Title: Red-chip Listing and the Impact of the New Acquisition Regulations on It
Author: Fei guoping
Date: 2007-01-05
Abstract: In the Regulations Regarding the Acquisition of Domestic Enterprises by Foreign Investors jointly issued by the MOFCOM, SASAC, SAT, SAIC, CSRC and SAFE, which is effective as of September 8, 2006, there is a section regarding the regulations on SPVs. The new acquisition regulations have evoked great repercussion in the society, and it is believed that the provisions regarding SPVs will increase the costs and uncertainty of red-chip listings of SPVs, which will result in the shrinking of red-chip listings. While after careful analysis of the terms and provisions, up to now, it is still uncertain what impact the new acquisition regulations will have on red-chip listings, as the relevant government authorities, especially the China Securities Regulatory Commission (CSRC), has great power of discretion. As a result, it is still too early to make the conclusion that red-chip listings will be hard to carry out.
Key Words: red-chip listing; new acquisition regulations; one-year term; CSRC
Red-chip listings refer to overseas listings by the actual controller of a domestic enterprise in the name of an SPV established in such offshore centers as Cayman Islands, Virgin Islands and Bermuda after the actual controller thereof expands the capital and stocks of the SPV with domestic equity or assets, and acquires the assets of the domestic enterprise. SPVs fall into two categories: SPVs established in the name of companies, a practice mainly adopted by stated-owned enterprises; and SPVs established in the name of natural persons, a measure usually taken by private enterprises. The most common way to achieve red-chip listings is to establish an SPV in the name of natural persons, and the term red-chip listing mentioned in this article refers to this way of getting listed if there is no other notice.
In the Regulations Regarding the Acquisition of Domestic Enterprises by Foreign Investors (hereinafter referred to as new acquisition regulations) jointly issued by the MOFCOM, SASAC, SAT, SAIC, SRC and SAFE which is effective as of September 8, 2006, there is a whole section, which falls under Chapter 4--Acquisition of Domestic Companies by Foreign Investors Using Equity as a Means of Payment, regarding regulations on red-chip listings in the aspects such as the establishment of SPVs, the acquisition of domestic enterprises by SPVs and the listing of SPVs. The articles concerned are as follows:
Article 40: Overseas listing of a special purpose vehicle shall be subject to approval by the securities regulatory authority of the State Council.
Article 42: Where a domestic company establishes a special purpose vehicle overseas, it shall apply to the Ministry of Commerce for completion of the verification and approval procedures.
Article 47: The domestic company shall, within 30 days of the completion of overseas listing by the special purpose vehicle or the overseas company connected with the special purpose vehicle, report the status of the overseas listing and the financing proceeds repatriation plan to the Ministry of Commerce and apply for replacement of a non-annotated foreign-invested enterprise approval certificate. Also, the domestic company shall, within 30 days of the completion of overseas listing, report the status of overseas listing and provide relevant record filing documents to the securities regulatory authority under the State Council. The domestic company shall also file the financing proceeds repatriation plan to the foreign exchange administration authority and implement the plan under the supervision of the foreign exchange administration authority. After the Domestic Company has obtained the non-annotated approval certificate, it shall apply to the registration administration authority and the foreign exchange administration authority for replacement of non-annotated foreign-invested enterprise business license and foreign exchange registration certificate within 30 days.
If the domestic company fails to report the matter to the Ministry of Commerce within the aforementioned time limit, the annotated approval certificate of the domestic company will automatically become void, the equity structure of the domestic company shall restore to the status before the equity acquisition, and the domestic company shall go through modification registration in accordance with Article 36 hereof.
1.The impact of the new acquisition regulations on the establishment of SPVs
Article 42 of the new acquisition regulations stipulates that the establishment of SPVs by domestic companies shall be verified and approved by the Ministry of Commerce. According to this article, only SPVs established by domestic companies are subject to verification and approval, while such procedures are not required for SPVs established by natural persons. From the Provisions on the Examination and Approval of Investment to Run Enterprises Abroad, issued by the Ministry of Commerce in October, 2004, the regulations apply only to the establishment of enterprises overseas by domestic enterprises. Article 3 hereof stipulates: to run enterprises from overseas investment refers to the activities to establish enterprises abroad or to obtain the ownership or management of existing enterprises through new establishment (solely foreign-owned, equity joint venture, contractual joint venture), acquisition, merger, equity participation, capital injection, and share swap by domestic enterprises.
