The recovery in the world’s capital markets has put initial public offerings back on the agenda. For in-house counsel, an IPO can be a once-in-a-lifetime challenge
By Julia Zhu
As the financial tsunami which hit in the second half of 2008 has subsided, capital markets across the globe have come back to life. Of these, the recovery of the Hong Kong and mainland Chinese markets has been particularly evident (see Top 20 China IPOs, page 26).
After a long, cold winter, the time may now be right for companies to take advantage of the thaw. But for in-house legal teams, two big questions remain: where to list, and how?
Home or away
“If a company is preparing to list either at home or overseas,” says Li Yuanyang, a partner at JC Master Law Offices, “it first needs to consider the specific requirements of the exchanges on which it might list, and combine this with an analysis of the company’s situation, in order to decide whether the company can list and on which exchange.”
When it comes to the approvals process and requirements, lawyers in the field usually consider a listing in China to be more difficult than a listing overseas. According to Yang Xiaolei, a partner at King & Wood in Beijing, “in general terms, domestic listings are the most difficult, with the highest requirements”. But that is not the end of the story. “The requirements of main boards overseas are higher than growth boards. Hong Kong, Singapore and the US markets have higher requirements than European markets,” adds Yang.
According to Jiang Xinglu, a partner at Grandall Legal Group in Beijing, “the way the system of approvals operates for Chinese listings is that strict examination is required by the China Securities Regulatory Commission (CSRC), and again by the exchange in question. Because of this, in comparison to other countries, government approval for a listing in China is somewhat stricter.” In contrast, European, American and Australian markets normally follow a registration system, which is more market-based than government-controlled. Market access thresholds for listings can be lower, and a listing can generally be carried out as long as documentation meets the required standard.
Once the IPO is complete, however, ongoing compliance requirements can be stricter overseas. According to Fang Litang, senior partner at Deheng Law Firm, “with Sarbanes-Oxley, US supervision of listed companies is the strictest. The markets in Hong Kong, Singapore and Tokyo are next in line, with pretty good systems of supervision. There are a relatively large number of loopholes in the supervision systems of the Chinese markets”.
This illustrates well the perhaps obvious point that there are two sides to every story. Stricter post-listing monitoring in the US often means that higher costs are incurred in ensuring that a listed Chinese company’s operation is beyond reproach. This could be why some Chinese companies might prefer to list elsewhere.
Balanced against the cost of ongoing compliance are the pricing characteristics of the various markets. Beijing Tian Yuan Law Firm has taken part in a number of Singapore listings. One of the firm’s partners, Liu Yan, comments that “although the requirements of the Singapore exchange are relatively relaxed, the issue price and market price/equity (P/E) ratio are relatively low.” Although the Chinese capital markets are renowned for their high entry thresholds and long lead-in times, they enjoy high P/E ratios and turnover, which can increase their attractiveness.
Generally speaking, the biotechnology, hi-tech and internet sectors are more favoured by US markets, especially Nasdaq, while property (real estate) is more likely to be pursued by Hong Kong. This depends on factors such as the evaluation of the enterprises and knowledge of sectors by investors in each place, as well as differences in geographical location.
And companies with particular characteristics may naturally be attracted to certain markets. Export-oriented companies, or those which have established a market presence overseas, may gravitate towards overseas markets. Another key question is whether a market can satisfy a company’s financing needs, and whether the mechanism for subsequent financing is flexible enough. Of course, the professional standard of available intermediaries and the level of fees for listing, as well as the timing of the IPO, should also be carefully considered.
Lure of the mother market
Although a company can, in theory, choose where to list, “it is not usual for Chinese companies not to list in the mother market because it is still domestic Chinese investors who best understand these companies,” says Liu Fengliang, a partner at Commerce & Finance Law Offices in Beijing. Consequently, a domestic listing may sooner or later be included in a Chinese company’s strategy. To date, a number of Chinese companies listed overseas have returned to the nest, reflecting political demands for support for the mother market, but also illustrating the rapid development of the Chinese stock markets themselves.
