The China Securities Regulatory Commission (CSRC) last year promulgated and implemented the Rules for the Spin-off of Listed Companies (for Trial Implementation), with new rules containing specific provisions on the domestic and overseas listing of spin-off subsidiaries of A-share listed companies in terms of the conditions, implementation procedures and information disclosures for spin-offs, as well as verification and control by intermediaries.
Since the new rules, 23 A-share listed companies have announced their intentions for spin-off listings of their subsidiaries in the domestic securities market. Among them, five companies plan to list on the main boards of the Shanghai Stock Exchange and Shenzhen Stock Exchange, three on the Star Market, seven on the ChiNext stock market, and two on the Beijing Stock Exchange, while the remaining six companies have not yet announced their intended market.
Since 2022, spinning off subsidiaries and listing them in the domestic securities market is now a first choice for most A-share listed companies. Amid the spin-off trend, this article analyses legal issues to focus on in the current regulatory regime.
Article 2 of the new rules clarifies that the spin-off of a listed company means spinning off part of its business or assets for listing as a subsidiary. By nature, a spin-off is therefore the restructuring and integration of assets and business. Unlike standard IPOs, the business and assets in a spin-off may be actually operated or held by different legal entities. Based on the commercial consideration of placing companies of the same industry or business form in the same system, and the compliance consideration of resolving horizontal competition, business and asset restructuring is a necessary part of a spin-off and listing.
Article 6 of the new rules sets specific requirements for the independence of spin-off subsidiaries. These include: meeting regulatory requirements on horizontal competition and related party transactions; independence in assets, finance, organisations and personnel; and no serious defects in independence.
Compared with ordinary companies being listed, the subsidiary spin-off and listed company are companies under the same consolidated statement and same system, generally with cross-personnel, capital exchanges and collaborative procurement and sales, as well as sharing of assets and production management systems.
In the IPO of a spin-off subsidiary, it is therefore more crucial to resolve the issue of independence of its business, assets, finance, organisations and personnel. Recently, Chinese automaker BYD terminated the spin-off listing of BYD Semiconductor. The company’s sales to related parties account for a relatively high proportion of operating income, which has been the focus of inquiries and concerns in its IPO review, causing obstacles to going public. Under the new rules, business and asset restructuring and a subsidiary’s independence require more attention in the IPO of spin-off companies than in ordinary companies.
In the process of spin-off and listing, through business and assets restructuring, the asset package to be listed is finally placed into the same listing entity, and the integration of similar businesses, or separation of different businesses, is realised. In practice, asset restructuring generally includes equity transfers, asset transfers, the division of the enterprise, and mergers.
In the case of video surveillance equipment manufacturer Hikvision spinning off a cloud platform and smart home services provider called Hangzhou EZVIZ Network (pre-disclosure), the asset spin-off between the two companies was conducted mainly through asset transfer, involving office equipment, intangible assets, production equipment, etc. The transfer price was mostly based on net book value.
In the case of Shanghai Electric Group spinning off Shanghai Electric Wind Power Group, the restructuring was conducted through a merger, where the entity to be listed merges other subsidiaries engaged in wind power equipment-related businesses.
From these cases, it can be seen that the process of spin-off and restructuring may involve the historical development, material asset changes and business structure changes of the entity to be listed.
From a legal perspective, it is necessary to pay special attention to price fairness issues when it comes to equity or asset transfers and mergers – and when the asset transfer price is significantly abnormal and the equity price is lower than net assets – which may cause concern during the listing process. Compliance with the restructuring procedure is particularly important. As the parent company is a listed company, restructuring needs to follow the decision-making procedure of internal governance rules.
In a state-owned enterprise, the restructuring of relevant assets needs to undergo the necessary approval, examination, evaluation and filing procedures for state-owned assets. In practice, failure to perform relevant procedures often leads to defects in historical development and asset sales.
Meanwhile, in the process of assets and business restructuring, attention should be paid to the transfer of business contracts, the split of current accounts, closing and transfer of assets, transfer of employees’ labour relations, transfer of business qualifications, tax compliance of special restructuring, and a clear basis for classification and effective division of assets, businesses and personnel. In addition, the new rules impose restrictions on assets available for a spin-off.
