China’s State Council kickstarts market for PRC-listed depositary receipts for overseas listed shares

Introduction to the blueprint
  • On 22 March 2018, the State Council released a high-level blueprint for a pilot plan aimed to kickstart the process of coordination among the China Securities Regulatory Commission ("CSRC") and other PRC regulators that will introduce an important channel for future equity financings in the People’s Republic of China ("PRC").
What new equity financing channels are being introduced?

  • Under the pilot plan, which was first announced at the annual meeting of China’s two legislatures in March 2018, selected listed red-chip companies (i.e. companies registered outside the PRC whose main business activities are conducted in the PRC) are to be permitted to issue depositary receipts in the PRC for overseas listed shares. The depositary receipts will be tradeable on a PRC stock exchange and issued by a depositary, who will hold the overseas listed shares on a segregated basis from the rest of its assets, and exercise the rights on such shares on behalf of the receipt holders. The rights of the share issuer, the depositary and the receipt holders will be set out in a deposit agreement, to which every holder of the receipts from time to time will be deemed to have automatically acceded.
  • In addition to depositary receipts, the pilot plan will enable certain qualified red-chip companies, and other eligible companies registered in the PRC, to issue new shares to be listed and tradable on a PRC stock exchange.
What companies will be selected?
  • Companies using the new equity financing channels must be in compliance with the national strategy, possess core technology and a strong recognition in the market.
  • Each participating company must be an innovative enterprise with certain scale in one of the following sectors: Internet, big data, cloud computing, artificial intelligence, software and integrated semiconductors, high-end equipment manufacturing, and companies in other high new-technology industries and strategically emerging industries (such as biotech).
  • Listed red-chip companies participating in the plan must have a market capitalisation of no less than RMB200 billion. Other participating companies without an existing overseas listing (such as certain red-chip companies and companies registered in the PRC) must have either:
    • a latest annual turnover of not less than RMB3 billion and a valuation of not less than RMB20 billion; or

    • a rapidly growing turnover, leading international technology that has been developed on its own, and a relatively leading competitive position in the industry (in accordance with specific standards to be formulated by the CSRC).
  • Before a participating company becomes profitable, its controlling shareholders, controllers, directors and senior management may not sell down those of the company’s shares that were acquired by them prior to its listing.

What other conditions apply?
  • Generally speaking, participating companies who issue shares on a PRC stock exchange will need to satisfy the conditions for public share offering. Participating red-chip companies must comply with the laws of the place where they are registered, and the protection afforded to investors by such laws must not be lower than the PRC legal requirements. Companies operating variable interest entity ("VIE") contractual control structures will be subject to additional requirements, to be determined by the CSRC and other government authorities prudently based on various circumstances.
  • For issuers of depositary receipts, the following additional requirements apply:

    • details and risks of differences in voting rights, VIE contractual control structures and other special arrangements must be fully disclosed in the initial offering prospectus; and

    •  investors must enjoy equivalent protection as if they were the holders of the underlying overseas listed shares. These rights will be enforced by the depositary on the investors’ behalf.
  • All information disclosed by participating red-chip companies in accordance with overseas regulations must be made available in Chinese to PRC investors at the same time. Overseas financial statements must be made available to PRC investors in accordance with one of the following requirements:

    • PRC GAAP; or

    • other GAAP recognised by the PRC Ministry of Finance as equivalent to PRC GAAP; or

    • International Financial Reporting Standards or US GAAP, with reconciliation for differences to PRC GAAP.

What do we think will be the likely impact of the new blueprint on the market?
  • Companies eligible to participate in the pilot may, in light of the new depositary regime and ongoing competition between stock exchanges in and outside the PRC, be re-considering their IPO plans (including revisiting potential dual listings).
  • With the new depositary market as an additional source of finance, for the purpose of a listing in the PRC it may no longer be necessary to unwind existing VIE structures, or restructure existing different classes of shares. The plan signals a loosening of a ban in mainland equity markets on VIE structures, which have been used by many of China’s tech entrepreneurs to set up their companies.
  • The main issue to be further clarified by the CSRC is whether the depositary receipts issued by the participating companies will be fully convertible into their underlying overseas listed securities (and vice versa). Assuming this to be the case, it may potentially provide arbitrage opportunities and create challenges for cross border capital flows.
  • We expect that the CSRC, together with other government authorities, will soon release more detailed rules relating to depositary arrangements, equal treatment of investors, and cross-border funds flow and settlement mechanisms.