Thesis |
Chinese Overseas Indirect Listing and its Solutions [Volume 5 – 2015] |
11 February 2015 |
| (ZI Mo Qi) PDF download |
| Chinese Overseas Indirect Listing and its Solutions Zi Mo Qi |
1. Introduction1.1. Background Information |
As of December 2009, the top three countries (districts) that received the foreign direct investments(FDI) from China are Hong Kong 164.499 billion dollars, British Virgin Islands(BVI) 15.061 billion dollars ,and Cayman Islands 13.577 billion dollars, the amounts by three of which far surpass anyone that falls behind them. And as of 2005, the fourth largest FDI that China received came from BVI. Further as of June 6, 2010, there’re 566 companies from China in total that are listed in foreign stock exchanges are registered in the so called offshore areas. And of all the private companies that are listed in 5 major stock exchanges in the world, mainly the New York Stock Exchange, the NASDAQ Stock Exchange, the Singapore Stock Exchange, the Hong Kong Stock Exchange and the AIM of the London Stock Exchange, 89 used Bermuda, 26 used BVI, 208 used Cayman Islands, 80 used Singapore, and 12 used Hong Kong. [1] |
For Chinese small companies, mainly those private companies, it is very hard for them to raise money. In the earlier period usually some PEs or VCs will be involved, those investors invest large amounts of money and acquire some shares of the company, but they will not hold those shares forever because the main objective of those funds is to make profits so they are waiting for the best time to sell their shares and exit. Normally they will do so as long as the company get listed in the stock exchange. But in China there’re certain obstacles making the normal two steps way much harder. |
This is mainly due to the foreign currency control and because Chinese stock market administration uses substantive examination method to check each company’s condition and profit, so it will require the company to earn a large amount of profits for a certain period of time before the IPO. So the standard to get listed is extremely high in China and most of the companies won’t survive to that day. It is especially the case for the IT companies, most of which don’t even make profits till today such as the Youku in China, an online video company. Last of all, even after all that the companies finally get listed in the Shanghai or Shenzhen Stock Exchange, and the investors finally make huge profits, but they can only receive their payments in Chinese currency RMB, because there’re strict controls on flow of the foreign currencies under the capital account. So it’s very hard for those foreign companies to send their money back to their home countries. |
So under those harsh environments, the Chinese companies find a way to circumvent all those restrictions. They are using the offshore areas to build a new structure to raise funds. They are mainly using two types of structure to finance themselves. The the ‘red chip mode’ and the ‘VIE structures’. |
2. Chinese Companies Using Offshore Structures to Get Listed Overseas2.1. Historical Context Of The Overseas Listing |
Basically there’re two types of structure that the Chinese companies will use when they want to get listed overseas. The direct listing and the indirect listing. The first structure is called the “H shares mode”, and the other is called the “red chip mode”.[2] In the first mode, a company will be registered in the mainland China, which puts the company under the jurisdiction of the mainland China and the Chinese law will apply. And then the company will try to get the approval by the government to issue their stocks in the Hong Kong Stock Exchange Market, or they will further change their stocks into American Depository Receipts(ADR) and raise funds in the US market. In China we also call it the “Overseas listed foreign shares” which denotes that the shares are listed overseas and invested by foreign investors, which is distinct from another way to raise funds from overseas investors-the ‘B shares’, a secondary market in the Shenzhen Stock Exchange for those stocks listed in mainland China to attract foreigners. Other than the similarity that they both targeting foreign investors, the difference between those two are in “B shares”, the companies are listed in mainland China, Shenzhen Stock Exchange, while in the “H shares” companies are listed overseas, primarily in Hong Kong and US. |
Another model is the “red chip model”. The companies using this model will first set up a special purpose vehicle or a holding company in one of the OFCs, mainly in Cayman Islands or BVI, after restructure of debts and shares, they will use the round-trip capital mode to acquire the companies in mainland China, and afterwards the offshore companies will get listed overseas. This is just the overview of the “red chip mode”, I will explore this issue later. The “red chip mode” always falls under the gray area, while the “H shares mode” is absolutely legal. |
Since there is a bright way to get listed, why use the red chip mode? Because in the middle of the 1990s, the State Owned Enterprises(SOE) were facing serious management problems, most of them either went bankrupt or on the verge of bankruptcy. |
So in this context, a reform was undergoing in the SOEs. The purpose is clear, after the restructure of the debt, the shares and the management structure, the most important thing for the SOEs is to get funds, and the best case is that they can get the funds continuously. So they will not bother to find bank loans, because it will eventually be paid back, besides all the banks in China are SOEs so they are facing the same situations. The best way to do that is to raise funds in the stock exchange market. But at that time the market is not big enough to hold so many giant SOEs. So they were thinking of going abroad to get listed in foreign markets.[3] |
Between the year 2000-2010, among all the SOEs getting listed overseas, only two of them used the “red chip mode”, most of them used the “H shares mode”. The reasons for this are clear. First of all, the SOEs will need government approval in order to get listed overseas using the red chip mode. In 1997, the State Council of China issued an Administrative Order, the “Circular of the State Council Concerning Further Strengthening the Administration of Share Issuance and Listing Overseas”, also known as the 1997 red chip guide, it stipulates that all the companies should get approval from the China Securities Regulatory Commission(CSRC). It is extremely hard to get these approval , because the CSRC is a central government agency, only the SOEs with the equal status as the CSRC can influence their decisions, so only the SOEs directly under control of the State-Owned Assets Supervision and Administration Commission of the State Council(SASAC) has this power to sway the CSRC. [4] So other SOEs under the control of the local government is not able to get the approval. |
Second of all, not only CSRC is involved in this red-chip mode, but the National Development of Reform Commission(NDRC), the Ministry of Commerce(MOFCOM), and the State Administration of Foreign Exchange(SAFE) is also involved. Because there’re two parts involved in the red chip mode before IPO. First of all, the company has to go abroad to register a shell company in the OFC, in this case when the company needs to go abroad, the company has to get approval from both the NDRC and the MOFCOM; Second, when the company uses round-trip capital to invest in the domestic companies, it will involve foreign currencies, because the shell company raises funds overseas. So in this case SAFE plays a significant role. Because there’re so many administrative agencies involved and so many requirements needed to be fulfilled, so that’s why the SOEs don’t want to use the red chip mode. However, compared with the red chip mode, in the case of applying directly to get listed in the Hong Kong Stock Exchange, or any other foreign stock exchange, the situation is easier, because the law states that only a certain number of financial requirements needed to be met when the company is applying to CSRC. So basically under the H shares mode, it’s the administrative approval system; but under the red chip mode it’s the qualification approval system. In the former one the full discretion lies in the hands of the officials, but in the latter, the law sets a standard, all the companies have to do is to meet those standards.[5] Although the requirements are extremely high, especially for private companies, but that’s not a problem for the SOEs, money is not an issue, political problems are. |
Third, and the most important thing is that why there’re so many parties involved in the red chip mode. Because the state fears that there may be some cases of the loss of state assets. In the case of the H shares mode, both the assets and company stays in the the jurisdiction of mainland China, but if the red chip mode is to be applied, the assets have to be transferred to the OFC jurisdictions, which may result in the transfer of state owned assets to the private hands. In fact, there’re indeed some cases of the loss of state owned assets to the foreign areas involving many corrupted officials. And that is the main reason this model has been criticized. |
However, the choice of the private companies is completely an opposite one as opposed to the SOEs. They prefer the red chip mode. Because first of all, the financial requirements of the overseas direct listing is extremely high for the private companies, and second of all the supervision focus had not been concentrated on the backs of the private companies at that time, because at that time the private companies have not been strong enough to attract the attention. The 1997 red chip guide can only be applied to companies or organizations, but it can not be applied to individuals, which means a OFC shell company has to be set up by one of Chinese onshore companies or organizations. For example if a company is set up by an individual shareholder in the OFC, whether such regulation would still apply remains uncertain. So for a period of time, the private companies remain in the vacuum of supervision. That’s the main reason why the private companies prefer to use the red chip mode. |
But why there’re such a difference between the two types of enterprises? In the 1997 red chip mode guide, the word describing the subject is Central Enterprise and the Local Enterprise. And it even sets a yearly quota on the number of companies that could be listed overseas. And the red chip mode guide is still currently effective. So strong existence of planning economy is shown. And the bureaucrats and supervision divisions are for service of the state not for the market nor for the people. Though the freedom for the private companies lasts for some time, but it’s only a very short period of time. Soon the good old days faded away. |
2.2. History of the Indirect Listing |
In the Chinese financial practices of overseas listing, there are usually 4 ways to do that. So in academics those practices are divided into two categories. The first is called direct listing, and the second is called indirect listing.[6] Basically, the former means that listing under the domestic company’s name, while the latter means that listing under the foreign company’s name which has the actual control of the domestic company which has the real intention to raise money. The latter is also called the red chip mode because the company having the real business activity is a Chinese company, and China is also called the red China, and chip is a metaphor of the casino’s practice as opposed to the blue chip also used in casino which is referred to the giant company listed in a stock exchange, because the blue chip has the highest value, which means the blue chip company can perform both in good and bad times.[7] The name red chip is coined by the Hong Kong economists Alex Tang in 1992. Because those companies listed in Hong Kong are at first SOEs, so they are presumed to have better quality. In the latter years, some of private companies are also use the same method to list in Hong Kong market, they are referred to as small red chips or fake red chips compared to the huge size of the SOEs.[8] |
Those 4 ways mentioned before, 3 of which are related to the indirect listing, the other one is related to the direct listing. The details of direct listing will be discussed below, in short because the IPO standard in China consists of merit based substantive approval system so there are many requirements including the financial status requirement that have to be met and this is especially troublesome under the circumstances where the CSRC will determine for the market based on those financial report whether the company trying to be listed is worth investing. And also CSRC acts the long arm jurisdiction which means it also exercise jurisdictions to the companies trying to be listed overseas，normally if the company is trying to get listed overseas, and if the company is registered in China then the Chinese Company Law should apply, however as for the the standards to list overseas shall be determined by the foreign securities authorities or stock exchanges.[9] This has draw many criticisms the Hong Kong Stock Exchange has criticised the mainland government for distorting the independence and integrity of the Hong Kong market after the government in a first attempt trying to regulate the red chip mode and issue the 1997 red chip mode guidance.[10] So actually there are two standards, one is the market exit criteria determined by the CSRC and the other is market access criteria determined by the foreign stock exchange.[11] And more often the situation will be that the CSRC standard will be far severer than the foreign stock exchange standard. This practice sparks many criticism and discussions. |
For this section the focus will be on indirect listing. The methods of indirect listing consists of Reverse Merger (RM), special purpose acquisition corporation (SPAC) and VIE structure.[12] |
2.2.1. Reverse Merger |
The Reverse Merger is an easier way to get listed compared to the cumbersome procedures of IPO. The reverse merger means that the company acquire a company already listed on the stock exchange. Those acquired companies are usably on the brink of delisting because of their poor performances. Because of this special characteristics the companies’ share prices are usually very cheap so by buying these companies those problematic IPO procedures can be avoided and the cost is not very high. However, the problems are no less than the connivences, especially after 1997 in the Circular of the State Council Concerning Further Strengthening the Administration of Share Issuance and Listing Overseas ( 97 red chip mode guidance), in Art. 5 it states that internal institutions and enterprises are prohibited from listing their shares through shell firms by purchasing share-holding rights of overseas listed companies. So in this sense after 1997 the road of RM is a deadend. |
2.2.2. SPAC |
