What the Star Market has changed

The piloting of a registration-based IPO system for the Star Market is of epoch-making significance to the capital market in China. This Nasdaq-style board of the Shanghai Stock Exchange has brought additional room and vitality to the market by going beyond the established philosophy for A-share IPO examinations, paving the way for innovations and breakthroughs in a variety of institutional arrangements. Since the Star Market was opened, Shu Jin Law Firm has provided legal services for 15 Star Market IPOs as issuers’ counsel, including five companies that listed successfully and one firm currently in the registration process. This paper provides a brief introduction to a few significantly influential innovative arrangements made by the Star Market.

Putting valuation at the core. Before the Star Market was launched, there were legal barriers against the A-share IPO filing by companies, which have not made profits or have unrecovered losses. Thus in those days, China’s dotcoms and e-commerce giants had to go overseas in pursuit of listing on foreign capital markets.

The successful Star Market IPO of Zelgen Biopharmaceuticals, as the first listed A-share issuer that had not made a profit, started a new chapter for the A-share market. The Star Market has upended the 30-year long conventional IPO philosophy of China’s capital market that was only focused on historical profits and established a market-oriented rule that puts valuation at the core. It also has broken the stereotypical mode of IPO pricing at the fixed P/E ratio, attracting greater market and investor attention toward the issuers’ capability of technological innovation and potential for future growth. It gives a huge impetus to the accelerated market-based transformation and internationalization of participants, including issuers, institutional investors and investment banks.

Red-chips listing. Although the China Securities Regulatory Commission (CSRC) permitted eligible pilot red chips to go public by issuing shares or depositary receipts in domestic markets in accordance with established procedures in 2018, no red chips had successfully listed on the A-share market before the Star Market was launched.

The Star Market has improved the IPO system and operational arrangements for red chips, responded to their requests and investors, charted the road map for domestic A-share listing of red chips and sped up the return of tech red chips/China concept stocks to the A-share market. The successive listing of CR Microelectronics, Ninebot, SMIC and other well-known red chips on the Star Market has provided a clear answer for many enterprises torn between going public overseas or seeking a domestic listing. It also has paved the way for outstanding companies listed overseas to return to the domestic capital market, and provided a good reference point for the admission of red chips to the Star Market under the registration-based IPO system.

Employee stock option incentives plan over the IPO process. Before the Star Market was launched, an IPO applicant was not allowed to have any uncompleted stock option incentives plan for equity certainty considerations. Any asset management plan or similar methodof shareholding in existence will add to the difficulties in or create barriers to an IPO examination.

The Star Market permits applicants to develop an option plan prior to listing and implement it afterwards, creating a link between stock incentives arrangements and the certainty of listing, and also enhancing employees’ reasonable expectations of effective incentives. In addition, the Star Market rules explicitly allow employees’ indirect shareholding through asset management plans or other holding vehicles (including employees’ participation in strategic placements by setting up an asset management plan). This permission has enriched the stock incentives methods and channels, with innovative institutional design and arrangements made in terms of employees’ capital contribution in the form of technological achievements, recipients and the proportion of incentives, grant price and Class II restricted shares (the recipients of incentives may, after meeting eligibility requirements, acquire shares of their employer at a grant price without prior capital contribution and are free to trade shares when the restriction period expires).

The Star Market’s innovations and breakthroughs in the employee stock ownership and option incentives plans are recognized among many applicants.

Differentiated arrangements for voting rights. Although listed A-share issuers are legislatively permitted to issue preference shares before the Star Market was launched, there were still many barriers in reality against listed companies’ differentiated arrangements for voting rights.

The Star Market rules make it clear that the companies with differentiated arrangements for voting rights may apply for listing, and also set forth requirements as to market capitalization, holders and the shareholding percentage, differences and transfer restrictions and time limits.

The permission for the listing of companies with differentiated arrangements on voting rights has broken through the rule that “shares of the same class must carry the same rights and benefits”, as defined by China’s Company Law. It is also aligned with the class shareholder system in the international capital markets and provides more corporate governance structure options for qualified tech-innovative companies. Some companies with differentiated arrangements for voting rights, such as UCloud and Ninebot, have filed for listing or gone public on the Star Market in succession.

In addition to the important innovations mentioned above, the Star Market has made more market-based trials on the definition of horizontal competition, reasonable judgment on related party transactions, tolerance of the valuation adjustment mechanism (VAM) clauses, requirements on the cleanup of “three types of shareholders” (i.e., contractual private funds, asset management plans and trust plans) and requirements on mandatory delisting for compliance reasons. In addition, the up-to-date service attitude and pragmatism manifested by the stock exchange in the Star Market IPO filing and examination process have materially boosted the efficiency of evaluation and shored up the confidence of all participants in the securities market.

The launch of the Star Market is a major milestone in China’s capital market development. Over the past year, as the “test field” for China’s capital market reforms, it has made a number of innovations and breakthroughs, which have turned into a variety of duplicable good practices. 2020 marks the first year of the registration-based IPO system established by the new Securities Law. We have reasonable grounds to believe that as the registration-based IPO system is advancing further in becoming the norm, China’s capital market will be more market-oriented and international, and provide stronger support for enhancing the technological innovation capacity and competitiveness of the real economy.

The Securities team of Shu Jin Law Firm