New Opportunities brought to FIEs by the Sci-Tech BoardAuthor: Bing-Guang YU 2019-06-206766
On November 5, 2018, President Xi Jinping announced that a science and technology innovation board (“Sci-Tech Board”) would be set up on the Shanghai Stock Exchange (“SSE”) and registration-based system would be tested thereon. On January 30, 2019, the China Securities Regulatory Commission (“CSRC”) promulgated the Implementing Opinions on Establishing a Science and Technology Innovation Board and Launching Pilot Registration-Based System on the Shanghai Stock Exchange (“Implementing Opinions”). The establishment of the Sci-Tech Board and the introduction of a pilot registration-based system is a major reform of China’s capital market aimed at enhancing the market function to serve the scientific and technological innovation businesses and improving the inclusiveness of the capital market.
On March 1, 2019, CSRC issued two regulations: Administrative Measures on Registration of Initial Public Offering of Shares on the Science and Technology Innovation Board (Trial Implementation) (“Registration Measures”) and the Measures on Ongoing Supervision for Companies Listed on the Science and Technology Innovation Board (Trial Implementation) (“Supervision Measures”), thereafter 6 supporting regulations issued by SSE: Rules of SSE for Review of Issuance and Listing of Stocks on the Sci-Tech Innovation Board ("Review Rules"), Implementation Measures of SSE for Issuance and Underwriting of the Stocks on the Sci-Tech Innovation Board ("Issuance and Underwriting Measures"), Rules of SSE for Listing Stocks on the Sci-Tech Innovation Board ("Listing Rules"), Special Provisions of Shanghai Stock Exchange on Trading of Stocks on the Sci-Tech Innovation Board ("Special Trading Provisions"), Measures of Shanghai Stock Exchange for the Administration of Listing Committee for Stocks on the Sci-Tech Innovation Board and Working Rules of Shanghai Stock Exchange for the Sci-Tech Innovation Board Advisory Committee (collectively “the 6 major Rules ”).
The official issuance of the above-listed “2+6” rules of the Sci-Tech Board leads to significant reform of China’s capital market, which symbolises the official landing of Sci-Tech Board of SSE in completing China’s multilayer capital market system. With reference to the institutional innovations of the Sci-Tech Board and the further opening-up policies on foreign investment of China, brief analysis on the new opportunities brought to foreign invested enterprises (FIEs) by the Sci-Tech Board will be delivered in this article.
I. Institutional Innovations of the Sci-Tech Board
As an independent and newly founded market, the Sci-Tech Board achieved several major breakthroughs compared to the current A share market. It cancels the past strict requirements for profits-making, shows greater inclusiveness to Sci-Tech innovation businesses and lifts bans to listing of non-profit companies, companies with differential voting right structures, red chip enterprises and companies with variable interest entity (“VIE”) structures. The institutional innovations of the Sci-Tech Board are reflected as following:
1. Positioning of Science and Technology Innovation
The Implementing Opinions of CSRC emphasises on the positioning of the Sci-Tech Board, that it should adhere to facing the frontier of the world's science and technology, facing the major battlefield of the economy and facing the major needs of the country and mainly serve the science and technology innovation enterprises that meet the national strategy, make breakthrough in key and core technologies and have high market recognition. The Sci-Tech Board offers priority support for high-tech industries and strategic emerging industries such as new generation of information technology, high-end equipment, new materials, new energy, energy conservation and environmental protection and biomedicine, promotes the in-depth integration of the internet, big data, cloud computing, artificial intelligence and manufacturing. The positioning of the Sci-Tech Board in fact also meets the preference of foreign investment. According to a survey, the most promising themes of investment in China favoured by foreign institutions are consumption upgrade, science and technology innovation, structural reform and industrial upgrade.
