After the Provisions on Mergers and Acquisition (2006) became effective, the CSRC published a list of documents for SPV’s overseas listing application in March 2007.[68] Among the list, a more stringent regulatory requirement is put forward by the CSRC. Where the domestic enterprise plans to list on foreign stock exchange’s main board, the audit reports for the previous three years shall be submitted. For listing on foreign stock exchange’s growth enterprise board (GEB), the audit reports for the previous two years shall be submitted. In essence, the above stipulations require domestic enterprises not to apply for indirect overseas listing until their operation has lasted for a certain number of years.
While the MOFCOM and the CSRC were strengthening their regulation of indirect overseas listing, the SAFE also put forward more stringent regulatory requirements on the foreign exchange administration involved in the preliminary steps of indirect overseas listing. On August 4, 2007, the SAFE''s Department of General Affairs issued the Circular of the SAFE''s General Affaires Department on the Implementing Rules of 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” (hereinafter the Implementing Rules on Foreign Exchange Administration (2007)) which came into force on the date of promulgation.
Compared to the Implementing Rules on Foreign Exchange Administration (2005), the Implementing Rules on Foreign Exchange Administration (2007), in the Part “KEY POINTS OF VETTING”, provides extremely strict requirements for foreign exchange registration. For example, as for the foreign exchange registration for the transfer of domestic assets or equity interests to a newly incorporated SPV by the domestic resident, the applicant shall explain the financial position for previous three years in the business and financing plan. As for the level of competent authorities, SAFE’s subsidiaries at the provisional level shall be responsible for the foreign exchange registration related to domestic natural person residents, and the SAFE is in principle charge of the foreign exchange registration related to domestic legal person residents.[69] Another example, as for the foreign exchange registration of the establishment or control of overseas SPVs, where the foreign investor is a foreign enterprise that completes foreign exchange registration of investment abroad but has not maintain continuing operation within the endorsed scope of business for three years, the application for the foreign exchange registration of the establishment, or the merger with or acquisition of domestic enterprises shall be refused.[70] These requirements de facto provide a precondition for the application of foreign exchange registration that the overseas SPV or related domestic enterprises shall maintain continuing operation for at least three years.[71]
Though the Provisions on Mergers and Acquisition (2006) and the Implementing Rules on Foreign Exchange Administration (2007) significantly increased the compliance costs on each operational step of domestic enterprises’ indirect overseas listing, they are jointly implemented by the competent authorities such as the MOFCOM, the CSRC and the SAFE, and indeed helpful for the regulation of domestic companies seeking to be listed abroad. In this sense, these two regulatory documents have certain positive implications. It is regretful that there has been no approval issued by the MOFCOM or the CSRC for domestic private enterprises’ establishment of overseas SPVs, cross-border merger and acquisition between related parties, and indirect overseas listing. More ironically, a large group of domestic private enterprises realized indirect overseas listing upon building a red-chip structure through various means such as “borrowing” existing equity structure, warehousing of shares and the VIE model, to evade the vetting requirements set by the Provisions on Mergers and Acquisitions (2006). According to related statistics, there have been over 400 domestic private enterprises that accomplished indirect overseas listing from early 2007 to June 30, 2011. In addition, the small red-chip companies tend to go publicly listed at diversified locations abroad, as evidenced by the presence of China-based companies not only in the traditional stock exchanges such as in Hong Kong, Singapore, New York, but also in Frankfurt, London and Korea.
IV. FURTHER ANALYSIS AND OUTLOOK
A. Analysis of the historical background
It can be seen from the above parts that China''s indirect overseas listing regulatory framework has been developed from scratch and become more and more complex. Independent from the regulatory framework for direct overseas listing, this regulatory framework has a dual-track system providing separate oversight rules for the listing of grand red-chip and small red-chip companies, that is, the Grand Red-chip Circular and the Provisions on Mergers and Acquisition (2006) are both applicable to the grand red-chip companies while only the latter is applicable to the small red-chip companies. Fairly speaking, the history of this regulatory framework is closely related to the evolution of China’s and international capital market environment. In early 1990s, China’s securities market was still in its primary stage, and as a result of the one-sided understanding of joint-stock system and the functions of securities market, the overseas listing of domestic enterprises was endowed with great implications: (i) attracting foreign investors and absorbing foreign capital to promote the transformation of SOE operating mechanism; (ii) learning from other countries’ experiences in developing securities market; (ii) functioning as an important aspect of the Chinese securities market’s opening to the external world. Consequently, the Chinese government selected a few SOEs to be listed abroad for the sake of maintaining the image of Chinese enterprises and strengthening foreign investors’ confidence.[72] Just before the return of Hong Kong, some domestic enterprises transferred assets abroad and went through indirect overseas listing without approvals, which might cause loss of state-owned assets, damaged the image of Chinese SOEs and weakened the foreign investors’ confidence about Chinese companies. Under such circumstances, the PRC State Council promulgated the Grand Red-chip Circular of which the core aim is to prevent the loss of state-owned assets. From the angle of system design, the Grand Red-chip Circular stipulates that in the case of indirect overseas listing with domestic assets, if the asset formation process is unrelated to overseas assets, the regulation should always be as strict as possible; if the domestic assets were derived from foreign investments in the PRC Mainland, the regulation can be relatively flexible and regulatory requirements of different strictness levels shall be put forward in accordance with whether the assets have been held by three years or longer.