Another method that is used primarily is to set up a new SPV and list the new SPV overseas. The procedures are as follows: |
First of all, set up a new SPV. The new SPV is usually registered in the offshore financial centers due to the convenient registration process, low management cost, confidential status, low tax burden and the convenient financial services those OFCs provide. The OFCs widely used by the Chinese companies are British Virgin Islands (BVI), Cayman Islands and Hong Kong. The BVI company is usually used for the tax purposes and the Cayman Islands company is used as the SPV to be listed and Hong Kong is used to enjoy the benefits resulting from the Mainland and Hong Kong cooperation.[13] |
Second of all, using the newly registered SPV to raise funds. Because China has a tight control over the capital account , so the funds are usually raised from the following two channels. The first is called the bridge capital. The bridge capital is provided by the companies who have foreign entities overseas and have the capabilities to raise foreign currencies in the foreign markets. The operation is to first transfer money to the account of the bridge companies’ domestic branch, and then the bridge company will send the equal amount of the foreign currencies to the SPV’s account. The second way is to find the foreign VC and PE to invest in the SPV. In practice when the start up companies try to receive the investments from the PE or VC, they will first require that the Start Up sets up a SPV in the overseas to receive investments. |
Thirdly, round trip investment. It can be assets acquisition or shares acquisition. The methods used can be direct money purchase or exchange of companies shares. Previously the exchange of each companies shares are not allowed but now it is available under No.10 and No.75 Order[14] |
Fourth, get listed overseas. This involves the supervision of the foreign securities authorities and foreign stock exchanges. The most popular destination includes the Hong Kong stock exchange, the NASDAQ, the New York Stock exchange, the Singapore stock exchange. Other orthodox ones include the London Stock exchange, the Toronto Stock exchange and so on. |
Sixth, the venture capital withdraw money from the company. After successfully listed overseas, the PE and VC can finally gain profits by selling their shares in the secondary market. |
Seventh, transfer money raised in the foreign markets to domestic companies. This is usually the reason why the companies decided to go overseas in the first place. |
2.3. Regulations Involved |
The history for the red chip mode is full of twists and turns. The first case that a Chinese private companies using red chip mode to get listed overseas is the Shenyang Jinbei Auto in October 9, 1992. It first set up a US company called the Brilliance Auto. Then it formed a joint venture company with the Shenyang Jinbei Auto, which is registered in Bermuda. And last it successfully got listed in the New York Stock Exchange.[15] It raised the curtain of Chinese Companies going overseas to get listed. In this period, most of the companies listed overseas are Stated Owned Companies.[16] Even Shenyang Jinbei on the appearance is a private company, however in fact the contribution assets were from the government. However, the management was different from the other SOE because it was managed by the private person. The general manager is called the Yang Rong, it is him who make the small SOE into a huge enterprise and finally list in the New York Stock Exchange. Finally he tried to use the MBO to make the SOE to be a private company. In the end he was prosecuted by the State for embezzling the State Owned assets. After Yang Rong fled to US, he brought suits against the Chinese Government in the US court, but the Chinese Government used state immunity to protest the US’s court jurisdiction.[17] |
2.3.2. 97 Red Chip Guideline |
After the golden age, the CSRC feared that the State Owned Assets will transferrer overseas, so they issued the Circular of the State Council Concerning Further Strengthening the Administration of Share Issuance and Listing Overseas(1997),which is also known as the 97 Red Chip Guideline. This guideline mainly targets the State Owned Enterprise, because in Art. 2 it says that “the share-holding unit(s) inside the country should obtain consent in advance from the provincial people’s government or the competent department under the State Council based on its subordination thereto.” In Art. 3 there is a similar sentence.[18] This guideline regulates three kinds of activities, the first one is listing with the assets, especially the listing with domestic assets invested through the foreign assets, which says if the assets are not possessed by the foreign companies for more than 3 years, then this assets cannot be used for overseas listing.[19] |
The second type is listing “by purchase, exchange of shares, allocation or by any other means for listing shares overseas”.[20] These two types have to seek approval from the authority. The third type is completely prohibited, which is “listing their shares through shell firms by purchasing share-holding rights of overseas listed companies.”[21] |
However, although this Order targets for the SOE, however, the private companies are also regulated. Because the direct listing is not possible because it is subject to approval by the authorities and the the most used indirect listing form acquiring shell company is banned, so other solution is needed. Fortunately, this Order only regulates the behaviour of the company, not the individual. So setting shell company by individual and then using the company to acquire the domestic company become the new practice. |
2.3.3. No Action Letter |
After the rather short golden period with no supervision on the private companies between 1997 and 2000, circumstances changed completely on June 9, 2000. On that day the CSRC declared that: “Encourage direct domestic listing, discourage the behaviour of indirect listing.” This situation is stimulated by the Yuxing Info Tech Investment Holdings Limited (Yuxing), a company focusing on the computer productions. Yuxing used a BVI company to get listed in the Hong Kong Growth Enterprise Market(GEM). It only uses 1 dollar as consideration to purchase the domestic company. Moreover, both of the owner of the company changed their Chinese Nationality, and they purchased the passport from a small island country, so basically the 97 red chip guide does not apply to them. But right after the listing, the company are suspended by the CSRC, and asked to be reexamined. |
The CSRC gave 3 reasons why they did this. First of all, although Yuxing is registered in the foreign countries but essentially it is a Chinese cooperation; Second, Yuxing maybe involved in the loss of state owned assets; Third, Yuxing purposely avoid the regulation of Chinese law therefore it violates the public policy. So the CSRC asked the company to reapply to the CSRC. |
This action of the CSRC attracted huge amounts of criticisms from the Hong Kong market, they said that the CSRC inappropriately interveined in the administration of the Hong Kong Stock Exchange and the spirit of rule of law by Hong Kong market. Because of huge pressure, the CSRC finally let this go.[22] |
Right after the declaration of its stands, the Circular of China Securities Regulatory Commission on Issues Concerning Stock Issuance and Public Offering Abroad of Overseas Corporations which Involve Domestic Equity administrative act had been issued, also known as the No.72 Order. It put the overseas listing under strict scrutiny. In Article 2, it says that “Legal opinions on the matters of overseas stock issuance and public offering not subject to the document coded GuoFa [1997] No.21 from lawyers shall include, but not limited to, the following contents.” This is what we call the rule of no action letter. It stems from the US rules, where the US has this kind of ‘no action letter’. [23] But in the Chinese context, it added some new meaning . Because before the No. 72 Order, there is nothing to regulate the activities of the private companies. But the CSRC thought it was not right to use the word “approval” or “sanction”, because these words have a sense of order, thereby implying hierarchy. But hierarchy only exits in the bureaucratic system, so it is inappropriate in the eyes of the CSRC to apply it to the private companies. But the CSRC still wanted to supervise the activities of the private companies, so they just needed a new name. Finally the CSRC decided that they would not use the name denoting hierarchy but use the words that “we do not have objections in the listing of the XXX companies.” But because the lawyer will submit all the materials involving the companies, and the CSRC will take a substantial review on every details of it, not just a formal one, so essentially it had no difference with the “approval” or “sanction”. |
2.3.4. No.11 and No. 29 Order |
But on 2003, this No.72 Order had been abolished due to severe opposition from the market. Because even after the substantive approval, there still many scandals in the market.[24] So the no action letter did not do any bit of good to the market. However, the market only enjoyed 2 years of freedom. On January, 2005, the SAFE issued the ‘Notice 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’, also known as the No.11 Order. And in the same year in April, the SAFE issued another Order, the Notice of the State Administration of Foreign Exchange on Relevant Issues of Registration of Overseas Investments Contributed by Domestic Individual Residents and Foreign Exchange Registration of Merger or Acquisition with Foreign Investments, the No.29 Order. The two orders put strict restrictions on the use of foreign currencies. First, if the companies wanted to use the stocks or any other assets instead of the money to be the consideration in the transfers of the the other companies stocks, then it had to be approved by the SAFE.[25] This is extremely devastating for the red chip mode. Because the red chip mode involves the shell companies registered in the OFC to come back to acquire the Chinese inland companies, so it must involve the use of foreign currencies, because the money is raised overseas and the Chinese currency Renminbi is not a freely convertible currency. So many companies come up with the idea of using assets instead of money to be the consideration in order to avoid foreign currencies controls. Clearly this road is completely blocked. |
Second, the rest of things are easier for the SAFE, because from now on every move you make is under the watch of them. For example, you have to disclose your management structure, whether it is the same with the domestic company. And every changes you make in the company structure has to be reported to the SAFE, like “the increase or decrease of investments, transfer of stock rights, merger, division, contribution of stock right investments to a foreign party, provision of domestic asset-involved guaranty to a foreign party, or any other similar major matter, the domestic individual resident who directly or indirectly owns the maximum stock rights of the overseas enterprise,” all of which should be reported within 30 days.[26] Those two orders are huge blows to the market. |
2.3.5. No.75 Order |
Again because the huge opposition from the market resumed, the situations changed again. In October 21, 2005, the SAFE issued another Order called the “Circular of the SAFE on Printing and Distributing the Operational Rules on Foreign Exchange Administration for Financing and Return Investments by Domestic Residents through Special-Purpose Overseas Companies,” the No. 75 order. The biggest change is that no prior approval is needed if it involved stock for stock exchange or other similar activities not using money as consideration, however it should be kept on record in the local foreign currency administration office afterwards. However, a detailed explanations of how the process is done and the exact pricing method are needed, of course if it involved the state owned assets, a confirmation letter from the SASAC should be provided. So even the situation had not been improved much, but it reopened the door for the companies to use the red chip mode. And on the year May 29, 2007, the SAFE issues the “Notice of the General Affairs Department of the State Administration of Foreign Exchange on Issuing the Operating Rules for the Notice of the State Administration of Foreign Exchange on the Relevant Issues about Foreign Exchange Control over the Financing and Return Investment of Domestic Residents through Overseas Special Purpose Companies,” the No.106 Order, which is to specify the requirements in the No. 75 Order. |
However, things turned 180 when the year came to 2006. On October, 2006, six departments together issued an Order called “the Interim Provisions on the Takeover of Domestic Enterprises by Foreign Investors ,” the No.10 order, the issuing authority of which involved China Securities Regulatory Commission, Ministry of Commerce, State Administration for Industry and Commerce, State Administration of Foreign Exchange, State Administration of Taxation, State-owned Asset Supervision and Administration Commission of the State Council. This Order changed the ecosystem of the red chip mode completely and it is still in effect today. |
2.3.6. The No.10 order |
There are three major changes in the No.10 order. |
First of all, the authority of approval has been lifted to the central government level. In Article 42, the establishment of special purpose vehicle(SPV) should require the approval from the MOFCOM. In Article 11, when the SPV registered in foreign countries acquire or merge with the Chinese domestic companies, the approval from the MOFCOM is needed. Previously, when the foreign SPV returns to Chinese domestic market to make investment, unless the amount of money involved in the transaction is large, only the approval from the local commercial administration agency is needed. So many companies delicately design the structure of this deal in order not to exceed the amount set by the MOFCOM so that the transactions can be proceeded in the local government.[27] Because the assessment of the central government is extremely slow. However, from now on, it doesn’t matter. |
Secondly, CSRC has regained the approved power after the 2000 No.72 Order had been abolished. In Article 40, the transaction of the overseas listing of the SPV should get the approval from the CSRC. Based on the above Article and the Article 238 of the Securities Law, the CSRC issued the order “New Regulation on Red Chip Mode Listing,” it stated that all the activities involved in the red chip mode listing should be approved by the CSRC, and it required 26 other materials approved by other agencies including the most important in-principle approval from the MOFCOM and the temporary approval certificate for the SPV from the MOFCOM.[28] |
