The year 2018 witnessed a new record in the number of domestic enterprises that listed in Hong Kong in recent years. This column describes the main ways available for domestic enterprises to list in Hong Kong and the principle factors to consider when selecting the different ways that are helpful for domestic enterprises and investment institutions in their decision-making when they are on the verge of investing in Hong Kong’s capital market.
Red chips method. Red chips are divided into “small red chips” and “big red chips”, and both need an offshore company serving as the proposed listing entity. The offshore company will generally be established in the Cayman Islands or other jurisdiction with a certain tax haven function. The key that distinguishes a small red chip from a big red chip is whether the proposed listing entity is a Chinese-entity-invested holding enterprise. If it is a Chinese-entity-invested holding enterprise, then a big red chip is constituted and compliance with the relevant provisions of the Notice of the State Council on Further Strengthening the Administration of the Offering and Listing of Shares Overseas is required.
If a Chinese-entity-invested holding enterprise is not involved, a small red chip is constituted and compliance mainly with such regulations as the Provisions for the Acquisition of Domestic Enterprises by Foreign Investors, the Notice of the State Administration of Foreign Exchange on Issues Relevant to Foreign Exchange Administration in Connection with Offshore Investment/Financing, and Round-trip Investment by Domestic Residents Through Special Purpose Vehicles, is required.
Although the concept of a Chinese-entity-invested holding enterprise appears in the red chips guidelines, accurate definitions of neither “Chinese-entity-invested” nor “Chinese-entity-invested holding enterprise” are given in the guidelines. The usual understanding in practice is that Chinese-entity-invested is not equivalent to state-invested, as it includes other domestic organisations (including foreign-invested enterprises in China) while excluding wholly foreign-owned organizations and natural persons (including natural persons of foreign nationality and Chinese nationality). A Chinese-entity-invested holding enterprise includes situations where Chinese entities directly or indirectly hold more than 50% of the shares in the proposed listing entity, and where, although Chinese entities do not hold more than 50% of the shares, a Chinese entity is the largest shareholder.
H-share method. In this, the listing is completed by way of a joint stock limited company established in China offering foreign-invested shares on the Stock Exchange of Hong Kong. It is mainly governed by such regulations as the Special Provisions of the State Council for the Offshore Offering of Shares by and Listing of Joint Stock Limited Companies.
CHOICE OF METHODS
The red chips method can thoroughly achieve the objective of injecting domestic assets into an offshore entity, and the subsequent financing procedures through additional offerings of shares or offerings of bonds are relatively simple, not requiring the approval of the international department of the China Securities Regulatory Commission (CSRC). However, the red chips method will generally involve a series of domestic and foreign restructurings for injecting the domestic assets into an offshore entity, and the domestic tax costs for such restructurings, and the overseas or domestic bridge loan financing costs, are continuously increasing.
The H-share method essentially does not involve any cross-border restructuring, and if an adjustment of the domestic structure of the proposed listing entity is not involved, and subject to the satisfaction of the conditions of listing in Hong Kong, a listing application may be submitted to the international department of the CSRC once the limited company has been converted into a joint stock limited company. However, subsequent financing through additional offerings of shares and convertible bond offerings will require the approval of the international department of the CSRC, and whether the full tradability issue can be resolved also directly affects the selection of the H-share method.
However, the full tradability pilot project, launched at the beginning of 2018, is progressing smoothly, and as at July 2018 there were a total of three H-share full tradability pilot enterprises, i.e., Legend Holdings, AviChina, and Weigao Group, and it is likely that the scope of the full tradability pilot project will be expanded further.
Each proposed listing entity should conduct an analysis based on its own circumstances before choosing its way of listing in Hong Kong. Below are certain factors to consider and provide corresponding recommendations.
NEEQ listed company. On 21 April 2018, the National Equities Exchange and Quotations (NEEQ) executed a Co-operation Memorandum of Understanding with Hong Kong Exchange and Clearing Limited, which permits companies listed on the NEEQ to apply to offer H-shares and list on the Stock Exchange of Hong Kong without delisting from the NEEQ. The author recommends that such companies first list by the NEEQ + H method and later realise full tradability by further applying for the full tradability pilot project or H + A method.
Joint stock limited companies with special business qualifications. The red chips restructuring of a joint stock limited company is often affected by the holding of shares in the company by its directors, supervisors and senior management, which requires reconverting the joint stock limited company into a limited company.
However, for certain companies that have special business qualifications, the reconverting will involve a change in the company name and corporate form, which could affect such affairs of the company as the invitation and submission of bids during the course of the reconverting. The author recommends that, before opting for the red chips method, such a company carefully considers the effect that such a reconverting could have on its business.
Domestic enterprise controlled by a domestic entity. When establishing a red chips structure, this type of company usually needs to do so by way of outbound investment by the domestic entity, and if state-owned assets are involved, when the restructuring is carried out, the price at which the domestic withdrawal of the state-owned assets and the tax base loss that may occur in the offshore withdrawal after listing are relatively major issues for the state-owned assets. If the outbound investment involves a large amount of foreign exchange remitting offshore, the difficulty of realising the restructuring will increase substantially.
If a big red chip is involved after the restructuring, the probability of securing the approval of the CSRC for an offshore listing is extremely small if the period starting from completion of injecting the domestic assets into an offshore entity is less than three years. If an adjustment to a small red chip would also be difficult to realise, the author recommends opting for the H-share method.
Domestic enterprise engaging in business that is on the foreign investment negative list. If a domestic enterprise belongs to this, particularly business in which foreign investment is prohibited, then consideration would mainly focus on a red chip with a variable interest entity (VIE) structure.
Yu Yan is a partner at Tian Yuan Law Firm. He can be contacted on +86 10 5776 3888/+86 138 1175 9539 or by email at email@example.com