SOE H-share IPOs: Party building and corporate governance

By Fan Xingcheng, Dentons

Against the backdrop of state-owned enterprise (SOE) reforms, the Stock Exchange of Hong Kong (HKEX) has become the preferred IPO destination for SOEs as it can help improve corporate governance and achieve mixed ownership changes. These companies would usually issue H shares in their IPOs. The main reason is that, the issuers of H shares, being incorporated under and regulated by China’s laws, would be subject to the direct or indirect regulation of these current laws, regulations and other normative documents (including the Constitution of the Communist Party of China).

As a long-standing renowned international capital market, the HKEX is celebrated for its rigorous and sound listing rules and guidance. The listing rules apply to Chinese companies as they float H shares on the HKEX. On top of that, the HKEX and Securities and Futures Commission (SFC) will pay special attention to whether the companies have sound governance structures when reviewing the submissions. For example, as to the SOEs issuing H shares, their articles of association shall include party building content.

Cornerstone Investment
Fan Xingcheng
Senior Partner

How to reflect party building activities in the articles of association and how to satisfy the basic requirements of being listed in Hong Kong need to be considered and elaborated upon. The relationship between the following three points should be resolved: the need to understand the goal of SOE reforms; the need to accurately understand the purpose of adding the party building content in the articles of association; and the need to be compliant with the general philosophy of the international capital market of a sound corporate governance mechanism.

The goal of SOE reforms is to establish a complete governance mechanism, set up a modern corporate system with clear property rights and duties and responsibilities, the separation of corporate management and government administration as well as a reasonable management approach, and to maintain or increase the value of state-owned assets. To include the party building content in the articles of association is an inevitable requirement as the leadership of the party needs to be asserted, and is aimed at establishing a modern corporate system in line with Chinese economic development requirements and with Chinese characteristics.

The attitude of the international capital market towards the corporate governance mechanism is to fully respect and honour the general meetings of shareholders, the board of directors and the board of supervisors as they exercise their rights and authority and bear the consequences and responsibilities within their respective remit, and to make sure that companies are fairly involved in market competition as free-market players. This is a philosophy of modern corporations widely accepted in market economy countries.

How to accurately master and reflect in the articles of association the three needs is a new topic that needs to be addressed for SOEs aspiring for sound and science-based governance. In the author’s view, these three layers of needs do not conflict with each other at all, on the contrary, they can coexist harmoniously. To include the constitution of the party is to secure its leadership. The goal of facilitating the improvement of corporate mechanisms in SOEs through reform is in full alignment with the corporate governance philosophy of the international capital market.

In practice, there are two principles that need to be ascertained. First, the leadership of the party must be secured in the articles of association. However, the leadership of the party is not asserted through the intervention of the company’s operation, but via the management of the “cadre” and the direction of corporate development, which means that the shareholder (for example, the State-owned Assets Supervision and Administration Commission of the State Council, or SASAC) shall be responsible for the appointment and review of its proxies. The party, however, should be responsible for the major direction of the company, for example, making sure it has corporate social responsibility measures and maintaining a balance between the labour union and development of the SOE, etc., while the company shall have autonomy over its operation, including making decisions on production based on market changes.

The second principle is the autonomy of the company over its operation. The company shall have a firm grip on its operations, including various decisions such as the employment and allocation of human resources, spending of capital and requisition of materials, while the SASAC or other state investors may exercise their rights as shareholders through their proxies. Other minor shareholders are also able to exercise their rights as shareholders. The Company Law has given rights to major shareholders, for example, the right to be involved in major decisions, the right to information, or options, the right to supervise the managers, etc. Minor shareholders may influence the management through their votes and ultimately manage the company.

Apart from that, shareholders may take advantage of various regulations (e.g., the HKEX listing rules, the Corporate Governance Code and Corporate Governance Report as well as the public company governance rules formulated by Chinese stock exchanges) to constrain the controlling shareholders from abusing their power, and strictly require companies to comply with rules, so as to ultimately exercise their supervision over corporate governance mechanisms.

The author, in providing legal services to SOEs as they issue H shares, has repeatedly received feedback and comments from the HKEX and SFC on the inclusion of party building in the articles of association. To answer these questions, the author has done an in-depth study on the Constitution of the Communist Party of China, the code of corporate governance for listed companies, the corporate governance code, policies on SOE reforms and the articles of association of SOEs.

In conclusion, as long as companies fully comply with two principles, they can demonstrate this seemingly obscure but essentially clear corporate governance mechanism to the international capital market and securities regulatory bodies, and obtain their recognition. The two principles are asserting the leadership of the party in the articles of association and securing the operational autonomy of the company, and ensure they perform their own respective functions.

Video in Mandarin Chinese –

Fan Xingcheng is a senior partner at Dentons


15th/16th Floor, Shanghai Tower
501 Yincheng Road (M), Pudong New Area
Shanghai 200120, China
Tel: +86 21 5878 5888
Fax: +86 21 5878 6866