Analysis of IPOs of biopharma companies in Hong Kong SAR (for sponsors)

Hong Kong has become the world’s second largest biotech financing centre since the Stock Exchange of Hong Kong (the “HKEx”) introduced Chapter 18A (the biotech chapter) of the Main Board Listing Rules in 2018. Biotech research features long R&D and investment cycles and biotech industry carries higher risks than traditional pharma and other industries. For this reason, the HKEx set up the Biotech Advisory Panel consisting of experienced international experts in the biotech industry. Listing departments may consult the Panel for advice relating to the field.

In recent years, the Hong Kong Securities and Futures Commission (SFC) has been taking frequent actions against sponsors for neglect of duty in listing applications, and has imposed penalties on a number of securities firms due to inadequate due diligence in the listing process. Given the SFC’s increasingly stringent regulation, negligence in performing due diligence may result in severe consequences. The key officers of sponsors should be involved and determine the breadth and depth of the due diligence review and the allocation of resources. They should assess the results and adequacy of the due diligence review to ensure that any issues identified are properly addressed. In the listing process of a biopharma company, the key officers are not allowed to delegate their duties as they are ultimately responsible throughout the entire due diligence process. Sponsors should take control of the due diligence process and be attentive and sensitive to attempts to ignore negative due diligence findings or resist further enquiries. They should perform their obligations under the Code of Conduct for Persons Licensed by or Registered with the SFC, the Corporate Finance Adviser Code of Conduct, the Management, Supervision and Internal Control Guidelines for Persons Licensed by Or Registered with the SFC, and the Additional Fit and Proper Guidelines for Corporations and Authorised Financial Institutions Applying or Continuing to Act as Sponsors and Compliance Advisers.

At the beginning of the listing process of biopharma companies, sponsors should work with their counsels to develop a comprehensive due diligence plan covering the following steps:

1. Examining the fundamental principles of drugs

2. Understanding the target market

3. Enquiring about core issues

    a. Assessing clinical development plans

    b. Assessing the regulatory outlook

    c. Ensuring the authenticity and reliability of data

    d. Investigating the company’s manufacturing capabilities

4. Takeaways from HKEx’s feedback on application review

Given the high degree of specialisation and entry barriers in the biotech and medical device sectors, sponsors should always seek independent, objective and verifiable advice during the due diligence process from, for example, key opinion leaders (KOLs), lead researchers, contract research organisations (CROs), manufacturers, and partners. They are expected to work with the counsel and the company’s management to select the proper participants and then conducts due diligence with the company’s management withdrawn.

I. Examining the fundamental principles of drugs

In accordance with the HKEx’s due diligence requirements, the sponsor should critically assess the fundamental scientific explanations and rationales. Not relying solely on presentations by the company’s management, the sponsor should also seek supporting statements from assessments of its deal team/pharmaceutical research analysts, interviews with KOLs and principal investigators, and third party scientific publications. In addition, the sponsor is required to critically assess clinical development plans and regulatory outlooks and conduct due diligence on clinical trials to ensure the authenticity and reliability of data from clinical trial protocols. The sponsor should also review clinical study reports, scientific papers, government and non-profit research publications, patent research and third party data sources to assess the authenticity of trials.

II. Understanding the target market

The sponsor should understand the target market for the drug or biologic, such as the patient population. It can conduct market research through a patient advocacy group, industry consultant, or even the engaged independent consulting firm. The sponsor can assess drug pricing and penetration estimates which are not disclosed in the prospectus. It should have a good knowledge of the competitive environment, such as other drugs approved or in development, comfort and satisfaction of doctors with current market leaders and standards of care, the efficacy of comparable drugs, the operability of the route of administration, pricing and subsidies. In disclosing barriers to commercialisation, the sponsor should present several aspects of how to penetrate the market, the company’s marketing strategy, the target number of doctors, the size of sales force required and pharmacoeconomics.

III. Enquiring about core issues

The sponsor should critically assess the company’s objectives, strategies, and required expertise, and ensure that the team is staffed with professionals with expertise in e.g. microbiology, genetics, pharmacokinetics, toxicology, and comparator selection. The sponsor should have an independent, objective assessment of the following core issues:

• What analysis findings should be assessed?

• What are the possible routes of administration (e.g. oral vs. intravenous)?

• Inter-patient (horizontal vs vertical) differences;

• Half-life, plasma/urine concentrations, tissue distribution;

• Bioavailability and food interactions;

• Toxicity, safety and efficacy profile;

• All adverse and serious adverse events;

• Are the test methods and study design appropriate for the intended indication?

• Study design - open-label versus blind trial/placebo controlled? Randomised? Validated (e.g., approved by an institutional review board (IRB))?

• Does the study comply with applicable guidelines (e.g., the good laboratory practice (GLP) or good clinical practice (GCP))?

• Are the route of administration, clinical dose and duration of treatment continuously being improved?

