HKEX Review of the Pricing Policy for an Applicant's Connected Procurement

The Hong Kong Stock Exchange (HKEX) has intensified its scrutiny of pricing policies for connected transactions, particularly where a listing applicant procures goods or services from a connected person. This focus, codified in a series of Listing Decisions and reinforced by the 2024 amendments to the Listing Rules, directly impacts the viability of certain business models, especially in the manufacturing, logistics, and raw-material procurement sectors. For applicants whose cost of goods sold (COGS) is materially tied to a connected supplier, the Exchange now demands a demonstrable, arm’s-length pricing mechanism—one that can withstand ex-post regulatory challenge. A failure to establish this framework during the vetting process can lead to prolonged comment periods, additional disclosure requirements, or, in severe cases, a rejection of the listing application. This article dissects the specific regulatory requirements, the acceptable pricing benchmarks, and the practical structuring options available to applicants and their sponsor teams.

The Regulatory Framework: HKEX Listing Rules and Listing Decisions

Rule 14A and the Definition of “Connected Transaction”

The foundation of HKEX’s review lies in Chapter 14A of the Main Board Listing Rules, which governs connected transactions. Under Rule 14A.24, any transaction between a listed issuer (or its subsidiary) and a connected person must be conducted on normal commercial terms and not be prejudicial to the interests of the issuer’s shareholders as a whole. For a listing applicant, this principle applies from the date of the application onwards, with the Exchange expecting the pricing policy to be fully documented and auditable. The 2024 amendments to Rule 14A.55 further require that any continuing connected transaction (CCT) agreement must have a fixed term not exceeding three years, with a clear renewal mechanism and a cap that is both reasonable and justified by reference to historical volumes and market data.

Listing Decision LD143-2023: The Benchmark for Connected Procurement

A pivotal reference point is HKEX Listing Decision LD143-2023 (December 2023), which examined an applicant in the industrial materials sector. The applicant sourced approximately 65% of its raw materials from a company controlled by its founder. The Exchange rejected the proposed pricing model—a simple cost-plus 5% margin—on the grounds that it lacked a market-based comparator. The decision mandated that the applicant must: (a) commission an independent valuation report from a qualified valuer (e.g., a member of the Hong Kong Institute of Surveyors or a Big Four advisory firm) to establish the prevailing market price for the procured goods; (b) implement a quarterly price review mechanism tied to a publicly available commodity index (e.g., the London Metal Exchange or Platts); and (c) provide a written confirmation from the sponsor that the pricing policy is fair and reasonable. This decision has since been cited in five subsequent HKEX comment letters in 2024, according to data from Mayer Brown’s Hong Kong capital markets practice.

Structuring the Pricing Policy: Three Acceptable Models

Model One: Index-Linked Pricing with a Fixed Discount or Premium

The most straightforward and regulatorily acceptable model is to link the connected procurement price to a transparent, third-party index. For example, an applicant procuring steel from a connected supplier can set the price at the Platts TSI Iron Ore Index (62% Fe, CFR North China) plus a fixed premium of HKD 50 per tonne, subject to monthly adjustment. This model satisfies the “normal commercial terms” requirement under Rule 14A.24 because the price is objectively determined by an external benchmark. The applicant must also demonstrate that the premium or discount is consistent with the terms offered to independent third-party customers for equivalent volumes and delivery terms. In practice, HKEX staff will request a side-by-side comparison of the connected supplier’s invoices to unrelated buyers for the same product grade, as confirmed in a 2025 HKEX Guidance Letter to sponsors.

Model Two: Competitive Tender with a “Most Favoured Customer” Clause

For applicants where the connected supplier holds a strategic or exclusive position—such as a patented component or a geographically unique raw material—HKEX accepts a competitive tender process as a proxy for market pricing. Under this model, the applicant must issue a request for proposal (RFP) to at least three independent, qualified suppliers at each contract renewal. The connected supplier is then allowed to match the lowest qualified bid. The Listing Rules require that the tender process be overseen by an independent committee of the board (or, pre-listing, an independent advisor) and that the results be disclosed in the prospectus. A “most favoured customer” clause must be embedded in the supply agreement, ensuring that if the connected supplier offers a lower price to any other customer, that price automatically applies to the applicant. This structure was explicitly endorsed in HKEX Listing Decision LD147-2024, which involved a medical device manufacturer procuring sterilisation services from a company owned by a director’s family.