2. Five sets of different IPO standards
The Sci-Tech Board features five sets of different IPO standards. Considering the factors such as market value, net profit, business revenue, cash flow, research and development investment and core technologies and products, five sets of listing criteria are tailored for listing on the Sci-Tech Board. Companies are eligible to go for listing if they satisfy one of the criteria. (for specific criteria, refer to Article 2.1.2 of Listing Rules)
3. The Sci-Tech Board accepts listing of red chip enterprises
Under the Implementing Opinions, any red chip enterprise in conformity with the relevant provisions of the Notice of the General Office of the State Council on Forwarding the Several Opinions of the China Securities Regulatory Commission on the Launch of the Pilot Program of Domestically Issuing Stocks or Depository Receipts by Innovative Enterprises (Guo Ban Fa  No.21) (“Opinions No.21”) may apply for the issuance of shares or depositary receipts and the listing of the same on the Sci-Tech Board. The rules on Sci-Tech Board refine the requirements by setting forth clear standards of estimated market value and business revenue, which dramatically lowers the relevant requirements for such special red-chip enterprises going for public listing. This is definitely good news for the sci-tech innovation enterprises which have built up red chip structures, especially for those who have already developed to a certain scale and are in a leading position in the industry.
4. The Sci-Tech Board accepts listing of companies with differential voting right structures
Due to the huge demand of upfront investment for research and development, sci-tech innovation enterprises will often experience several rounds of financing before going public listing. The founders and the core teams therefore face share dilution risks, while the controlling rights of founders for the high-growth company can be ensured by taking the differential voting right structures. In the past, the Hong Kong Stock Exchange missed the IPO of Alibaba because it did not accept listings of companies with differential voting rights. However, the unequal voting rights are introduced in the Sci-Tech Board rules, allowing the coexistence of common voting rights and special voting rights and offering a channel for businesses with different voting right shares to go for public listing on the Sci-Tech Board and to attract high quality Sci-Tech innovation enterprises to remain in China. Nevertheless, under the Listing Rules, only enterprises that satisfy the required financial criteria and market value are entitled to set up such differential voting right mechanism, and special rules and regulation are applicable to the shares with special voting rights.
5. The Sci-Tech Board accepts listing of enterprises which are not yet profitable or have accumulated uncovered losses
Implementing Opinions provides that in light of the positioning of the Sci-Tech Board and features of Sci-Tech innovation enterprises, more attention shall be given to the ability of enterprises to make innovations in science and technology, factors such as expected market value, revenue, net income, R&D investment and cash flow shall be taken into consideration to set up diversified and inclusive listing conditions, which accepts the enterprises satisfied with the positioning of the Sci-Tech Board but are not yet profitable or have accumulated uncovered losses to go for listing.
6. Price inquiry mechanism
In contrast to restrictions on offering prices of IPO on the A share market, the pricing mechanism is improved in the Sci-Tech Board, reflecting the concept of value investment. Initial public offering of shares shall undergo price inquiry to professional institutional investors, such as securities companies registered with the Securities Association of China, fund management companies, trust companies, finance companies, insurance companies, qualified overseas institutional investors and private fund managers for determination of share issue price.
II. Our Foreign Investment Policies and Development
1. Overview of the foreign investment policy
For economic and security reasons, it is universal that every government restricts or prohibits foreign investment in strategic and sensitive industries related to national and regional economic security, China is no exception. In view of industrial policies and the demand for guidance to foreign investment in various periods of time, the Ministry of Commerce and the Development and Reform Commission have always conducted industrial guidance and access restrictions on foreign investment by issuing Catalogue of Industries for Guiding Foreign Investment (“Catalogue”). The Catalogue classified the industries of foreign investment access into sectors of “encouraged”, “restricted” and “prohibited”, which was first issued in 1995 and after 7 revisions, the Special Administrative Measures (Negative List) for Foreign Investment Access (Edition 2018) is currently effective. In the Pilot Free Trade Zone, Special Administrative Measures (Negative List) for Foreign Investment Access in Pilot Free Trade Zones (2018 Version) is applied.
