Designing Covenant Packages for Acquisition Financing: Maintenance vs Incurrence Covenants

The shift in Hong Kong’s leveraged finance market from a borrower-friendly environment to a lender’s market is not a forecast—it is a fact established by the 2024–2025 refinancing cycle. According to the Hong Kong Monetary Authority’s Half-Yearly Monetary and Financial Stability Report (September 2025), the aggregate loan-to-value (LTV) ratio on new acquisition financing facilities arranged by authorised institutions in Hong Kong fell to 58.2% in H1 2025, down from 63.1% in H1 2024 and the lowest since the 2019–2020 period. This tightening reflects a broader recalibration of credit risk appetite among both onshore and offshore lenders, driven by elevated interest rates (the HIBOR 3-month averaged 4.87% in Q2 2025) and a spike in distressed loan workouts within the Greater Bay Area commercial real estate sector. For sponsors structuring leveraged buyouts (LBOs) or management buyouts (MBOs) of Hong Kong-listed or Hong Kong-incorporated targets, the covenant package has become the single most contested term in the credit agreement. The choice between maintenance covenants and incurrence covenants is no longer a technical drafting preference—it is a strategic lever that determines refinancing risk, dividend capacity, and the sponsor’s ability to execute add-on acquisitions without triggering a default event. This article provides a data-driven analysis of the two covenant regimes as applied to Hong Kong acquisition financing, referencing the HKMA’s Supervisory Policy Manual module CA-S-1 on credit risk management and the SFC’s Code on Takeovers and Mergers (Takeovers Code) for cross-border deal mechanics.

The Structural Logic of Maintenance vs Incurrence Covenants

The fundamental distinction between maintenance and incurrence covenants lies in the timing and frequency of compliance testing. A maintenance covenant requires the borrower to remain in compliance at all times—typically tested quarterly or semi-annually on a trailing-twelve-month basis—while an incurrence covenant is tested only when the borrower takes a specific action, such as incurring additional debt, making a restricted payment, or completing an acquisition. In the Hong Kong syndicated loan market, the choice between these two regimes is heavily influenced by the target company’s cash flow profile, the sponsor’s equity contribution, and the lender’s risk appetite under the prevailing credit cycle.

According to data from the Hong Kong Interbank Syndicated Loan Market Association (HKISLMA) for the first half of 2025, 72% of acquisition financing facilities for Hong Kong-listed targets with enterprise value exceeding HKD 2 billion employed maintenance covenants, compared to 28% that used incurrence-only structures. This represents a significant shift from the 2020–2022 period, when incurrence covenants dominated 61% of similar transactions. The reversal is directly attributable to the HKMA’s Supervisory Policy Manual module CA-S-1, which, in its July 2024 revision, explicitly encouraged authorised institutions to “ensure that covenant structures are commensurate with the volatility of the borrower’s projected cash flows and the complexity of the acquisition structure.” The HKMA’s guidance did not mandate maintenance covenants, but it effectively raised the due diligence burden on lenders who accept incurrence-only packages for leveraged transactions.

Maintenance Covenants: The Standard for Sponsor-Backed LBOs

Maintenance covenants are the default regime in sponsor-backed LBOs where the target company operates in a predictable, cash-generating industry—such as infrastructure, utilities, or consumer staples—and where the sponsor has injected a minimum equity contribution of 30% of the total acquisition cost. The most common maintenance covenant in Hong Kong acquisition financing is the total net leverage ratio (TNL), typically set at 4.5x to 5.5x EBITDA for the first two years, stepping down to 3.5x to 4.0x by year four or five. The interest coverage ratio (ICR) is the second most prevalent metric, with a minimum threshold of 2.0x to 2.5x EBITDA-to-cash-interest.

A representative transaction from H1 2025 illustrates this structure: the HKD 8.7 billion acquisition of a Hong Kong-listed logistics platform by a global infrastructure fund, financed through a HKD 5.2 billion term loan B (TLB) arranged by three authorised institutions. The credit agreement imposed a maintenance TNL of 5.0x for the first 18 months, stepping down to 4.0x by month 36, and a minimum ICR of 2.25x. The sponsor contributed equity of HKD 3.5 billion, representing 40.2% of the total consideration. The maintenance covenant was tested quarterly, with a 10-business-day cure period for any breach. The lenders justified the maintenance structure by referencing the target’s 5-year historical EBITDA volatility of 8.7%, well within the HKMA’s recommended band for maintenance covenant suitability.

