III. THE RE-ESTABLISHMENT OF REGULATORY FRAMEWORK
Domestic companies were no longer required to obtain the CSRC’s approval for their indirect overseas listing after the no-action letter system was repealed. Therefore, the lowered compliance cost ushered in a boom of indirect overseas listing of Chinese private companies. From 2003 to 2004, a total about 120 Chinese private companies were indirectly listed abroad, raising a total fund of nearly US$ 3 billion. However, there were worries hidden behind the prosperity. The foreign-capitalization of private enterprises through indirect overseas listing induced problems such as capital flight, asset loss (especially state-owned assets) and ''disguised'' foreign capital. The related competent authorities under the PRC State Council were very concerned about these problems and launched the re-establishment of the regulatory framework, aiming at strengthening the regulation of overseas investment and absorption of foreign investment from the angles of M&A by foreign capital and foreign exchange control.[56]
The first breakthrough of the above-mentioned regulatory framework re-establishment was in the area of foreign exchange control. On January 24, 2005, the SAFE issued the Circular of the State Administration of Foreign Exchange on Issues Concerning Improvement in the Administration of Foreign Exchange in Connection with Mergers and Acquisitions by Foreign Investors (HUIFA [2005] No. 11, hereinafter the No. 11 Foreign Exchange Administration Circular). First, the No. 11 Foreign Exchange Administration Circular establishes a requirement for the foreign exchange control related to the establishment of SPVs. Domestic residents who invest abroad and directly or indirectly establish or control enterprises abroad shall carry out approval and registration procedures with reference to the Provisions Regarding the Foreign Exchange Control for Investments Abroad (hereinafter the Foreign Exchange Control Provisions)[57]. Second, the No. 11 Foreign Exchange Administration Circular establishes a foreign exchange control requirement for SPVs’ round-tripping investment. If a Chinese resident wishes to obtain an instrument of equity or other property right in a foreign company by selling domestic assets or equity, he/she is required to obtain the verification of the foreign exchange administration. Without verification, a Chinese resident may not use his/her domestic assets or equity as consideration for equity or other property right in a foreign enterprise. Third, the No. 11 Foreign Exchange Administration Circular raises the level of competent authorities for the foreign exchange registration related to SPVs’ round-tripping investment. Any application for foreign exchange registration from a foreign-invested enterprise established by a Chinese resident through the merger or acquisition of a domestic enterprise by a foreign enterprise shall be approved by the SAFE.
Subsequently, in order to define the scope of the No. 11 Foreign Exchange Administration Circular, the SAFE issued on April 21, 2005 the Circular on Relevant Issues of Registration of Overseas Investments Contributed by Domestic Individual Residents and Foreign Exchange Registration of Merger or Acquisition with Foreign Investments (HUIFA [2005] No. 29, hereinafter the No. 29 Foreign Exchange Administration Circular). According to the No. 29 Foreign Exchange Administration Circular, “foreign exchange registration for foreign-invested enterprise established upon merger and acquisition with foreign investment” and “foreign exchange registration for merger and acquisition with foreign investment” referred to in the No. 29 Foreign Exchange Administration Circular shall include the following circumstances: (i) the establishment of a foreign-invested enterprise by a foreign investor in the PRC Mainland; (ii) the purchase of the equities of a Chinese party in a foreign-invested enterprise by a foreign investor; (iii) the purchase of the equities of a Chinese party in a Chinese-funded enterprise by a foreign investor; (iv) the capital increase of a domestic enterprise (either a foreign-invested enterprise or a Chinese-funded enterprise) by a foreign investor. In detail, under the following three circumstances, the obligation of foreign exchange registration for the establishment of a foreign-invested enterprise by a foreign investor in the PRC Mainland shall be fulfilled: (i) a foreign investor establishes a foreign-invested enterprise in the PRC Mainland, and agrees to purchase and operate the assets of a domestic enterprise through such foreign-invested enterprise; (ii) a foreign investor agrees to purchase the assets of a domestic enterprise and invests in establishing a foreign-invested enterprise by such assets for the operation thereof; (iii) a foreign investor newly establishes a foreign-invested enterprise in China, and agrees to control another enterprise in the PRC Mainland or holds any right to the revenue or franchise operation of a particular asset through such foreign-invested enterprise. Such foreign exchange registration items may be “foreign exchange registration for the foreign-invested enterprise”, “foreign exchange registration alteration for the foreign-invested enterprise”, and “foreign exchange registration for overseas investment in which foreign exchange funds are received for the transfer of equities”. Meanwhile, it is emphasized by the No. 29 Foreign Exchange Administration Circular that individual residents that have not completed the foreign exchange registration shall not be allowed to make overseas investment or undertake foreign exchange business in capital items.
