Activity on the New Third Board has continued to warm to its current red-hot state since 2014. This is due to the board expanding country-wide, the transaction settlement system going online, and the implementation and expansion of the market-maker system. Parallel with this, major investment firms have been closely pursuing companies proposing a listing on the New Third Board.
If an investor proposes an acquisition, its short-term focus falls on whether the enterprise is qualified to list and trade on the New Third Board in addition to considering its growth potential and ability to increase its acquisition and investment value. Accordingly, an investor should conduct due diligence of the enterprise before investment or acquisition.
As when investing in an enterprise to be listed on a main board, the enterprise’s connected transactions and horizontal competition remain a focus of attention for the investor when conducting the legal due diligence for an investment in, or acquisition of, an enterprise to be listed on the New Third Board. The authors have handled a number of recent listings of this type and would like to analyze and explore the regulatory requirements for connected transactions and horizontal competition on the New Third Board.
Determination. Pursuant to articles 31 and 32 of the Detailed Rules for the Disclosure of Information by Companies Listed on National Equities Exchange and Quotations (for trial implementation), the term “connected transaction of a listed company” refers to a transfer of resources or obligations occurring between a listed company and a connected party. The connected parties and connected relationships of a listed company include the circumstances set forth in Enterprise Accounting Standards No. 36: Disclosure of Connected Parties, as well as other circumstances determined by the listed company, sponsoring securities broker or regulator based on the principle of substance over form.
Regulator requirements. No specific explanation of connected transaction matters is given in the conditions and basic criteria that listed companies are required to satisfy as set out in the Business Rules of National Equities Exchange and Quotations and the Guidelines on the Basic Criteria Applicable to the Conditions for Listing Stocks on National Equities Exchange and Quotations, both for trial implementation. Formally, this may give one the mistaken impression that the New Third Board has no regulatory requirements regarding the connected transactions of companies to be listed on the board or that its regulation of these connected transactions is not strict.
The New Third Board does in fact have regulatory requirements regarding the connected transactions of listed companies, as connected transactions do not only directly affect and influence the profit and value of a listed company, but also usually have a direct connection with such regulatory requirements as corporate governance mechanism, the company’s compliant operation, independence, etc. Based on currently available documents, connected transactions are permitted to exist, provided that they satisfy certain conditions. However, the New Third Board’s criteria for reviewing connected transactions are not as strict as those for IPOs.
The basic attitude of National Equities Exchange and Quotations Co., Ltd. (NEEQ) when reviewing the connected transactions of listed companies is currently compliance and minimizing. “Compliance” means that they should comply with market-determined pricing and operational requirements, such that the prices and conditions of connected transactions are fair and that such transactions are not used to divert profits. In terms of procedures, those specified in the company’s articles of association and relevant rules and regulations must be performed. The transaction amount and specific nature of the transaction should not prejudice the independence of the listed company. Finally, information disclosure obligations should be performed regarding connected transactions.
Determination. There are no dedicated regulations or regulatory documents to date regarding the specific criteria for determining horizontal competition on the New Third Board. From the perspective of review practice, when the regulator is determining whether horizontal competition exists between a company and a competitor, it will usually conduct its examination based on several items. First, the sales territory of, or targeted buyers for, the products or services of the two. Second, if they have niche products, the regulator can examine whether there is a significant difference in the production processes for the products. Third, the regulator will consider the features of, and business methods in, the relevant industry. The New Third Board makes no substantive difference in how they determine horizontal competition and IPOs.
Regulator requirements. There are no specific provisions on horizontal competition set out in the conditions and requirements for listing on the New Third Board. However, both the Measures for the Administration of Initial Public Offerings of Stocks and Listings and the Measures for the Administration for Initial Public Offerings of Stocks and Listings on Second Boards (collectively, the IPO Rules) expressly stipulate that there may not be horizontal competition between a company and its controlling shareholder, actual controller or other enterprises that it controls.
Some, influenced by the IPO Rules’ requirements, are under the impression that enterprises to be listed on the New Third Board must eliminate horizontal competition before listing, and that they cannot list if they fail to do so. Based on information currently available, as well as information gained from the authors’ queries to review and regulatory authorities during recent projects, NEEQ’s horizontal competition review requirements are not as strict as the criteria for IPO reviews in practice, as they do not require that companies eliminate horizontal competition before listing. Instead, an enterprise can list if it fully discloses the situation and its shareholders give a genuinely workable undertaking to resolve the horizontal competition. Shanghai Power Science & Technology, presently listed, is now in this situation, for example.
Enterprises and investors should note that, although the New Third Board does not mandatorily require that horizontal competition be resolved prior to listing, it nevertheless ultimately needs to be resolved. Accordingly, enterprises should endeavour to resolve any horizontal competition before listing so as to avoid it affecting their listing schedule and any subsequent IPO plan.
Cindy Hu is a partner and Gu Qiuhua is an associate of East & Concord Partners
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