Thirdly, in Article 45, Article 46 and Article 47, it says that the certificate of the approval for the establishment of the SPV is only valid for 1 year. The certificate will hold a mark of ‘valid for 1 year’. And after the successful overseas listing, the domestic company should inform the MOFCOM of the plan of the transfer-back of the raised funds, and switch the marked certificate to the unmarked certificate. If the domestic company fails to report to the MOFCOM within the former time limit, its approval certificate with a remark will be invalidated automatically, its equities structure will resume to the state prior to the equity-based takeover. In this case the time available for the overseas listing is extremely short and if the overseas SPV can not finish IPO, then everything will return to zero. It will be an extremely risky decision to use the red chip mode. |
3. The Ways to Circumvent the No. 10 Order3.1. VIE structure |
The VIE structure is first used by the foreign companies to enter into the market forbidden by the regulations but now because of the tight control of the No.10 order, there are more and more companies using the VIE structure to circumvent the No.10 order along with other administrative orders. |
The first VIE structure in China is first adopted by Sina, one of the Chinese internet tycoons and one of the first patch of internet companies listed in NASDAQ in the 2000, catching the heat wave of “.com” at the end of the 20th century. |
By the time Sina received the foreign investments build the VIE structure, China has not entered into WTO and foreign companies are not allowed to own shares in the telecommunication industry.[29] So Sina comes up with a way to circumvent the regulation. In essence, Sina registered a SPV in an OFC, and the SPV is the vehicle to get listed overseas. The SPV owns 100% shares of the domestic wholly foreign owned entity (WFOE). This WFOE has complete control over the Sina company which has the actual principle business activities but not through owning share instead it is thorough a serious of contracts. Those contracts include the loan agreement, share pledge agreement, voting rights proxy agreement, license agreement.[30] So the only difference between the previously mentioned SPAC and the VIE structure is that in the VIE structure the SPV does not gain control through owning shares but through a set of contracts. |
3.1.1. Definition of VIE Structure |
Why such practice called the VIE structure? VIE means variable interest entities. It is a definition under the FASB interpretation No.46. It is not a new practice, however it is a new accounting concept emerging after the the Enron scandal. Before the Enron scandal, this practice has been existing for a very long time however only the companies having the majority vote rights will be asked to consolidate financial statement. After the scandal, those companies fulfilling the requirement of the FIN 46 will be asked to consolidate the financial statement. It is the accounting criterion that substance is over formality. |
The FIN 46 defines the VIE to have the following characteristics:[31] |
|
3.1.2. Contracts in the VIE Structure |
The core of the VIE structure is a series of contracts. The lone agreement is the core agreement, while the others are revolving around the loan agreement and strengthening the control of the it. |
3.1.2.2. Loan Agreement-Core Contract [32] |
Loan agreement is the core of the contract control structure. Because the purpose of the VIE structure is to raise funds from the foreign markets and transfer the funds back to Mainland China. Controlling the transfer of the fund is to control the company in mainland China. In order to do that, the investors design a scheme where the funds transferred to mainland China are repaid by the shares in the mainland China’s company where the law allows. |
There are several ways to receive money from the foreign investors. The first way is through entrusted loan, in which the foreign investors designate a bank to lend money to the mainland company. However, the downside is that there will be additional costs resulting from the lending. The second way is through affiliate enterprise lending, where the fund is transferred through the account of the foreign company to the account of the mainland company. The third way is by letting the foreign investors company pay the debt incurred through the daily running of the mainland company. This is a way supported by the creditors of the mainland company because it is a kind of assurance, and raise the credit of the mainland company. |
3.1.2.3. Other Contracts |
In order to guarantee the repayment of the debt, the shares are pledged to the investors. The investors enjoy the priority right to be repaid when it comes to bankruptcy. After the agreement goes into effect, the companies are not allowed to pledge the shares again including but not limited to the act of sale, transfer and etc, resulting in the negative effect of the shares.[33] |
3.1.2.3.2. Voting Rights Proxy Agreement |
It designates that the mainland China shareholders irrevocably agree that the delegates designated by the foreign investors in the board meeting will act on behalf of the foreign investors to voting rights granted by laws and article of the company on various issues including and agree that the board structure of the mainland company should be the same as the foreign companies structure. This article is to let the foreign investors have the voting rights without actually owning shares of the company.[34] |
3.1.2.3.3. Exclusive Option Agreement |
This contract stipulates that the investors shall have the exclusive purchase rights of the companies shares and assets and the companies will give up the right of first refusal of the companies shares and assets. Before the investors exercise the exclusive purchase rights the companies can not in any form handle the property or shares of the company.[35] |
3.1.2.3.4. Licensing Agreement |
This contract stipulates that the investors provide exclusive technical support and exclusive licensing to the mainland companies in turn the mainland company will pay the fees resulting from the support from the investors. This contract guarantees that the investors will receive profits from the mainland company and support the running of the listed company.[36] |
3.2. Structure of the VIE |
The basic Structure of a Chinese companies employing VIE is as follows: |
There are 2 BVI companies, 1 Cayman company and 1 Hong Kong company. The advantage of each OFC is explained before. The reasons to set up 2 BVI companies are as follows: The BVI-A is used as the holding company. If the natural person directly control the SPV then they are subject to the No.75 order. According to Art. 6, they have to transfer the money raised overseas back to the domestic companies within 180 days. With BVI A, whether Art.6 still applies remains in the gray area. The second reason is that if the actual controller who wants to opt out or if there are some changes in the business area, then the controller can directly sell the BVI A and with the minimum interference with the performance of the Cayman company which is the listed company and at the same time enjoy the benefits of the low taxes . The third reason is that if in the future the companies decide to venture into a new business area, then a new son company BVI-C can be directly set up under the BVI-A, alongside with BVI-B, separating brand, management and risks from the Cayman listed company. The fourth is that there are no period of selling prohibition in the BVI company law, so the founder can sell their shares in the market immediately as soon as the Cayman company is listed. |
Above is the reason to set up BVI A, the main reason to set up BVI B is to act as a cushion between both sides, the side of the domestic company and the side of the Cayman listed company. When the controllers sell the shares in the Cayman listed company, and it will further result in the change of the share structure of the domestic company, according to the domestic law they have to report to the authorities. But with BVI B as a cushion, the share structure of the domestic company remain unaffected. On the other hand, when there are some inappropriate personal behaviour from person a and person b, because there is BVI B between the listed company and the domestic company, so the share price of the listed Cayman company will have some kind of protection. |
Graph.1 Quoted from Wang Wei[37] |
Now let’s see some real examples on how this works. Below is the example of Zoomlion. First of all, there are 3 outside investors in the HK SPV-A, the Zoomlion HK holding and the HK SPV-B guarantees that the no matter how the outside investors change, up it will not affect the Zoomlion Mainland China, and down it will not affect Luxembourg company. Second, LU holding A is the master control, so the new business can be accommodated under the LU holding A by setting up different LU holding B C D etc. If the company wants to get out of the Italian market, then it can be done by selling the shares in the LU holding B owned by LU holding A, so the entire assets below LU holding A will be peeled off. And according to EU tax regulation, the Luxembourg company holding the shares of Italian company has to keep at least 12 months in order to enjoy the benefits of low tax. [38] The double structure of the LU holding company can circumvent this requirement. [39] |
Quoted from Ying Ye[40] |
In conclusion there are two simple rules in deciding how to build the offshore structure. The first rule is that the criterion to the jurisdiction chosen are mainly to enjoy the benefits of the bilateral treaty and the second rule is that when crossing border always build two layers of companies because it is easy to build new son company and most importantly it will help avoid the regulation of the onshore government regulation.[41] |
4. The Inherent Risks in the VIE Structure and the Relevant Cases Studies |
The first company which employs VIE structure to successfully list on the foreign stock exchange is the China Unicom. The whole process is as follows. However, not every company can be as fortunate as the huge state owned enterprise. There are still many risks that are exposed and some of those risks even can not be regulated. There are mainly 3 types of risks. The first one is the VIE structure might not be lawful, because the VIE structure is used to circumvent the control of the NO.10 order. The second risk is that the VIE structure uses contracts to control the firm so it is not as tightly controlled as using the shares and seats and voting rights in the board meeting. If the contract is unilaterally breached then the cost of remedy can be very long and painful, combined with the first unlawful risks, the claim might not be accepted at all so there can be no way to receive any kind of remedy. The last risk is that because the VIE structure is highly unstable and are not as transparent because the muti-layer companies and the complicated affiliation, added with the previous two risks they will have some negative impacts on the share prices especially for the foreign investors who do not clearly know what really happened in the foreign market. |
If those risks break out then it will have two negative impacts. The first is that the companies can not successfully list in the foreign stock exchanges. Because the internal authorities may at any time require the company to stop the proceedings based on purposefully circumventing the law. |
The second is that the foreign investors will be severely harmed. Because if the VIE structure is null and void, then the link between the foreign shell company and the actual company will be severed and there will be no connection between the two, the foreign investors can only invest in the worthless shell company, then their shares are penniless. |
4.1. The Illegal Risk [42] |
The basis of the VIE structure in essence is a series of contracts. The purpose of these contracts is to avoid the regulation of certain rules, especially the NO.10 order. In General Principles Of The Civil Law and Chinese Contract Law, they both stipulate that these behavior that purposefully avoid the regulation of certain rules are unlawful and should be null and void. In General Principles Of The Civil Law Art. 58 paragraph 7 and Contract law 52 paragraph 3, it says that those that performed under the guise of legitimate acts conceal illegitimate purposes are null and void. |
Civil acts that are null and void shall not be legally binding from the very beginning. |
Baosheng Steel Company is a SOE. It is the first company which is publicly revealed to be punished by the regulators concerning VIE structure. In October 2010 the company exchange shares to acquire a Hong Kong registered company. This Hong Kong registered company owns a WFOE in Mainland China, the WFOE uses VIE structure to control the actual company. The VIE structure is fully disclosed in the documents submitted to the New York Stock Exchange. But on March 2011, the process is stopped by the local government which is the direct competent supervisor of the Baosheng Steel Company on the grounds that the VIE structure violates the “existing industries and public policies regulating foreign investments”.[43] So the company decided to stop the cooperation with the WFOE and retrieve the submission from the New York exchange. The foreign listing has completely failed. Some people say that this is because the Baosheng Steel Company is in a sensitive industries, not because the authorities completely deny the VIE structure. This conclusion has some merits however this kind of action will definitely add further doubts and uncertainties to the firm. |
Also, in the CIETAC Shanghai VIE case and the Supreme Court VIE case, both of the ruling said that the VIE structure in null and void. Both used the same reason which is the Art. 58 (7) in the General Principle of Civil Law and Art. 52 (4), which says using legal form to disguise the illegal purpose shall be null and void.[44] In the CIETAC Shanghai case, it involves the video game industry, and video game industry is explicitly prohibited from entering by foreign companies.[45] In the Supreme Court Case, the Chinachem is a foreign company, and it wanted to invest in the Minsheng Bank, which is in finance industry, and foreign companies are prohibited from entering the finance industry. So the Chinachem used a Chinese company SME Company to invest in the Minsheng Bank, and used the VIE structure to control the Minsheng Bank. However, the company A does not want to give profits to the Chinachem thorough VIE structure, so the Chinachem sued the company. However, in both cases the VIE structure is not acknowledged. |
The ruling is criticised largely by the legal group, because according to German theory the Umgehungsgeschaft, it says determining the legality of any behaviour trying to evade the law is actually a matter of law interpretation, and evading the law should not be automatically illegal, so therefore an independent theory does not exit.[46] However in this case it neither interpreted the purpose of the law, nor it interpreted the purpose of the behaviour and also it did not weigh the costs and benefits of the behaviour, and it only says that the behaviour is illegal. [47] |