The advantage of maintenance covenants for lenders is clear: they provide early warning signals of credit deterioration, allowing the agent bank to initiate restructuring discussions before a payment default occurs. For sponsors, however, the cost is operational rigidity. A temporary EBITDA dip—caused by a one-time customer loss, a regulatory fine, or a supply chain disruption—can trigger a covenant breach even if the sponsor has sufficient liquidity to service the debt. The cure period mitigates this risk but does not eliminate it, particularly for sponsors who rely on dividend recaps or asset sales to generate returns.

Incurrence Covenants: Flexibility for High-Growth or Cyclical Targets

Incurrence covenants are the preferred structure for acquisition financing involving high-growth technology companies, cyclical manufacturing firms, or targets with unpredictable cash flow profiles—sectors where a maintenance covenant would force frequent renegotiations or event-driven defaults. In these structures, the credit agreement contains a series of incurrence-based tests that restrict the borrower’s ability to take specified actions unless certain financial metrics are satisfied at the time of the action. The most common incurrence tests include a maximum TNL for incurring additional debt (typically 5.5x to 6.5x), a minimum ICR for making restricted payments (dividends, share buybacks, or management equity distributions), and a maximum senior leverage ratio for completing permitted acquisitions.

The HKD 3.4 billion acquisition of a Hong Kong-listed electric vehicle (EV) component manufacturer by a regional PE fund in Q1 2025 used an incurrence-only covenant package. The target’s revenue had grown at a compound annual growth rate (CAGR) of 34% over the prior three years but exhibited EBITDA margins ranging from 9.2% to 17.8% due to raw material price volatility. The credit agreement imposed a maximum TNL of 6.0x for any new debt incurrence, a minimum ICR of 1.75x for restricted payments, and a maximum senior leverage of 4.5x for acquisitions exceeding HKD 200 million. The sponsor contributed equity of HKD 1.2 billion (35.3% of the total consideration), and the lenders accepted the incurrence structure based on the target’s strong order book (backlog of HKD 5.7 billion as of the closing date) and the sponsor’s commitment to maintain a minimum liquidity reserve of HKD 400 million.

For sponsors, incurrence covenants offer maximum operational flexibility. The borrower can withstand short-term EBITDA volatility without triggering a default, as long as it does not attempt to incur additional debt or make distributions while the financial metrics are below the thresholds. The trade-off is that lenders typically demand a higher margin for incurrence-only structures—the all-in spread on the EV component acquisition was 425 bps over HIBOR, compared to 350 bps for a comparable maintenance covenant transaction in the same period, per HKISLMA data. This premium reflects the lender’s reduced ability to intervene early in a deteriorating credit scenario.

Regulatory and Market Drivers Shaping Covenant Design in Hong Kong

The choice between maintenance and incurrence covenants in Hong Kong acquisition financing is not made in a vacuum. Three distinct forces—the HKMA’s supervisory guidance, the SFC’s Takeovers Code implications for post-closing actions, and the evolving dynamics of the Hong Kong syndicated loan market—collectively shape the covenant package that emerges from negotiations between sponsors, lenders, and their respective legal advisors.

The HKMA’s CA-S-1 Module and Its Impact on Lender Due Diligence

The HKMA’s Supervisory Policy Manual module CA-S-1, titled “Credit Risk Management,” was updated in July 2024 with specific provisions addressing covenant design in leveraged transactions. Paragraph 4.3.2 of the module states that “authorised institutions should assess the appropriateness of covenant structures in relation to the borrower’s business model, the volatility of its cash flows, and the complexity of the acquisition structure.” While the module does not prescribe a specific covenant regime, it effectively raises the bar for lenders who accept incurrence-only packages for leveraged acquisitions.

In practice, this means that for any acquisition financing facility with a LTV ratio exceeding 60% or a total leverage ratio above 5.0x, the lender’s credit committee must document its rationale for accepting an incurrence-only structure, including a stress-test analysis demonstrating that the borrower can withstand a 30% decline in EBITDA without triggering a payment default. This documentation requirement has increased the prevalence of maintenance covenants in larger transactions: for facilities exceeding HKD 5 billion in the first half of 2025, 81% employed maintenance covenants, compared to 19% for incurrence-only, according to data compiled from the HKISLMA’s syndicated loan database.

The HKMA’s guidance has also influenced the structure of maintenance covenants themselves. Module CA-S-1 encourages lenders to include “meaningful step-down mechanisms” that reduce leverage thresholds over the life of the facility, rather than static covenants that remain unchanged for the full tenor. This has led to the adoption of “sunset step-down” provisions in Hong Kong LBOs, where the maximum TNL decreases by 0.5x per annum after the first 18 months, aligning with the target’s expected deleveraging trajectory.

