Bulls, bears and big moves

What trends are being observed in the region’s capital market strongholds, and what regulations are helping drive them?

Hundreds of Chinese companies step towards US listing

The China Securities Regulatory Commission’s Trial Administrative Measures for Overseas Securities Offering and Listing by Domestic Companies came into force on 31 March 2023, together with the supporting guidelines.

According to the 27 November 2023 Notice on Strengthening Financial Support to Boost Growth of Private Economy, “eligible private companies are supported in going public on overseas stock exchanges, so as to make the most of the markets and resources at home and abroad”. This notice was jointly issued by China’s eight regulatory agencies, including the People’s Bank of China (PBOC), the National Administration of Financial Regulation (NAFR) and the China Securities Regulatory Commission (CSRC).

By 6 December 2023, nearly 200 Chinese companies had filed with the CSRC, and 52 had completed their registration of overseas listing and received their notice of registration. Of them, 21 companies chose to go public on US stock exchanges, four on the New York Stock Exchange (NYSE) and 17 on the Nasdaq.

The US capital markets are multi-layered. The NYSE and Nasdaq are becoming increasingly mature through continuing layering and evolution. The Nasdaq has three distinct tiers: the Global Select Market, the Global Market and Capital Market. The Nasdaq Global Select Market has the highest listing standards, and the Nasdaq Capital Market has the lowest. Of the Chinese enterprises that completed a filing with the CSRC and planned to list on the Nasdaq, 12 companies disclosed their choices of market layer: one company chose the Nasdaq Global Market and the remaining 11 enterprises chose the Nasdaq Capital Market. The table below details the listing standards for the Nasdaq Capital Market:

Listing standards. The lower listing standards are most attractive to Chinese companies. Among the Chinese enterprises listed on the Nasdaq, the “net income standard” is usually adopted for their initial listing. This standard imposes much lower net profit requirements than the financial requirements imposed on companies seeking to list in the Chinese mainland.

Listed companies. Listings on the Nasdaq Capital Market are mainly for smaller tech firms and high-growth emerging companies. The Nasdaq Capital Market has shaped an investor base interested in high-growth, high-tech and innovative businesses, and which is highly willing to invest in tech innovators and high-growth enterprises. Therefore, if China-based tech firms and high-growth emerging companies go public on the Nasdaq Capital Market, they are more likely to win over investors and gain higher valuations.

Listing modes. The listing modes available on the Nasdaq Capital Market include IPO, ADR, reverse merger and special-purpose acquisition company (SPAC). Enterprises may choose the listing mode most suitable for their own conditions. If the SPAC mode is used, regardless of whether the listing is successful or not, the shares will become tradable immediately on completion of the allotment, effectively shortening the time required for listing. This mode is very attractive to China’s small and medium enterprises seeking to list in the US.

In addition, the high liquidity level of the Nasdaq Capital Market means easier and greater financing opportunities for enterprises. Frequent trading will also give a boost to the price discovery mechanism.

According to public disclosures, the compliance of the variable interest entity (VIE) structure is on the CSRC’s priority list for compliance review of companies filing for registration of overseas listing. The common feedback is to ask the issuer to provide additional information on foreign exchange management, overseas investment and other regulatory procedures involved in the VIE setup and reverse merger, and the payment of taxes and fees in accordance with the law. Due to the complexity of the VIE structure, the CSRC may solicit the opinions of authorities such as the National Development and Reform Commission, the Ministry of Industry and Information Technology and the Ministry of Commerce when examining the issuer with a VIE structure, which will result in an extended period of registration.

In August 2023, the CSRC made it clear that it would continue to unblock overseas listing channels for Chinese companies. To date, companies with successful VIE registration include J&T Express (Hong Kong red-chip listing) and Cheche Technology (US SPAC listing). This success brings confidence to companies intending to go public overseas via the VIE.

In addition to the VIE structure, the CSRC also pays extra attention to the compliance of employee equity incentive plans (including whether each plan has gone through the decision-making procedure and domestic regulatory procedures for foreign exchange), personal information protection and data security (including whether information is provided to third parties and whether necessary information protections are in place).

In the US, the US Securities and Exchange Commission’s (SEC) Statement on Investor Protection Related to Recent Developments in China and the Disclosure Considerations for China-Based Issuers, makes it clear the SEC is concerned about the accuracy of the following information on Chinese companies that seek to list in the US:

• Authenticity of financial statements;
• Information acquisition and supervision;
• The issuer’s organisational structure;
• Regulatory environment;
• Shareholders’ rights;
• Corporate governance; and
• Differences in reports submitted by intermediaries.

The description of relevant facts must be more rigorous, detailed and comprehensive, and must be disclosed in a targeted manner:

• Description of the issuer’s business, which shall distinguish shell companies from actual business operators;
• The uncertainty in the issuer’s financial position and performance of major contracts due to China’s policy changes;
• Detailed financial information;
• Whether the operating entity and, if applicable, the issuer have completed their CSRC filing; and
• A review of the accounting firm engaged by the issuer, as required by the Holding Foreign Companies Accountable Act.

Opportunities usually coexist with challenges. Listing on a stellar capital market like those in the US will create positive signal effects for issuers. Also, the stringent regulatory systems of domestic and foreign capital markets will translate into broader recognition among investors.