The main business or assets of the spin-off subsidiary shall not be those:
- That receive the investment made by the listed company with offered shares and raised funds in the past three accounting years, unless the aggregate raised funds used by the subsidiary in those past three accounting years do not exceed 10% of the net assets of the subsidiary;
- That are purchased by the listed company through a significant asset restructuring in the past three accounting years; and
- That are the main business or assets of the listed company at the time of IPO and listing.
The process of spin-off and listing is also the process of establishing the independence of spin-off subsidiaries. To ensure the safety of investors in the securities market, the spin-off operates independently from the parent company, avoiding unfair related-party transactions, horizontal competition that causes material adverse effects, and issues that lead to benefit transfer, profit transfer or debt evasion.
The spin-off’s independence in business, assets, finance, organisation, production and personnel is an essential condition for its listing. Being free of serious defects in independence is also a focal point in an IPO review.
In practice, due to factors such as brand linkage, unclear asset division, and difficulty in establishing independent purchasing and sales channels, there are often many problems regarding the independence of spin-off subsidiaries. These include: sharing a set of systems for production, finance, office and personnel management; mutual authorisation of brands; mixed use of such assets as domain names; unclear ownership of research and development results; high dependence on related party sales; and the high overlap rate of major customers.
The new rules clarify that there must be no serious defects in the independence of spin-off subsidiaries. However, the test of “serious defects” is rather vague, except that the rules clearly provide that there shall be no cross-employment of officers and financial personnel after the spin-off.
In the case of BYD terminating the spin-off and listing of BYD Semiconductor, the related party sales amount of BYD Semiconductor accounted for 55%, 59% and 63% of operating income, respectively, during the reporting period, increasing annually without any downward trend.
In the case of Midea Intelligent Lighting & Controls Technology, a subsidiary of Midea Group that also withdrew its IPO application, its related party sales accounted for 34%, 24% and 21% during the reporting period. At the end of the reporting period, it also still had many overlapping customers with Midea Group.
In the case of battery materials producer GEM terminating the spin-off and listing of Jiangxi Green Recycling (GER), GEM announced the decision was because the independent operation time of GER after the spin-off and business restructuring would be fewer than two years.
Judging from the relevant cases and previous experiences, the spin-off subsidiary should pay attention to the following aspects to maintain its independence:
• Maintaining independence of brands and trade names. It is better to have independent brands, trademarks and independently formed goodwill;
• Being independent in technology and research and development, not mixing its core technology with that of the parent company, with independent R&D personnel carrying out independent R&D, patent application and technology transformation;
• Keeping independent production and sales, establishing independent purchasing and sales channels, reducing the overlap of customers, with independent production and business premises and equipment, and independent production management systems; and
• Keeping independent financial management with funds not polled and managed by the group, with independent financial personnel who do not hold posts and get paid by the group, using independent financial systems such as enterprise resource planning and business planning and consolidation.
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India’s capital market is a part of the financial market related to the issue and transfer of securities, where capital funds comprising both equity and debt are issued and traded. Capital markets deal with securities such as shares, debentures and bonds, and companies access them to raise funds needed to finance corporate activity.
India’s capital market has evolved in recent years with various government economic reforms and regulatory actions.
The capital market is divided into two inter-dependent components, namely the primary market and secondary market.
The primary market deals with the fresh issuance of securities by issuers such as companies, banks and non-banking financial institutions, central and state governments, and public sector undertakings.
It is through this market that funds flow from investors to corporates for purposes such as capital expenditure, to meet working capital requirements, greenfield and brownfield projects, repayment or prepayment of loans and general corporate purposes.
In the primary market, the public issue of securities is carried out by way of an offer of securities for subscription, through an offer document known as a prospectus. A company offers its securities to the public for the first time through an initial public offering (IPO). In addition to IPOs, companies raise funds by issuing securities through methods such as qualified institutions placement (QIP), rights issue, preferential issue, private placement, further public offer (FPO) and issuance of American depository receipts, and global depository receipts, etc.