(I) Assessing clinical development plans

The sponsor should understand the following issues: Is the company’s proposed trial focus acceptable to the regulator? Are there other drugs already approved on this endpoint? If it is a new endpoint, has the National Medical Products Administration (NMPA) provided any positive feedback or even agreed to a priority review or fast track? What is the company’s proposed development timeline? Does the timeline cover key milestones? Is the timeline realistic and achievable, or overly optimistic? What is the company’s clinical trial registration process? Is a recruitment centre required? Where are the target regions?

(II) Assessing the regulatory outlook

The sponsor should gain a thorough understanding of the following issues: What messages are conveyed from the communications between the company and  he regulator? What is the next plan of communications, including minutes of meetings, informal communications, written correspondence and responses? Are there any regulatory issues with similar drugs in development? Are there any “clinical holds” or other warning signs? Has the regulator inspected the  anufacturing facility to ensure compliance with the current good manufacture practices (cGMP)?

(III) Ensuring the authenticity and reliability of data

The sponsor is required to verify the data provided or cited by the company from multiple sources, such as scientific papers, government and non-profit research publications, search reports from intellectual property (IP) offices, independent third party data, clinical study reports (CSRs, published or unpublished, first draft or final version). As required by the HKEx, the sponsor should ensure that the prospectus disclosures accurately and in detail describe all adverse and serious adverse reactions, the adverse events, attributability of the adverse events to the design of the experiment, and the incidence of adverse events in comparable study designs.

(IV) Investigating the company’s manufacturing capabilities

The sponsor should conduct an investigation of the company about the following issues: Will the company manufacture the products independently or via an appointed third party contract manufacturing organisation (CMO) in the future? What are the technical challenges in manufacturing drugs, especially large molecule ones? Does the company rely on a single source supplier or is there any back-up supplier that can be a substitute? How will commercial scale-up (plant, land, personnel and local government financial support) be achieved after the drug is launched? Has the manufacturing facility been inspected or approved by the NMPA? Is the staffing for internal process development, chemistry, manufacturing and control (CMC) adequate?

IP due diligence is critical for a biopharma company. During the due diligence exercise, the sponsor should keep a variety of evidence, including written records (e.g., patents and related chain of ownership, IP agreements, employee invention transfer agreements, and IP-related decisions), due diligence interviews, patent protection status, duration and geographical scope, exclusivity or enforceability of proprietary ownership. If the company has an IPR dispute, the sponsor should understand the current status, the timing of key awards and settlements, etc. of the dispute. In addition, the sponsor should also understand whether there is any third party infringement of the company’s IPRs and the measures taken, whether the company is using rights of any government or university, and whether there are any issues in the protection of trade secrets.

IV. Takeaways from HKEx’s feedback on

application review In the past two years, when reviewing the prospectus of a biopharma company, the primary concerns shown in the HKEx’s feedback are as follows:

(I) Biotech

• Defined terms: The company should clarify the meanings of scientific and technical terms when first used.

• A complete and faithful disclosure of adverse reactions:

The sponsor should ensure that the company has disclosed all the adverse and serious adverse reactions occurring during the clinical trials without omission and also explained the known and potential unknown side effects.

• A description of the clinical endpoint: How does the company assess the efficacy (based on, e.g., the presence of some biological activity, elimination of disease, symptom reduction, absence of symptoms, and life extension).

(II) Accounting

• Accounting for payments: How does the company account for the preliminary, annual, milestone and royalty payments under licensing and cooperation agreements?

• Breakdown of research and development costs. The costs should be recorded specifically to each core product and pipeline product and to each phase of trials.

• Stock incentive mechanism: How does the company determine the fair value of shares issued to employees? The company is required to explain the ifference between the recent common stock valuation and its estimated issue price.

• Use of proceeds: Does the estimated proceeds meet the requirement of the development plan? The HKEx requires the company to ensure it has available sufficient working capital to cover 125% of the costs for at least 12 months from the date of listing.

(III) IP legal advice

During the listing of a company under Chapter 18A, the sponsor should obtain legal advice from the international counsel and the in-house patent counsel of the company.

The IP legal advice is to assist the sponsor in the due diligence of the company’s IP to confirm it. In addition to disclosures in the prospectus, patent legal advice usually covers the following:

• The company is the registrant and exclusive owner of its patents;

• The company's main product candidates are protected by at least one patent that has been granted to the company;

• No facts have been found to show that the company’s patents are unpatentable, invalid or unenforceable;

• There are no IP related lawsuits, disputes or threats;

and

• The IP related statement in the prospectus does not contain any major omissions or misstatements.

1. IP due diligence.

Due to the long research and development period and high investment, drugs rely heavily on IP and strong IP protection to maximise financial benefits. Since IP is one of the core assets of a biopharma company, it is important for the sponsor to carry out due diligence to evaluate the value and risks of the company’s patents in the IPO course. Given the high technology and complex legal requirements of drug patents, due diligence requires to cover many dimensions. Even the slightest omission may lead to a potential hazard in a post-IPO dispute or the investigation by the SFC. In-depth due diligence is time and cost consuming. In order to develop comprehensive findings within the IPO period of months, the sponsor is required to conduct due diligence step by step in order to balance effectiveness, efficiency and cost control.

