Understanding red-chip structures in Cayman Islands

    By Calamus Huang, Jessie Xu and Ericsson Yu, Harneys in Shanghai

    Over the decades, Hong Kong has become the preferred listing venue for Chinese companies that are ineligible for listing on Chinese stock markets and/or are seeking to finance themselves on the global stage. However, Chinese enterprises listing with Hong Kong Exchanges and Clearing Limited (HKEX) directly must comply with the directions and mandates of the China Securities Regulatory Commission (CSRC) and obtain its approval. The shares issued by successful applicants are called H shares, and every new additional issuance of H shares shall be qualified with prior written approval from the commission, which can be a very time consuming and costly process.

    Calamus Huang
    Partner at Harneys in Shanghai
    Tel: +86 21 2030 7840
    Email: calamus.huang@harneys.com

    This caused the creation of the so-called “red-chip” structure (RCS), inspired by the term “blue chip” in American stock markets. In the early days of poker games, players bet in blue, white and red chips, and the blue chips had the highest value. The terminology was then borrowed and used to describe high-priced, stable and/or long-lasting stocks in the US. Probably because the colour of red represents good fortune and joy in Chinese culture, and is used extensively across Greater China, the special structure initially employed by high-valued Chinese enterprises to list themselves on the HKEX was thus described a “red-chip” structure.

    Nowadays, red chips do not necessarily mean those mature companies that represent the stalwarts of an industry. Private or smaller-scale enterprises adopting the same structure will nonetheless be called red chips.

    Working definition

    Adopting the RCS will allow Chinese companies to indirectly list on the HKEX. For this purpose, the RCS mainly connotes two different legal frameworks – the shareholding framework and the variable interest entity (VIE) framework.

    Shareholding framework. This framework will be required to incorporate an offshore holding company or a special purpose vehicle (SPV) as the listing company, the shares of which will ultimately be listed and traded on the HKEX, normally in the Cayman Islands. Such an SPV will then indirectly, through certain SPVs incorporated in Hong Kong, hold the equities in the underlying domestic operating company (OpCo), which holds the China-based assets and interests.

    VIE framework. Using the framework of equity control is not always feasible due to the relevant restrictions under PRC law, such as restrictions on foreign investment in certain industries. For example, a wholly foreign-owned enterprise (WFOE) cannot provide online news services, nor can an OpCo be owned by a WFOE. In this context, the adoption of the VIE structure helps those companies with foreign ownership to circumvent the potential restrictions.

    The offshore portion of this structure up to the WFOE level is exactly the same as the traditional shareholding RCS, and is only different from it in that the WFOE’s control of a VIE, being a domestic Chinese company with no foreign ownership that owns and operates the underlying business, is achieved through a set of contractual agreements instead of equity ownership.

    With a VIE structure, foreign shareholders can become the ultimate beneficiaries of the economic interests of the VIE, consolidate the financial performance of it with the overseas subsidiaries held by the same listing company, and face fewer regulations in conducting or investing in business in China.

    Using a red-chip structure

    There was a steady increase in the number of HKEX listing companies incorporated in the Cayman Islands from 2017 to 2020, while no such increase was observed for listing companies incorporated in other jurisdictions including the British Virgin Islands (BVI). By the end of 2020, 1,319 mainland China enterprises were listed on the HKEX, out of which 1,026 employed the RCS and a vast majority were incorporated in the Cayman Islands.

    Jessie Xu
    Counsel at Harneys in Shanghai
    Tel: +86 21 2030 7805
    Email: jessie.xu@harneys.com

    One question inevitably arises: Why is the Cayman Islands so welcomed? Being one of the UK’s overseas territories means that the Cayman Islands shall be rightly regarded as a British common law jurisdiction. This not only means its legal framework is on an equal footing with Hong Kong, but also means its courts are subject ultimately to appellate supervision by the judicial committee of the Privy Council in London. Such participation of English judges in the judicature of these jurisdictions links their laws and legal systems to one of the great legal traditions of the world so that their courts can apply orthodox and predictable legal doctrines and procedural approaches in deciding commercial disputes.

