On 17 February 2023, the China Securitis Regulation Commision (“CSRC”) promulgated the Trial Administrative Measures of Overseas Securities Offering and Listing by Domestic Enterprises (“Trial Measures”) and five (5) supporting guidelines (collectively referred to as “New Filing Regulations”). The New Filing Regulations will take effect on 31 March 2023. The New Filing Regulations introduce the filing regime for both direct and indirect overseas offerings and listings of companies in China (“Chinese Issuers”), improving China’s rule for overseas listings and making the overseas listing of Chinese Issuers enter into a new era of the filing regime.
The Special Regulations of the State Council concerning Floating and Listing of Shares Overseas by Companies Limited by Shares, the Notice of the State Council on Further Strengthening the Administration of Share Issues and Listings Overseas and the Notice on the Implementation of Mandatory Provisions in Articles of Association (AoA) for Companies Listed Overseas(“Mandatory Provisions”) shall be repealed on 31 March 2023.
This article summarises some material changes brought by the New Filing Regulations to the initial public offering (IPO) of Chinese Issuers, espcially impacts on the typical structures of H-share, red-chip and variable interest entities (VIE), as well as the employee stock option program (ESOP). Overseas investors who have interest in China Concept Stocks may have a glance on major changes and impacts caused by the New Filing Regulations.
A. Approval Regime is Changed to New Filing Regime
The H-share structure is one of direct overseas listings for Chinese Issuers, which is commonly used where the listed entity is a joint-stock company incorporated in the Chinese Mainland. Such company usually lists its domestic equity on the Hong Kong Stock Exchange (“HKEx”) as such direct listing happens mainly in HKEx rather than other overseas venues such as Nasdaq or the New York Stock Exchange. Before the New Filing Regulations, H-share issuers are required to apply to CSRC under the old approval regime and must obtain an acceptance letter before they submit listing application to HKEx. Only after acquiring the CSRC approval would they have opportunity to attend hearing by HKEx.
Under the New Filing Regulations, H-share issuers will be required to apply to CSRC for filing within 3 business days after applying to HKEx for listing, without getting prior approval from CSRC. On 24 February 2023, HKEx conducted consultation for the intended amendments to their listing rules, proposing to add new provisions to the listing rules requiring Chinese Issuers to submit a notification issued by CSRC confirming their completion of the filing procedures at least 4 business days before the expected hearing date.
B. Changes to H-share Full Circulation Scheme
H-share full circulation scheme under the New Filing Regulations will also be subject to the filing regime. Shareholders who hold domestic unlisted shares of H-share issuers may apply to convert their unlisted shares into listed shares for trading on HKEx. Issuer will be authorized to file with CSRC on behalf of those shareholders. The filing of the H-share full circulation scheme may proceed simultaneously with the application for the overseas listing and offering filing with CSRC, or separately after the IPO.
C. Mandatory Provisions in AoA
After the implementation of the New Filing Regulations, the Mandatory Provisions will be repealed. H-share issuers will no longer be bound by the Mandatory Provisions in the AoA. However, according to the requirements of the New Filing Regulations, Chinese Issuers using H-share structure need to ensure their AoA are consistent with the Guidelines for the AoA of Listed Companies (which was adopted mainly for domestic listings in China rather than overseas listing) and other CSRC regulations.
D. Procedures for Filing of H-share Listing
We set out the following diagram of the filing procedures for Chinese Issuers intending to list on HKEx in H-share structure under the New Filing Regulations :
The red-chip structure will firstly has an offshore holding company, i.e., a special-purpose vehicle (“SPV”), which is formed and injected with assets and interests of Chinese Issuers. Such offshore holding company will list its shares on an overseas stock exchange. The red-chip structure has two typical categories by different sizes and regulations: state-owned red-chip and private red-chip. A state-owned red-chip refers to a red-chip structure in which the ultimate beneficial owner (UBO) of Chinese Issuer is usually a Chinese government entity, while the private red-chip has an individual UBO. Pursuant to the New Filing Regulations, such overseas listings by using red-chip structure are contemplated as indirect overseas offerings and listings under the filing regime .