Since the establishment of the Shanghai and Shenzhen stock exchanges in 1990, the two markets have gradually shifted away from an initial geographical division and an identical development model to a specialist division of labour. “There is currently some difference between the orientation of the two exchanges,” says Wang Li, a partner at DeHeng Law Offices. “Shanghai mainly admits companies onto the main board, especially blue chip projects, and of course will include future international board companies. Shenzhen is increasingly serving smaller main board enterprises and high-growth innovative companies.”
And the markets continue to develop. At the end of 2009 ChiNext was established in Shenzhen, and work is currently underway with the aim of launching an international board in Shanghai. (See ChiNext: still some way to go, left, and International board raises expectations, page 30.)
Mencius said “time is not as important as place, place is not as important as people”. No matter where a listing takes place, it will be a team effort which requires coordination among the issuing company, underwriters, external lawyers, accountants and other intermediaries (such as surveyors). Each has their own role to play.
Many domestic law firms have ample experience in advising on both domestic and overseas listing projects (see Top China IPO legal advisers, page 23).
A high-quality and experienced professional team will prove decisive in making a listing a success. However, just depending on this team is not enough. Lawyers in the field are almost unanimous in believing that the company’s own in-house legal department will play a key role in pushing forward the whole listing project.
“When it comes to risk management and project management, the company’s own legal consultancy department will be more methodical and more effective,” says Wang at DeHeng Law Offices.
Lu Hongda, a partner at Zhong Lun Law Firm in Beijing, believes that the existence of a designated legal department within the company that wants to list will help to take forward the listing in three major ways. “Firstly, it is important to understand the company’s standard procedures and historical evolution and the legal issues around the way the business is run; a legal department can really improve things in these respects. Secondly, full participation by the company’s legal department in the listing process means that the department can put forward proposals that will minimize the impact on the company’s operations. Thirdly, the level of familiarity the legal department has with the company’s operations will benefit the work of the intermediaries.”
Yue Yun, a partner at Kingall Lawyers in Shanghai, observes that companies which have not set up a legal department can be much less effective in working with the intermediaries. The lack of in-house lawyers may require the intermediary to look at many issues from scratch, spending large amounts of time on basic issues, with the most likely result being unnecessary delays in the listing process.
These points may be even more important for companies preparing to list on ChiNext. “Because some enterprise companies have been in existence only for a short time, they have placed emphasis on expanding their business, and in relative terms may pay insufficient attention to internal functional units. Consequently, they may not meet the listing criteria,” points out Chen Wei, a partner at Llinks Law Offices in Beijing. So, as well as expanding their operations during the pre-listing phase, Chen suggests that such companies should pay close attention to operational matters.
In-house and out
“External lawyers are like a comprehensive specialist clinic, focusing on treating illness, but the important role for corporate counsel is preventing illness,” says Shao Chunyang of Jun He Law Offices.
External counsel are engaged to carry out thorough investigation into the regulatory aspects of the company’s listing, and to issue legal opinions on it. “The main role of external lawyers is to describe and set out the company’s restructuring, operations and share issuing from a legal perspective, as well as the legal aspects of the listing, to reduce the risk to investors,” says Li Zheng of Heng Xin Law Office.
In contrast, corporate counsel are not required – or permitted – to issue independent legal opinions. “Their first responsibility,” says Liu Rong, a partner at Guantao Law Firm in Beijing, “is standardizing the company’s daily operating activities, preventing (at least to some extent) the appearance of major legal risks”. Next in line, says Liu, comes “helping the intermediaries carry out the listing work,” including the collection and organization of relevant company material, investigating any major problems, and helping with the drafting and approval of application documents.”
Responsibilities and challenges
“Corporate counsel can be relative strangers to the laws and regulations involved in a listing,” says Shi Haiyan, a partner at Capital Equity Legal Group. When faced with this situation, external lawyers hope that corporate counsel will not limit the scope of their work to everyday business, but will also get to grips with the regulations involved in a listing.
Wang at DeHeng Law Offices echoes this opinion. “In-house counsel usually focus on the legal matters associated with daily operations, and can lack sufficient experience or skills to handle large capital-raising projects. They always face challenges when coping with external lawyers,” she says. Bastion Law Firm’s Xu Yanna believes that corporate counsel “should get themselves familiar with securities law and IPO rules, which can greatly facilitate the IPO process of companies”.