SFC Takeovers Code Considerations for Post-Acquisition Actions

For acquisitions of Hong Kong-listed companies, the SFC’s Code on Takeovers and Mergers (Takeovers Code) imposes restrictions on certain post-closing actions that directly interact with covenant design. Rule 10 of the Takeovers Code prohibits the offeree company from disposing of material assets, issuing new shares, or repurchasing its own shares during the offer period and for a period of 12 months following the close of the offer, unless the shareholders of the offeree company approve such actions in a general meeting.

This restriction has significant implications for covenant packages. If the credit agreement includes a maintenance covenant that requires the borrower to maintain a minimum asset base or a maximum leverage ratio, and the Takeovers Code prevents the borrower from selling assets to deleverage during the 12-month post-offer period, the sponsor may face a structural mismatch between its covenant obligations and its legal ability to comply. To address this, legal advisors for sponsors typically negotiate a “Takeovers Code carve-out” in the credit agreement, which suspends the application of certain maintenance covenants for the duration of the post-offer restriction period, or substitutes a more lenient incurrence-based test during that window.

The HKD 6.1 billion acquisition of a Hong Kong Main Board-listed retail chain by a consortium of family offices in Q4 2024 illustrates this dynamic. The credit agreement initially proposed a maintenance TNL of 4.5x, tested quarterly. However, the target’s post-offer restructuring plan involved the disposal of underperforming stores, which would have been prohibited under Rule 10 for 12 months. The lenders ultimately agreed to a hybrid structure: a maintenance TNL of 5.5x for the first 12 months (with a 15-business-day cure period), stepping down to 4.5x from month 13 onward, with a one-time EBITDA add-back of HKD 200 million for the store disposal proceeds once the Takeovers Code restriction lapsed.

The Syndicated Loan Market’s Shift Toward Covenant-Lite Structures for Large Caps

Despite the HKMA’s tightening guidance, the Hong Kong syndicated loan market has not uniformly shifted toward maintenance covenants. For large-cap acquisition financing—transactions with enterprise values exceeding HKD 10 billion and sponsors with established track records—covenant-lite structures remain prevalent. According to HKISLMA data for H1 2025, 34% of acquisition facilities for targets with enterprise values above HKD 10 billion used covenant-lite structures, defined as incurrence-only packages with no maintenance financial covenants and only a “no default” representation at the time of each drawdown.

This bifurcation reflects the market’s recognition that large-cap sponsors—typically global PE firms with dedicated portfolio operations teams—can manage credit risk through active monitoring and relationship-based governance, rather than through rigid covenant testing. The lenders in these transactions are often relationship banks that have extended multiple facilities to the same sponsor across different jurisdictions, and the pricing premium for incurrence-only structures (typically 50–75 bps over maintenance covenant pricing) is accepted as a cost of maintaining the relationship.

The HKD 15.2 billion acquisition of a Hong Kong-listed property development company by a global alternative asset manager in March 2025 used a covenant-lite structure. The credit agreement contained only a single incurrence test: a maximum TNL of 6.5x for any new debt incurrence, with no maintenance covenants, no ICR floor, and no restricted payments test. The sponsor contributed equity of HKD 6.0 billion (39.5% of the total consideration), and the lenders—a club of four authorised institutions—relied on the sponsor’s track record of 12 successful exits in Hong Kong over the prior decade, combined with a personal guarantee from the sponsor’s founding partner for the first HKD 2.0 billion of the facility.

Practical Considerations for Sponsors Negotiating Covenant Packages

For sponsors, the negotiation of a covenant package is not a binary choice between maintenance and incurrence regimes. The most effective strategies involve hybrid structures that incorporate elements of both, tailored to the target’s specific cash flow profile, the sponsor’s exit timeline, and the prevailing market conditions. Three practical considerations merit particular attention in the current Hong Kong market.

The EBITDA Definition and Add-Back Negotiation

The single most contested clause in any acquisition financing credit agreement is the definition of EBITDA and the allowable add-backs. In Hong Kong, the standard EBITDA definition in syndicated loan agreements typically excludes non-recurring items, extraordinary charges, and share-based compensation, but the scope of permissible add-backs is subject to intense negotiation. For a target company that has recently completed a restructuring or is undergoing a post-acquisition integration, the sponsor will seek to include “run-rate cost synergies” as an EBITDA add-back, while lenders will resist this unless the synergies are demonstrably achievable and backed by a third-party consultant’s report.

