HKEX Review of an Applicant's Compliance with Debt Covenants

The Exchange’s December 2024 updated guidance on debt covenant compliance reviews, published as HKEX-GL114-24 (replacing the 2013 version), imposes a materially higher evidentiary burden on applicants with material outstanding borrowings. For companies targeting a Main Board listing in 2025-2026, the HKEX now expects proactive disclosure of any covenant breach — or even a material risk of breach — as part of the listing application process, with the sponsor required to opine on the issuer’s ability to maintain compliance for at least the next 12 months post-listing. This shift reflects the regulator’s broader focus on financial resilience in a high-interest-rate environment, where floating-rate debt and cross-border covenant structures have become flashpoints. For CFOs and sponsor legal teams, the practical consequence is that a standard audit confirmation of “no default” no longer suffices; the Exchange will scrutinise the specific terms of each debt facility, the calculation mechanics of financial covenants, and the issuer’s historical compliance trajectory.

The Regulatory Framework: From GL52-13 to GL114-24

The Exchange codified its expectations in GL114-24, “Guidance on an applicant’s compliance with debt covenants,” published on 20 December 2024. This supersedes the previous guidance note GL52-13 (issued September 2013) and aligns with the HKEX’s broader Listing Rule amendments on financial viability introduced in 2023.

Scope of Application: All Material Debt Facilities

GL114-24 applies to any applicant with outstanding borrowings that, individually or in aggregate, exceed 25% of the applicant’s total assets as at the latest balance sheet date, or where the applicant has previously disclosed a covenant breach in its track record period. The guidance defines “material borrowings” by reference to HKEX Listing Rule 4.06(2), which requires disclosure of defaults on “material borrowings” in the prospectus. Materiality is assessed on both a quantitative and qualitative basis — a facility representing less than 25% of total assets may still be material if it contains cross-default provisions linking to other facilities or if a breach would trigger a change-of-control clause.

Sponsor Obligations Under Paragraph 17 of the Third Schedule

The sponsor must now include in its due diligence work programme a specific review of all debt covenants applicable to material borrowings, covering the entire track record period (typically three completed financial years under Rule 8.05). Paragraph 17 of the Third Schedule to the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32) requires the prospectus to disclose any event of default that has occurred during the track record period and that remains uncured as at the date of the prospectus. GL114-24 makes clear that the sponsor must verify not only the occurrence of defaults but also the applicant’s interpretation of covenant calculations — particularly where covenants are expressed in accounting terms that may differ from HKFRS or IFRS.

Key Areas of Scrutiny: Covenant Calculation and Interpretation

The Exchange’s review focuses on three specific areas where applicants most frequently fail to provide adequate disclosure: the definition of financial covenants, the treatment of carve-outs and waivers, and the impact of cross-default clauses.

Financial Covenant Definitions and Accounting Methodology

A recurring issue in HKEX review comments is the mismatch between covenant definitions in loan agreements and the accounting policies used in the applicant’s financial statements. For example, a debt-to-EBITDA covenant may define EBITDA differently from HKFRS — excluding non-recurring items, adding back share-based compensation, or using a trailing twelve-month calculation rather than an annual figure. GL114-24 requires the applicant to reconcile these definitions explicitly in the prospectus, with a table showing the covenant calculation under the loan agreement’s terms alongside the corresponding HKFRS figure for each reporting period. The sponsor must confirm that the reconciliation is arithmetically correct and that the applicant has consistently applied the same methodology throughout the track record period.

Carve-Outs, Waivers, and Amendments

Where a lender has granted a waiver of a covenant breach, the Exchange will examine whether the waiver is unconditional and irrevocable. A waiver that is subject to a subsequent review, or that applies only for a specified period (e.g., a 12-month forbearance), does not satisfy the requirement for a clean disclosure. The sponsor must obtain the original waiver letter and confirm that no conditions precedent remain outstanding. If the loan agreement was amended to relax a covenant, the Exchange will treat this as a material change in terms, requiring disclosure in the prospectus and an explanation of why the amendment does not indicate financial distress. The guidance cites a 2023 case where an applicant amended its interest coverage ratio from 3.0x to 2.0x six months before filing; the Exchange required the sponsor to opine on whether the amendment was made in contemplation of the listing and whether the original covenant was commercially reasonable at inception.

Cross-Default and Material Adverse Change Clauses

Cross-default provisions — where a default under one facility triggers a default under another — are a particular focus. The Exchange expects the applicant to map all cross-default triggers across its debt portfolio, including those in bilateral loans, syndicated facilities, and bond indentures. Where a cross-default clause is linked to a “material adverse change” (MAC) clause, the sponsor must assess whether the MAC clause is objectively determinable and whether any event during the track record period could reasonably be argued to constitute a MAC. The guidance notes that MAC clauses in Hong Kong law-governed loan agreements typically follow the Loan Market Association (LMA) form, but deviations from the standard wording should be disclosed and analysed.