4.2. The Compliance Risk [48] |
In May 11, 2011 , Alibaba, the largest online business company breached the contract it signed with the other shareholders like Softbank and Yahoo. Alibaba took control of the Alipay, the Chinese Paypal, an online third party payment instrument, without the consent of the board meeting. |
Alibaba group is a company registered in Cayman Islands, it is owned by Ma Yun the founder of Alibaba, Yahoo, and Softbank Investment group. Alibaba group has two companies in mainland China, the Alipay and the a WFOE. Alibaba group owns 70% of the shares of Alipay. In June 2009 and October 2010, Alibaba group transferred the shares of Alipay to a company called Zhejiang Alibaba, which is a company set up in mainland China and wholly owned by Ma Yun himself. However, because Zhejiang Alibaba has VIE relations with the WFOE company owned by Alibaba group, so in fact the company is controlled by Alibaba group. |
On the first quarter of 2011, the People’s Bank of China (PBOC) sent letter of inquiry and asked every company who has applied for the electronic payment license, whether they have they have foreign investors owning shares in the company including VIE structure. Yahoo and Softbank insisted that the company should use VIE structure to gain the license because this does not violate any rule. However Ma Yun said that he wanted Alipay to gain complete legal status. So on the last night of the submission deadline Ma Yun unilaterally breached the contract and in the written submission he says that Alipay is completely owned by the Chinese investors. |
The debate heated. The question is how the Softbank and Yahoo will allow the transfer of shares of Alipay to Zhejiang Alibaba to happen in the first place. Did they know the situation or did they not? According to Ma Yun’s words, he just transferred the shares within the Alibaba group and the shares price is based on the actual market price so there should be no problems. Softbank and Yahoo seemed to allow this to happen silently maybe because they know if not using the VIE structure than there will be no chance for the company to pass the audit of the PBOC. In the end they settled, the agreement said that when Alibaba get listed both foreign investors will be compensated in lum sum payment of 37.5% of the market value not less than 20 billion US dollars and not exceeding 60 billion US dollars. |
Ma Yun said that he just did something that had to be done, because it involved the company’s future. Since in June 21, 2010, the central bank of China issued the Administrative Order-the Administrative Measures for the Payment Services Provided by Non-financial Institutions, in Article 9 it stated that “The business scope of foreign-funded payment institutions, the eligibilities of overseas investors, the ratio of investments of overseas investors and other such matters shall be determined by the PBOC in other initiatives and be submitted to the State Council for approval,” which means if there were foreign capital invested in Alipay, then it must wait until new administrative act is issued, which is very uncertain. Moreover, in Article 50 it stated that “These Measures shall come into force on September 1, 2010,” and in Article 48 it further stated that “Any non-financial institution which has engaged in payment services before these Measures come into force shall apply for a Payment Business Permit within one year from the date when these Measures become effective. Otherwise, it may not continue the payment services,” which means that the deadline for the application of the payment license is September 1, 2011. But what complicates situations was that in August 6, 2010, the shares held by Softbank and Yahoo had been transferred to Alibaba Zhejiang, a domestic-funded enterprise because the issuance of the previous administrative order. Since then Alibaba Zhejiang had signed a contract with Softbank and Yahoo, which stipulated that Alibaba Zhejiang would be granted intellectual property rights of Alipay held by Yahoo and Softbank and received software technical support from Yahoo and Softbank. In return it will pay fees to Softbank and Yahoo. In this way it can circumvent the administrative order. This kind of arrangement is called the VIE structure. But the turning point was in January 26, 2011, on this day the central bank of China faxed Alibaba, asked them if they were using VIE structure. So on this day the President of the board Ma Yun said that he made “the imperfect but only right solution” that he unilaterally terminated the VIE structure.[49] |
The VIE structure was regarded as the alternative for the so called red chip mode listing-the private company using offshore company going abroad to get listed. Because in recent years the red chip mode listing has been deterred by a series of Administrative Orders. But since the VIE structure is based on a contract so that it stands the risk to be breached. The incident of Alipay changed the game from top to bottom. However, the interesting thing is that the other major company called Tencent, also applied for the license using VIE structure and they get the license without breaking the VIE structure.[50] Because of this people start to question the real intention behind Ma Yun’s choice, whether he is really as forced as he claimed to be. So finally the focus shifts from the government’s attitude toward the VIE structure to the inherent instability of the VIE structure. |
4.3. Corporate Governance Risk [51] |
Under the VIE structure, often the CEO and legal representative of the listed company and the mainland actual company is the founder. The founder often keeps the license and certifications, official seal and financial seal, in the Chinese law, “those with the seals keep the initiative and those who are the legal representatives keep the seals.” This system in a material way undermines the authority and control of the boarding system. |
The China Cast Education Corporation (CAST) is an example. In CAST, the foreign investors expelled the founder of the company, Chen Zi’ang, although they won the battle in the control of the boarding system but they lost control of the company. Months before the expel, the founder has already transferred the capital of the company amounted to 510 million yuan to his personal account and sold two education centers to the third parties. After the expel, because the founder took away the license and the company seals, so the company is not able to file their annual report to the stock exchange resulting the delisting of the company and transferring to pink sheet market.[52] |
4.4. The Transparency Risk [53] |
The company using VIE structure to list in the US stock exchange has to report to the SEC and consolidate financial statement according to the FIN46. However, the question is that what kinds of activities need to be consolidated? So company may purposely manipulate the financial statements and carefully select the business activities that need to be included in the financial statements. The Muddy Water selling short of the New Oriental is based on this. |
On July 11 2012, New Oriental releases the newest report saying that the company used considerations to transfer the shares of Beijing New Oriental (the actual company) to a company owned by Yu Minghong, the founder of the New Oriental. Previously, the actual company is owned by 11 cofounders but now the company is wholly controlled by Yu Minghong himself. On July 17, the New Oriental in their report says that the company received the letter of investigation from the SEC, immediately after the release of this information the stock price of the company fell 34.32%. After this the Muddy Water released a report questioning that there are financial frauds in their financial report and the stock price fell another 35%. |
The founder Yu Minghong said that he never imagined this would happen. In his words his action is totally different from what Ma Yun did. Because he acted in a bright way. He honored the VIE structure, not to break them. In fact he strengthened the VIE structure. What he did was trying to strengthen the structure of the company. Because in the past some decisions are turned down by some of the 11 shareholders despite that there are clear cut clauses in the contracts. Furthermore, most of the 11 shareholders were not on duty anymore and most of them only had very small amounts of shares in the company. So what he was doing was merely to enhance the efficiency of the company. Even if the company did not make the statement. |
However, the SEC’s investigation is not focused on the transfer of shares. It focused on confirmation of the financial status. From the point that the shareholder are not active to the point of the transferring of shares, what did the shareholders actually do? Did they do something that influenced the listed company’s profits? Essentially this is a question of whether the financial interests of the shareholders would influence the financial interests of the company. Especially when there were 11 cofounders, there is a high possibility that the consolidation of the financial statement would not be possible. |
5. Other Ways avoiding the No.10 Order |
The No.10 Order is used to regulate the behaviour of foreign SPV purchase, so in fact it regulates the behaviour of affiliate acquisition. Another purpose of the No.10 Order is that the normal FDI should not be interrupted, however foreign SPV purchase is in fact a FDI, so how to e So on the one hand its says that any merger which has the same owner should be subject to control however on the other hand it says that the FDI should not be subject to the No.10 Order, however again it says that the FDI should not be used as a method to evade regulation. |
In the No.10 Order, the ace is the cards is Art. 11, which puts every related to affiliate acquisition under supervision, and secondly it says that it shall not evade the regulation by foreign investment. Art. 15 says that “The parties to a merger shall explain whether there is relationship of affiliation among the parties. If there are two parties belong to an actual controller, the parties shall disclose the actual controller to the approval authority, and shall explain its purpose of merger and whether the result of evaluation is in conformity to the reasonable market value. The parties thereto shall not evade the above provision by means of trust, custody or any other means. ” Combined with the first part of Art.11, it means that anything that tries to evade the regulation of No. 10 Order is not possible. However, in the second part of Art.11, it also leaves space for the maneuver, because the FDI is permitted and not subject to No.10 Order. |
5.1. Change of the Nationality |
The first method is to change the nationality of the owner. In Art.11, it uses the word domestic natural person, so if the person is not a foreign national, then the No.10 Order will not apply. The recent case employing this strategy successfully is the CIFI Group a realestate company (CIFI). The three owners of the CIFI have the permanent residence of a foreign country for a long time, so in the legal opinion issued by the law firm, the lawyer writes that because they have the permanent residence of a foreign country, so they are not domestic natural person therefore the No.10 Order does not apply. This is the most convenient strategy, however, the Art.15 sets the last defence of the No.10 Order, because it says if the parties to the merger are the same people then “The parties thereto shall not evade the above provision by means of trust, custody or any other means.” Whether the change of nationality belongs to the “any other means” is uncertain.[54] |
5.2. Borrowing Channel |
In Art. 52, paragraph 3 it says that “Where a foreign investor merges or acquire a domestic enterprise by its foreign investment enterprise established in China, it shall be subject to the relevant provisions on merger and division of foreign investment enterprises, and the relevant provisions on domestic investment by foreign investment enterprises.” The spirit is that the normal FDI should not be interrupted. However, how to define what is normal is not defined. It opens the possibility for evasion. The foreign SPV can set up a WFOE company in the domestic market to acquire the company to avoid the No.10. In the recent case, the TIANGONG INT’L employed this strategy. However, there is always risk, because in Art. 11 paragraph 3, it says that “The parties thereto shall not evade the above provision by the domestic investment of a foreign investment enterprise or by any other means.”[55] |
5.3. First selling then buying afterwards |
Because the purpose of the No.10 Order is to check whether there is affiliation of relationship, so that it can regulate the SPV purchase. So one way to avoid the affiliation of relationship test is first sell the shares or assets to one third party company completely unrelated to the SPV, and buy the shares or assets from the third party. The Chinacornoil used this method, afterwards they said that the third part company was unable to pay money and then get the company’s share back from the third party company. However, it involves huge moral risks so should not be used too often.[56] |
6. The Problems of Chinese Financial Market6.1. The History of the Financial Market |
Why all the companies want to list overseas and go through all these troubles and bear the high so many risks and why not just list in the domestic market? There are many reasons behind this. Now lets analyze them one by one. |
In the transformation period from the planned economy to market economy, the biggest challenge is the reconstruction of the SOEs. At that time the SOEs are in heavy debt. So the capitalization of the company shares is a primary solution to the problems of the SOEs. Because reconstruction of the debt needs huge amount of money, but the state do not have such capital, so the government turned their eyes to the stock market. They wanted to rely on the market to raise money. So the orientation of the stock market is for the SOEs to get out of debt.[57] On 1990, the Shanghai Stock Exchange opened and one month later the Shenzhen Stock Exchange opened.[58] Because of this purpose, the companies listed in the Stock Exchange is not the best companies but those inferior ones that need capitals. The management structure is not competitive because most of the senior managers are appointed by the State. The share structure of the company is not reasonable, because most of the shares are owned by the State, the minority shareholders do not have any voice in the management of the companies. Furthermore, many of the shares owned by the State are not allowed to trade in the stock exchange because some industries have to be controlled by the State, for example the petroleum industry. The China Petrol has the largest market value among A shares.[59] However, there is only 2% of the shares that is publicly traded. The problem of this situation is that these unequal treatment of different kinds of shares will not have a positive effect on the corporate governance. Moreover, such low amount of shares that are publicly traded will add doubts to the actual value of the shares because the market worries that if there will be more shares that are issued in the future they will lower the current price and change the dilute the current shares structure, making the minority shareholders even weaker. In conclusion because the stock exchange is built by the State to solve the financial problems of the SOEs, so actually the State acts as both players and referees. The rules of the market are tailored for the SOEs, the private companies are hard to get chances. |
