On 8 November 2018, Fang Xinghai, the vice chairman at the China Securities Regulatory Commission (CSRC) said in a forum that the regulators were assessing a plan to extend the H-shares full convertibility pilot programme to more enterprises, with a view to fully roll out the programme as soon as possible once the pilot programme was successful.
This news is no less important to the capital market than the establishment of the technology innovation board with a registration-based system experiment, which was announced roughly at the same time.
Under the context of such reform, this article aims to take a retrospective look at the regulatory evolution of the H-shares full convertibility.
H-shares refer to the shares issued by mainland China-registered companies limited by shares listed in HKEx (Stock Exchange of Hong Kong) and open to foreign investors for subscription and transaction upon being approved by the CSRC, also known as state-owned enterprises (SOE) shares in their early days.
According to the State Council’s Special Rules Regarding the Issuing and Listing of Shares Overseas by Companies Limited by Shares, H-shares are categorised into two types, as overseas listed “foreign shares” and “domestic shares”. The former are issued and circulated in foreign capital markets while the latter ones cannot be.
The Notice on the Centralised Registration and Depository of non-Overseas Listed Shares of Overseas Listed Companies and the Implementation Rules of the Registration and Depository of Non-Overseas Listed Shares of Overseas Listed Companies, issued by the CSRC in 2007, added a new type of shares – “non-overseas listed foreign shares”, on top of the above-mentioned overseas listed foreign shares and domestic shares.
These non-overseas listed foreign shares are not issued and circulated in foreign capital markets, as per the domestic shares, and shall be registered and deposited with the China Securities Depository and Clearing Corporation (CSDC).
The key issue of full convertibility of H-shares rests with whether or not the depository shares, the non-overseas listed foreign shares and domestic shares of Hong Kong-listed domestic companies deposited before listing in Hong Kong under the framework of H-shares, are tradable in Hong Kong capital markets. The debate around H-shares full convertibility has never stopped since Qsingtao Brewery issued H-shares in June 1993, the first of its kind.
In 1995, the State Council stipulated that domestically listed foreign shares (B-shares) can be converted into H-shares based on law. Livzon Pharmaceutical, CIMC and Vanke are among the companies that gained approval from the CSRC before the issuance of H-shares to convert domestically listed foreign shares into overseas listed foreign shares.
In 2005, China Construction Bank debuted in Hong Kong with its H-share IPO and was approved by the CSRC to convert its domestic shares into overseas listed foreign shares. China Construction Bank thus became the first and only company with fully convertible H-shares. The listing of China Construction Bank spurred an extensive debate around the full convertibility of H-shares, without any consensus reached.
In September 2006, in the HongKong exchange’s Listing Decision of HKEx-LD56-1 – “Whether and under what circumstances could the domestic shares of Company X held by Company Y be listed on the HKEx as H-shares and sold in the open market?”, HKEx requires that the following conditions be met before domestic shares can be listed on the H-shares market, including: (1) The listed company had established a clear methodology for the convert of domestic shares to H-shares, and had publicly announced that methodology to investors in listing documents; (2) the listed company gained prior approval from the CSRC, and (3) the listed company met the established administrative procedures for listing on the HKEx. This decision literally hands the decision making of the full convertibility of H-shares over to the CSRC.
At the end of 2012, the CSRC issued The Regulatory Guidelines on Issuing Shares Overseas by Companies Limited by Shares and the Application Documents and Approval Procedure, bringing with it an overhaul of H-shares. This reform abolished the substantive restrictions – articles 4, 5 and 6 on H-shares listing (i.e., the company should have no less than RMB400 million (US$59 million) in net assets, US$50 million in raised funds, and RMB60 million in after-tax profits in the preceding year – streamlined the domestic approval procedure for H-shares listing, and gave a green light to the convertibility of non-overseas listed foreign shares into overseas listed foreign shares. Since then, all of the foreign shares of the H-shares company deposited before an H-shares IPO can be listed and tradable in Hong Kong capital market. But there is still an obstacle preventing domestic shares from being tradable.
As was expected for years, in April and May 2018, upon CSRC approval, the CSDC and Shenzhen Stock Exchange issued the Implementation Rules of H-shares Full Convertibility Pilot Programme (Trial) and Guidelines on H-shares Full Convertibility Pilot Programme (Trial).
Under these rules, overseas-listed companies in the pilot programme approved by the CSRC can convert their non-overseas listed shares deposited with Beijing office of the CSDC into overseas-listed shares in Hong Kong, which are then tradable in Hong Kong. By November 2018, Legend Holdings, AviChina and Wego had successfully completed the pilot programmes. The stage was set for the rollout of the H-shares full convertibility policy.
Full convertibility of H-shares will expand the fundraising methods and incentivise the management teams of domestic companies, and will also help boost corporate governance, protect the interests of minority shareholders and improve the confidence of investors.
The challenges cannot be ignored, though. There are issues yet to be sorted out, for example, once fully convertible, how the large amount of deposited non-listed shares might affect the capital market, and with full convertibility, how the H-shares framework in Hong Kong market may affect the prevalent “little red chips” mode. Will regulators tighten the regulation of the listing of little red chips? The full convertibility of H-shares will clearly have a far-reaching impact on the capital market, an issue which the author will follow closely.
Liu Wen is a partner at Commerce & Finance Law Offices. He can be contacted on +86 139 2521 3344 or by email at [email protected]