The secondary market or stock exchange is a market for the purchase and sale of securities that have been initially offered to the public in the primary market and listed on the Stock Exchange.
Securities are exchanged in the secondary market through registered brokers and sub-brokers of the stock exchange, enabling initial buyers in the primary market to re-offer securities to any interested buyer at mutually accepted price.
The secondary market provides liquidity and marketability to the existing securities in the market by creating a continuous market for the purchase and sale of securities by investors. Thus, the secondary market promotes the growth of the primary market and capital formation and is often referred to as the backbone of the capital markets.
Currently, seven stock exchanges function in India, namely the Bombay Stock Exchange (BSE), National Stock Exchange (NSE), Multi Commodity Exchange, Calcutta Stock Exchange, Metropolitan Stock Exchange, National Commodity and Derivatives Exchange and Indian Commodity Exchange.
As of 2022 year-end, 5,313 companies in India are listed across the BSE, NSE and Multi Commodity Exchange, with all-India market capitalisation of INR283 trillion (USD3.47 trillion).
The main participants of the capital market include issuers of securities such as companies, banks, non-banking financial institutions, governments, PSUs, statutory and other bodies; investors such as qualified institutional buyers, anchor investors, foreign portfolio investors, alternate investment funds, venture capitals, private equity, angel funds, high net worth individuals, retail individual investors, pension funds; and intermediaries such as stock brokers, sub-brokers, share transfer agents, bankers to an issue, trustees of trust deeds, registrars to an issue, merchant bankers, underwriters, depositories, depository participants, credit rating agencies, etc.
The capital markets are regulated by the Securities and Exchange Board of India (SEBI), which was established in 1988 as an executive body and given statutory powers in 1992 through the Securities and Exchange Board of India Act, 1992 (SEBI Act, 1992). to protect the interests of investors in securities and promote development and regulation of the securities market as it deems fit. These measures include regulating business in stock exchanges and other securities markets; prohibiting fraudulent and unfair trade practices; promoting investors’ education and training of intermediaries; prohibiting insider trading in securities; regulating substantial acquisition of shares and company takeovers; registering and regulating intermediaries; and undertaking inspection, inquiries and audits of intermediaries and self-regulatory organisations.
The SEBI also has quasi-judicial, quasi-legislative and quasi-executive powers, as well as power to issue informal guidance. Under provisions of the Securities Contracts (Regulation) Act, 1956 and SEBI Act, 1992, the SEBI is empowered to make regulations governing various aspects of the capital markets.
The instruments of the capital markets are referred to as securities. The term “securities” is defined under the Securities Contracts (Regulation) Act, 1956 to include shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature of any incorporated company or other body corporates.
Examples of securities include equity shares, preference shares, shares with differential voting rights, debentures including fully convertible debentures, non-convertible debentures and optionally convertible debentures, bonds, foreign currency convertible bonds, foreign currency exchangeable bonds, Indian depository receipts, derivatives, futures, options, warrants, real estate investment trusts, infrastructure investment trusts, securitised debt instruments, municipal bonds and exchange-traded funds.
A depository is a company where the securities of a shareholder are held in electronic or dematerialised form at the request of the shareholder through the medium of a depository participant. It also provides services related to transactions in securities.
According to section 2(e) of the Depositories Act, 1996, depository means a company formed and registered under the Companies Act, 2013, granted a certificate of registration under section 12(1A) of the SEBI Act, 1992. Dematerialisation is the process converting physical certificates of an investor to an equivalent number of securities in electronic form.
A depository participant is an agent of the depository through which it interacts with investors and provides depository services. Complying with SEBI requirements, registered depository participants can include public financial institutions, scheduled commercial banks, foreign banks operating in India, state financial corporations, custodians, stockbrokers, clearing corporations or houses, non-bank financial companies, and registrar to an issue or share transfer agent.
Currently, there are two depositories in India, namely the National Securities Depository and Central Depository Services (India), which held 289 and 640 registered depository participants, respectively at 2022 year-end.
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