CSRC Issues Guidelines for Full Tradability of H-shares

On November 15, 2019 the China Securities Regulatory Commission (CSRC) issued the Guidelines on Applying for the Full Tradability of Unlisted Domestic Shares of H-share Companies (i.e. those incorporated in Mainland China and listed on the Hong Kong Stock Exchange) (“Guidelines”). Under the Guidelines, qualified companies listed or planning initial public offerings on the H-share market may apply for a full tradability of their shares in accordance with the applicable laws and regulations (“full tradability”), an initiative receiving increased awareness from both domestic and overseas capital markets. This article intends to introduce the main content of the Guidelines and the regulatory spirit reflected therefrom, briefly analyzing the impact of the full tradability of the H-shares on the Chinese capital market. 

Background 

The full tradability of H-shares refers to a mechanism where domestic-funded shares (e.g. legal person shares or state-owned shares) held by companies incorporated in mainland China and listed on the Hong Kong Stock Exchange (HKEX) can be issued and traded in the H-share market. 

Previously in 1993, when Tsingtao Brewery became the first company listed on the H-share market, A-shares and H-shares were separated into two groups: (i) pre-IPO shares (i.e. shares issued prior to initial public offerings and therefore subject to certain restriction on tradability, which may include state-owned shares, legal person shares and foreign-owned shares); and (ii) fully-tradable listed shares. Due to the restriction on tradability, the transfer procedures for pre-IPO shares were similar to those for unlisted private equities. 

In 2008, the A-share market reform on the structure for holding of shares (i.e. a reform under which A-shares that were not fully-tradable are converted into fully-tradable shares) allowed pre-IPO shares to be listed and traded upon the expiration of a 12-month or 36-month lock-up period. 

By contrast, H-shares held by sponsors of companies listed on the H-share market were never made fully-tradable, resulting in the separation between fully-tradable listed H-shares and unlisted pre-IPO shares of the H-share companies. 

Due to the restriction on tradability of pre-IPO shares in the H-share market, domestic companies, especially private-owned companies, were reluctant to list on the H-share market; instead, they preferred to adopt the red-chip structure. 

It is in this context that the CSRC began proactively seeking the full tradability of H-shares, and following the success of the full tradability pilot programs in Legend Holdings, AviChina and Weigao Group (“Pilot Programs”), the Guidelines was eventually issued, marking the achievement of full tradability of H-shares.

Main Changes Proposed by the Guidelines

The Guidelines mainly addresses the following issues, namely, (i) unlisted domestic companies planning initial public offerings overseas may apply for a full tradability of their shares; (ii) domestic unlisted shares, once listed and traded on the HKEX, shall not be converted into domestic listed shares anymore; (iii) shareholders of domestic unlisted shares may choose to reduce or increase their holding of H-shares in accordance with relevant rules (at the current stage, increasing holding of H-shares is not attainable due to technical reasons); and (iv) a full tradability of H-shares of a company shall have no direct impact on the corresponding A-share market. 

Additionally, it stipulates the procedures for the approval of full tradability, the share registration and the clearing and settlement. Further to the Pilot Programs, the Guidelines has for the first time provided comprehensive rules on the full tradability of H-shares. It removes restrictions on the size or industry of the qualified companies by specifying that a company and its shareholders may decide, at their discretion, whether to apply for a full tradability, provided that other applicable regulatory requirements, such as foreign investment access policies, are satisfied. 

Moreover, there is no limit on the total number of companies approved for full tradability, nor is there a specific timeframe for implementing the full tradability; instead, the full tradability will be carried out by application in an orderly manner, i.e. an application for full tradability will be approved as long as it has met all relevant regulatory requirements.  

Our Observations

By liberalizing the listing and trading of pre-IPO shares, the full tradability of H-shares would  ease the main concerns of the private-owned companies and incentivize them to list on the H-share market, while enhancing the vitality of a highly open market. 

Notably, any refinancing of companies listed on the H-share market is still subject to the regulatory approval, which is more complicated compared with companies listed on the H-share market through the red-chip structure and thus may still raise concerns for private-owned companies. In accordance with the HKEX rules, for a company listed on the HKEX using the red-chip structure, issuance of new shares, which make up no more than 20% of the total shares listed on the HKEX, only requires an approval by the board of directors of the company. 

Meanwhile, given the uncertainty of the “window guidance” that may be issued by the CSRC in connection with various businesses from time to time, such as those related to real estate businesses, quasi-financial businesses, or issues such as shares reserved for equity incentive plan, practically speaking, the possibility that the competent authority would reject a company’s application for full tradability still cannot be fully ruled out. 

In addition, issues concerning the full tradability, such as the foreign exchange settlement and the tax filings in regard to the sale of H-shares converted from domestic-funded pre-IPO shares, remain to be clarified. 

The further development of regulatory rules and how the practice may evolve, also remains to be seen.