The advantage of the current indirect overseas listing regulatory framework is that it covers all operational steps of the indirect overseas listing process, including establishing SPVs abroad, SPVs’ obtaining the controlling interest in domestic enterprises and the SPV’s listing and issuing shares abroad. Furthermore, high-level authorities are in charge of the vetting for related regulatory matters, as the regulatory power is mostly concentrated in competent authorities under the PRC State Council. For example, the MOFCOM is in charge of vetting for the establishment of SPVs abroad, and an SPV’s mergers with and acquisitions of domestic companies via its status of related party or equity acquisition, the CSRC is in charge of vetting for SPVs’ listing and issuing shares abroad, and the SAFE and its provincial subsidiaries are in charge of foreign exchange registration. Obviously, such an allocation of regulatory power will facilitate the communication and coordination among the competent authorities, which are important for ensuring an effective regulation. However, some deficiencies exist in this regulatory framework and the related regulatory system and practice.
First, it is not completely reasonable to separately establish different regulatory regimes for the offering and listing of securities by grand red-chip and small red-chip companies. Under the dual-track regulatory framework, grand red-chip listing refers to the overseas listing of overseas Chinese-invested companies, and small red-chip listing at first refers to the overseas issuance of shares by foreign companies involving domestic equity, and after the revocation of no-action letter system, refers to the overseas issuance of shares by SPVs established by domestic enterprises abroad and not belonging to an overseas Chinese-invested company. However, the Grand Red-chip Circular and Small Red-chip Circular did not give any explanation of the connotation and extension of the grand red-chip and small red-chip concepts. In practice, almost all approvals made by the former SCSC or the CSRC in accordance with the Grand Red-chip Circular were in regard with the indirect overseas listing of SOEs. In light of this and the historical context of the Grand Red-chip Circular, the concept of overseas Chinese-invested company should refer to an overseas company in which a SOE in the PRC Mainland owns the holding interest, while the concept of small red-chip company should refer to an overseas SPV in which a domestic resident natural person or a non-SOE has the controlling interest. However, the scopes of grand red-chips and small red-chips have always been controversial since the Small Red-chip Circular was issued.[80] Moreover, the boundary between these two concepts is indeed unclear in practice as there has been the precedent that the CSRC took the Grand Red-chip Circular as the legal basis for approving a domestic private company’s application for indirect overseas listing.[81] In my opinion, from the view of either the form or the essence, there is no significant difference between the operation modes of and primary legal issues involved in the indirect overseas listing of a SOE and a non-SOE, so it is completely unnecessary to establish different regulatory regimes to oversee these two types of listing activities.
Secondly, there are blind spots in the coverage of indirect overseas listing regulatory framework. The stipulation that domestic enterprises must obtain approval from the CSRC before listing abroad established in Article 238 of the PRC Securities Law (2005 Revision) is literally the highest legal basis for regulations of both direct overseas listing and indirect overseas listing, and therefore, its coverage should extend to all scenarios of domestic enterprises’ indirect overseas listing. However, the Grand Red-chip Circular and the Provisions on Mergers and Acquisitions (2006), as laws subordinate to the PRC Securities Law (2005 Revision), did not set regulatory requirements for all scenarios of indirect overseas listing. For example, an overseas company whose controlling shareholder is a foreign natural or legal person seeking to be listed outside the PRC Mainland with its interest in the assets of a domestic enterprise neither belongs to the category of overseas Chinese-invested companies regulated by the Grand Red-chip Circular nor to the category of overseas SPVs regulated by the Provisions on Mergers and Acquisition (2006). In the case that a foreign holding company seeks to establish a foreign-invested company in the PRC Mainland by means of direct investment or by means of acquiring a domestic enterprise, they also only need to go through the common vetting and registration procedures in accordance with applicable foreign direct investment regulations and foreign exchange regulations. These listing modes mentioned above are different from the grand red-chip and small red-chip listing, neither touching upon cross-boarder transfer of interest in state-owned assets nor bringing the risk of loss of interest in domestic assets, but they are identical with indirect overseas listing of domestic enterprises at least in the forms and corporate structures. Moreover, if the related overseas listed company engages its business primarily in the PRC Mainland or earns revenue mainly from the PRC Mainland, it is oftentimes considered a China-based company just like the grand red-chip and small red-chip companies. As a result, the indirect overseas listing regulatory framework should include regulatory arrangements with respect to the above-mentioned overseas listing scenarios. Furthermore, the participants related to the indirect overseas listing, besides domestic enterprises, include market intermediaries such as domestic and foreign auditors, lawyers and investment banks. However, there are not any regulation for such market intermediaries and their cross-border business. The lack of regulatory constraints will inevitably lead to market failure, which is one of the major causes of the financial fraud committed by China-based companies listed on the U.S. stock exchanges.