In addition, in the Circular on the State Administration of Foreign Exchange on Relevant Issues concerning Foreign Exchange Administration of Financing and Return Investment Undertaken by Domestic Residents through Overseas Special Purpose Vehicles, only domestic resident legal persons applying for foreign exchange registration for overseas registration shall submit the approval documents issued by the administrative department of overseas investment, while there are no such requirements for domestic resident natural persons. As a result, the new acquisitions regulations exert very little influence on the establishment of SPVs by domestic natural persons.
2. The impact of one-year term on overseas listings
According to Paragraph 2 of Article 45 of the new acquisition regulations, the Ministry of Commerce shall issue to the domestic company an approval certificate with “equity held by an overseas special purpose vehicle, valid for one year from the date of issue of the business license” annotated thereon. Pursuant to Article 45, in case that an SPV fails to get listed abroad within one year from the date of acquisition, it shall report the status of the overseas listing and the financing proceeds repatriation plan to the Ministry of Commerce, the annotated approval certificate of the domestic company will automatically become void, and the equity structure of the domestic company shall restore to the position before the equity acquisition.
The one-year term for overseas listings has become a controversial issue after the promulgation of the new acquisition regulations, and it is believed that the time limit will greatly increase the risks of overseas listings; this, however, is not actually the case.
(1) The scope of application of the one-year term. From the structure of the new regulations, special provisions regarding special purpose vehicles are stipulated in a section under Chapter 4--Acquisition of Domestic Companies by Foreign Investors Using Equity as a Mean of Payment, therefore, the section regarding SPVs is an integral part of Chapter 4, which is only applicable to acquisition by foreign investors using equity as a means of payment. At the same time, Paragraph 2 of Article 39 stipulates that the provisions of this Section shall apply to SPVs using equity as a means of payment to acquire the shareholders’ equity in a domestic company or the newly issued shares of a domestic company.
From the contents of the provisions, only Article 45 and Article 47 shall be applicable to the one-year term for oversea listings. Article 44 to Article 47 of the new acquisition regulations prescribe the examination and approval procedures of the acquisition of domestic enterprises by SPVs using equity as a means of payment, from the submission for approval to the Ministry of Commerce to the approaches in case of failure of overseas listings. The examination and approval procedures are more or less the same as those for acquisition by general foreign investors using equity as a means of payment, except for the submission to the CSRC for approval. In addition, according to Article 47, in case an SPV fails to get listed overseas within one year, the procedures for amendment registration of the domestic enterprise are the same as those for acquisition by general foreign investors using equity as a means of payment. Therefore, from the abovementioned articles, the one-year term shall only be applicable to red-chip listings by cross-border share swap, with the exclusion of the existing cash acquisition.
(2) From the process of examination and approval. The enterprise intending to go listing overseas obtains the one-year-term approval certificate after the acquisition of an domestic enterprise has been approved by the Ministry of Commerce and the overseas listing has been approved by the CSRC. Afterwards, the process concerning government approval mainly includes the application for modification of running enterprises from overseas investment to the Ministry of Commerce and the application for modification of foreign exchange for overseas investment to the local foreign exchange administrative authorities. The biggest uncertainty of the one-year term is whether the enterprise intending to get listed can be approved by the overseas securities regulatory authorities and stock exchange within the time limit, rather than the examination and approval of domestic government departments.
3.The impact of the examination and approval by CSRC on overseas listings
Article 40 of the new acquisition regulations stipulates that the overseas listing of an SPV shall be subject to approval by the CSRS, the most controversial provision in the new regulations. The CSRC earlier required in the Circular on the Issues Regarding the Share Issuance and Listing Overseas, promulgated on June 9, 2000, that enterprises intending to go red-chip listing shall acquire a “no comment letter” from the CSRS. This stipulation, however, was canceled in June, 2003, since when the CSRS hasn’t intervened in red-chip listings. While in the new acquisition regulations, the CSRC again requires that red-chip listings shall be subject to approval by the CSRC. From the administrative permits published on the website of the CSRC, there are as many as 26 documents the enterprise intending to go listing overseas shall submit, compared with the submission of a legal opinion letter by a Chinese registered lawyer required in the “no comment letter”, which shows that the examination of overseas listings stipulated in the new acquisition regulations is stricter than the “no comment letter”. However, from relevant existing regulations it is still uncertain whether and how the CSRC will intervene in overseas listings.
(1)The scope of examination by the CSRC.