    Taxation. Entities incorporated in the Cayman Islands are also not subject to taxation on corporate income or capital gains. There is no stamp duty charged on share transfers (with limited exceptions), or withholding tax imposed on payments of dividends to shareholders.

    The Cayman Islands Cabinet Office further allows Cayman exempted companies to apply for a written undertaking that they will not be subject to any Cayman tax on profits, income, gains or appreciation for a period of up to 30 years, should these taxes ever be introduced in the islands.

    Confidentiality. Under the Companies Act (as revised) of the Cayman Islands, an SPV, being an exempted company incorporated in the Cayman Islands, must keep and maintain a register of members that may, but need not be, kept at the registered office. The register of members of a Cayman SPV is not filed with any government or regulatory authority, and is not available for public inspection. The memorandum and articles of association, as well as any director or shareholder resolutions of a Cayman SPV, are not available to the public. In the BVI, the memorandum and articles of association of an SPV are available for inspection upon payment of a fee.

    Efficiency. In Cayman, the memorandum and articles of association of an exempted company shall take effect upon adoption of a special resolution passed by the shareholders, and is not subject to the approval of any government authorities. However, in the BVI, the memorandum and articles of association of a business company will not take effect until it is registered with the Registry of Corporate Affairs.

    Under the HKEX listing regime for overseas companies, the Cayman Islands is a recognised jurisdiction that attracts less security in corporate governance than an acceptable jurisdiction such as the BVI. The HKEX has adopted and is continually enforcing special measures for BVI-incorporated applicants.

    For example, article 4.1 of the HKEX Country Guide – the British Virgin Islands requires BVI-incorporated issuers to demonstrate how their practices conform to the requirements on the Joint Policy Statement Regarding the Listing of Overseas Companies. These will cause unnecessary delays that can be avoided by incorporating the entity in the Cayman Islands.

    Ericsson Yu
    Intern at Harneys in Shanghai
    Email: ericsson.yu@harneys.com

    Co-operation with the CSRC. On 22 March 2018, China’s State Council approved the launch of the Pilot Programme of Innovative Enterprises Domestically Issuing Stocks or Depository Receipts, and agreed that eligible red chips shall be included under the programme.

    On 5 November 2018, the Cayman Islands Monetary Authority entered into a memorandum of understanding (MoU) with the CSRC, which was designed to enhance the exchange of supervisory information and cross-border enforcement co-operation with regards to Cayman Islands-registered companies that carry out public or private securities offerings in China and/or have securities trading on China’s stock exchanges.

    On 30 April 2020, the CSRC issued the Announcement on Arrangements for the Domestic Listing of Innovative Red-Chip Enterprises under the Pilot Programme. Seen in this vein, the MoU has paved the way for those Cayman incorporated red chips to list on the Shanghai Stock Exchange’s Star Market.

    Currently, there are two alternative routes for red chips to list on the Star Market. One is for a Cayman listing company to issue shares directly to Chinese shareholders. The other way is for a Cayman listing company to engage a depository institution that will issue Chinese depository receipts (CDRs) to Chinese shareholders.

    Under the CDR approach, the depository institution may further entrust an asset management agency to manage the offshore-based underlying securities. The complexity of this method decides that it is less employed by the interested red chips.

    Five Cayman red chips have been successfully listed on the Star Market with a VIE structure, and only one adopted the CDR approach. The explanation for this may be that for a red chip with a VIE to list itself on the Star Market via issuing shares, the CSRC will consult the State Council, the National Development and Reform Commission and the Ministry of Commerce for their opinions concerning the operation of the OpCo of that red chip. This will not take place in the case of the issuance of CDRs.


    Aristodemou Loizides Yiolitis, Shanghai Representative Office (Cyprus)
    Unit 2, 9/F, Tower 3, Lujiazui Finance Plaza
    826 Century Avenue, Pudong New Area,
    Shanghai – 200120, China
    Tel: +86 21 2030 7888
    Email: china@harneys.com