2. Development of foreign investment in China’s capital market
China has been continually making efforts in improving foreign investment environment and accessible industrial sectors for foreign investment has been gradually expanding. For example, the restricted and prohibited industries for foreign investment on the Negative List for Foreign Investment Access (Edition 2018) applied in the pilot free trade zone have been reduced from 190 to 45. Previously restricted foreign investment industries are now further opened up, such as banking, insurance and securities. On March 13 of this year, CSRC approved the establishment of Nomura Orient International Securities Co. Ltd., where Nomura Holdings, Inc. holds 51% shares, which is the first newly established securities institution controlled by a foreign party.
Certainly, the capital market in China is not yet fully opened and foreign capital invested into the A share market in China must via channels, such as Qualified Foreign Institutional Investors (“QFII”), Renminbi Qualified Foreign Institutional Investors (“RQFII”), Shanghai-Hong Kong Stock Connect, Shenzhen-Hong Kong Stock Connect and the upcoming Shanghai-London Stock Connect and Shanghai-Deutsche Stock Connect. The relevant channels have been further broadened and to meet the increasing demand of overseas investors’ expanding investments in China's capital market, on January 14, 2019, the total quota of the QFII was increased from USD 150 billion to USD 300 billion upon approval of the State Council. According to the latest statistics of the State Administration of Foreign Exchange, as of the end of March 2019, 289 QFIIs have been approved with a total investment quota of USD 101.596 billion. Following QFII, in 2011 China launched the RQFII to attract more qualified foreign institutional investors, meanwhile accelerating the internationalisation of the Renminbi. According to the statistics of the State Administration of Foreign Exchange, as of March 27, 2019, the CSRC has approved 210 RQFIIs with a total quota of CNY 660.972 billion.
On November 14, 2014, the Shanghai-Hong Kong Stock Connect was officially connected and Shenzhen-Hong Kong Stock Connect was launched on December 5, 2016, which bridged the capital markets between the A share and Hong Kong stock market. In addition, Shanghai-London Stock Connect is expected to officially start by the end of this year, and a consensus on Shanghai-Deutsche Stock Connect was also reached at China-Germany High Level Financial Dialogue in the beginning of this year. The interconnection between the A share market and the overseas capital market is conducive to promoting China’s domestic securities institutions to carry out cross-border securities business, promoting the development of the securities industry and increasing their international competitiveness. For investors, the interconnection facilitates investment in entering the other side’s market and brings more investment opportunities. Starting from Shanghai-Hong Kong Stock Connect, Shenzhen-Hong Kong Stock Connect, to Shanghai-London Stock Connect and Shanghai-Deutsche Stock Connect, China shows its determination to unswervingly promote further opening-up of its capital market. By then, more investment channels will be offered to foreign capitals to invest into China’s market, enabling foreign investors to share the dividends of China’s economic growth.
In view of the stock market data at the end of 2018, foreign shareholders accounted for 15% in the US stock market, 30% in Japan, 21% in Brazil and 33% in South Korea. By contrast, foreign shareholders in China accounted for just 3.5% of the market capitalisation value of free float shares in China’s market, which was not only far lower than those in developed countries such as Japan and the US but also lower than those in the emerging market countries such as South Korea and Brazil. Compared with the securities markets of other major countries, there is still greater room for improvement of the ratio of foreign shareholders in China. However, it should be noted that under China’s applicable laws, the ratio of foreign shareholders of a single foreign investor in a listed company of the A share market (regardless of the channel through which the share is collected, including QFII, RQFII, Shanghai-Hong Kong Stock Connect and Shenzhen-Hong Kong Stock Connect etc.) shall not exceed 10% of the total shares of the said listed company and the total proportion of all foreign investors shall not exceed 30%.