Some lawyers suggest that corporate counsel would benefit from a deeper understanding of the operation of domestic capital markets, and knowledge of financial issues. “In-house lawyers should understand the company’s business model and the characteristics of the industry,” says Liu Fengliang, a partner at Commerce & Finance Law Offices in Beijing. “There is a need to rely on corporate counsel to solve problems which arise at the intersection of financial and legal issues, such as confirming sensitive sales income and the reconciliation of financial reports.”
After engaging investment banks and external lawyers, the need for effective communication and coordination will increase. So will the possibility of conflict. “Corporate counsel will face particular pressure and challenges”, says Liu Su, a Beijing partner at Haiwen & Partners. “On the one hand, they need to work with external lawyers and other intermediaries to take the listing forward. On the other hand, they need to implement the instructions of the company’s internal management. If they lack good skills in coordination and balancing different influences, they will become completely exhausted.”
The strain of multiple responsibilities
As the middle man between the internal and external teams, and the lubricant that oils the wheels of the listing, how can corporate counsel respond satisfactorily to the various demands that are placed upon them?
China Ping An Insurance listed on the Hong Kong stock exchange in June 2004, and in March 2007 carried out a domestic A-share listing. The company’s chief legal consultant, Yao Jun, suggests that the in-house legal team needs to be familiar with every aspect of the listing, and adopt an active rather than a passive approach. “Because investment banks and external lawyers lack understanding of the company’s business, the questions they ask and the documents they demand may not be appropriate to the company. When this happens, the company’s legal consultants should ‘filter’ these questions and demands, turning the intermediaries’ requests into a form which the company can fully meet,” he says. “Even if the intermediaries’ questions and demands are totally appropriate to the company, the in-house legal consultant needs to help them implement and fulfil these requirements in coordination with other departments in the company.”
China Publishing Group is expected to list at the end of this year. “The in-house legal team should maintain good communication with the company’s management,” its representative, Mao Yuansheng, stresses. “And when differences occur, it must be stressed that the ‘bottom line and foundation’ for dealing with all problems are the laws and regulations.”
It may be a cliché, but communication is key. “Some in-house lawyers have a tendency to communicate with external lawyers face-to-face or orally, and not in writing. But this is likely to lead to inconvenience in communication and create additional risks,” points out Li Zhiyong, a partner at Chang Tsi & Partners in Beijing.
All in all, for both the company and its external advisers, the objective should be the same: to ensure that the company lists successfully and meets its financing requirements. With this common objective, whether the company’s legal team is coordinating with external partners, or removing internal obstructions, there will be fewer constraints and more consensus.
Information disclosure the biggest risk
At the operational level, lawyers who have been involved in successful listings suggest that corporate counsel need to pay particular attention to issues of information disclosure.
“For Chinese companies, the biggest legal risk comes from the insufficient disclosure of information,” says Liu Xiangming, a partner at Jin Ding Partners in Nanjing. “If a company carefully conceals something, the issuer’s law firm will have difficulty discovering the existence of the relevant facts. Under China’s current credit system, there are some facts which simply cannot be verified, such as providing guarantees for other parties or getting involved in litigation.”
Yang Guang, a partner at Lan Tai Partners, says that “the biggest risk that the company faces is that the issuer cannot provide authentic, complete information, or that there are omissions or points which are concealed.”
International board raises expectations
While Shenzhen has moved forward with ChiNext (see ChiNext: still some way to go on page 22), Shanghai has not been standing still. Since 2009, there have been repeated calls for a Shanghai international board. This is now widely expected. In the view of Shao Chunyang, a partner at Jun He Law Offices in Shanghai, “the establishment of an international board in Shanghai reflects the work that has been done to make Shanghai an international financial centre. However, the question is when this can really happen. It depends on a lot of factors, including the maturity of the legal system, the liberalization of foreign exchange policy, the stability of domestic and international capital markets, the confidence of investors towards China’s economic growth, the availability of appropriate professional personnel and the construction of hardware for the financial system. Thus, it can’t be hurried.”