It is suggested that issuers accurately position themselves and select the appropriate market for listing. Qualified intermediaries should be engaged as early as possible to provide guidance on compliance, gain a full understanding of the equity or VIE structure and domestic and foreign shareholders, conduct a prudent assessment of business activities involving sensitive industries such as information security, and complete the pre-listing procedures for overseas listing in a timely manner to ensure compliance with domestic and foreign laws and regulations.

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Dizzy heights of spin-off success

A spin-off usually refers to the separation of one or more business segments from an existing listed company, aiming to effect an independent listing of the separated segments, either as a new listed company or through another existing listed company.

Spin-offs can achieve several important business and financial objectives, including:

• Increasing shareholder value when the separately listed company achieves higher valuation;
• Facilitating investors’ evaluation and targeted investment decision-making in the delineated business and the risk characteristics of each listed company;
• Boosting performance of each listed company by enabling the respective management teams to focus on their distinct core businesses; and
• Offering the separated companies flexibility to pursue capital allocation strategies that suit their individual business needs and priorities.

From the perspective of an existing (parent) listed company, a spin-off might not only streamline its operation, it might also release it from bearing the full operating cost of the entities (newcos) that are to be spun-off.

Depending on the structure of the spin-off, the parent company may enjoy the economic benefits of the growth of the newco after obtaining additional capital from the spin-off, while maintaining its control over the newco, resulting in a strong balance sheet and financial performance.

HONG KONG RULES

A newco must satisfy all requirements of the Rules Governing the Listing of Securities on the Stock Exchange of Hong Kong for new listing applicants. In addition, practice note 15 of the listing rules (PN15), particularly, sets out the policy of the Hong Kong Stock Exchange (HKEX) with regard to proposals submitted by Hong Kong-listed companies to effect a separate listing on the HKEX or elsewhere of assets or businesses wholly or partly within their existing groups.

DIFFERENT TO IPO

The following table shows the key differences in listing rules between a spin-off listing and an initial public offering in a general situation.

SPIN-OFF CONCERNS

In the following section, this article looks at some key concerns from regulators during spin-off applications and listing applications filed by newcos.

No one asset/two listing. The parent must retain sufficient assets and operations to support its separate listing status. Normally, the listing committee would not accept one business (the newco’s) to support the two listing status (the parent and the newco). In short, the parent is required to retain, in addition to its interest in the newco, sufficient assets and operations of its own, excluding its interest in the newco, to satisfy independently the requirements of chapter 8 of the listing rules.

Independence. The listing rules require that newcos must be capable of carrying on their business independently of their parents in operational, management and financial aspects. The HKEX does not accept significant overlap between the directors and senior management of a newco and its parent. The newco should have a sufficient number of executive directors who have no conflict of interest to run the business of the newco, and who will not consider the interests of the controlling shareholder alone. In addition, demonstration of the newco’s independence may be affected by significant continuing connected transactions contemplated after the spin-off or the parent’s financial assistance to the newco in the form of, for example, shareholders’ loans, guarantee or pledge of its assets.

Competition. The parent should try its best to avoid retaining any business that may compete or is likely to compete with the business of the newco. The HKEX requires clear business delineation between a parent and its newco, and may consider various factors to determine if there is a clean delineation, such as geographic region of the business, target customers and business model, as well as other protections like strong corporate governance measures in managing conflicts of interest, or provision of non-compete undertakings by the parent.

Assured entitlement. PN15 provides a parent to have due regard to the interests of its existing shareholders by providing them with an assured entitlement to shares in a spin-off newco. This could be done either by way of a distribution in specie of existing shares in the newco or by way of preferred application in any offering of existing or new shares in the newco.

In a typical case of distribution in specie, a newco will issue new shares to the existing shareholders of its parent on a pro rata basis, either directly or through the parent. Where the assured entitlement is provided by way of preferential subscription, the newco will give the existing shareholders of the parent a preferential right to subscribe to the shares of the newco in the IPO. Where the parent decides not to provide, or cannot provide due to practical difficulties the assured entitlement to its shareholders, it must obtain approval from its shareholders, or seek a waiver from the listing committee.

Other concerns. In normal circumstances, the HKEX will not consider a spin-off proposal within three years of a company’s listing.

In a spin-off involving a distribution in specie, the mechanics of distribution shall be designed carefully, which includes the terms of the distribution, the timing of the board meeting to approve the distribution, the record date, the book closure and dispatch of share certificates in the context of the listing timetable.

Finally, in both spin-off and IPO, any agreements binding on the parents/shareholders of the proposed listing company, and any consents or restrictions or veto rights relating to the disposal of material assets or businesses that are relevant need to be assessed and dealt with.

CONCLUSION

Spin-offs and listings are relatively mature in the Hong Kong stock market. A spin-off provides an effective means for a listed company to manage its capital resources and raise new capital for its own business development.

In recent years, numerous Hong Kong listed companies have successfully spun-off part of their businesses and launched separate listings. Among these, a significant proportion have been spin-offs of property management from property developer companies.

In 2023, following the announcement of spin-off plans by two e-commerce giants, Alibaba and JD.com, we saw interest in spin-offs in more diversified industries. From 2022 to 2023, more than 40 Hong Kong listed companies, from technology, biopharmaceutical, finance, real estate, manufacturing, consumer goods and energy industries, announced their intention to spin-off and launch a new listing on Hong Kong or PRC domestic securities market.

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