With the clarification of the regulatory policies of indirect overseas listing, the regulatory framework for direct overseas listing was established from scratch. In accordance with Article 85 of the PRC Company Law (1993)[28], the PRC State Council enacted the Special Provisions of the State Council on the Floatation and Listing Abroad of Stocks by Joint-stock Limited Companies (hereinafter the Special Provisions on Direct Overseas Listing) [29]; In accordance with the Special Provisions on Direct Overseas Listing, the SCSC, the CSRC and relevant competent authorities severally or jointly promulgated several other regulatory documents that lay down specific requirements for H-share companies on issues such as the corporate governance, on-going disclosure obligations, foreign exchanges control, reduction of state stockholding and the centralized registration and deposit of unlisted shares.[30] It can be seen from these efforts that the Chinese regulatory authorities have been enforcing separate regulation for direct and indirect overseas listing ever since such activities began.
In addition, it is worth noting that, to comply with applicable domestic laws, the pre-operational stage (i.e. establishing a special purpose vehicle (SPV) abroad and entitling such an entity to the controlling interest of a domestic company) of Chinese companies’ indirect overseas listing involves the regulation of three aspects, i.e. foreign direct investment, absorption of foreign investment and foreign capital import and export. According to the laws and regulations in force at that time, to be allowed to establish an overseas SPV, and to have such an entity obtain the controlling interest of a domestic company or establish a foreign-invested company in China, the domestic companies must obtain approval from business regulatory authorities and go through related registration at foreign exchange administrative authorities.[31] The above review and registration processes were mainly performed by provincial authorities of business administration[32] or by provincial branches of the SAFE.
II. THE DUAL-TRACK REGULATORY FRAMEWORK
In 1998, China''s first comprehensive securities legislation, the PRC Securities Law (1999)[33], was given birth. Article 29 of the PRC Securities Law (1999) stipulates that: “……A domestic enterprise must obtain approval from the China Securities Regulatory Commission before it directly or indirectly issue shares abroad or has its shares to be traded abroad.”[34] This is the first time that China’s highest legislature recognized through legislation that it requires approval from the CSRC for either direct or indirect overseas listing to take place. At that time, the increasingly strong private economy had fostered some relatively mature private companies which began to demand financing through capital market. From early 1998 to early 1999, Chinese enterprises including Hengan International Group Company Limited (HK: 1044), Eagles Brand Holdings Limited (SP: EBH) and Qiao Xing Universal Telephone, Inc. (NASDAQ: XING)[35] issued shares and got listed on foreign securities markets one after another. These companies are holding companies that engage their business principally in the PRC Mainland, and their issuance and listing of shares abroad did not go through the review and approval procedure of the CSRC. At the end of 1999, however, the indirect overseas listing of Yuxing InfoTech Holdings Limited (incorporated in Bermuda, HK: 8005, hereinafter Yuxing InfoTec)[36] aroused great attention of the CSRC, which directly led to its establishing the regulatory rules governing the indirect overseas listing of non-SOEs, hence marking the formation of a dual-track regulatory framework governing the listing matters of grand red-chip and small red-chip companies.
In 1999, the Chinese citizen, Mr. Zhu Wei Sha joined hands with other three founders to create Yuxing InfoTec, and then they set up a red-chip structure in which Yuxing InfoTec held the controlling interest in Golden Yuxing Electronics and Technology Company Limited (a Sino-foreign co-operative joint venture enterprise incorporated in the PRC Mainland, hereinafter Golden Yuxing) and Mr. Zhu Wei Sha was the actual controller.[37] As interpreted by the law firm in charge of providing legal opinions about Yuxing InfoTec’s overseas share issuance and listing, given the fact that the actual controller of the company was a natural person, Yuxing InfoTec should not belong to the category of overseas Chinese-invested non-listed companies as defined in the Grand Red-chip Circular, and thus it was not obliged to obtain the CSRC approval for its overseas listing matters. Yuxing InfoTec subsequently passed the listing hearing of the HKEX, finished the share offering in November 1999 and planned to go listed on December 8, when the CSRC delivered its order that the company should halt its overseas listing procedure. On the one hand, the CSRC believed that despite having been incorporated abroad, Yuxing InfoTec was essentially a Chinese company given its operating activities conducted in the PRC Mainland. On the other hand, since the Guidelines for Listing on the Hong Kong GEM already put into force on September 21, 1999 required domestic companies to obtain the approval from the CSRC before their listing on the Hong Kong GEM, Yuxing InfoTec’s indirect overseas listing without the CSRC approval may constitute circumvention of regulation. Therefore, the CSRC deemed it necessary for the company to obtain its approval before going listed abroad. Having learned this, Yuxing InfoTec went through the procedure required by the CSRC, obtained its approval for overseas listing on January 17, 2000, and became the first domestic private company listed on the Hong Kong GEM on January 31, 2000.[38] While processing this case, the CSRC circulated its criticism on the above mentioned law firm and the related lawyers. [39]
