The verification of ‘three types of shareholders’ in IPOs

The term, “three types of shareholders” refers to financial products such as contractual-type private equity funds, asset management plans, and trust plans, usually excluding partnership funds or corporate private equity funds. In June 2020, the China Securities Regulatory Commission (CSRC) issued the Questions and Answers on Initial Public Offerings (IPOs), which set out express requirements for the verification and disclosure of information on “three types of shareholders” who become shareholders of issuers during their listing on the National Equities Exchange and Quotations (NEEQ, also known as the New Third Board).

On 5 February 2021, the CSRC issued the Guidelines on the Application of Regulatory Rules – Disclosure of Information on Shareholders of Companies Applying for IPOs, requiring disclosure on whether shareholders (financial product) are registered under governmental agencies’ data bases or not.

Following the introduction of the above-mentioned guidelines, Shenzhen Stock Exchange, for example, has imposed further verification requirements where intermediaries are required to carry out a series of verifications including the issuer’s direct and indirect shareholder eligibility of holding shares in a company, and whether there is any transfer of benefits by using the shares they hold in the issuer.

With the introduction of the guidelines, the shareholder verification requirements have become more detailed and stringent than ever before. Fortunately, however, the guidelines on shareholder verification and disclosure still leave room for exemption applications for the “three types of shareholders” participating in call auctions.

The author would like to draw on his recent project experience in combination with regulatory requirements to present the difficulties in the verification requirements of conventional “three types of shareholders” in IPOs, and share a bit of experience in this respect.

Compliance and legality

In the author’s view, the issue should be considered from two perspectives: Whether the filing and registration procedures required for both “three types of shareholders” and their supervisors have been carried out; and whether “three types of shareholders” are in compliance with the regulatory requirements.

The People’s Bank of China’s Guiding Opinions on Regulating Asset Management Business of Financial Institutions (also known as the new regulation on asset management), provide a series of rules on the regulated operation of financial products, including the “three types of shareholders”. Therefore, in the review procedure of IPO applications, attention should be paid to whether the “three types of shareholders” are in compliance with the guiding opinions.

However, it should be noted that at the end of 2020, the transitional period for the introduction of the guiding opinions had already ended, and as a result the transitional arrangement alone may not be sufficient as a way to rectify non-compliance on the “three types of shareholders”. Therefore, the following aspects are generally of concern in the verification.

Whether the “three types of shareholders” are structured products with high leverage. First, it is necessary to distinguish whether the “three types of shareholders” are structured asset management products (financial products). If there is no structured asset arrangement for the “three types of shareholders”, they are naturally not structured products with high leverage.

In practice, the verification generally needs to check whether there is any structured arrangement in the product contract, such as the classification of prior investors, product income distribution arrangement, investor allocation according to their shareholdings, or different allocation arrangements set for different categories of investors.

According to article 21 of the guiding opinions, no share structure should be set for public equity products and open-ended private equity products, and such proportion must not exceed 3:1 for structured fixed income products, 1:1 for equity products, and 2:1 for commodities, financial derivatives products, and hybrid products.

If the current structure arrangements for the “three types of shareholders” do not comply with these requirements, they may be advised to take corrective measures. If corrective measures are not possible, the usual practice is to state that the “three types of shareholders” hold only a minimal number of shares in the issuer, which does not have a material adverse impact on the issuer.

Whether the “three types of shareholders” are closed-ended or open-ended. According to the guiding opinions, where an asset management product invests directly or indirectly in the equity of an unlisted enterprise and its beneficial interest, it should be identified as a closed-ended asset management product with clear withdrawal arrangements for the equity and its beneficial interest. The equity and its beneficial interest withdrawal date from an unlisted enterprise shall not be later than the maturity date of the closed-ended asset management product.

Among the “three types of shareholders” that the author has dealt with, quite a number are open-ended products that invest in NEEQ enterprises. Since NEEQ enterprises are unlisted public enterprises, according to the guiding opinions, “three types of shareholders” investing in NEEQ enterprises should be closed-ended asset management products.

For this kind of “three types of shareholders” that does not comply with the guiding opinions, unless their own rectification plans have already been in place, it may be difficult to require them to completely revise their mode of operation. For “three types of shareholders” that are specialised in investing in NEEQ enterprises, one of the possible solutions is to keep a closed-ended operation mode after a certain point of time, and undertake to continue the closed-ended mode for the future, if they are required to co-operate with the IPO applications of the invested enterprises.

In addition to the above-mentioned issues, it is also necessary to verify other matters stipulated in the guiding opinions such as the leverage of liabilities, the provisioning of risk reserves, and the external investment concentration of asset management products.

Intermediary responsibilities

Intermediaries should verify that reasonable arrangements are in place for “three types of shareholders” to ensure their compliance with the current requirements on lock-up periods and share reduction.

“Three types of shareholders” usually have a duration, upon maturity of which they will either be liquidated or renewed, in accordance with their agreement with the investors. “Three types of shareholders” are usually required to sign an undertaking that the product duration will cover the lock-up period, or in the event of non-renewal they will still comply with the share lock-up and reduction rules.

Besides, if an issuer is granted a listing, its entire existing stock of shares shall be automatically locked up by China Securities Depository and Clearing Corporation (CSDC) or its branch, in accordance with the rules of the CSDC and relevant regulations of the CSRC on lock-up of original shares. Normally shareholders are not able to reduce their shareholdings during the lock-up period.

Fang Xiaozhong is a partner at Grandway Law Offices