Many mainland Chinese firms are dipping their toes into capital markets for the first time but standards have often not been up to scratch and the penalties come just as Securities and Futures Commission (SFC) is preparing to toughen up listing regulations.

Last week, sources told Reuters that the commission will issue proposals in the next few weeks on stricter rules for IPO sponsors. It is expected to look at whether sponsors should be held liable for the contents of deal documents.

The SFC stripped Mega Capital (Asia) of its license and imposed a HK$42 million ($5.4 million) fine, saying the sponsor of Chinese fabric maker Hontex International Holdings' IPO had failed to obtain materially important information from suppliers and customers and had failed to act independently and impartially.

"It's a very clear message that sponsors will be held to account for serious deficiencies in listing applications," said James Wadham, a partner at law firm Clifford Chance in Hong Kong.

Hong Kong has been the world's biggest IPO market for two of the past three years, with $97.9 billion being raised on the city's markets between 2009 and the end of 2011, according to figures from Thomson Reuters.

As many firms raising money in Hong Kong are based in mainland China, regulators have found it difficult to take action against the company if there are problems with the IPO.

That means sponsors, who are responsible for preparing a company's IPO documents and ensuring compliance with listing rules, are seen as gatekeepers for new entrants to the market.

MARKET PULL-BACK?

Authorities have been stepping up their warnings. In March 2011, an SFC inspection of 17 sponsors found a raft of deficiencies in their work, including inadequate due diligence and disclosure to the stock exchange in listing applications.

The Hong Kong Monetary Authority said in April it had made recommendations to JPMorgan, UBS AG, HSBC, Royal Bank of Scotland and Deutsche Bank on ways to improve their listing work.

Wadham and other lawyers say that further strengthening of rules could have the unintended consequence of some big name banks pulling back from the market, which would mean work would then flow down to less experienced corporate finance advisers.

"Sponsors will be more careful from a risk management perspective, as, if you're a bigger player, having your license revoked will be very serious," said Mark Johnson, head of law firm Herbert Smith's Hong Kong practice.

Hontex went public in December 2009 but its shares were suspended just three months later after the commission alleged it had materially overstated its financial position in its listing prospectus.

The SFC said Mega Capital had conducted inadequate and sub-standard due diligence work but found no evidence that the firm was involved in any fraud.

Mega Capital's parent, Taiwan's Mega Financial Holdings, which is partly state-owned, said in a statement on Monday that it is not ruling out legal action against the auditors in the Hontex listing, but sees no effect from the SFC's penalty on the parent's finances or operations.

Its shares were 3.5 percent higher on Monday.

The regulator has also taken court action against Hontex, freezing the $128 million in proceeds from its listing but it is still trying to win the right to return that money to investors, with a court hearing scheduled later this year. All of Hontex's executives are believed to be either in mainland China or Taiwan.

($1 = 7.7619 Hong Kong dollars)

(Editing by Edwina Gibbs)

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