After the Yuxing InfoTec case came to an end, the CSRC began to devise common rules to specifically regulate Chinese private companies’ indirect overseas offering and listing of shares. The CSRC enacted in 2000 the Circular on Relevant Issues Concerning the Overseas Issuance and Listing of Shares by Foreign Companies Involving Domestic Equity (ZHENGJIANFAXINGZI [2000] No. 72, hereinafter the Small Red-chip Circular)[40], establishing the so-called “no-action letter system”. According the Small Red-chip Circular, if the issuance and listing of shares by foreign companies involving domestic equity falls within the Grand Red-chip Circular, the matter should continue to be handled in accordance with the Grand Red-chip Circular. Obviously, the Small Red-chip Circular is applicable to indirect overseas listing of non-SOEs as opposed to the Grand Red-chip Circular applicable to indirect overseas listing of SOEs.[41] As for substantial provisions, the Small Red-chip Circular requires that one foreign company involving domestic equity can only issue and list of its shares on two conditions, i.e. the domestic lawyer submits the legal opinions to the CSRC and the CSRC replies to the domestic lawyer with no objection following the review procedure. The above-mentioned legal opinions shall include, but not limited to, the following contents: (i) the general information of the foreign company and this issuance and listing of shares; (ii) where domestic institutions or citizens hold, directly or indirectly, the equity of the foreign company, the process of the formation and evolution of those equity shall be explained in detail, together with the opinion on their legitimacy and validity; (iii) where listed assets of the foreign company involve, directly or indirectly, domestic equity, the process of the formation and evolution of those equity shall be explained in detail, together with the opinion on their legitimacy and validity; (iv) explanation on the business of the domestic enterprises whose equity is held, directly or indirectly, by the foreign company, together with the opinions on its conformity with China’s industrial policy on foreign direct investment and other relevant laws and regulations.[42] It can be seen from the above regulations that the CSRC’s verification of domestic legal opinions focuses on the legitimacy and validity of the process of formation and evolution of domestic assets, and does not make judgment on the essence of overseas listing.
The Small Red-Chip Circular well defined the domestic verification and approval procedures prior to indirect overseas listing of Chinese non-SOEs, which has its positive meanings on the following two aspects. On the one hand, the Small Red-chip Circular serves as the guidance for the implementation of Article 29 of the PRC Securities Law (1999), requiring all foreign companies involving domestic equity to be reviewed by and obtain the approval of the CSRC before offering and listing of shares abroad. This makes up for the loophole in the regulation of non-SOEs’ indirect overseas listing after the Grand Red-chip Circular was implemented in 1997. On the other hand, the CSRC’s verification of domestic legal opinions is helpful for overseeing the lawful operation as well as the equity and asset restructuring of related domestic companies, along with preventing domestic assets (especially state-owned assets) from being illegally transferred abroad. However, there are deficiencies inherent to the no-action letter system. That is, the no-action letter’s nature of administrative license as implied by its status as a prerequisite for a foreign company’s overseas listing is in conflict with the stipulation of the PRC Administrative License Law (2003)[43] with regard to the power to establish an administrative licensing item.[44] More crucial is the tendency that overseas investors will become over-confident about the legitimacy and compliance of domestic companies’ operation if the CSRC conducts some degree of verification on their indirect overseas listing and issues a no-action letter. As a result, once domestic companies commit violations of related regulations (e.g. disclosure of false information) that are harmful to investors’ interest in the process of their overseas listing, it is unavoidable that the related securities services intermediaries will use the no-action letter as an excuse to evade their legal liabilities. Obviously, the no-action letter issued by the CSRC should not function as a credit guarantee, and in light of such concerns, the CSRC took two measures when devising the no-action letter system to dilute its quality as an administrative license. On the one hand, the CSRC requires the domestic law firms to apply for the no-action letter instead of the foreign companies involving domestic equity or the domestic companies held by them; And on the other hand, in the case of no action to domestic legal opinions, the CSRC’s reply is not issued in its own name, but in the name of one of its internal organs—the Legal Department, and the reply is sent to the domestic law firms instead of the foreign companies or the domestic companies held by them. Besides, the wording used in the majority of no-action letters is “no objection” instead of “consent” or “approval”.[45] Nevertheless, the 2002 event of false information disclosure by Euro-Asia Agricultural (Holdings) Company Limited (HK: 0932, hereinafter Euro-Asia Holdings) still intensified the controversy and concerns from all parties involved over the no-action letter system.[46] In view of the many legal defects of the no-action letter system, the CSRC announced its revocation on April 1, 2003 upon approval by the PRC State Council.[47] As of that time, the CSRC had issued over 200 no-action letters for indirect overseas listing of Chinese non-SOEs.[48]
It is necessary to note that the internet stocks began to be popular among overseas investors around 2000 after the internet technologies had considerably developed. Chinese-based value-added internet service providers, including SINA.com (NASDAQ: SINA), NetEase.com, Inc. (NASDAQ: NTES), and Sohu.com Inc. (NASDAQ: SOHU), were listed in the U.S. one after another. Constrained by China’s foreign capital utilization policies, instead of having an overseas SPV obtain the controlling interest in the domestic company, those companies above adopted a model called variable interest entity (VIE, commonly known as “SINA model” or “VIE model”), that is, arranging a series of contracts concerning business cooperation, the right to license, and business agency between the foreign-invested domestic company held by the overseas SPV and the domestic company whose main business is in the area restricted to domestic capital, so as to transfer the operating revenue and profits earned by the latter to the former.[49] Since then, VIE model gradually became the mainstream equity restructuring model used by domestic private companies involving industries closed to foreign capital before their indirect overseas listing.