A. Red-chip Structure is Included in Scope of Filing Regime
Prior to the New Filing Regulations, the private red-chip usually reorganise cross-border through a “two-step” approach to avoid regulations of the Ministry of Commerce of China which requires certain foreign companies to report before they acquire domestic companies in China. Under the New Filing Regulations, both the state-owned red-chips and private red-chips as indirect overseas offerings and listings are subject to the same filing requirements with CSRC after submitting the listing application to overseas stock exchanges.
Nevertheless, the red-chip structure will maintain its unique advantages after the implementation of the New Filing Regulations. For example, companies incorporated in the Cayman Islands, Jersey or the British Virgin Island (BVI) are easily accepted as qualified issuers by major overseas stock exchanges for their common law system and the sufficient protection of minority shareholders’ rights and interests. Foreign investors also prefer to hold shares at the level of overseas holding company instead of directly holding shares in the Chinese Mainland. It is worth noting the New Filing Regulations require applicants to report information of the UBO and other major shareholders holding more than 5% of the shares or voting rights of the issuers.
B. Who are Companies in the Chinese Mainland?
CSRC will look into the substance rather than the form of the enterprises to decide whether they are subject to the filings. Issuers that meet both the following conditions will be regarded as indirect overseas offerings and listings subject to the filing regime.
If an issuer does not meet the abovementioned conditions but submits a listing application as non-domestic (or regional) issuers to an overseas stock exchange in line with the relevant regulations, and the risk factors disclosed are mainly related to the Chinese Mainland, the securities company and the issuer’s Chinese legal counsel shall follow the substance over form principle to make a comprehensive analysis and conclude whether the issuer falls within the scope of the filing regime or not.
C. Negative List Regime for Overseas Listing
The New Filing Regulations have established a negative list system for overseas listing. A Chinese Mainland company is prohibited from offerings and listing on overseas exchanges where (a) the industry is prohibited to IPO under laws, regulations and relevant state rules, (b) the intended overseas offering and listing may endanger national security, (c) criminal offenses may be involved, (d) the Chinese Mainland company is under investigations for criminal charges or major violations of laws and regulations, or (e) there are material disputes over major shares. The supporting guidelines of the New Filing Regulations further explain the following situations where the overseas offering and listing is prohibited.
For industries that are explicitly prohibited from offering and listing by laws, administrative regulations or relevant state rules, compulsory education subject-based training institutions and for-profit kindergartens are forbidden for listing under the Negative List for Market Access. It is believed that the government may publish industry policies to prohibit certain industries from financing from the capital markets.
D.Procedures of Filing for Red-chip Listing
The procedures of the filing procedure for Chinese Issuers intending to listed on HKEx in the Red-chip structure are similar to the abovementioned diagram for H-share filing processs under the New Filing Regulations. But companies intending to use the red-chip strcture need to establish the red-chip structure before applying for listing on HKEx.
A. VIE Structure is Regulated
Companies of the Chinese Mainland, especially those companies involved in the internet with the internet content provider (ICP) licenses usually use the structure controlled by agreements (“VIE Structure”) . China’s regulation over the VIE structure has not been clearly specified for the last two decades until the supporting guidelines of the New Filing Regulations, which require issuers with VIE structure to make the following explanation of the VIE structure in the filing submission:
In addition, if the issuer has a VIE structure, the issuer’s Chinese legal counsel shall verify and state in accordance with the following requirements:
We understand that the New Filing Regulations have expressly included the VIE structure into the filing for overseas listing . A CSRC senior officer indicated in a press conference that VIE structure companies that satisfy the compliance requirements will be filed for overseas listing. However, it should be noted that in the past, companies with VIE structure are usually subject to foreign investment restrictions or prohibitions. The New Filing Regulations requires the issuer’s Chinese legal counsel to verify whether the VIE structure involves foreign investment restrictions or prohibited areas, which may actually affect the use of VIE structure.
B. VIE Structure Revisit - Considering the Negative List for Foreign Investment
VIE structure is generally a special arrangement made for overseas listed companies when there are restrictions on foreign investment or foreign shareholding percentage in a certain industry (such as hospitals and internet content). Such structure was intentionally overlooked by laws and regulations. Under the New Filing Regulations, the criteria for determining whether a VIE structure can be successfully filed includes compliance requirements, with reference to the Special Administrative Measures for Foreign Investment Access, international treaties and agreements relating to foreign investment access as well as other specific industrial regulatory rules.
