Implementing employee stock options for overseas-listed companies

By Yao Ting and Ge Ge, AnJie & Broad Law Firm

In recent years, more and more Chinese enterprises, from startups to listed companies, have implemented stock-based incentive plans.

A stock-based incentive plan reduces the liquidity burden of enterprises compared with a cash-based incentive plan. A community of shared interests is developed between the enterprise and employees because the employees become shareholders of the enterprise.

A stock-based incentive plan is an important way to attract talent. Because of this, multinational companies in mainland China are also considering stock-based incentives to enhance their attractiveness as they compete for talent against some excellent and well-known domestic companies.

For multinational companies listed outside China, the issues that need to be considered when implementing a stock-based incentive plan for employees in China are:

    • Foreign exchange registration and taxation issues in China;
    • The compliance of laws of the jurisdiction where it is incorporated;
    • Exchange regulatory requirements;
    • Incentive effect; and
    • Compliance procedure and costs.

Q: What implementation paths are recommended?

Yao Ting
AnJie & Broad Law Firm

A: The first is the circular No.7 path. The Circular of the SAFE [State Administration of Foreign Exchange] on Relevant Issues Concerning Foreign Exchange Administration over Involvement of Domestic Individuals in Equity Incentive Plans of Overseas Listed Companies (circular No.7) stipulates the foreign exchange regulation rules for employees of domestic companies participating in stock-based incentive plans of overseas-listed companies. Circular No.7’s core content is:

    • Individuals involved in a stock-based incentive plan of an overseas-listed company shall, through the domestic company with which they are affiliated, entrust a domestic agency to centrally handle relevant matters such as the foreign exchange registration, the account opening, and the fund transfer and exchange.
    • Matters such as option exercises, purchases and sales of relevant stocks or equities, and relevant fund transfers, shall be centrally handled by an overseas institution.

After the completion of registration under circular No.7, the funds required for the employees to exercise their rights can be legally remitted and the income related to the stock-based incentive in the form of foreign exchange can be legally transferred back to China.

A second recommendation is the offshore trust path. Under offshore trust paths, a domestic company as the principal and a trustee (usually a trust institution) will enter a trust deed with the stock-based incentive targets as the beneficiaries.

The special purpose vehicle (SPV) established by the trustee holds the options or restricted shares and exercises or disposes of the share interests of the overseas-listed company and related dividends and other economic benefits on the instructions of the principal.

The domestic company has a right to retain the investment and management rights of the SPV.

Q: What are the main steps under the circular No. 7 path?

Ge Ge
AnJie & Broad Law Firm

A: First of all, the domestic agency should be entrusted to co-ordinate the implementation of the stock-based incentive plan. The domestic agency should be a domestic company involved in the stock-based incentive plan, or another domestic commercial presence that may handle asset custody business and is selected by the domestic company in accordance with the law, usually a domestic wholly owned subsidiary of the overseas-listed company in practice.

The domestic agency is fully responsible under circular No. 7 for the registration, the account opening, fund wire and exchange, the payment of taxes and the submission of quarterly reports to the local foreign exchange authority.

After the completion of registration under circular No. 7, the domestic agency will open a special foreign exchange account with a bank for the subsequent foreign exchange purchases or payments, foreign exchange settlement for funds remitted back from overseas, etc.

Q: What are the main steps under the offshore trust path?

A: The main steps are:

    • Draft trust-related legal documents;
    • Conduct the engagement due diligence of the principal;
    • Set up the trust and inject trust assets;
    • Opening the securities account and bank account by overseas holding company; and if the company intends to conduct registration under circular No. 7, the agency prepares relevant application materials and opens a domestic account in China.

Q: What are the advantages and disadvantages of the circular No. 7 path?

A: The circular No. 7 path is the most common and standard way for overseas-listed companies to grant stock-based incentives to their employees in China, where the registration under circular No. 7 can be approved with higher certainty, and the wire instruction of funds can smoothly proceed after the registration.

However, this path is subject to the disclosure rules of the stock exchange. And the domestic agency is required to disclose the employees involved to the local foreign exchange authority.

Further, circular No. 7 stipulates the scope of the receipts and expenditures of the foreign exchange account and requires that the domestic agency and account opening bank for the domestic agency submit relevant forms to the local foreign exchange authority regularly, which imposes an additional compliance burden on the domestic agency.

Q: What are the advantages and disadvantages of the offshore trust path?

A: With the offshore trust path, the holding of incentive shares by an independent trustee can help protect the incentive targets against creditor claims, or the credit risk of a nominee shareholder. In addition, separate brokerage accounts for employees are not needed under this path.

Furthermore, to a certain extent, it avoids possible hostile takeovers when the company is undervalued and its ownership is dispersed.

The disadvantages of the offshore trust path are its cumbersome process and the high cost of setting up and maintaining the SPV.

Yao Ting is a partner and Ge Ge is a paralegal at the AnJie Broad Law Firm

AnJie Broad Law Firm

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