6.1.1. Listing on the Domestic Market |
The reason why the companies won’t list on the domestic market is that listing on the domestic market is extremely hard. In Art.33 of the Measures for the Administration of Initial Public Offering and Listing of Stocks issued by the CSRC (No.32 order) it says that the company should meet the following standards: |
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The first three standards are very strict financial standards, and the fourth one is especially discriminating against the high tech companies because most of them are light assets companies and their core assets are intellectual properties which are intangible assets. |
Not only the financial status is hard to meet, also the company will have to pass the CSRC’s substantive review. The CSRC will not only focus on whether the company comply to laws and regulations they also focus on the material business activities of the companies, whether such business activities have a promising future is determined by the CSRC. There are currently two divisions in the CSRC scanning the documents submitted by the companies to be listed. The first is assessment office No.1 (No.1), the second one is assessment office No.2 (No.2). No.1 is responsible for the compliance review, No.2 is responsible for the business judgment. In Art. 13 paragraph 2 of the Securities Law, it stipulates that the company should having the capability of making profits continuously and a sound financial status. And in Art. 14 paragraph 7, it says that where a recommender shall be hired, as is prescribed by the present Law, the Recommendation Letter of Issuance as produced by the recommender shall be submitted as well. In the Recommendation Letter of Issuance, the recommender should give opinions on the prospect of the company according to Decision on Amending the Administrative Measures for the Sponsorship Business of the Issuance and Listing of Securities Art. 13 paragraph 4 it says that the recommender shall give opinions on the prospects of the company. Also, in Measures for the Administration of Initial Public Offering and Listing of Stocks issued by CSRC (No. 32 order), Art.14 says that an issuer shall have a complete set of operations and be capable of independently conducting market-based business operations. In Art.15, it says that an issuer shall have integrated assets. A production company should have production assets, lands and own or have the right to use intellectual property rights and Independent purchasing system. A non-production company should have the operations and assets associated with the relevant business activities. In Art. 28 it says that an issuer shall have a sound asset quality, reasonable structure of assets and liabilities, comparatively strong profit-making capacity and normal cash flows. In Art. 35 it says that an issuer shall not have any major debt-paying risk. Further in Art. 37 it outlined several cases which will be considered to undermine the profitability of a company including operational model, industrial status and business environment risks in the intellectual property right, and any other circumstances which will affect the companies capability to earn profits. And in Art. 40, it says that the projects as invested by raised funds shall comply with the relevant state industrial policies, investment management, environmental protection, land administration as well as the provisions of other relevant laws, regulations and rules. In Art. 41, it says that an issuer shall carry out an earnest analysis on the feasibility of a project so as to ensure that the investment project may have a good market perspective and profit-making capability. |
Not only the portability of the company will be required, also the money raised will be strictly limited to certain uses. In Art. 38, it says the raised funds shall be utilized for specified purposes and shall be used in its main business operations, as is the general principle. For those that are not financial enterprises, the fund can not be used in the financial investments. The most unreasonable and widely criticized is Art. 39, it says that the amount of raised funds shall be commensurate to an issuer’s present business scale, financial status, technical level and management capability. That means if you are a small company you can only raise small amount of money and if you are a large company you can raise large amounts of money but not exceeding the company’s scale and the definition of the scale is at the full discretion of the CSRC. So even if the company is popular with the investors and even if the company has a promising future and will grow larger, at the time of IPO, those things will not be taken into consideration. |
However, because the CSRC needs to substantially check the companies one by one, so it needs huge amount of efforts and resources. On the contrary, the CSRC is only a relatively small institution. There are only 2000 people who work in the CSRC, but there are over 3000 institutions and 30,000 natural persons who are directly involved in the CSRC.[60] And after the two assessment office scanning the profiles, the profiles will be submitted to the issuance examination commission, the organization in the CSRC which finally determines whether the company will pass the check or not. The commission is mainly composed of professionals. However, there are only 25 of them. And they will be divided into 3 working groups. Every time there are 7 people participating in the examination, if 5 of them vote pass then the company will finally get listed. The commission will hold 2 hearings in this process, the preliminary one and the final one. Those are the only 2 times that will involve the commission, which is step 6 and 7 as shown in diagram 2. |
As can be seen , the human resources committed in the SEC is severely not enough. So the CSRC can not process all the companies in the reasonable time. However, there is a time window for each firm to get listed, only on this short period of time can the company get the maximum price. So in the end, there is a phenomenon called the barrier lake, which means after the earthquake the water is trapped by a circle of rocks forming the lake. If the CSRC felt that there are too much work load that they can not process, they will temporarily stop receiving the applications. And that is exactly what happened in the 2013. As of December 16, 2013, 830 companies were waiting outside the door of CSRC, the largest incidence on history.[61] On December 30 2013, the door finally opened.[62] Now optimistically, it will at least take 3 years to process these companies.[63] The action of temporarily closing the door happened overall 7 times in Chinese financial market history.[64] |
Graph 3 quoted from Jiang Daxin[65] |
6.1.2. Directly Listing Overseas |
Directly listing overseas is another option apart from listing in the domestic market and indirect listing overseas. However this option is also filled with harsh requirements. The current systems of rules regulating the direct overseas listing are composed with these set of laws. On the top of them is the Chinese Securities Law (2006), in Art. 238 it says that Where a domestic enterprise directly or indirectly goes abroad to issue any securities abroad or whose securities are listed abroad for trading, it shall be subject to the approval of the securities regulatory authority under the State Council according to the relevant provisions of the State Council. This Article lays the foundation for the company to list overseas, which gives the CSRC authority to regulate the overseas listing. Based on this the CSRC makes two orders, the first one is Notice on Companies Listing On the Main Board Overseas,[66] the second one is the Guidance on Companies Listing on Hong Kong Growth Enterprise Market[67] Those two orders make the direct overseas listing very inconvenient. |
First of all, in the former, it says that the company has to satisfy the requirement of a net assets not less than 0.4 billion yuan, a net profits of not less than 60 million yuan in the last year, and a price to earning ratio not less than 50 million US dollars. These standards are so much higher than that to get listed in the domestic market, or that of Hong Kong Stock Exchange. |
Second, in the latter, there is a minimum requirement for the amount of money that has to be raised in the market, which prohibits the means a company can choose in order to get listed. So the company can not use exchange of shares, selling the prices that have been issued and all those means not raising money to get listed. In the Growth Enterprise Market (GEM), this is also the case, although no specific clause stipulating this however in the practice this is a de facto requirement. |
Thirdly, in the current policy, the stocks already issued before the IPO are not allowed to circulate in the foreign stock exchanges. They can only be transferred in private. The block of the exit of capital is one of the primary reason why the company wants to go overseas indirectly. |
Fourth, apart from the initial IPO, the following refinancing, the issuance of the convertible bond and the transfer from the GEM to the main board will apply the same standard and go thorough the same procedure as the IPO, and requires the CSRC’s permission. It is very burdensome for the issuer, and the standard is as unclear as the domestic listing, which will take considerations of profitability into consideration. |
Fifth, the CSRC will sometimes exercises windows guidance, which interveins the market. If they feel there is too rapid growth in the foreign currency reserve, they will issue informal guidance to restrict the companies from going overseas. Or they will restrict that the funds raised in the foreign market will not be allowed to transfer back to the domestic market and can only be used in the foreign projects. Or they will ask the companies to first issue in the A shares. Or they will restrict the prices of the shares issued in the H shares market not lower than prices of the A shares market.[68] |
In conclusion directly listing overseas is not much different from listing in the domestic market. They both require the CSRC’s permission, the CSRC will in exercise substantive review in both cases and the standards of the review is very uncertain. |
6.2. Bond Market |
There are overall three sets of rules governing the bond market, corresponding to three different types of bonds and markets. The first type is the company bond. This bond can only be traded in the stock exchange, the issuer has to be a listed company. And the procedure and standard of issuance are not much different from that of IPO.[69] Because of this character, the activity is supervised by CSRC, and the applicable rules are Company Law, Securities Law, and Regulations on Administration of Enterprise Bonds. The qualified investors are not mainly individuals. The second type are commercial paper or short term financing bill and medium-term notes. The maximum time limit of the first one is not more than 365 days, while the latter is within 3-5 years. They can only be traded in the inter-bank bond market. So the activity is regulated by PBOC and the Administrative Measures for Debt Financing Instruments of Non-Financial Enterprises in the Inter-bank Bond Market applies. The qualified investors are institutions. The third type is the enterprise bond, which is mainly traded in the inter-bank bond market. The peculiarity of this type is the issuer. The issuers of this type are mainly state-owned enterprises and in the recent years Local Government Financing Platform Companies, which is established by the local government or its administrative organs by contributing lands, fiscal appropriation or other assets or shares, for the purpose of city building, and have the independent legal personality.[70] The governing body is National Reform and Development Commission, and the applicable laws are Regulations on Administration of Enterprise Bonds. The qualified investors are mainly institutions. |
There is one thing in common about these types. The issuers of these bonds are mainly listed companies and huge state owned enterprises. For the former, it corresponds to the first type. For the latter, it corresponds to the other two types. Even when the second type is specifically designed to meet the needs of the small to middle companies. |
The reasons for these are complicated. First of all, in history, in 1981 the state bond appeared first, which is the first kind of bond in China.[71] Also, almost all the companies are stated owned enterprises in the beginning, so almost all the companies bonds are issued by the stated owned enterprises, in 1992 the Regulations on Administration of Enterprise Bonds. Moreover, in 1994, the first type of policy financial bond was issued. Only until 2005, did the short term financing bill came into place, and the medium term note had to wait until 2008 to be approved. Moreover, only until 2007 did the Pilot Rules on the Issuance of Corporate Bonds appeared. So the structure of the bond market is mainly treasury or quasi treasury note oriented. According to statistics, 80% of the bonds are treasury notes, financial bonds, policy financial bonds, and central bank bills.[72] |
Because of these structure, so for a long time the credit rating is not properly developed in China. The reason for this situation is that in the three types except for the second type, in order to issue the bonds, the first type has to be a listed company and goes through the procedure similar to IPO and the third type has to get approval from the NDRC, so they first has to go through a substantive check and moreover they are already listed companies and stated owned enterprises. Because of this de facto double proof system, there is no need for the credit rating. |
While in the second type, it is a very recent practice. Even though the procedure is registration system, so it is easier for the issuer, however, the buyer in the market is not interested. Because the structure of the market is huge state owned enterprises oriented. According to statistics, more than 60% of the market is held by the commercial banks.[73] So for the buyer there is no need to focus on the small companies bonds, because the amount is small and the risk is bigger. Also, the structure of the buyer in this market is institution oriented. These buyers are risk-averse and also because it is a OTC market so the liquidity is low. |