Practical Implications for Listing Timelines and Prospectus Drafting

The enhanced scrutiny under GL114-24 has direct consequences for the timeline of a listing application, particularly for issuers with complex capital structures or those operating in sectors with high leverage.

Front-Loading the Covenant Review

Sponsors should now begin the debt covenant review at the pre-A1 stage, rather than during the due diligence phase after the filing. The Exchange’s Listing Division has indicated that it will raise covenant-related queries early in the review process, and a failure to provide a complete covenant reconciliation at the first submission can delay the A1 hearing by 4-8 weeks. For applicants with debt facilities governed by foreign law (e.g., New York law, English law), the sponsor must engage local counsel to opine on the enforceability of the covenants and the consequences of a breach under that jurisdiction’s insolvency framework. This adds an estimated HKD 200,000-400,000 to the professional fees for a typical Main Board application.

Prospectus Disclosure: The Covenant Compliance Section

The prospectus must now include a dedicated section titled “Debt Covenant Compliance” (or similar), typically placed within the “Financial Information” section. This section must contain:

• A summary of all material debt facilities, including facility amount, drawn amount, interest rate basis, maturity date, and key financial covenants.
• A reconciliation of covenant calculations for each reporting period in the track record, with a clear statement of whether the applicant was in compliance.
• Details of any waivers, amendments, or forbearances obtained during the track record period, including the date, scope, and conditions of each.
• A forward-looking statement from the sponsor on the applicant’s ability to maintain covenant compliance for the 12 months following the prospectus date, based on the applicant’s projected financial performance and the terms of its debt facilities.

Impact on GEM Applicants and Transfer Applicants

GEM applicants face a slightly different standard. GEM Listing Rule 17.27 requires disclosure of defaults on material borrowings, but the Exchange has historically applied a less rigorous review to GEM applications. GL114-24 does not differentiate between Main Board and GEM, however, and the Exchange’s Listing Division has confirmed in informal guidance that the same evidentiary standards apply to both boards. For applicants seeking to transfer from GEM to the Main Board under Chapter 9 of the Main Board Listing Rules, the Exchange will review the entire track record period on the Main Board, including any period when the applicant was listed on GEM. This means a GEM-listed company with a previously undisclosed covenant breach may face a requirement to disclose that breach in the transfer application prospectus, even if the breach was waived at the time.

Cross-Border Considerations and Jurisdictional Nuances

Issuers with debt facilities governed by non-Hong Kong law, or those whose subsidiaries are incorporated in offshore jurisdictions, face additional compliance layers under GL114-24.

PRC-Controlled Issuers and Offshore Debt Structures

For PRC-controlled issuers with offshore debt (e.g., USD-denominated bonds issued by a BVI or Cayman special purpose vehicle), the sponsor must assess whether the offshore debt is structurally subordinated to onshore debt and whether the onshore operating subsidiaries are guarantors. If the offshore debt is not guaranteed by the onshore entities, the covenant compliance analysis should note this structural subordination and its implications for the issuer’s ability to service the debt. The Exchange has also flagged that PRC SAFE registration requirements for offshore debt must be confirmed as current, as a failure to maintain SAFE registration can constitute an event of default under the terms of many cross-border loan agreements.

Bermuda and Cayman Islands Law Considerations

Issuers incorporated in Bermuda or the Cayman Islands must ensure that their constitutional documents do not contain provisions that conflict with the debt covenants. For example, a Bermuda-incorporated issuer may have a bye-law requiring shareholder approval for certain borrowings, and a breach of this internal requirement could trigger a default under the loan agreement’s “compliance with laws” covenant. The sponsor should obtain a legal opinion from Bermuda or Cayman counsel confirming that the issuer’s internal governance procedures are consistent with the terms of its debt facilities.

Actionable Takeaways

1. Commission a standalone debt covenant due diligence report from the sponsor at the pre-A1 stage, covering all material debt facilities with a reconciliation of covenant calculations against HKFRS for each year of the track record period.
2. Obtain unconditional, irrevocable waiver letters for any covenant breach that occurred during the track record period, and confirm in writing that no conditions precedent to the waiver remain outstanding.
3. Engage local counsel in the governing law jurisdiction of each material debt facility to opine on covenant enforceability and the consequences of a breach, and include these opinions in the sponsor’s due diligence file.
4. Draft a dedicated “Debt Covenant Compliance” section in the prospectus that includes a forward-looking statement from the sponsor on the issuer’s ability to maintain compliance for 12 months post-listing, supported by projected financials and sensitivity analysis.
5. For applicants with cross-border debt structures, confirm SAFE registration (for PRC entities) and Bermuda/Cayman constitutional compliance before filing, and disclose any structural subordination in the prospectus.