In recent years, Chinese capital markets have gradually started to lead the boom in capital markets around the world. For a long time, there has been a marked difference in the value of the H -share and A-share markets. An increasing number of large enterprises have broadened financing channels by virtue of the A+H model. Certain enterprises that have erected a red-chip structure are now giving up on offshore markets, demolishing their red-chip structures and returning to the A-share markets on the mainland.
In contrast with the traditional return of red chips to mainland markets, at the end of 2013 Digital China Holdings smoothly returned to A-shares from H-shares through a spin-off and backdoor listing, opening a new means of financing for companies listed offshore.
On 12 July 2013, Digital China delivered a letter to Hong Kong Exchanges and Clearing (HKEx), applying to spin off its subsidiary Digital China Information Service (DCITS), with the latter to make a backdoor listing on the Shenzhen Stock Exchange using *ST Taiguang (*ST before a company name indicates there is a risk of delisting). On 26 December, *ST Taiguang published a new share listing report. The 340 million new shares issued by *ST Taiguang to merge DCITS by absorption and raise ancillary funds were listed on 30 December.
The review by HKEx of a spin-off application by a listed company is mainly conducted on the basis of principles set forth in practice note 15 to the Listing Rules, primarily consisting of the following:
- First, the effect of the entity to be spun off on the profitability of the parent. If the parent has been listed for less than three years, the Listing Committee will not normally consider its spin-off application. After the listing of the new company, the parent is required to retain a sufficient level of operations and sufficient assets, and in particular, it is not acceptable to the Listing Committee that one business supports two listing statuses. The parent and the entity to be spun off are required to explain in detail in the listing documents the commercial benefits of the spin-off, and the spin-off may not have an adverse impact on the interests of the shareholders of the parent.
- Second, HKEx requires the entity to be spun off to be independent from the parent in terms of its business, operations, directorship, management, administrative capability, etc.
- Third, the spin-off proposal must be approved by the shareholders of the parent.
- Fourth, an assured entitlement to shares. The Listing Committee requires the parent to provide its existing shareholders with an assured entitlement to shares in the new company, and ensure that they are all treated equally. However, where an offer of A-shares in mainland China by the entity to be spun off is involved, the parent is in the impossible situation of providing an assured entitlement to shares in the entity to be spun off, as, subject to relevant laws of China, foreign natural persons, legal persons and organisations other than qualified foreign institutional investors and foreign strategic investors are not permitted to invest in China’s A-share markets. In the Digital China spin-off case, HKEx granted Digital China an exemption on the condition that in its announcement of the spin-off proposal, it disclose the details of the exemption.
In addition to the parent being required to satisfy the relevant provisions of practice note 15 and secure the approval of HKEx for the spin-off, the entity to be spun off, as an issuer on the domestic A-share market, is required to satisfy the requirements of the PRC regulators, which mainly include requirements in respect of the substantive conditions for listing of such laws and regulations as the Company Law, the Securities Law, the Administrative Measures for Initial Public Offerings of Shares and Listings, the Interim Administrative Measures for Initial Public Offering of Shares and Listings on Second Boards, etc.
The domestic regulators have taken a stance of gradual liberalisation towards the spinning off by companies listed offshore of a portion of their business for listing on A-share markets. The regulators are of the opinion that as long as the legal entity that is to accept the spun-off business complies with relevant provisions of domestic laws in all respects, such spin-offs do not face legal obstacles. Furthermore, from the perspective of review policy, the domestic regulators have gradually moderated the substantive reviews of business value, increased the focus on comprehensively strengthening information disclosure, moving from an emphasis on a review of sustained profitability and the feasibility of the offering and investment project to truthfulness and completeness of information, while also paying greater attention to enterprises’ corporate governance.
The basic core requirements of the regulators in respect of enterprise listings are also continuously changing, and the Administrative Measures for Initial Public Offerings of Shares and Listings on Second Boards, for which comments began to be sought on 21 March 2014, represent one of the cornerstones for accelerating the establishment of a diversified equity market. Pursuant to the draft for comment, the requirement of sustained growth for entities proposing to list is abolished, as is the restriction on the revenue growth rate. This will undoubtedly give those enterprises that were previously blocked by the sustained growth requirement a new listing opportunity.
To date, in addition to China Digital, Zhejiang Expressway intends to spin off a subsidiary, Zheshang Securities, and list it on the main board of the Shanghai Stock Exchange. It has received the approval of HKEx, and its application has been accepted by the Shanghai Stock Exchange. Beida Jade Bird intends to spin off Hebei Beida Jade Bird Universal Fire Alarm Device and list it on the Small and Medium Enterprise Board of the Shenzhen Stock Exchange. It has secured the approval of HKEx, but has yet to submit its official A-share listing application. Truly International intends to spin off Truly Opto-Electronics and have it independently listed as an A-share. It has submitted its application to HKEx, and is awaiting its review.
Shape of things to come
With the continued optimisation of systems for regulating domestic capital markets, one can be confident that more enterprises listed on foreign capital markets will plan to open new financing windows on domestic A-share markets. Taking the long-term perspective, the rush by quality resource companies listed offshore to return to the mainland will increase the overall size of domestic capital markets, which will be conducive to elevating the financial position of domestic capital markets in Asia, and globally.
Additionally, increasing the size of stock offers will also be conducive to improving the excessive liquidity in the capital markets and over-inflation of the bubble. It would thus seem that red-chip enterprises returning to the mainland to list A shares by spinning off part of their business will become a new trend.
Lai Jihong (tel: +86 755 3325 6898; email: email@example.com) and Chen Limin (tel: +86 755 3325 6900; email: firstname.lastname@example.org) are partners at Zhong Lun Law Firm in Shenzhen