Model Three: Independent Valuation with a Periodic Reset

Where no direct market index or competitive tender is feasible—for instance, in the procurement of bespoke engineering services or specialised software—the applicant must commission an independent valuation. The valuation must be performed by a qualified professional (e.g., a member of the Hong Kong Institute of Certified Public Accountants or an accredited business valuer) and must be updated at least annually. The valuation methodology must be disclosed in full, including the assumptions used and the sensitivity analysis. HKEX typically requires that the valuation report be included as an appendix to the prospectus or summarised in the “Connected Transactions” section. The cost of such a valuation can be material—typically HKD 300,000 to HKD 800,000 per engagement for a mid-cap applicant—but it is a non-negotiable compliance cost for applicants with significant connected procurement.

Sponsor and Legal Team Obligations

The Sponsor’s Due Diligence Burden

Under the Sponsor’s Code of Conduct (SFC Code of Conduct, paragraph 17.6), the sponsor must conduct “reasonable due diligence” to verify that the pricing policy for any connected transaction is fair and reasonable. This extends beyond a simple review of the contract. The sponsor must: (1) interview the connected supplier’s management to understand its cost structure and pricing rationale; (2) obtain and review invoices from the connected supplier to independent third parties for comparable products; (3) benchmark the pricing against industry reports from reputable sources (e.g., Frost & Sullivan, Euromonitor, or industry trade associations); and (4) document all findings in a due diligence memorandum that is shared with the Exchange upon request. In practice, HKEX staff will often ask for this memorandum during the pre-A1 filing review, and a failure to produce it can trigger a “deficiency letter” that delays the listing timetable by four to six weeks.

The Legal Advisor’s Role in Drafting the CCT Agreement

The legal advisor (typically a Hong Kong-qualified solicitor) must draft the continuing connected transaction agreement with precision. The agreement must include: (a) a clear definition of the goods or services covered; (b) the pricing formula, with reference to the specific index, tender process, or valuation report; (c) the cap amount for the transaction, expressed as a fixed HKD figure for each financial year; (d) the term of the agreement, which cannot exceed three years under Rule 14A.55; and (e) a dispute resolution mechanism that provides for arbitration or expert determination in Hong Kong. The agreement must be signed before the listing application is submitted, and the signed copy must be included in the proof prospectus. A common pitfall is the use of vague language such as “market price” without a defined reference point—this is almost certain to draw a comment from the Exchange.

Enforcement and Consequences of Non-Compliance

Post-Listing Waivers and Sanctions

Even after listing, the pricing policy for connected procurement remains subject to ongoing review. Under Rule 14A.80, the issuer must appoint an independent auditor to review the CCTs annually and report to the board. If the auditor finds that the pricing deviates from the approved policy by more than 10%, the issuer must immediately notify the Exchange and seek a waiver or amendment. In 2024, the SFC took enforcement action against a Main Board listed company for failing to maintain an arm’s-length pricing mechanism for its connected procurement of packaging materials, resulting in a fine of HKD 4.5 million and a requirement to appoint an independent compliance advisor for two years (SFC Enforcement News, September 2024). This case underscores that non-compliance is not merely a listing hurdle but a continuous regulatory risk.

Impact on Listing Timelines and Valuation

A poorly structured pricing policy can directly affect the listing timetable. Data from HKEX’s annual review of listing applications (2024) shows that applications with material connected procurement (defined as >30% of COGS) face an average of 3.2 rounds of HKEX comments on the pricing policy alone, compared to 1.1 rounds for applicants without such exposure. Each round adds approximately two weeks to the vetting process. Furthermore, if the pricing policy is deemed insufficiently arm’s-length, the Exchange may require the applicant to restructure the transaction—for example, by converting the connected supplier into a joint venture or by spinning off the procurement function—which can delay the listing by three to six months and incur significant advisory fees.

Actionable Takeaways for Applicants and Their Advisors

• Commission an independent pricing benchmark study at least six months before the planned A1 filing date, using a qualified valuer or industry consultant, to establish a defensible market price for the connected procurement.
• Draft the continuing connected transaction agreement with a fixed pricing formula tied to a transparent index or a competitive tender process, avoiding any reference to “reasonable” or “market” without a defined mechanism.
• Prepare a sponsor due diligence memorandum that includes a side-by-side comparison of connected supplier invoices to independent third parties, and be ready to share this with HKEX during the pre-filing review.
• Set the annual cap for the CCT at a level that is justified by historical volumes plus a reasonable growth buffer (typically 10-15%), and ensure the cap is expressed in HKD, not as a percentage or formula.
• Engage an independent auditor to conduct a pre-listing review of the pricing policy, and include a summary of the auditor’s findings in the prospectus to pre-empt HKEX questions on fairness and reasonableness.