The second half of 2021 was an extraordinary time for Chinese companies seeking to list overseas, as well as for other relevant market participants. The Didi incident further deepened the anxiety and "mistrust" by US securities regulators on the risks associated with investing in China-based companies or that have most of their operations in China. The long-lasting battle between the US and Chinese securities regulators regarding the inspection of an issuer's accounting firm’s working papers, variable interest structures (VIE) and cybersecurity reviews, has drawn unprecedented attention and wide concern.
Since July, there have been few new China-based companies’ IPO cases in US stocks, and the share price of Chinese stocks has plummeted. There have been rumors in overseas media regarding the "blocking" of overseas listings of VIE structures and a return to the "road pass" era, when substantial examinations and procedures from the China Securities Regulatory Commission ("CSRC") were required beforehand.
On December 24, the CSRC promulgated the Administrative Provisions of the State Council on the Overseas Issuance and Listing of Securities by Domestic Enterprises (Draft for Comment) and the Administrative Measures for the Record-filing of the Overseas Issuance and Listing of Securities by Domestic Enterprises (Draft for Comment) (collectively, the "Draft Rules for Overseas Listing") for public comment. On Christmas Eve, the CSRC has sent a "Christmas gift" to those enterprises planning to list overseas and other market participants, bringing some warmth to the market during these cold winter nights.
We would like to share some preliminary observations on some of the key issues involved in the draft overseas listing rules.
In its interpretation of the Draft Rules for Overseas Listing and an online Q&A with reporters, CSRC mentioned that "the CSRC and the relevant authorities respect enterprises' independent choice of listing place in accordance with laws and regulations and have never wavered. Looking to the future, the direction of expanding opening-up will not change, and the attitude of supporting enterprises to make good use of these two resources will not change. Improving the regulatory system for overseas listing does not mean tightening the regulatory policy for overseas listing. We will continue to seek development through opening-up and promote development through regulation, maintain smooth overseas financing channels, provide clear, transparent and operable rules for overseas listing activities of enterprises, and build a more stable and predictable institutional environment."
The above comments are aimed at the previous concerns and worries of the market, which can be seen as a reassuring ray of hope.
The Draft Rules for Overseas Listing points out that " Indirect overseas offering and listing by domestic companies refers to such securities offering and listing in an overseas market made in the name of an offshore entity, but based on the underlying equity, assets, earnings or other similar rights of a domestic company which operates its main business domestically. Specific criteria shall be prescribed by the securities regulatory agency under the State Council "
We understand that the above statement includes VIE structure enterprises in the filing scope, and the CSRC spokesperson said in response to a reporter's question: "On the premise of complying with domestic laws and regulations, a VIE structure enterprise that meets the compliance requirements may be listed overseas after filing. As listed in the Rules, "where listing and financing are expressly prohibited by the laws and regulations of the State and the relevant provisions" shall not be issued and listed overseas, the author holds that such provisions shall not be broadly interpreted as forbidding the listing of enterprises with a variable interest structure but shall be interpreted as circumstances subject to specific provisions, such as a certain type of education.
However, the Rules also emphasize that domestic enterprises' offshore offerings and listings must comply with laws and regulations, as well as the requirements of the laws, regulations and rules on foreign investment, and must not disrupt the domestic market order or damage the legal rights and interests of domestic investors and public interests. It not only eliminates the concerns of VIE structure enterprises, but also demarcates the "compliance with foreign investment laws and regulations".
According to Article 3 of the Draft Rules for Overseas Listing, the determination as to whether a domestic company is indirectly offering and listing securities in an overseas market shall be made on a substance over form basis. If the issuer meets the following conditions, the offering and listing shall be determined as an indirect overseas offering and listing by a domestic company:
l The operating income, total profits, total assets or net assets of the domestic enterprise in the latest accounting year account for more than 50% of the relevant data in the issuer's audited consolidated financial statements for the same period;
l Most of the senior officers in charge of business operations and management are Chinese citizens or have habitual residences within the territory of China, and the main business operations are located within the territory of China or carried out mainly within the territory of China.
The above clarifies the meaning of "domestic". It further clarifies that a considerable part of the income of some companies is not derived from China and that shareholdings by domestic natural persons or companies of less than 50% is still considered as being Chinese shares. But it is not yet clear whether both criteria need to be met to qualify as “domestic” or if either criteria is sufficient.
Taking the US listing as an example, we tend to believe that a domestic enterprise is obligated to file with the CSRC within three working days after the first submission. Therefore, taking the rules literally, it seems to us that filing is not required beforehand. However, the Rules also grant the power to suspend, terminate and revoke the filing; that is, "the CSRC and the relevant authorities of the State Council have the power to require domestic enterprises to suspend or terminate overseas offering and listing, and the securities regulatory authorities of the State Council may revoke the filing if it has completed the filing." The standards for suspending, terminating, or revoking the filing are, in our opinion, relatively clear and predictable.
It remains to be seen whether "filing" is a substantive examination. After all, in the era of "no-objection letters" in red chips and other CSRC rules, similar expressions may be quite different in practice to the term "filing".
However, we noticed in the Q&A that "except for certain industries, the CSRC will establish a regulatory coordination mechanism with the authorities of relevant industries and sectors in China to strengthen policy convergence, information sharing and regulatory coordination, and will not require enterprises to obtain "road passes" from multiple authorities to reduce the regulatory burden of enterprises as much as possible." These and other statements reflect the basic principle and direction of "streamlining administration, delegating powers, and improving regulation and services".
The concept of the "grandfathering principle" needs further clarification. As the Draft Overseas Listing Rules propose, the “grandfathering principle" will apply. In the CSRC Q&A sections, it explains that “First, we will start applying the filing requirements to new offerings and listings. Only new initial public offerings and refinancing by existent overseas listed Chinese companies will be required to go through the filing process; other existent overseas listed companies will be allowed a sufficient transition period to complete their filing procedures”. We will follow up on how the “grandfathering principle” will be applied in practice.
A letter of regulatory opinions shall be provided at the time of record-filing, and a "letter of regulatory opinions" (if applicable) means that the timeframe for obtaining the letter of regulatory opinions is advanced. Whether a regulatory opinion letter is required and the criteria needed to judge whether a regulatory opinion letter is applicable still needs clarification. Previously, US securities regulators did not require a regulatory opinion letter.
Domestic legal opinion has also become an essential requirement for regulatory filing. What is the format of a domestic legal opinion? How much of the substantial opinions shall be included?
Of course, there are still quite a few details to be clarified.
According to the CSRC response, it is achievable to follow the principles of "reciprocity" and "prior consent". This provides space for further consultation between Chinese and US regulators on audit working papers and gives reassurance to market practitioners of China-based companies.
“Overseas securities regulatory authorities conducting investigation and evidence collection on overseas issuance and listing, and related activities of domestic enterprises may request the securities regulatory authority under the State Council for assistance in the investigation under the cross-border regulatory cooperation mechanism; the securities regulatory authority under the State Council may provide necessary assistance in accordance with the law. Domestic entities and individuals that provide relevant documents and materials in accordance with the requirements of overseas securities regulatory authorities for investigation and evidence collection shall report to the securities regulatory authority under the State Council and may provide such documents and materials only after obtaining the consent of the securities regulatory authority under the State Council and the relevant competent authorities under the State Council.”