This leads us to the third problem that the bond market in China is in fact threaded. The two markets are not connected are interchangeable. In the stock exchange, liquidity is higher, however, the institutional investors are not allowed to invest in these market, while in the OTC market, the individual investors are not allowed to invest in these market. The issuers and investors are not allowed to freely travel between these two markets. This practice lowers the liquidity and is not good to cultivate different risk preference investors. |
6.3. Private Fund |
The private fund means the issuance of the securities is not in a public manner, and can not use any means of advertising, public inducement or public issuance in any disguised form.[74] The form of the private fund includes venture capital(VC), private equity(PE), hedge fund(HF). Here the focus is on VC and PE. |
In the start up period of a company, in order to survive, grow or expand, the company has to find investors. Usually in the very early period, when the companies are very small, those investors are called VC, they only invest in small amounts of money not more than 1 million US dollars and acquire a percentage of share normally around 10%, not exceeding 30%. In the later period, after several rounds of raising capitals, the company grows into a large entity and sometimes in the near future they will seek public listing, usually within 3-5 years. At that period, the company needs large amounts of money to fastly develop or acquire their competitors, in this period, the investors are PE, they usually invest several million dollars to several hundred million dollars. |
The reason for those private funds to invest in a company is to seek profits, in order to do that, they need to find a way to withdraw their investment. Normally, there are several ways for the withdraw. The first way is to sell the shares to other investors, for example the VC sell their shares to PE, or a PE sell their shares to other PE. It is difficult to do that in the latter scenario but easier in the former. Because normally in the latter period, the PE will wait for the IPO because the rate of return is much better. The second way is to sell the shares back to the shareholders or the management(MBO), however, this way is harder for the private companies not listed. Because there are not many shareholders in the first place[75] and the management is usually the founder of the company and they themselves actually control large amounts of shares of the company. However, in the last scenario, it will happen in one condition, which is that the company signs the Value Adjustment Mechanism(VAM) with the investors. In the VAM, it will set some terms and if these terms are met then the company will repurchase the shares from the investors.[76] The third way is the most common way for the investors to finally gain profits which is IPO, the average price to earning ratio(P/E) in the Chinese high-tech companies listed in the US market is 49.6 times, while the P/E in the consumer companies are 27.31 times.[77] |
However, when it comes to IPO, they will face tremendous obstacles as discussed before. Secondly, in China the capital account is strictly controlled. If the company finally chooses to list overseas, then they can only choose US dollars fund; Also, if the company chooses to list in the domestic market, then it can only choose RMB fund. The opposite is also true, the type of money they accept determines the final destination for IPO. |
Another problem restricting the use of the RMB private fund is that before the establishment of Chinese growth enterprise market, the ChiNext in 2009, there is almost no need for the RMB fund. The situation is better now, even though the standard of listing in the ChiNext is higher than that of NASDAQ.[78] |
The third problem restraining the development of the private fund is that the existing period of the RMB fund is normally 3-7 years, while the Dollars fund normally exceeds 10 years. So the dollar fund can wait longer for the growth of the companies and do not seek short term profits. The characteristics of the high tech company means that the company is not able to gain profits in the short term. |
The last problem for the PE is that the validity of the VAM is questioned in China. In the HFFUND case, the Supreme People’s Court of People’s Republic of China(SPC), in the retrial the court partially confirmed the validity of the VAM. In the case, there are four parties involved. The HFFUND, the Shiheng company, the DIYA company(HK), and Lu BO. The HFFUND is a PE, the DIYA company owns 100% of the Shiheng company, and Lu Bo is the controller of the DIYA company. The four parties signed the Agreement to Increase Investment (Agreement), in the Agreement the HFFUND invested 20 million yuan in the Shiheng company, and owns 3.86% shares. In the agreement, the Art.7 (2) is a VAM clause, which says that if the Shiheng company cannot meet the targeted net profits of 30 million yuan in 2008, then the HFFUND can ask the Shiheng company to compensate and if the Shiheng company cannot fulfill the obligation then the HFFUND can ask the DIYA company to compensate. |
In the final ruling, the SPP confirmed that Article 7 (2) between HFFUND and Shiheng company is null and void according to Chinese Company Law. Because in Chinese Company Law, the appropriation of the profits has to go thorough certain procedures.[79] And also according to the capital maintenance principles and the doctrine of independent property, the company’s assets cannot be taken away without due process, which results in the detriment of creditors and therefore is deemed to injure the interests of the company.[80] The only two ways that the shareholders can get assets from the company are through capital reduction and allocation of profits. Both require certain procedures.[81] However, in the VAM clause, the HFFUND gets company assets without due process. |
On the other hand, the SPP ruled that the clause between the HFFUND and DIYA company should be valid. Because this is a contract between the shareholders not a shareholder and a company. The nature of the VAM is part of the Agreement. The Agreement in essence is to increase the value of the shares. So the VAM is a tool to adjust the value of the shares when the unexpected happens. So the shareholders merely return the wrong increase of the share price and give it back to the investors. Moreover, in the end, the SPP ruled despite that in principle the VAM between shareholders is valid, however, the VAM should be fair and equitable. |
In conclusion, the SPP ruled that first the VAM between the shareholders is valid while one shareholder and one company is invalid. And second, the equity of the VAM should be taken into consideration.[82] |
7. Reform7.1. Introduction |
There are multiple problems as discussed before in the Chinese financial system and this is why so many companies choose overseas indirect listing. The problems can be divided into two tiers. The first tier is between domestic market and foreign market. In the domestic market, the structure and function of the market should be improved. In the financial market, there are two types of ways to raise money, the first one is direct financing and the second one is indirect financing. The direct financing is that the financing without intermediary, namely the borrowers directly meet the lenders, while the indirect financing uses third party service such as a bank to act as an agent between the borrowers and the lenders.[83] So the solution to the problems in the domestic market can be approached from both sides of direct financing and indirect financing. On the part of the foreign market, it can be divided into two types. The first type is the direct listing and the second type is the indirect listing. For the direct listing, the 456 rule is too burdensome and should be deleted, and also the CSRC acts long arm jurisdiction and in fact intervein the judgment and jurisdiction of the foreign authorities. For the indirect listing, if the offshore company controls the domestic company by shares then it will be under the supervision of the No. 10 order, which is nearly mission impossible for the company to pass the check. If the offshore company controls the domestic company by VIE structure, there will be risks inherent in this structure. Both of the two types face the same capital account control problems. The currency cannot flow freely across the border. |
The second tire is related to supervision and control. The current situation is that in order to prevent the crimes, so everything is under strict control even when the normal business operation is jeopardized. While for this part, the prospect is not so optimistic, because it will go to the root of the economic and political structure of the Chinese society. However, there are still something that can be done. The first one is the most important one, which is the reform of the SOE and this is one of the main reason that the Chinese financial market is distorted and the corruption is high and the second one is to strengthen cooperation with the global anti-corruption activity. |
So in this chapter, some advises will be given concerning the parts discussed above. |
7.2. Registration System |
The registration system has been called for for a very long time. There are wide discussions that the substantive approval system should be abolished. The Chinese administration should mimic the US administration and adopt a registration system which means the merit and intrinsic value of the stocks will not be checked and as long as the information disclosure is true then we should let the market not the government detect the good stocks from bad stocks. |
However, is it really the case that there is no substantive check in the US system? In fact, the US registrations system is a Dual Registration structure.[84] Because in the Federation system, the power is distributed between the State and the Federal government. Except for fractional free issue, the stock is registered both on the State and the Federal level. In the Federal level, the authority of the Federal government is strictly restricted. They mainly check the authenticity of the information disclosure. However, in the State level, for a hundred years, the State exercises the substantive check.[85] The opinion that the Chinese issuer has not undergone substantive check in the US stock market is that because the stock is listed on the international board, on which the substantive check is exempted.[86] Moreover, the financial intermediary takes the partial responsibility of the substantive check and except for some special board such as the international board, the stock exchange exercises the substantive check.[87] |
Even in the US, the Academia is not without doubt to support the information disclosure based system. There are two types of criticisms. The first one is from the standpoint of investor protection, the second one is from the standpoint of systemic risk. The first approach questions the prudence of the investors, and they do not believe in the more sophisticated financial world the investor is capable to digest the information. The second approach believes that the financial market is so important that it should not be subject to the control of private parties. They believe that a more comprehensive and thorough control is needed that the financial market not only should be under the supervision of a new self-disciplined business group, it should also be subject to the control of the government authority which can interact and connect with the pubic interests and profits driven entities.[88] The theory is based on the fact that the inappropriate investment decisions will have negative externality on the other investors, and the 2008 financial crisis is an example. |
From the above discussion, we know that the US registrations system is not completely free from substantive check. It just distributes its power to several other different entities so the substantive check is through different channels. |
In the information disclosure system, it is in essence a compliance check. However, in the substantive approval system, the business value is also checked. The most important standard to check the business value in Chinese Securities Law is the ability to general profits sustainably.[89] However, even in the business value evaluation part, some of the criteria is in fact the compliance check. In the check, the CSRC will check the income, cost, period expense and net profits. In the income part, the connected transaction is checked. In the period expense part, they will check whether the loan interests and cost of the occupation of other funds is complied to the rules. In the net profits part, whether the accounting treatment of the governments subsidy is appropriate. All of them is actually compliance check. |
Moreover, whether the pure business evaluation is needed is another question. The Chinese market structure and the US market structure is different. There is comprehensive credit system in the US market, and the availability and reliability of the information is the foundation of the system. However, this advantage doses not exist in China. Also, in the US market, the investors are mainly institutional investors while compared to China, the investors are mainly individuals.[90] Because of this characteristic, the market is not as professional as the US market, so it is more vulnerable to crisis and moreover the ability to recover from the crisis cannot be compared to US. |
So how should the system changed. If we look at the real power in the US securities regulation system is the power of the SEC. As explained before, the CSRC is very small.[91] The CSRC is merely a ministerial level agency, while the companies they supervise many of which are SOEs and are also ministerial level agency. While the SEC is an independent agency, independent from the other three powers, and the commissioner is appointed by the president. Second, all the types of securities are under the supervision of the SEC, including bonds, commodities and contracts which are related to the securities investment. While the CSRC can only regulate the securities on the stock exchange the bonds traded in the inter-bank market are off the hands of the CSRC. And also, the SEC is not merely a administrative licensing authority, it is also a quasi judicial body, which can investigate, prosecute and punish the crimes.[92] However, the CSRC on focuses on the approval of the issuance, if lacks the following supervision after the issuance. For example, there is no circuit breaker authority in the CSRC, which means that when there are unusual fluctuations in the market the transaction can be stopped. |