Third, some core regulatory requirements for indirect overseas listing are not reasonable enough or clear enough, prone to breeding circumvention of related laws. Fairly speaking, the regulatory system and allocation of regulatory powers with regard to the establishment of SPVs abroad, SPVs’ acquisition of controlling interest in domestic companies and the overseas listing of SPVs are basically reasonable, but some core regulatory requirements cannot be fully justified. For example, the Grand Red-chip Circular takes the history of assets formation and the period of actual possession of such assets as the standards for setting the regulatory requirements on overseas listing of overseas Chinese-invested companies. In fact, the assets intended for listing, in essence, always belong to the category of domestic assets and should be equally regulated irrespective of whether they have been formed through foreign investment or whether the period of actual possession of such assets by the overseas Chinese-invested company has reached three years. Moreover, with regard to the step of taking controlling interests in the Domestic Company by the overseas SPV, the scope of the Provisions on Mergers and Acquisition (2006) is relatively narrow, in that it only covers the merger with or acquisition of a Domestic Company, and the change of the Domestic Company into a foreign-invested enterprise, those equity mergers and acquisitions of domestic non-foreign-invested enterprises by foreign investors and of domestic non-foreign-invested enterprises or foreign-invested enterprises by foreign investors via domestic foreign-invested enterprises are not subject to the Provisions on Mergers and Acquisition (2006).[82] According to the provisions of the Provisions on Mergers and Acquisition (2006) and the Handbook of Guidance for the Market Access Administration of Foreign Investment (2008)(hereinafter the Foreign Investment Handbook)[83], the latter two types of equity merger and acquisition shall be subject to the relevant rules on the alteration in investors'' equity of foreign-invested enterprises that were put forward before the promulgation of the Provisions on Mergers and Acquisition (2006), and the competent authorities for vetting and approval shall be the local department in charge of business.[84] It is just the Provisions on Mergers and Acquisition (2006) that provided the breach for quite many domestic private companies of those that completed indirect overseas listing after these provisions were promulgated to evade the vetting procedure required by the MOFCOM when building red-chip structures. This grey channel formed as an outcome of the game between market and government continuously challenge the bottom line of regulation, which drastically deteriorates the seriousness of regulations and rules. With regard to this point, one practitioner satirized somewhat more radically that “while the risk factors in the prospectuses for these grandfathered IPOs are downright frightening, the clean legal opinions given by PRC law firms for this model coupled with successful IPOs have cemented this as acceptable practice.”[85]
Fourth, the regulations for indirect overseas listing do not harmonize with those for direct overseas listing, which leaves broad space for regulatory arbitrage. As compared to indirect overseas listing, the entities seeking direct overseas listing are joint-stock limited companies incorporated in the PRC Mainland, for which the overseas offering and listing of securities are the only steps being regulated. The current regulatory regimes of direct overseas listing include the listing conditions, rules for corporate governance and compliant operation, rules for foreign exchange administration and some ongoing regulatory rules. For example, as to the financial conditions for overseas issuance and listing of shares, in the regulations for direct overseas listing, there are some quantitative requirements that domestic enterprises shall meet, namely (i) the net assets are not less than RMB 400 million; (ii) the profit after tax within the past fiscal year is not less than RMB 60 million; and (iii) the financing amount calculated in terms of reasonable and expected P/E ratio is not less than USD 50 million. While under the regulations for indirect overseas listing, there are no similar requirements.