2. Background investigation of patented technologies.

The sponsor can appoint a third party to find out the maturity of industry, the technological development path of key competitors, the hot spots and gaps of the technological development in the industry, and analyse the overall application trend, distribution and key technology of patents.

3. Investigation of potential patent ownership disputes.

The sponsor should investigate agreements on ownership of inventions and creations in the employment contract between the inventor and the company and the transfer certification of the inventor’s patent application right. The investigation should focus on whether there is a written contract between the company and its third party partner and whether the contract contains a clear agreement on the IP ownership, so as to establish the integrity of the right chain.

4. Investigation on the stability of patents.

In pharmaceutical industry, even granted patents may be invalidated. As the criteria of review for drug patents change dynamically, patents are vulnerable to invalidation for some dosage forms and treatment methods. In recent years, an increasing number of requests for invalidation of drug patents has been accepted by China's Patent Reexamination Board. For a biopharma company, the stability of patents is of great importance. The sponsor should conduct investigation carefully to draw a reliable conclusion, taking into account the real-time regulatory review criteria.

5. Reliability of clinical data.

The inauthenticity of clinical data or loss of clinical trial data will not only significantly increase the cost of data recovery and retrieval, but also lead to delay or failure in the approval process of regulatory authorities in serious cases. The sponsor should ensure that the company has records of data entry and change and appropriate detection, review and authorization procedures to prevent data from tampering. As any improper disclosure of confidential or patent information will give rise to legal liability, product development and commercialization may also be delayed.

The sponsor should pay sufficient attention to the security of the company’s trial data.

6. Investigation of third-party partners.

The complex process of research and development, clinical trials to commercialisation requires sophisticated scientific research and technical capabilities. It is therefore crucial for the company to manage its clinical activities in an orderly manner. Failure of third party partners such as CROs, CMOs, sales and marketing agents or distributors to fulfil their obligations or terminate the cooperation agreements without cause will affect not only the business growth ability of the biotech company but also the regulatory approval and commercialization of its products.

The sponsor should evaluate the biotech company’s mechanism and process for selecting third party partners, including co-outsourcing and outsourcing policies for prequalification evaluation, as well as their expertise and capabilities. The sponsor should also conduct sufficient feasibility studies, including preclinical studies, clinical trials, and the whole process from manufacturing to

supply or distribution of drugs or medical devices. In addition, the biopharma company, its CROs, CMOs and designated distributors must establish internal control systems and comply with GCP^[1], cGMP and good supply practice (GSP)^[2]. The sponsor should urge the biotech company to establish an ongoing performance monitoring mechanism, using key performance indicators (e.g. product development, clinical trial timelines, milestones and costs) to measure performance.

7. Government regulation and compliance.

The time required for a biopharma company to obtain approval from the NMPA and foreign regulators is unpredictable, usually long after the start of clinical trials and dependent on many factors. In addition, approval policies, regulations or the type and amount of clinical data required for approval may change in the of a product’s clinical development, as well as from jurisdiction to jurisdiction. The sponsor should ensure that biopharma company (i) has established and maintains a complete and up-to-date database of laws and regulations; (ii) actively verify these data to ensure timely updates of any changes in laws and regulations in the database and timely assessment and response to the impacts of those changes; (iii) has a preventive compliance programme, code of conduct, compliance policy and an appointed compliance programme owner for non-compliance, frauds or illegal activities; (iv) provides regular compliance trainings for employees; (v) develops a reporting mechanism to receive reports and complaints and protect whistle-blowers from retaliation; and (vi) formulates policies and procedures for investigating noncompliance or misconduct.

Conclusion

Among a series of reform measures taken by the HKEx, allowing unprofitable biotech companies to go public is one of the biggest highlights. This, however, does not mean lower threshold for listing. Sponsors are relatively unfamiliar with the business, products and expertise of biopharma companies, and the currently small number of companies listed under Chapter 18A provides few precedents and less comparable experiences.

Therefore, sponsors may be subject to penalties such as disqualification by the HKEx or even post-IPO investigation by the SFC if they fail to conduct due diligence properly and assess the risks inadequately due to unfamiliarity the company’s business.

Before 2018, the United States is the only choice for biopharma companies to go public. Since the introduction of Chapter 18A, however, Hong Kong SAR is providing more advantages. Backed by the resources from China and attracting experienced private equity funds from Europe and the United States, the new potentially preferred destination sees a good prospect for its biotech industry. Due to the high risk of investing in biotech companies, it is difficult for investors to assess the company's value. When the number of such listed companies reaches 30, the HKEx will expand the range of products to include ETFs and structured products based on relevant representative indexes, so as to help retail investors diversify their risks. Sponsors play an important role in the listings of biopharma companies. Good due diligence and sophisticated IP legal advice will not only help sponsors thoroughly understand the expertise of biopharma companies and the ecosystem of the subindustry, but also meet the  equirements of the listing rules of the HKEx and security laws and regulations.