Though China’s private economy has gradually grown strong by late 1990s, without substantive changes of China’s securities market, multiple factors considerably limited the willingness and feasibility of private companies’ domestic equity financing, hence forcing them to seek help from overseas capital market. First, the duties to service the reform of SOEs assigned to China’s securities market had not been fulfilled, and the ownership discrimination exists de facto so widely that there is hardly any opportunity for private enterprises to approach domestic securities market. Compared to the foreign developed multi-level capital markets that can better meet the financing needs of enterprises, the structure of China’s securities market was fairly simple. At that time, the Small and Medium Enterprise Board (SME Board) and the GEB had not been created and the financing needs of enterprises with different sizes and at different development stages could therefore hardly be duly satisfied. At the meantime, the overseas capital markets had already been equipped with multi-level capital platforms including the main board, the GEB and the OTC market, facilitating the financing for SMEs and growth enterprises. Third, compared to the flexible listing conditions in foreign advanced stock exchanges, the requirements for IPO and listing domestically are more stringent. For example, Article 33 of the Regulatory Rules for Initial Public Offerings and Listing of Shares[73] stipulates that the requirements for an issuer''s IPO shall include but not limited to the following: (i) having a positive net profit of over RMB 30 million accumulatively within the latest three accounting years; (ii) having a net cash flow of over RMB 50 million accumulatively, or having a business income of over RMB 300 million accumulatively within the latest three accounting years. These conditions are considerably higher than those required by the stock exchanges on which overseas-listed Chinese companies are concentrated.[74] Fourth, China’s regulations of securities market lack alternatives in many aspects, whereas the overseas regulations are more flexible and provide more room for the enterprises to realize their interests. For example, before April 2005, the so-called phenomena “equity division” was very common for almost all China''s domestic listing companies, i.e. the shares of a listing company were categorized as tradable shares and untradeable shares. The shares of a listing company issued before its IPO were regarded as untradeable shares that cannot be traded on domestic stock exchanges. Obviously, there was no smooth exit for private equity investment in a listed company, and the value of the shares held by initiators could not be fully realized. For another example, prior to 2006, the listed companies were prohibited from implementing equity incentives, which hampered their ability to attract and retain high-level management personnel, and core technical and business staff, as well as hindered the establishment of a sound incentive and constraint mechanism.[75] Fifth, the transparency and efficiency of regulation and investors maturity of China’s securities market are also far behind those of the advanced securities markets. Moreover, under the influences of domestic regulatory policies, even choosing direct overseas listing, the private enterprises will still face the practical obstacles such as “ownership discrimination”, un-tradable shares, prohibition of equity incentives and inefficient financing.[76] In this market environment, the Chinese government has the following attitudes towards indirect overseas listing: on the one hand, indirect overseas listing is primarily positive to development of private enterprises in a way that it can help them fully and efficiently absorb foreign investments, but an issue that cannot be ignored is whether the preliminary steps of indirect overseas listing are fully compliant and may cause loss of state-owned assets; on the other hand, though the PRC Securities Law (1999) had established principles governing the regulation of indirect overseas listing, without experience in regulation of cross-boarder listing and enough determination, the CSRC was not adequately confident about providing effective regulation of this matter, and thus had to employ the way of learning by doing. As such, it is understandable that the CSRC swiftly enacted the Small Red-chip Circular and did very much work to reduce the quality of administrative license inherent in the no-action letter system right after the Yuxing InfoTech event.
After the no-action letter system was repealed, the problems inherent in the indirect overseas listing of massive private companies upon foreign-capitalization like capital flight and the overseas loss of interest in domestic assets became increasingly prominent. First, China carried out a thorough amendment for the PRC Company Law (2004 Revision) and the PRC Securities Law (2004 Revision) in 2005, and on this basis, the CSRC strengthened the legislation, revision and revocation of securities regulatory laws, thus achieving large improvement in the regulatory system, as well as in the publicity and transparency of the regulatory enforcement. Second, the reform of domestic listed companies’ equity division rapidly progressed from April 2005 and was largely completed by the end of 2007, which marks “the confluence between the basic systems of the Chinese and the world’s capital markets.”[77] Third, with approval from the CSRC, the SZSE opened the relatively independent SME board in the main board market in May, 2004 and established the GEB independent from the main board market in May 2009, for the purpose of providing financing platforms for the many SMEs and ventures with strong growth and innovative capacities. These actions enriched the levels and structure of China’s securities market and expanded its depth and broadness. Fourth, along with the progress of SOEs’ restructuring and listing, in recent years, the listing resources provided by SOEs to the domestic securities market have been decreasing. To attract the potential listing resources, the competition between overseas stock exchanges and between the overseas and the domestic stock exchanges has intensified, exerting some degree of pressures on China’s objective to enhance its securities market competitiveness and adjustment of overseas listing regulatory policies.[78] Moreover, China has enjoyed surplus of international current account and capital account in each year since 2003, and the foreign exchange inflow under capital account increased the difficulty and complexity of designing and executing monetary policies.[79] Just in the context as described above, the Chinese government shifted its attitude towards indirect overseas listing to a significantly different point of regarding it primarily as a source of negative impacts, and began to consider it necessary to limit indirect overseas listing. Moreover, the arrangement to assign the competent authorities in charge of business at provincial level and the SAFE agencies at provincial level the duty to regulate the preliminary steps of indirect overseas listing is not conducive to a thorough and uniform oversight of the outflow of interests in domestic assets as well as the overall position of foreign exchange inflow and outflow. To solve such problems, the SAFE enacted the No.75 Foreign Exchange Administration Circular on the basis of the No. 11 Foreign Exchange Administration Circular and the No. 29 Foreign Exchange Administration Circular, and the MOFCOM, the CSRC and the SAFE, together with other three competent authorities, jointly enacted the Provisions on Mergers and Acquisition (2006), hence establishing a regulatory mechanism based on multi-ministry cooperation under the PRC State Council.
B. Defects and deficiencies