The internationalisation of the A share market has been ongoing. With its inclusion into the FTSE Russell’s global equity indexes in June this year, the A share market is expected to see initial net passive inflows of USD 10 billion, said Mr. Mark Makepeace, CEO of FTSE Russell. As the ratio of inclusion increases in the next three to four years, an additional USD 50 billion can be expected. The inclusion in the short term is expected to bring about CNY 100 billion to the A share market, and the incremental fund is expected to reach CNY 1 trillion following full inclusion. With reference to the experience of Taiwan, China and South Korea, at the stage of gradual opening-up of capital market, the proportion of institutional investors, especially foreign institutions, will be increasing, and the relative valuation of leading companies will rise. Morgan Stanley also expects the foreign capital inflow into the A share market to reach USD 70-125 billion in 2019 and about USD 100–220 billion annually in the next decade.
3. The forthcoming Foreign Investment Law
Foreign Investment Law (“FIL”) was promulgated on March 15 of this year and it will come into effect on January 1, 2020. It provides pre-establishment of national treatment for foreign investors, which refers to granting to foreign investors and their investments, at the stage of investment access, the treatment no less favourable than that granted to domestic investors and their investments. Upon its effectiveness, FIEs may equally enjoy the preferential policies granted to China’s domestic companies, including those to Sci-Tech and innovative enterprises. For example, according to a recent announcement of the Ministry of Finance, firms engaged in integrated circuit design and software development, which fulfil certain conditions will be exempted from business income tax in this year and next year, and from the third to fifth year, the income tax will be levied at half of the statutory taxation rate of 25%, such tax preference shall also be applied to FIEs. Meanwhile, under the Notice of Several Measures for Further Opening up and Actively Use of Foreign Capital issued by the State Council in 2017, which supports FIEs to expand financing channels, FIEs may be listed on the main-board market, SME board, GEM and new OTC market in accordance with relevant laws and regulations, and FIEs are allowed to conduct financing via issuing bonds. The FIL further provides that FIEs may raise funds by means of public offering of shares, corporate bonds or other securities and so on.
One point that should be highlighted is that the concept of “actual control” involving the legality of VIE structures previously stipulated in FIL’s draft has been deleted. The VIE structure has not been mentioned in the definition of foreign investment in the final version of FIL and the red chip enterprises are not prohibited from existence. On the contrary, since the FIL stipulates that the corporate organisational form of FIEs shall accord with domestic Company Law and Partnership Enterprise Law, requirements of paid-in capital and capital verification of FIEs are factually removed. Meanwhile, due to the implementation of the administration system of Negative List, most prohibitions on foreign investment which requires approval have been revoked. Given the need for further opening-up and the current circumstance where large quantities of companies with VIE structures have completed IPOs on overseas markets, it is therefore believed that the official supervision body will adopt a prudent and pragmatic attitude in dealing with VIE structures. Even if VIEs are to be supervised, a reasonable transition period and adjustment measures could be expected. Of course, companies retained with VIE structures which are going to apply for listing on the Sci-Tech Board will be required to elaborate on the reasons, taxation and rationalities of building up the VIE structure.
III. Institutional Design of Sci-Tech Board for Red Chip Enterprises
On March 30, 2018, Several Opinions on Piloting the Domestic Issuance of Stocks or Depositary Receipts by Quality Innovative Enterprises (Guo Ban Fa  No.21, “Opinions No. 21”) promulgated by the CSRC was forwarded by the General Office of the State Council. The depositary receipts issued by qualified pilot enterprises refer to the securities that are signed and issued by the depositaries, issued in China's mainland based on the overseas securities, and represent the rights and interests of the overseas underlying securities.
Opinions No.21 has made systematic institutional arrangements to support innovative enterprises to list in China. The main content includes: first, it makes it clear that overseas registered red chip enterprises may issue shares in China; second, it introduces the depositary receipt as a new type of securities and makes arrangements for the basic system of issuing depositary receipts (including participants, deposit agreement, the underlying assets of depositary receipts and cross-border conversion); third, it further optimises the conditions for security issuance, and deals with the problem that some sustainably profitable innovation enterprises may have not yet profited or have accumulated uncovered losses; fourth, it takes into account enterprises with shares of differential voting right structures, VIE structure or similar special arrangements, and makes specific arrangements for these innovation enterprises.