During this period, in addition to the dual-track model adopted in regulation of indirect overseas listing, China gradually established a regulatory model treating grand red-chips and small red-chips differently in the preliminary steps for indirect overseas listing. These preliminary steps include direct investment abroad, financing through indirect overseas listing and the related foreign exchange administration. For example, the old policies only required the domestic companies to obtain approval from related competent authorities and go through foreign exchange registration when establishing companies abroad through direct investment, whereas such approval and registration were not mandatory for domestic natural persons seeking to establish companies abroad through direct investment.[50] In fact, most Chinese private enterprises seeking indirect overseas listing adopted the corporate structure in which domestic natural persons directly hold overseas SPVs when reorganizing their equity structures. It is obvious that the above approval and registration are mainly suitable for grand red-chip companies. For another example, the SAFE independently or jointly with the CSRC issued several regulatory documents that require the grand red-chip companies to register for foreign exchange from issuance of shares abroad, and provide stipulations on the procedure of opening special overseas foreign exchange accounts and the time limit for transferring the funds raised abroad back to China.[51] The related competent authorities did not give specific stipulations on the foreign exchange administration pertaining to small red-chip companies’ overseas financing.
Furthermore, it is worth mentioning that the MOFCOM, the State Administration of Taxation (SAT), the State Administration for Industry and Commerce (SAIC) and the SAFE jointly enacted in 2003 the Interim Provisions on Mergers with and Acquisitions of Domestic Enterprises by Foreign Investors (hereinafter the Provisions on Mergers and Acquisition (2003))[52]. Despite the primary objective to standardize mergers with and acquisitions of domestic enterprises by foreign investors, the Provisions on Mergers and Acquisition (2003) have significant implications on regulation over indirect overseas listing as foreign SPV’s obtaining the controlling interest of domestic enterprises is a necessary preliminary step for most domestic companies’ indirect overseas listing. First, these provisions are applicable for both foreign investors and the domestic acquisition targets regardless of their ownership (whether state-owned or private), which laid some degree of foundation for unifying the regulations of small red-chips and grand red-chips from the angles of overseas investment and absorption of foreign investment. Second, the term “merger with and acquisition of domestic enterprises by foreign investors” is clearly defined. “Merger with and acquisition of domestic enterprises by foreign investors” shall be accomplished by means of “equity merger and acquisition” or “asset merger and acquisition”. The former means a foreign investor purchases the equities of the shareholders of a non-foreign-invested enterprise in the PRC Mainland (hereinafter a Domestic Company) by agreement or subscribes to the capital increase of a Domestic Company, so as to convert and re-establish the Domestic Company as a foreign-invested enterprise, while the latter means a foreign investor establishes a foreign-invested enterprise and purchases by agreement and operates the assets of a domestic enterprise through that enterprise, or, a foreign investor purchases the assets of a domestic enterprise by agreement and establishes a foreign-invested enterprise with such assets to operate the assets.[53] Third, the competent authority for the review and approval of the establishment of a foreign-invested enterprise upon merger and acquisition is clarified. The application of establishing a foreign-invested enterprise upon merger and acquisition shall generally be vetted and approved by the competent authority in charge of foreign trade and economic cooperation at provincial level; if the foreign-invested enterprise established upon merger and acquisition is of a particular type or industry, the former MOFTEC shall be the competent authority for the review and approval.[54] Fourth, the standard for the consideration of a merger and acquisition, as well as the regulatory requirements for the payment of such consideration are stipulated. The parties to a merger and acquisition shall determine the transaction price on the basis of the appraisal result of an domestic asset appraisal institution on the value of the equities to be transferred or the assets to be sold; if a foreign investor uses the shares over which he has the right of disposal or the Renminbi-denominated assets legally owned by him as means of payment, such payment shall be subject to verification and approval of the foreign exchange control authorities.[55] In general, the Provisions on Mergers and Acquisition (2003) did not set notably more stringent requirements on the review and approval of establishing overseas SPVs and overseas SPVs’ obtaining the controlling interest in domestic companies.