Global Law Office partner Zhang Tao offers the following analysis. “The establishment of an international board can not only enable Chinese investors to invest in top-rank international listed companies, but may also encourage red chip companies listed on overseas markets to make some adjustments to their operations, and come back to the domestic market.” Nonetheless, a number of issues still require further investigation and discussion: whether the system underpinning Chinese share transactions can gain the approval of foreign companies, whether foreign exchange controls will be cancelled, whether domestic intermediary organizations – including underwriters and lawyers – are of a high enough professional standard to handle this new business, and the ongoing amendments at the legislative level of the PRC Companies Law and the PRC Securities Law.
As summarized by Liu Su, a Beijing partner at Haiwen & Partners, the establishment of an international board will bring both opportunities and challenges to domestic law firms and other intermediary organizations.
DeHeng Law Offices’ Wang believes that there are many legal risks in the listing process, the biggest of which relate to regulatory issues and litigation; both require the company to make full disclosure.
Yanzhou Coal has listings in three places: on the Hong Kong exchange (since 1998), American depositary receipts on the New York Stock Exchange, and the Shanghai exchange. Zhang Baocai, the company’s secretary general, suggests that “in-house lawyers should pay particular attention to the problem of competition between the listed company and its controlling shareholders. The biggest risks are how the company makes best use of preferential tax policies in its restructuring, and dealing effectively with the disclosure of information about the IPO.”
Liu of Haiwen & Partners believes that corporate counsel need to continue to pay attention to the release of information after the listing has taken place. “After the listing, the company needs to face a large number of public investors. Corporate counsel therefore need to continue to play an active role, pay attention to the latest legal developments, and identify internal administrative problems, so that the company ship can be steered safely.”
The in-house legal team will be called upon to assist the external lawyers to carry out their investigations, covering such issues as connected transactions and compliance, and including tax, property, environmental issues, human resources and valuations. If any problems are discovered, the legal team needs to be proactive in discussing ways of solving these problems, and must not avoid or conceal them. Secondly, senior management may treat their external legal advisers as hostile litigation lawyers, taking offence at their highlighting of problems, and may as a result delay or even obstruct the disclosure of information. In-house lawyers need to be proactive in talking to and persuading senior managers to change their way of thinking, in order to reduce the risk of information being concealed.
Once in a lifetime
Capital markets lawyers who have spoken to China Business Law Journal for this article have offered the following tips to in-house counsel facing an IPO:
Get familiar with IPO rules, procedures and required documents, as well as the roles and responsibilities of various agencies.
Be aware of the goals that need to be achieved at each stage and the responsibilities that corporate counsels should assume.
Coordinate with various departments of the company, and persuade them to be supportive during the due diligence and ensure they provide documents in a timely way.
Figure out the key issues of supervision and compliance, and the common risks that companies usually encounter, as well as the solutions to these issues.
Before the IPO, the focus should be on the legality of operations, the ownership of property, compliance, connected transactions and non-competition. After the IPO, the focus should shift to information disclosure, including monthly, quarterly and annual reports.
SOEs and private enterprises
The risks faced by companies can also vary according to their ownership model. Preparations for an IPO will therefore differ depending on the model used.
“Large-scale state-owned enterprises have long histories, large-scale assets and many connected parties. Because of these features … the internal legal team’s pre-listing work in restructuring will therefore be relatively substantial,” says Chen at Llinks.
With respect to private enterprises, improving corporate governance is the core focus. Wang Jianyun, a partner at Wang Jing and Co in Guangdong, points out that “the biggest risk faced by ‘private’ or non-state enterprises is a lack of clarity in the shareholding rights or a non-standard processes of obtaining shareholding rights. Irregular internal operations are another relatively large risk.”
Although an IPO is a once-in-a-lifetime event for a company, Yan Yu, a partner at Jia Yuan Law Firm, says corporate counsel need to get involved in the whole process. This way, they “will be able to understand the whole restructuring and listing process, and accumulate experience. This can lead to far-reaching improvements to the performance of their legal teams.”