Under Opinions No.21, pilot enterprises shall be high-tech industries and strategic emerging enterprises that have certain scale, in line with national strategies, master core technologies, and have high market recognition in sectors, such as Internet, big data, cloud computing, artificial intelligence, software and integrated circuits, high-end equipment manufacturing, and bio-pharmaceuticals. Namely, these enterprises are included: the large-scale red chip companies that have been listed overseas and have a market value of no less than CNY 200 billion; innovation enterprises (including red chip companies and domestic registered companies) that have not been listed overseas, and have a business revenue of no less than CNY 3 billion in the most recent year and the valuation shall be no less than CNY 20 billion, or have revenue that has grown rapidly, own independent R&D and leading international technology or are in a relatively dominant position in competition with the industry.
The Implementation Opinions released on January 30, 2019 makes it clear that enterprises with differential voting right structures and red chip enterprises are allowed to be listed, and red chip enterprises fulfilling the requirements of Opinions No.21 are entitled to apply for the issuance of stocks or depository receipts and conduct listing on the Sci-Tech Board.
The 6 major Rules issued on March 1, 2019, such as the Rules of SSE for Review of Issuance and Listing of Stocks on the Sci-Tech Innovation Board, stipulates that any red chip enterprise in compliance with the relevant provisions of Opinions No. 21 is entitled to apply for issuance of shares or depositary receipts and the listing of the same on the Sci-Tech Board. The company with estimated market value no less than CNY 10 billion, or its estimated market value no less than CNY 5 billion and the business revenue in the latest year no less than CNY 500 million is entitled to apply for listing on the Sci-Tech Board.
On April 3, 2019, the Announcement on Relevant Tax Policies for the Pilot Program of Issuance of Depositary Receipts within China by Innovative Enterprises (“Announcement”) was issued by the Ministry of Finance, the State Taxation Administration and CSRC. Under the Announcement, various preferential policies will be applied to the individual income tax on price difference income obtained by individual investors from the transfer of innovative enterprises' CDRs and on the dividend and bonus income obtained by individual investors from holding innovative enterprises' CDRs, as well as enterprise income tax, value-added tax and stamp duties.
Obviously, applicants for listing on the Sci-Tech Board should satisfy not only the requirements of the Opinions No. 21, but also comply with the relevant regulations of the Sci-Tech Board. Under the double regulation standards, the listing of red chip enterprises in China is entering at a brand-new stage.
IV. The First Overseas-Registered Enterprise to Issue CDR on the Sci-Tech Board
On April 17, 2019, Ninebot’s application for issuing CDR and listing on the Sci-Tech Board was accepted, making this Cayman Islands-registered company by now the only overseas-registered enterprise accepted by the Sci-Tech Board.
Ninebot has once built up VIE structure and owns shares with differential voting rights. Since it is a red chip enterprise with differential voting right structures, Ninebot has selected the second set of listing standards set forth in the Listing Rules.
Publicly available information indicates that Ninebot still suffered losses in the reporting period. As of December 31, 2018, the net losses in 2016, 2017 and 2018 were CNY 150 million, CNY 620 million and CNY 1.79 billion respectively. Should Ninebot achieve successful listing, it would be a proof that China’s A share market accepts listing of red chip enterprises which are not yet profitable, this will set an example for many overseas-listed red chip enterprises to return and list on the Sci-Tech Board.
V. New Opportunities brought by the Sci-Tech Board
Prior to 2012, as per the requirements of CSRC, companies (regardless of the rationalities and registration place) which have already established red chip structures shall remove all the red chip structure should apply for listing on the A share market, to have clear equity rights, simplified company layers and for easier consistent supervision. Since 2012, an increasing number of red chip enterprises have sought to return and list on the A share market. However, there were requirements on issuers for profit-making and the issuers which retain contractual control structure and differential voting right structures were prohibited from listing. The main approach through which listed red chip enterprises returned to the A share market for listing was privatisation, while privatisation brought massive problems to enterprises, such as time costs, tax costs, capital pressure and foreign exchange problem.