[86] For another example, as to foreign capital utilization policies, the regulations of direct overseas listing require that the use of the funds raised via listing and issuing shares abroad should be in line with China’s industry policies and policies on the use of foreign capital, while under the regulations of indirect overseas listing, despite the presence of similar requirements on foreign-invested companies in the PRC Mainland controlled by overseas listed entities, quite some domestic enterprises have circumvented the above restrictions through the means of the VIE model.[87] One more example relates to CSRC’s administrative license items. Under the regulations for directly overseas listing, besides H-share IPO, the subsequently H-share additional offering, the issuance of H-share convertible corporate bonds, and H-share companies’ transfer of listing from the GEB to the main board of overseas stock exchanges, shall be approved by the CSRC. Under the regulations for indirect overseas listing, though overseas SPV’s IPO and the cross-border transfer of domestic assets or equity interests to overseas SPV shall be approved by the CSRC, almost all matters of overseas SPVs’ capital alteration after their IPO fall out the scope of CSRC’s vetting procedure. It is obvious that in the above aspects, the regulations of indirect overseas listing are relatively easy, the domestic compliance costs assumed by Chinese companies are relatively low, and the efficiency of overseas financing is relatively high.
Finally, the transparency of regulatory requirements and the enforcement require to be improved. On the one hand, a large portion of the regulatory requirements are established by low-level authorities, which are oftentimes embodied in the normative documents enacted by competent authorities under the PRC State Council, such as the CSRC, the MOFCOM or the SAFE, or even by the internal departments of the MOFCOM or the SAFE, and are thus at a lower level than the laws and administrative regulations. Among these normative documents, some regulations are contrary to the principles and spirit of the higher-level laws. For example, it is required by the Provisions on Mergers and Acquisition (2006) that a cross-border merger and acquisition between related parties shall, with no exception, be approved by the MOFCOM, but the Foreign Investment Handbook stipulates that an application of cross-border merger and acquisition that may be accepted shall meet one of the following two additional requirements: (i) the foreign company is a listed company; or (ii) the establishment of the foreign company has been approved, and the foreign company is actually in operation and makes round-tripping investment with profit.[88] Furthermore, for some regulatory documents, a number of substantial regulatory requirements are implied in the procedural stipulations. For example, the CSRC requires in the list of documents for SPV''s overseas application that the domestic enterprises shall have engaged in continuing operation for longer than two or three years. For another example, the Implementing Rules on Foreign Exchange Administration (2007) requires that an overseas SPV or a related domestic enterprise shall have engaged in continuing operation for at least three years before applying to go through the related foreign exchange registration. On the other hand, the regulatory information is not sufficiently open to the public, which may hinder the provision of clear compliance guidance to the market. For example, neither the Grand Red-chip Circular nor the Provisions on Mergers and Acquisition (2006) stipulates the conditions of domestic approval for indirect overseas listing; except for the stipulation that the vetting procedure for indirect overseas listing should be completed within twenty working days, there is no other specific rule on the CSRC’s approval procedure. For another example, according to incomplete statistics, the CSRC has published only fewer than thirty approvals accumulative for grand red-chip listing (incl. overseas asset injection into a red-chip listed company), far below the actual number of grand red-chip companies; as to the record keeping for grand red-chip companies in accordance with the Grand Red-chip Circular, the CSRC has never made any announcement to the public.[89]
C. Some Policy Proposals
As stated above, the indirect overseas listing regulatory framework grew out of the special historical background of the early state of China’s economic reform and opening up, and the dual-track regulatory framework has gradually formed along with the country’s economic development and changes in ownership structure. In view of the material changes in the domestic and international capital markets over recent years, the above-mentioned regulatory framework should conform to the new situation and carry out proper revisions to remedy the problems exposed in regulatory practices.