The No. 11 Foreign Exchange Administration Circular and the No. 29 Foreign Exchange Administration Circular established clear foreign exchange control requirements for the preliminary steps of domestic non-SOEs’ indirect overseas listing, which increased the compliance costs for the regulated firms and thus de facto constrained the indirect overseas listing activities to some degree. Such situation is obviously unfavorable to the financing of non-SOEs (especially the high-tech enterprises) through international capital market. Moreover, the No. 11 Foreign Exchange Administration Circular and the No. 29 Foreign Exchange Administration Circular did not give rise to a uniform and complete foreign exchange control system as they were applicable only to domestic individuals’ overseas investments and the foreign exchange control items involved in mergers and acquisitions by foreign capital, but were not applicable to those involved in overseas investments of domestic institutions and round-tripping investments. As such, the SAFE issued on October 21, 2005 the Circular on Relevant Issues Concerning Foreign Exchange Administration for Domestic Residents to Engage in Financing and in Round-tripping Investment via Overseas Special Purpose Vehicles (HUIFA [2005] No. 75, hereinafter the No. 75 Foreign Exchange Administration Circular). The No. 75 Foreign Exchange Administration Circular became effective as the date of November 1, 2005 and repealed the No. 11 Foreign Exchange Administration Circular and the No. 29 Foreign Exchange Administration Circular. Different from the No. 11 Foreign Exchange Administration Circular and the No. 29 Foreign Exchange Administration Circular, the No. 75 Foreign Exchange Administration Circular regulates the domestic residents’ cross-border capital trades as well as the investing and financing activities via overseas SPVs specifically from the angle of foreign exchange administration. In addition, the No. 75 Foreign Exchange Administration Circular established a uniform foreign exchange control system for the financing and round-tripping investment of domestic natural persons and legal persons via overseas SPVs.[58] Furthermore, the No. 75 Foreign Exchange Administration Circular for the first time clearly defines the concepts such as “round-tripping investment”, “SPV”, and “control” which play an important role in the regulation of indirect overseas listing.[59]
Specifically, the No. 75 Foreign Exchange Administration Circular establishes the following requirements for foreign exchange control. First, a domestic resident shall, before establishing or controlling an overseas SPV, apply for going through the procedures for foreign exchange registration of overseas investments; Second, a domestic resident shall apply for going through the foreign exchange registration regarding the owners’ equity of the SPV he holds and its changes, if he wishes to inject assets of a domestic company owned by him to the SPV or to conduct overseas equity financing after injecting domestic equity or assets to the SPV. Third, an SPV undergoing material capital changes that do not involve round-tripping investment shall apply for going through the procedure of foreign exchange registration regarding overseas investment or the procedure of putting the changes on record.[60] On November 24, 2005, the SAFE''s Department of General Affairs established some implementing rules for the No. 75 Foreign Exchange Administration Circular, to specify the application documents of foreign exchange registration, general principles and key points of vetting, and the scope of authorization by the SAFE to its subsidiaries.[61] It is stipulated by this document that SAFE’s subsidiaries at provisional level is generally in charge of the foreign exchange registration related to the establishment or control of enterprises abroad, except that the SAFE is in charge of the foreign exchange registration related to the establishment or control of enterprises abroad by domestic SOEs; SAFE’s subsidiaries at provisional level is also responsible for the foreign registration related to the establishment, or merge with or acquisition of domestic enterprises by overseas SPVs. In general, the No. 75 Foreign Exchange Administration Circular’s stipulations on foreign exchange registration are clear and reasonable, and the related implementing procedures are specific and complete. In particular, it is stipulated by this circular that the foreign exchange registration procedures involved in the preliminary steps of private enterprises’ indirect overseas listing are handled only at SAFE’s subsidiaries at provincial level, which provides some convenience and is helpful for reducing the financing costs in connection with indirect overseas listing. As a result, some practitioners view the No. 75 Foreign Exchange Administration Circular as an important mark of “the red-chip gate’s reopening”.[62]