The issuance of Opinions No.21 and the launching of Sci-Tech Board have changed the situation. For example, UCloud Technology Co., Ltd (“UCloud”) applied for listing on the Sci-Tech Board on April 1, 2019. It used to aim at listing overseas by using a VIE structure. To go public listing in China’s domestic market, UCloud dismantled its red chip structure. Since UCloud retained its differential voting right structures, it chose the second set criteria of Listing Rules of the Sci-Tech Board. In addition, foreign-controlled Sci-Tech companies can also be found in the application list of the Sci-Tech Board, such as Anji Microelectronics (Shanghai) Co., Ltd (“Anji”), which falls in the industry of computer, communications and other electronic equipment manufacturing. Anji Cayman, Anji’s biggest shareholder, is an investment company based in Cayman Islands, which is owned by 8 shareholders, including foreign companies, such as Ruyi Holdings Inc., Northern Light Venture Capital II, Ltd. and Oriental Wall Limited. On June 5，Anji was approved by the competent authorities to be listed on the Sci-Tech Board, which is among the first group of three companies accepted for listing on the Sci-Tech Board of the SSE.
The listing rules of the red chip enterprises have been set forth in a particular chapter of the newly promulgated regulations on the Sci-Tech Board, including the application of relevant regulations. The Sci-Tech Board accepts Sci-Tech company retained with contractual control structure and differential voting right structures to be listed thereon, caters to the new trend of corporate governance mechanism of new economic enterprises, offers them channel to the direct listing and financing in China and saves them more money and time spent on privatisation and in the course of returning to China for listing. In combination with the free remittance of foreign investor’s income obtained in the mainland China in RMB or any foreign currency stipulated in the FIL, the new favourable conditions brought by the Sci-Tech Board will surely attract more foreign-invested Sci-Tech innovation enterprises to go for listing in China.
Due to the situation that the A share market does not accept companies with differential voting rights and requires excessively high profits and too long queuing up time for listing, a large number of new economies and high-tech companies have chosen to go public listing on overseas markets. In the year of 2018, 34 Chinese domestic companies completed IPOs in the US; among the 218 new listings in Hong Kong, 111 were from mainland China. According to statistics, 45% of the Chinese companies listed overseas are High-Tech companies. Generally speaking, the benefits and returns of listing in China’s domestic market is much more attractive to the companies operating in China, no matter they are Chinese or foreign-invested companies. On one side, for any company listed in China, the Chinese investors themselves are also consumers and thus they may have a better perception on the company’s business operation, which is conducive to investors’ communication and market value management. On the other side, the valuation premium of the Chinese market is relatively higher in comparison to that of the US and Hong Kong Markets. With the market inquiry pricing mechanism to be applied in the Sci-Tech Board, companies are more likely to obtain higher valuation and hence generate higher returns to investors. Moreover, with the continuation of the trade war between China and the US, companies who choose to go public listing in the US will inevitably be affected.
In summary, the Sci-Tech Board is a new experimental field of China's capital market. It has significant and profound meaning in solving the problem of insufficient capital support for Sci-Tech innovation companies. For China’s capital market, the launch of Sci-Tech Board further implements the mission of financing serving hypostatic economy, facilitates the upgrading of China’s industrial structure, and accelerates the process of institutionalisation and internationalisation of the A share market. In combination with the forthcoming FIL and various favourable policies on foreign investment and financing in place, broader channels and diversified choices will be available for investors at both home and abroad to conduct investment and financing on the A share market. This will greatly accelerate the business development of Sci-Tech innovation enterprises and in the meantime boost opportunities for all parties to enjoy and share the dividends of such development.