So the reform of the CSRC should be initiated. First of all, all the types of securities should be under the supervision of the CSRC, and secondly the level of the CSRC should be improved from the ministerial level vice premiere level. Thirdly, the staffs and budgets of the CSRC should be increased. Fourthly, more powers should be invested in the CSRC, and the trend is for the CSRC to evolve to the quasi judicial body. They should be able to take actions when the unusual circumambiences occur and also seal the accounts, freeze the money, monitor the suspect and prosecute the criminals. |
The suitability rule should be introduced. In the US the SEC can issue guidance on what is a suitable customer. They can federalize the definition and make it a Federal applicable rule. |
The main criticism of the strengthened role the the CSRC is that it will be never enough, because China is a huge country only the CSRC is not capable of supervising so many activities. That is why in the provincial level, the local government should act as the first line of gate keeper just like the US State government. Also, the CSRC can keep the compliance check and the the part of the business value check which is closely related to the compliance check. The rest of the business value check should be given to the stock exchanges. Also, for the financial intermediaries, the role of the lawyers should move forward, and not to act as the final signer. They should take the responsibility in drafting the share prospectus and not the underwriters. For the underwriters, when they are removed from drafting prospectus, they should focus on underwriting. Moreover, because the market is not mature in China, so each share should be underwriting by the syndicate, and they should take joint liability. Moreover, the commercial responsibility insurance system should be established. |
7.3. The Multi-layer Capital Market System |
Another major issue is the Multi-layer Capital Market System. Because the major problems concerning the Chinese financial market is that the standard is inflexible so it does not reflect the needs of the high tech companies. However, it is not appropriate to change the standard completely. So build a board which specifically suits the need of the high tech company is a better option. In this way, it also offers partial solution to the registration system, because in the new board, the standard can be lower to some extent. |
In the US, there are three layers of the financial markets. The first layer is the main board including the New York Stock Exchange and the American Stock Exchange. The American Stock Exchange is in the service for the small and middle sized company. The second layer is the over the counter market including the NASDAQ, OTCBB and PINK SHEET, the third layer is the regional stock exchange, including the Philadelphia Stock Exchange, the Cincinnati Stock Exchange, the Pacific Stock Exchange, the Middle West Stock Exchange and the Chicago Board Options Exchange.[93] |
In the second tier, the NASDAQ is the National Association of the Securities Dealers Automatic Quotation. In 1968, the NASDAQ first tried the solve the fractions between different OTC, so it build the first national quotation system. In 1975, the NASDAQ declared that only the stocks listed in the NASDAQ can be quoted, so again it was independent from other OTC. After 2006, the NASDAQ is divided into three parts the first one is the NASDAQ Global Select, NASDAQ Global Market and NASDAQ Capital Market. |
The OTCBB is the Over The Counter Bulleting Board, which is set up by NASDAQ in 1990. It is not a board, it is only a quotation system. Any stocks which do not satisfy the requirements of the NASDAQ or delisting from NASDAQ will trade in the OTCBB. In the OTCBB, there is no listing standard, the company only needs to file their quarter and annual financial report to the SEC and disclose these reports to the public. |
The PINK SHEET market is at the bottom. The PINK SHEET market is like the OTCBB and is not a dealing system but only a price quotation system.[94] In 1999, the electronic quotation system is introduced. After 2000, the market is organized by the PINK company. There is no requirement to list on this market and there is even no financial disclosure requirement, any stock which has two market makers who are willing to trade this stock the price of which will show on the quotation system. |
In all of the markets which provide dealing function, only the AMEX and the NASDAQ target the high tech and small to middle sized company. In the AMEX the profit criteria is not less than 750,000 US dollars. Even in the NASDAQ, not every section is suitable for the high tech and small companies. In the NASDAQ the standard of the Global market is the highest, which is even higher than the NYSE Big board by 10 percent in each of the financial requirement.[95] In the global market, the aggregate earnings should be more than 11 million dollars and the profit of the each of the previous three consecutive years have to be positive and in each of the two recent fiscal years the net profits have to be over 2.2 million dollars. Or under option 2, 3 and 4, there is no requirement of earnings however it has other requirements in cash flow, revenue and equity.[96] In the Global Market the pre-tax income in two of three previous years should be more than 1 million or with other financial requirements, while in the Capital Market the capital income should be more than 750,000 or with other financial requirements. In this sense, NASQAQ has become a board that has the characteristic of both the first and second tier of market.[97] |
Another characteristic of the US stock exchange the stocks in each of the market is interchangeable, if it meets the requirements of the higher board, then it can transfer to the higher board, and if it fails to meet the requirement of the higher board, then it will be delisted to the lower board. Also, the market maker system is another special features of the second tier market. Although today, the NASDAQ is almost the same as the NYSE, however, from the beginning when it was only a OTC market, in order to create the liquidity in the market, the NASDAQ introduced the market maker system, in which the market maker acts as an intermediary to buy and sell shares and they earn the price difference. The market maker is obliged to buy the shares in order to create the liquidity of the market. In order to trade in the market, each of the shares has to have at least 3 market makers and in average there are 12 market maker per company, and for the big ones there are 40 market makers.[98] |
Compared with the Chinese stock exchange. In China the Shenzhen Stock exchange first established the SEM board in 2004, however, the financial requirement is exactly the same as the main board, only the amounts of the shares are different.[99] The GEM board was established in 2009, the financial requirement is significantly lowered,[100] however, compared with the NASDAQ, it is still much higher, it is almost the same as the NASDAQ Global Market. Moreover, in the NASDAQ, there are other options which do not need to meet the profits requirements, instead other requirements such as the cash flow, equity, market value and total assets as long as shareholders number can be used as the judging criteria. |
So in order to create a market really suitable for the small sized company and the high tech companies, a new board is needed. It is preferably a OTC market, in this market there should be the market maker system in order to create liquidity, and the in the market the registration system should be established and the qualified investors should be those with the ability to bear the risks. |
7.4. The Bond Market |
The problems in the bond market is that the market structure is pro big companies. In order to solve this problem, two reforms are needed. First of all, the liquidity of the market should be increased and the types of the investors should be multilateral. Now the stock exchange and the inter bank market is divided, but in the future they should be connected so that the liquidity can be increased. The National Social Security Fund, the commercial banks and the insurance companies should all be able to participate in the market. Another solution is that the types of the product designed specifically for the small companies should be increased. There are mainly three types of tools toward small companies, which are SME collective note, Private Placement Bond and Debt Financing Instruments of Non-Financial Enterprises. The SME collective note is to combine the small companies together, and credit them as a whole. However, because the untrustworthy credit rating system, so this act does not have the credit upgrade effect, most buyers will require the collateral. And also because the procedures are too cumbersome. So in the end, this sells badly, which only accounts for 0.19% in the market.[101] The Private Placement Bond does not function well either, because of the same reason as the first type and it is traded in the Stock Exchange and compared to inter-bank market, Chinese Stock Exchange market is very small.[102] The last type should be the main tool for the small company, because it is traded in the inter-bank market, and in the inter-bank market it is a registration system and regulated by National Association of Financial Market Institutional Investors. However, the practice started on April 2008, not long after the bond was issued, June 2008 the PBOC stopped the practice, the total amount of 73.5 billion RMB trade failed to complete. In October in order to inject liquidity into the market, the PBOC re-permitted this action, however, it reiterated that the focus should be on big companies.[103] |
7.5. Indirect Financing for Micro and Small Business |
Today most of the companies in China relies on loan from banks. However, the small companies cannot get money from banks. This is due to several reasons, the most important one is the interest rate control. The interest rate control is the opposite to interest rate liberalization, which means that the interest rate is not protected by the authority and is totally determined by the supply and demand of the market.[104] Interest rate liberalization in China started from 1996, and till now only the upper limit of the deposit interest rate and the low limit of the loan interest rate are controlled.[105] On June 8, 2012, the PBOC widened the fluctuation band for the limit, setting the upper limit of the deposit rate 1.1 times higher and low limit of lending rate 0.8 times the normal rate.[106] And further on June 20, 2013, the PBOC issued the order, the low limit of the lending rate was abolished. [107] |
The rate liberalization will have several impacts on the business model of the banks. For now most of the banks in China are state owned banks, and most of them only lend money to the huge enterprises.[108] Now the income structure of the Chinese banks are largely cost of carry, namely the difference between the lending rate and deposit rate. This type of income in the big five is on average more than 70%, in the other commercial banks, the rate is more than 80%, some of them even reached 90%. Compared to the other foreign banks, the average percentage is only 50%. The reasons for this is large due to the reform in the stated owned banks, which is part of the reform in the state owned enterprises. During that time, the percentage of the non performing loans in the banks are in average 17.9 percent, so except for building 4 assets management companies to peel off those loans and the state treasury injecting the funds into the banks, the other method is to widen the gap between the loan and deposit rate, so that the banks can have better profits.[109] Now the non-performing rate is only 1.1% and the gap between the two rates are from 1990 1.44% to 2011 3.15%.[110] |
However, if the interest rate is liberalized, the competition will be harder, because the large companies will choose those whoever offer the lowest lending rate. So the banks will have to go to find other new business instead of sticking to the large companies. There are two things that can be done, the first one is to find some high risks business, because high risks mean high profits the second one is to be innovative. Under the pressure the banks will turn to previously ignored small companies. |
The experience from the US banks Wells Fargo is pretty enlightening. It is the largest bank focusing on small companies. The Wells Fargo generates 56% of profits from the retail bank business, and in 2012, it became the largest bank by market value and the 5th by total assets in US. Its ROTA and ROE is 1.2 times higher than the industry average.[111] Its loan rate targeting at the micro and small business is 2.05% higher than the loan targeting at middle and big sized companies. |
The success can be reduced down to several parts. The first part is that it clearly studies the market and divides the clients into 10 types. The second part is that it designs an automatic processing system. It developes a ranking system that evaluates the risks of different types of customers, if it meets the criteria then the loan is automatically approved, no collaterals and other procedure is needed. The third part is that it has a very efficient risk management system, which uses big data to find out the information. Moreover, it builds a tracking system, which tracks the behaviour of the borrowers. It will alert the bank before the bad results happen and will reward the good performer for alleviating the credit and further reducing the loan process in order to avoid the adverse selection risk. |
From the experience from the Wells Fargo, we can see that concentrating on the small business and strengthening the risk management ability is the key to success. There are two hypothesis in the banking industry that can explain this. The first one is the long term interaction hypothesis and the other is monitoring hypothesis.[112] The first one says that because the information asymmetry, only those have a long term interaction will know the situation. The second one says that in a common group the small business will act for their whole groups interests to monitor each other. |
From the above we can see that the breakpoint is to allow the private parties to set up banks. Because the private banks will not have the resources of the big banks, so they have to dig into the the small business which the big banks ignore, and if they concentrate on this, in the long term it will generate nice profits. This kind of actinon will be one step toward the liberalization of interest, because it is a test for the result after the liberalization. |
7.6. Ease the Procedures in the Overseas Listing |
The biggest headache in the overseas listing is first the No.10 order, and second the No.75 order. These are the ground rules, other orders such No.124, No.106, No77, No.53 are all the detailed supplementations to the No.10 and No.75 order. |
