Models for foreign listing of domestic enterprises, regulation of outbound funds

With the increasingly stricter legal regulations on A-share initial public offerings of domestic enterprises in China, the new policies put out for “new economy companies”, “biotech and pharmaceutical enterprises” and “weighted voting rights” by Hong Kong Exchanges and Clearing Limited (HKEx) and the China Securities Regulatory Commission (CSRC) policy announcement on a pilot project for full tradability of H-share listed companies, domestic enterprises have been frenetically training their sights on foreign markets.

The principal structures for the foreign listings of Chinese domestic enterprises are the “H-share model”, “large-red-chip” and “small-red-chip” models (including both direct shareholding and indirect shareholding models, i.e., VIE structures). Under the H-share model, a domestic enterprise is reorganized as a company limited by shares and, after securing CSRC approval, it may directly offer H-shares and list abroad. After listing, the shares in the hands of the foreign public shareholders of a domestic non-pilot enterprise may be traded openly in the market.

The “large-red-chip” model refers to a domestic enterprise’s realization of a foreign listing through the establishment of an overseas-listed entity. Under this model, the domestic enterprise is required to secure CSRC approval before listing and the domestic assets resulting from domestic investments and held by the overseas listed entity must be for a full three years.

Generally, under the “small-red-chip” model, a domestic natural person with Chinese nationality establishes a special-purpose vehicle offshore and, through it, invests in relevant domestic assets, and the offshore entity (e.g., a Cayman Islands company), controlled by the SPV established offshore, usually serves as the listed platform. Under a VIE structure, the SPV established offshore will establish in China a foreign-invested enterprise that will execute a series of control agreements with the domestic enterprise to realize the transfer of the profits the domestic assets generate for the offshore-listed entity. With this model, the full offshore tradability of the equity can be realized.

Since the date of implementation of the Provisions for the Acquisition of Domestic Enterprises by Foreign Investors (Circular No. 10), the investment in relevant domestic assets by a special purpose vehicle established by a domestic natural person with Chinese nationality for the purpose of a foreign listing requires the approval of the competent Chinese authorities. Under the “small red chip” direct shareholding model, the approvals of the relevant government authorities required pursuant to Circular No. 10 can be circumvented by converting the domestic enterprise into a Sino-foreign equity joint venture and further transforming it into a wholly foreign-invested enterprise, or by the natural person changing his or her nationality or by using an indirect shareholding method and setting up a VIE structure.

VIE structures mainly apply to industries in the restricted and prohibited categories of the Catalogue for Guiding Foreign Investment in Industry (amended in 2017) and the Special Administrative Measures for Access by Foreign Investors (Negative List) (2018 version). In April 2018, HKEx also issued a revised listing decision document, HKEX-LD43-3, specifying that VIE structures might be used solely for the purpose of resolving foreign-investment restrictions, namely, domestic enterprises, in sectors where such investment was not restricted or prohibited proposals to list in Hong Kong, might not use a VIE structure.

Secondly, the means by which domestic renminbi funds can be conveyed abroad is also a key concern of domestic institutional investors. Under the “small-red-chip” model, foreign exchange registration for a round-trip investment may, in accordance with the Notice of the State Administration of Foreign Exchange on Issues Relevant to Exchange Control in Connection with Offshore Investment/Financing and Investment Round Tripping Through Special Purpose Vehicles by Domestic Residents and the Notice on Further Simplifying and Improving Exchange Control Policies Relating to Direct Investment, be carried out through the listed platform set up abroad by a domestic natural person with Chinese nationality.

Where relevant rights and interests involve state-owned assets or where a listed company cannot be directly traced back to a domestic natural person and an institutional investor directly invests in an overseas-listed platform, it is required to carry out overseas investment recordal and forex registration in accordance with the Administrative Measures of the National Development and Reform Commission for Outbound Investments by Enterprises, the Administrative Measures of the Ministry of Commerce for Outbound Investment and the Notice on the Issuance of the Provisions for Exchange Control in Connection with Direct Foreign Investments by Domestic Institutions (Decree No. 30). In addition to the “small-chip-model”, an institutional investor may, provided it satisfies the conditions for a qualified domestic institutional investor and following approval from the Chinese government, invest in negotiable securities, such as stocks and bonds, on foreign capital markets.

Pursuant to Decree No 30, “if a domestic institution transfers all or part of its equity in an enterprise in which it has a direct foreign investment to another domestic institution, the relevant funds shall be paid in China in renminbi”. Although the equity transferee can pay the consideration in China in renminbi, it is, nonetheless, required to carry out outbound investment recordal in respect of its outbound investment. When a domestic institutional investor acquires the foreign equity held by a domestic natural person with Chinese nationality, in practice, further confirmation needs to be carried out with the exchange control authority as to whether payment needs to be made in renminbi.

It is worth mentioning that, with the further formulation of such documents as the Foreign Investment Law (Draft) and the (Bill for Revising the) Implementing Regulations for the Law on Promoting Private Education (Draft Sent for Review), the structure of future foreign listings by domestic enterprises, particularly VIE structures, may feel a certain impact. Additionally, foreign securities regulators hold different regulatory stances in respect to the different structures Chinese enterprises used in the course of their foreign listings – a point also deserving further attention.

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Willow Wei is a counsel at Dentons