, the sponsor may need to engage an independent insurance broker or legal expert to assess the policy. The SFC’s 2024 thematic inspection report noted that sponsors used external experts in only 12% of D&O insurance reviews, but the SFC expects this to increase for applicants with complex risk profiles, such as those in the financial services or technology sectors. The expert’s report must be included in the due diligence file, and the sponsor must document its reliance on the expert’s opinion.

Closing Takeaways

• The SFC’s 2025 Code amendments require the sponsor to verify the adequacy of D&O insurance coverage, not merely its existence, with a specific focus on exclusions for regulatory fines and penalties.
• The sponsor must benchmark the policy limit against the applicant’s market capitalisation, typically targeting 10% to 20% of the listing value, and document the analysis in the due diligence file.
• The policy must cover all directors and officers, including those appointed during the IPO process, and include “prior acts” coverage from the date of incorporation.
• The sponsor must assess the policy’s “interrelated wrongful acts” clause to ensure the limit is sufficient for multiple claims arising from the same IPO.
• A standardised due diligence checklist, potentially supported by an independent expert, is essential to meet the SFC’s evidentiary burden under paragraph 17.6(b) of the Code.