According to Article 6 of the latest Special Administrative Measures (Negative List) for Foreign Investment Access (Edition 2021), a company of China’s Mainland engaging in investment in fields prohibited by the Negative List for Foreign Investment Access which intends to list and offer shares overseas, shall obtain the approval of the State authorities. Foreign investors shall not participate in the operation and management of the company, and their shareholding percentage shall be subject to the relevant provisions on administration of domestic securities investment by foreign investors. Issuers with VIE structures need to pay attention to whether the relevant agreement arrangements meet the compliance requirements.
For now it is still unclear how other departments will further publish regulations in concert for VIE structure. Overseas stock exchanges may also adjust their guidelines and disclosure requirements for companies in the Chinese Mainland in response to the New Filing Regulations.
A. Personnel Disqualified from ESOP
According to the New Filing Regulations, specific domestic personnels such as directors, senior management, core technical personnel or core business personnel of the company, and other personnel who will have a direct influence on the business performance and future development of a H-share company. The company may issue securities overseas to specific domestic personnels for the purpose of ESOP. However, the following personnel shall not be the objects of ESOP.
B. Verification Requirements for ESOP
For issuers who plan to implement ESOP, whether directly overseas listed or indirectly overseas listed, the issuer’s Chinese legal counsel should verify the ESOP as required by the supporting guidelines. The specific verification points are set out as follows :
The New Filing Regulations implement the filing regime for both direct (H-share) and indirect overseas listings (Red-chip and VIE). It is a profound reform to China’s overseas listing regulatory system, and the impact will be far-reaching. The filing regime and supporting guidelines of the New Filing Regulations are operable but some issues are still pending further clarification such as the regulation of existing companies with VIE structure and the overseas listing of companies in industries with restricted foreign investment. In addition to the New Filing Regulations, we need pay attention to the updated guidances and disclosure requirements of major overseas stock exchanges in response to the New Filing Regulations in China.
1. Decision of the State Council on Repealing Certain Administrative Regulations and Documents (Decree No.758 of the State Council) and Article 35 of Trial Measures
2. Article 16 of Trial Measures
3. Article 55 of Rule Amendments Following China’s Mainland Regulation Updates and Other Proposed Rule Amendments Relating to PRC Issuers
4. Article 1(3) of Guidelines on the Application of Regulatory Rules - Overseas Securities Offering and Listing No. 2: Guidelines on the Content and Format of Filing Materials
5. Article 7 of Guidelines on the Application of Regulatory Rules - Overseas Securities Offering and Listing No. 1
6. Chapter 2 and Chapter 3 of Trial Measures, and Article 2 of Guidelines on the Application of Regulatory Rules - Overseas Securities Offering and Listing No. 1
7. Article 2 and Article 3 of Trial Measures
8. Article 1(3)(3) of Guidelines on the Application of Regulatory Rules - Overseas Securities Offering and Listing No. 3: Guidelines on the Content of Filing Reports
9. Article 15 of Trial Measures
10. Article 8 of Trial Measures
11. Article 3 of Guidelines on the Application of Regulatory Rules - Overseas Securities Offering and Listing No. 1
12. Items 141 and 143 of Negative List for Market Access (Edition 2021)
13. Chapter 2 and Chapter 3 of Trial Measures, and Article 2 of Guidelines on the Application of Regulatory Rules - Overseas Securities Offering and Listing No. 1
14. Article 2(3)(4) of Guidelines on the Application of Regulatory Rules - Overseas Securities Offering and Listing No. 2: Guidelines on the Content and Format of Filing Materials
15. Item 6 of the Q&A with the official of relevant department of CSRC published by CSRC on February 17, 2023
16. Article 3(2) of Guidelines on the Application of Regulatory Rules - Overseas Securities Offering and Listing No. 1
17. Article 2 of Guidelines on the Application of Regulatory Rules - Overseas Securities Offering and Listing No. 2: Guidelines on the Content and Format of Filing Materials