Our Voices

China Adopts Rules to Lure Innovative Overseas-Listed Companies Back to China’s Stock Exchanges

By Megan J. Penick, Jeffrey A. Rinde, Jing Li and Joy Xiao

On March 22, 2018, the China State Council published an opinion (the “Opinion”) of the China Securities Regulatory Commission inviting qualified innovative overseas-listed corporations to sell shares or issue Chinese Depositary Receipts ("CDRs")[1] on China’s stock markets.[2] This move is aimed at luring China-based technology companies, such as Baidu, Inc. (Nasdaq:BIDU) and Alibaba Group Holding Ltd (NYSE:BABA), back to Mainland China’s stock markets.  Under previous rules, such companies had been barred from listing in China because they are owned through contractual arrangements (otherwise known as Variable Interest Entities or VIEs) by non-Chinese holding companies.[3]

The Pilot Enterprises

In order to qualify for this initiative, companies referred to as “pilot enterprises” should operate in high-technology and strategic emerging industries in areas that correspond with China's national strategies while maintaining ownership of core technologies which have achieved large-scale acceptance in the marketplace. Areas of core technologies include internet, big data, cloud computing, artificial intelligence, software and integrated circuits, high-end equipment manufacturing and bio-pharmaceuticals.[4]

Pilot Enterprises include

1. Overseas-listed "red-chip" companies whose holding companies are incorporated or registered overseas (such as in the Cayman Islands) and yet maintain their principle place of business in Mainland China. In order for such a company to qualify, the company must have a market value of at least RMB200 billion (or approximately US$31.7 billion).

Based on research conducted by Tencent Finance,[5] there are currently only six companies that qualify as Pilot Enterprises: Alibaba Group Holding Limited, China Mobile Communications Corporation, Baidu, Inc., JD.com Inc., Netease, Inc. and China Telecommunications Corporation.

2. Non-overseas listed innovative enterprises (including "red-chip" enterprises and China registered companies) are companies with operating income of at least three billion yuan (or almost US$500 million) in the most recent year, or companies with a valuation of at least RMB20 billion (or approximately US$3.2 billion). In addition, a Chinese company may be considered an innovative enterprise if the company, as measured by its operating income, has grown rapidly and achieved a comparatively dominant position in the marketplace by developing leading international technologies through its own research and development efforts.  Similar to high valuation new technology start-ups in the U.S., the Chinese media has dubbed qualifying innovative enterprises as “unicorn companies.”[6]

Presently, there are approximately 124 companies in China that qualify as “innovative enterprises,” with a total valuation of approximately RMB3.9 trillion or US$618 billion.[7] Allowing such companies to list on China’s stock markets may be an effective way to encourage Chinese unicorn companies to list their shares in China in lieu of overseas stock markets.

The specific standards for Pilot Enterprises are set by the Chinese Securities Regulatory Commission.

Methods of Listing in the Chinese Markets include

Selling shares or issuing CDRs

  • Red-chip enterprises can issue CDRs in China’s stock markets.
  • Qualified pilot red-chip enterprises can apply to issue shares in China’s stock markets.
  • Enterprises registered in Mainland China can apply to issue shares in China’s stock markets.

The Opinion briefly discusses related regulatory requirements and governing laws surrounding the issuance of securities, information disclosure, investor protections, legal liabilities and organizational management, among other things. However, note that the discussion of regulatory requirements in the Opinion was not in depth or in detail and one must look to other laws and, perhaps, later regulations or guidance to determine how to best effectuate these new listing opportunities.

Our View

A substantial number of Chinese companies have gone public overseas using a VIE (or variable interest entity) structure, which allows for an overseas registered holding company to control the China domestic registered company (or operational entity) through a series of contractual arrangements. China-based companies pursued such arrangements to capture the allure of an overseas stock listing, including the perceived access to a broader international investor base.  However, such listings came at a price as, historically, such companies were prohibited from listing in China due to the foreign ownership structure.  In addition, the process of delisting in order to re-list in China was often perceived as overly burdensome, as companies in most instances would have to first go private, deconstruct the VIE structure, and then apply for listing on the Chinese stock market through an initial public offering (IPO). This newly issued Opinion serves to open the Chinese markets to successful overseas-listed entities by allowing foreign registered China-based companies to sell CDRs on China’s stock markets.  With a limited number of qualified overseas-listed China-based companies, it remains to be seen whether this new Opinion will entice China’s high flying technology companies to also seek a listing in their “home” markets.

CKR Law will continue to monitor developments surrounding this new initiative.  Should you require further information on this or other China-related matters, feel free to contact our New York-based China Law team, including Partners Jeffrey A. Rinde (jrinde@ckrlaw.com), Megan J. Penick (mpenick@ckrlaw.com), Jing Li (jli@ckrlaw.com) and Associate Joy Xiao (jxiao@ckrlaw.com).



DISCLAIMER:  This article is not intended to provide legal or tax advice, and no legal, tax or business decision should be made based on its contents.  This legal update may be considered attorney advertising in some jurisdictions. 

[1] A CDR is a certificate issued by a Chinese bank that represents a pool of foreign equity that is traded on local Chinese exchanges. Foreign companies can use CDRs to allow both Chinese institutional and private investors to own their stock.

[3] VIE structures are commonly used by China-based companies in sectors that have restrictions over foreign investment under China’s Foreign Investment Industrial Guidance Catalogue, as amended. Such sectors include, among other things, telecommunications, e-commerce and online gaming. The VIE structure is currently the only way that non-Chinese investors may hold shares in companies in these restricted sectors.

[5] https://finance.qq.com/a/20180330/026300.htm. Note that this list could possibly also include Tencent Holdings Limited itself, according to other sources. See http://stock.eastmoney.com/news/1374,20180402851898275.html.

[6] A unicorn is a startup company valued at over $1 billion. See https://en.wikipedia.org/wiki/Unicorn_(finance).