There is great controversy over whether Article 40 of the new acquisitions will apply to overseas listings by means of cash acquisition of domestic enterprises. From the contents of Article 40, it seems that all overseas listings, whether through cash acquisition or equity acquisition, shall be subject to approval by the CSRS. While from the context of this Article and with references to the stipulations in Article 39, Article 40 seems to apply only to equity acquisition. In addition, the regulations on the submission of listing application documents to the CSRS by the company intending to go listing in Article 45 of the new acquisition regulations apply only to equity acquisition.
Of course, even if Article 40 of the new acquisition regulations doesn’t require the examination and approval of red-chip listings through cash acquisition; it does not necessarily mean that the CSRS has no right of regulation on the overseas listing by an SPV through cash acquisition of a domestic enterprise. According to Article 238 of the Securities Law, any domestic enterprise that directly or indirectly issues any securities abroad or lists its securities abroad for trading shall be subject to approval by the CSRC according to relevant provisions of the State Council. The State Council specifies the regulation right of the CSRC in the Circular of the State Council concerning Further Strengthening the Administration of Share Issuance and Listing Overseas promulgated in 1997. However, the CSRC hasn’t intervened in red-chip listings since the cancellation of “no comment letter” in June, 2003.
In the Regulations Concerning Administration Permit of Indirect Overseas Listing of Securities by Domestic Enterprises, issued in September 2006 by the CSRC, there are no explicit stipulations regarding the examination and approval of red-chip listings by means of cash purchase. In the documents required to submit for administrative permit, Item 22 stipulates that the company shall submit an acquisition consultant’s report shall assess the issuing price of the SPV’ shares to be listed overseas. The acquisition consultant’s report is the essential document to be submitted to the CSRC for the overseas listing of an SPV. While according to the new acquisition regulations, only in the case of equity acquisition of a domestic enterprise requires the engagement of an acquisition consultant and an acquisition consultant’s report. As for the assessment of the issuing price of the shares to be listed overseas, it is obviously an examination to ensure that the overseas issuing price of the shares of an SPV is not lower than the share value of the domestic company the SPV acquires. Of course, we can not make a conclusion from this that the examination and approval by the CSRC applies only to red-chip listings by means of cross-border share swap, but after all, it is a question needs to be clarified.
From the above analysis, the new acquisition regulations do not necessarily mean that the CSRC will get more involved in red-chip listings. As for whether red-chip listings by means of cash purchase shall be subject to examination and approval by the CSRC, it is still to be determined by the CSRC.
(2)The impact of the CSRC on red-chip listings
According to the administrative permit published by the CSRC, an enterprise intending to go listing overseas shall submit documents issued by the people’s government at the provincial level approving the overseas listing of the domestic enterprise through an SPV, a stipulation means that the overseas listing of a domestic enterprise shall be examined and approved by a local government at provincial level prior to the submission to the CSRC for verification and approval. According to general examination and approval procedures, the enterprise shall submit the documents to the SCRS step by step, which may start from the local people’s government at the county level or the local people’s government at the city level (depending on the level of jurisdiction an enterprise locates).
The administrative permit also requires the submission of the approval documents and certificates for overseas investment of an SPV in establishment of enterprises issued by the business administrative departments. As has been mentioned above, an SPV established in the name of a natural person is not subject to examination and approval by the Ministry of Commerce. The lack of coordination between the CSRS and other departments in the examination and approval procedures may put domestic enterprises, which establish SPVs in the name of natural persons, in an embarrassing situation when they fail to go through the examination and approval procedures due to the lack of necessary documents. The problem shall be solved with the further coordination between the Ministry of Commerce and the CSRC.
Besides, the assets evaluation report and the domestic legal opinion letter of the acquired domestic enterprise are not required in other departments; the formation of the above-mentioned two documents will increase the costs of the enterprises intending to go listing.
To sum up, the impact of the new acquisition regulations on red-chip listings are mainly in two aspects:
(1)The new acquisition regulations stipulate the procedures of red-chip listings by means of cross-border share swap. Due to the fact that this is still a new practice, the regulators tend to be cautious and meticulous, and they will conduct overall control and examination in principle, therefore, red-chip listings by means of cross-border share swap may not be carried out extensively at the moment.
(2)As for the already existing red-chip listings, i.e., red-chip listings by means of cash acquisition, it is yet to be determined what impact the new regulations will have on this practice. The CSRC will play an important role in the process: if the CSRC doesn’t interfere in the process, as in the past, the new acquisition regulations will have little impact on red-chip listings by means of cash acquisition. If the CSRS deems that the practice shall be subject to approval, it will inevitably increase the time costs as well as policy risks.
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