The HKD 4.8 billion acquisition of a Hong Kong-listed healthcare services provider in Q2 2025 involved a 12-month post-closing integration plan that projected HKD 320 million in annualised cost synergies. The sponsor negotiated an EBITDA add-back of 50% of the projected synergies for the first two covenant testing periods, subject to a cap of HKD 160 million. The lenders required a verification report from a Big Four accounting firm within six months of closing, confirming that at least 75% of the projected synergies had been realised. If the verification threshold was not met, the add-back would be reversed, and the sponsor would have 30 business days to cure any resulting covenant breach.

Cure Rights, Equity Cure, and the Sponsor’s Commitment

The cure period—the window during which a borrower can remedy a covenant breach before it constitutes an event of default—is a critical term in any maintenance covenant package. In Hong Kong acquisition financing, the standard cure period ranges from 10 to 20 business days, with the option for the sponsor to inject additional equity (the “equity cure”) to bring the borrower back into compliance. The equity cure is typically limited to two or three occasions over the life of the facility, and the amount of equity injected is often capped at a percentage of the original facility amount—commonly 10% to 15%.

The HKD 3.2 billion acquisition of a Hong Kong GEM-listed software company in Q1 2025 included an equity cure provision that allowed the sponsor to inject up to HKD 400 million (12.5% of the facility) on up to three occasions over the five-year term. Each equity injection was treated as an increase in the sponsor’s equity contribution for purposes of calculating the LTV ratio, but the lenders retained the right to accelerate the facility if the sponsor failed to cure a breach within two consecutive testing periods. This structure gave the sponsor operational flexibility while preserving the lenders’ ability to exit if the sponsor’s commitment was insufficient.

Cross-Border Considerations for BVI or Cayman-Listed Targets

For acquisitions of targets incorporated in the British Virgin Islands (BVI) or Cayman Islands but listed on the Hong Kong Stock Exchange (HKEX), the covenant package must account for the differences in corporate law and insolvency regimes. BVI and Cayman companies are not subject to the same statutory restrictions on financial assistance as Hong Kong-incorporated companies under the Companies Ordinance (Cap. 622), which can affect the sponsor’s ability to provide upstream guarantees or security.

In practice, lenders financing acquisitions of BVI or Cayman targets typically require a legal opinion from the target’s jurisdiction of incorporation confirming that the covenant package—particularly any maintenance covenant that restricts the target’s ability to make distributions or dispose of assets—does not violate the target’s constitutional documents or the applicable corporate law. The HKD 5.5 billion acquisition of a Cayman Islands-incorporated, Hong Kong-listed gaming company in Q4 2024 required a Cayman legal opinion confirming that the incurrence covenant restricting restricted payments was enforceable under the Cayman Companies Act, and that the lenders could seek specific performance of the covenant in the Grand Court of the Cayman Islands.

Actionable Takeaways for Sponsors and Their Advisors

The design of a covenant package for Hong Kong acquisition financing requires a fact-specific analysis that balances the sponsor’s need for operational flexibility against the lender’s requirement for credit risk monitoring. The following five takeaways are derived from the market data and regulatory guidance discussed above.

1. For targets with EBITDA volatility exceeding 15% or revenue growth above 25%, an incurrence-only covenant package is structurally superior to a maintenance regime, but sponsors should expect a pricing premium of 50–75 bps over maintenance covenant pricing based on H1 2025 HKISLMA data.

2. The HKMA’s CA-S-1 module (July 2024 revision) effectively requires lenders to document the rationale for incurrence-only structures on facilities exceeding 5.0x leverage, making it imperative for sponsors to prepare a stress-test analysis demonstrating the target’s resilience to a 30% EBITDA decline before commencing negotiations.

3. For acquisitions of Hong Kong Main Board-listed targets, the Takeovers Code Rule 10 post-offer restrictions on asset disposals and share repurchases require a 12-month carve-out or hybrid covenant structure to avoid a structural compliance mismatch.

4. The EBITDA definition and allowable add-back for run-rate cost synergies is the most negotiated clause in Hong Kong LBO credit agreements; sponsors should budget for a third-party verification report (typically from a Big Four firm) within six months of closing to support any synergy-related add-backs.

5. For BVI or Cayman-incorporated targets, sponsors must obtain a legal opinion from the jurisdiction of incorporation confirming that the covenant package is enforceable under local corporate law, particularly for maintenance covenants that restrict distributions or asset disposals.