In less than one year, however, material changes occurred in indirect overseas listing regulatory policies and the regulatory framework also began to shift to cooperation among multiple competent authorities and interrelation between regulatory powers. On August 8, 2006, the MOFCOM, the State-owned Assets Supervision and Administration Commission (SASAC), the SAT, the SAIC, the SAFE and the CSRC jointly issued the Provisions on Mergers with and Acquisitions of Domestic Enterprises by Foreign Investors (hereinafter the Provisions on Mergers and Acquisition (2006) which came into effect on September 8, 2006.[63] This new document established more stringent regulatory requirements on the three operational steps involved in indirect overseas listing. First, where a domestic company sets up an overseas SPV, it shall apply to the MOFCOM for vetting and approval.[64] Second, where the merging company is a related party or an SPV seeking to carry out equity merger with or acquisition of a domestic enterprise, it shall apply for vetting of the MOFCOM. Article 11 of the Provisions on Mergers and Acquisition (2006) stipulates that “domestic enterprises or natural persons shall, when they, in the name of the overseas companies legally established or controlled by them, merge with or acquire domestic companies that are related parties, apply to the MOFCOM for approval; this requirement shall not be circumvented by means of domestic investment of the foreign-invested enterprises or otherwise”. Article 32 requires that an equity merger with or acquisition of a domestic company by a foreign investor shall approved by the MOFCOM. The previous procedure in which the competent departments in charge of business at provincial levels will conduct examination and approval process for domestic enterprises’ establishing companies abroad and foreign investors’ establishing foreign-invested enterprises through mergers with and acquisitions of domestic companies was herein changed. As a result, the investment administration involved in the preliminary operational steps of indirect overseas listing was all concentrated to the level of the MOFCOM, a higher authority in charge of related vetting. Third, Article 40 of the Provisions on Mergers and Acquisition (2006) stipulates that the overseas listing of SPVs shall be approved by the CSRC, which implies the reinforcement of the requirement set by Article 238 of the PRC Securities Law (2005 Revision) that a domestic enterprise must obtain approval from the CSRC as for its direct or indirect overseas listing. Fourth, the approval requirement for the merger with or acquisition of domestic enterprises by foreign SPVs after their overseas listing is put forward. The merger with or acquisition of a domestic company by an overseas listing company using cash to pay shall be approved by the MOFCOM or the competent department in charge of business at provincial level. If the consideration is paid by equity, the MOFCOM shall be the competent authority for approval.[65] Fifth, the time limit for the completion of overseas listing of an SPV after the equity merger and acquisition is clearly stipulated. After the obtainment of MOFCOM’s approval for the equity merger with and acquisition of domestic enterprises by the overseas SPV, MOFCOM’s approval for a foreign investment enterprise, and CSRC’s approval for the overseas listing of shares by the overseas SPV, the domestic enterprises may apply to the company registry for the business license for a foreign investment enterprise. Within one year as of the issuance of the business license, the overseas SPV shall complete the listing procedure and report to the MOFCOM the situation of overseas listing and the proposal of financing income retrieval, otherwise MOFCOM’s approval for a foreign investment enterprise shall be automatically invalidated, and the equity structure of the domestic company shall be restored to the status before the equity merger and acquisition.[66]
It is noteworthy that, though the Provisions on Mergers and Acquisition (2006) did not expressly specify to which situations of foreign investors’ mergers with and acquisitions of domestic SOEs the provisions should apply, in view of practice, these provisions are widely applicable to indirect overseas listing of Chinese SOEs and private enterprises.[67] However, this did not essentially change the dual-track regulatory framework with regard to grand red-chips and small red-chips, because the Grand Red-chip Circular and the Provisions on Mergers and Acquisition (2006) should simultaneously apply to grand red-chip companies’ listing while the CSRC’s regulatory duties set by these two normative documents are not identical. According to the former, the CSRC should oversee the injection of domestic assets into overseas Chinese-invested companies (including the assets injected before and after an overseas IPO) as well as the overseas listing of overseas Chinese-invested companies, but according to the latter, the CSRC , , , can only conduct vetting for overseas listing of the SPVs. Obviously, as compared to the Grand Red-chip Circular, the Provisions on Mergers and Acquisition (2006) entitles the CSRC to smaller regulatory power.