In all the inconvenience those order creates, the most inconvenience of all is the foreign currency control. In China, for a long time the foreign currency is tightly controlled. The basic regulation in control in China can be divided into two parts, the first part is the current account, the second one is the capital account. The current account mainly includes the trade, and the capital account mainly includes three parts, the FDI, the securities investments and the foreign debt. After 1994, the current account is liberalized, as long as the actual transaction happened. However, the capital account is partially controlled. The FDI is liberalized while the securities investment is controlled. In the FDI, the foreign currency can be retained in the company’s account, however, because the securities investment is controlled, so in order to prevent the foreign currency to invest in the securities, so the ‘Order of Payment Exchange Settlement Procedure’ is introduced. In this system, the money cannot be used for equity investment and lending it has to have actual needs and within the scope approved by the authority. The proof of the actual need has to be provided, and the money is directly paid to the counter party.[113] |
Normally, in order to solve the problems there are two ways. The first way is called ‘offshore loan against domestic guarantee’.[114] In this case, the company deposit an amount of money to one bank in one bank, and the bank will issue a letter of guarantee to the branch bank in the other country, and the company can withdraw the equal amount of money. The second way is called falsify the trade transaction, because the current account is not controlled.[115] |
This affects two things. The first one is the development of the RMB VC. This is a vicious circle. In the circle, the standard of the domestic stock exchange is high, so it will force the companies to go overseas, and because the foreign currency is tightly controlled, so the RMB VC is not competitive, so less qualified companies are nurtured so the quality cannot be lowered. The second one is that it impedes the normal activity of the fund raising and investment. In the No.75 Order, in Art. 6 it says that “The profits, dividends and foreign exchange income from capital variation, which are gained by a domestic resident from a special purpose company, shall be transferred into China within 180 days as of the day when they are gained.” Another inconvenience is that in Art. 7 every major change in the SPV shall be filed in the foreign currency administration. [116] |
Another order relating to the foreign investment is the Notice of the General Affairs Department of the State Administration of Foreign Exchange on the Relevant Operating Issues concerning the Improvement of the Administration of Payment and Settlement of Foreign Currency Capital of Foreign-funded Enterprises No. 142 Order. In this Order, the Order of Payment Exchange Settlement Procedure applies, and it can only be used in the scope approve beforehand. In this case three bad scenarios will happen. First of all, if there is no actual needs, the foreign currency has to be retained in the foreign account, so the company cannot enjoy the benefit of the appreciation of RMB. Secondly, if the company uses the VIE structure, then the money can not be provided for the VIE. Thirdly, if the company uses red chip mode, then the foreign currency cannot be settled and used as the M&A money to acquire new companies.[117] |
8. The Current Status and the Future8.1. Registration System and the Multilayer Financial Market |
There are multiple steps that have been taken to tackle the above problems in correspondence to the suggestions above. |
Building the registration system and the multilayer financial market is the national policy set in the recent government report,[118] these two topics are interrelated. However, how these should be done is the major issue. Xiao Gang, the president of the CSRC, draws the picture by answering the interview by the Securities Times, in which he gave three opinions. He says that first the registration system will revolve around the information disclosure. Secondly, the CSRC will be responsible for setting the rules for both issuance and listing. Thirdly, some of the checking power will be sent to the stock exchange. |
In terms of the multilayer financial market, despite the current Small and Middle Sized Enterprise (SME) board and Growth Enterprise board (GEB) , another board more suitable to the characteristic of the small and high tech company is needed. It should allow the companies to list on the board without profits requirement. On January 16, 2013, the National Equities Exchange and Quotations (NEEQ) was established. The predecessor of the NEEQ is the Agency Share Transfer System(ASTS). The NEEQ is the national stock exchange established by the State Department and is managed by NEEQ Co. Ltd.. Previously, there were only two types of companies in the ASTS, which are companies from the NET and STAQ system, the first of which was build inside the Shenzhen Stock Exchange, and the latter of which was in the Shanghai Stock Exchange.[119] The purpose is to build an OTC market connected by the internet. However, due to several reasons, the transaction volume was very inactive. So in 2001, the Securities Association of China issued the Rules of ASTS(证券公司代办股份转让服务业务试点办法), the NET and the STAQ was actually merged and the ASTS was established. In 2002, in order to solve the transfer of shares of the delisting company, the delisting company was taken by the ASTS. [120] In 2006, Rules on Zhongguancun High Tech Companies Trading on ASTS(证券公司代办股份转让系统中关村科技园区非上市股份有限公司股份报价转让试点办法) was issued, and the unlisted company in the Zhongguancun Science and Technology Park was allowed to trade on this market.[121] Now overall there are 800 companies listed on the new board.[122] |
The listing standards are greatly lowered. In the Rules of NEEQ (全国中小企业股份转让系统业务规则), in Art. 1.6 it says that the NEEQ establishes the Primary Brokerage Sponsor System（主办券商制度）, under this role, it is the brokerage firm who recommends the company and coaches the companies performances after the listing. Also in Interim Rules on NEEQ Co.Ltd.(全国中小企业股份转让系统有限责任公司管理暂行办法), Art. 20 says that the main role of the brokerage firm is to recommend, monitor, acting sale, and market maker. Further, in Rules of NEEQ Art. 1.10, it says that the company can have over 200 shareholders before listing, for those companies having over 200 shareholders, it should be approved by the CSRC. Even there are still some requirements, however, it opens the gate for the company. In Art. 2.1 (2), it says that the company should have the ability to gain profits sustainably, however, it does not have any requirements on the 3 years consecutive growing profits, and the minimum profits requirement. And most important of all, in Art. 1.11, it says the company is self-regulated, in Art. 29 of the Interim Rules on NEEQ Co. Ltd. it says that the NEEQ company punishes the unlawful behaviour and only under special circumstances provided in the Securities Law should the CSRC step in. And in the, Art. 21-22 says that the NEEQ company is in charge of checking the documents. This will be much easier than the scanning process conducted in the CSRC. |
In Art. 1.8 it says that only the qualified investors are allowed to trade in the market. Further in Rules on Qualified Investor in NEEQ (全国中小企业股份转让系统投资者适当性管理细则 (试行 )) in Art. 3 it says that the institutional investor should have registered capital more than 5 million yuan if it is a limited liability company and actual receipt capital more than 5 million yuan if it is a partnership company. In Art 5. it says that the natural person should have securities assets more than 500 yuan under his account one day prior to the trade, and should have more than 2 years of trading experience or the background in finance, accounting, economics or investment. |
The most important innovation is that the board will build market maker system. And market maker is not the only option. In Rules of NEEQ Art. 3.12-3.14. It says that the company can choose the market maker, agreement transfer, and aggregate auction. |
However, the problems of the NEEQ is that it lacks liquidity. Because for now most of the trading is done by agreement transfer. So in the future the best option is to build a uniform settlement system. Also, in the future, the qualified investment threshold will be lowered, or otherwise there will never be enough liquidity in the market. However, in the mean time, the information disclosure system and the power of the supervision authority should be well built. Last but not least, the expansion transferring system should be built, and it will either set the rules for the company to list on the main board or other board, or it will divide the into different segments like the NASDAQ. |
8.2. Direct Listing Overseas |
On the part of direct listing overseas, previous documents regulating this behavior is the CRSC Notice on Direct Listing Overseas(中国证券监督管理委员会关于企业申请境外上市有关问题的通知(1999) No. 83 Order). In this Order, it set the rule that the net assets should be not less that 400 million yuan, the net profits should not be less than 60 million yuan and the amount of fund raised should not be less than 50 million US dollars.[123] Now the No.53 Order is replaced by the New Order On Direct Listing Overseas(中国证券监督管理委员会公告[2012]45号――关于股份有限公司境外发行股票和上市申报文件及审核程序的监管指引), in this No. 45 Order, the “456” requirement is deleted. |
8.3. Indirect Listing |
In this part, on July 14, the SAFE Notice on the SPV Overseas Fund Raising and Round Trip Investment(国家外汇管理局关于境内居民通过特殊目的公司境外投融资及返程投资外汇管理有关问题的通知(汇发[2014]37号) ) No. 37 Order is issued by the SAFE in replace of the famous No.75 Order. In the No. 37 Order, several improvements are made. |
First, it simplifies the procedures for the foreign exchange registration. In the procedure, in No. 75 Order, the foreign exchange registration is not a “registration” instead it is in fact an substantive approval system, the business plan, the shareholders structure and the overseas financing arrangements need detailed explanations, the sources of the assets need the authority’s ratification and the pricing method needs to be explained[124] Also, in the subsequent detailed operating rules No. 106, it in fact puts every step involving in the indirect listing under surveillance, from establishing SPV to injecting assets to overseas listing to return investment. Also, it says that all the major capital modification without the involvement of the return investment shall within 30 days go thorough the modification procedure and archive filing in the foreign currency administration.[125] However, under No. 37 Order, all these are largely simplified. Only the identity of the shareholder and the certification of the ownership of the assets and the business plan are needed. No detailed background check and explanations and no authority’s ratification is needed. Moreover, only the change relating to capital increase or decrease, stock right assignment or exchange, merger or division and the change in the basic information of registration of a company should be filed in the foreign currency administration, also the time limit of 30 days is erased. |
Secondly, it clarifies the procedures for the foreign currency registration. The return investment should take as reference the procedures of the registration in the the normal FDI.[126] Also, the procedure of the ex post facto registry is specified. In the No.75 Order, it only says that after company made up the foreign currency registration, the administration can handle the subsequent matter. In the operating rule No.106 Order, one of the procedure rule is given, for the first time it set the rule ‘first punish then register’, but it was subsequently abolished.[127] However, in the subsequent operating rule No. 77 Order, it restated that the previous rule, however lacking the specific procedure. So the purpose of the Order is understood differently in different places, in some places the ex is allowed while in others it is not. In the new No.37 Order, it now sets the specific rules for punishment and the ex post facto registry so the procedures are clear now.[128] |
Thirdly, the freedom to use the money raised is greatly improved. In the No.75 Order, the money raised in the foreign market should be transferred back to China within 180 days. Now under No. 37 Order, the money raised can be kept by the foreign SPV’s account. Moreover, the No.37 build the money channel between across the border. It allows the domestic company to lend money to the SPV and change the foreign currency to support the commercial activities. |
8.4. Liberalization of Interest Rate and Foreign Currency Control |
In the SAFE Notice on Voluntary Exchange Settlement in Experimental Site(国家外汇管理局关于在部分地区开展外商投资企业外汇资本金结汇管理方式改革试点有关问题的通知 No. 36 Order), it made multiple breakthroughs in the foreign currency control system. In the old No. 142 Order, the ‘Order Payment Foreign Exchange Settlement System’, equities investment and lending are not allowed.[129] However, in the No.36 Order, the SAFE selects 16 regions to experiment on the Voluntary Foreign Exchange Settlement System, in Art. 4 it says that the foreign currency can directly send to the foreign companies’s account. |
Another method used to ease the foreign currency control is the cross border RMB. The cross border RMB is a new business. Because it is in fact not related to foreign currency control, because it is RMB. The different supervising authority can confirm the previous statement, because the foreign currency is regulated by SAFE while the RMB is regulated by the PBOC. Because RMB in the previous years is not used widely by in the market, so the cross border of RMB is meaningless. However, for now RMB is the 7th largest payment currency in the world according to SWIFT.[130] The cross border RMB will certainly have huge impact on the foreign currency control, if the reserve of offshore RMB is enough and the need of RMB is increased and the RMB is widely accepted as the payment currency, then the need for the foreign currency will be diminished, therefore the development of the cross border RMB will in fact breaks down the foreign currency control. |
There are three pillars building the framework of the cross border RMB. The first one is the establishment of the overseas clearing bank of RMB. By now there are 10 clearing banks in Asia and Europe.[131] The second pillar is the establishment of the Shanghai Free Trade Zone(FTZ). In the FTZ, the company and individual enjoy certain freedom in the transfer of the RMB. The third pillar is the cross border RMB lending. The experiment side is chosen in Shenzhen Qianhai. |
In the Shanghai FTZ, the PBOC Supporting Opinions on the Financial Reform of Shanghai FTZ (中国人民银行关于金融支持中国（上海）自由贸易区建设意见(2013)) gives many supporting policies for the ease of the cross border RMB. In the FTZ, basically, the RMB can cross the border freely, however outside the FTZ, the control is the same. In Art. 2.6, it says that the money between the FTZ account and the all other account in and outside the FTZ is freely transferable. And, in the Art. 2.7 it says that the account in the FTZ can cross border capital raising and cross border guarantee. In Art. 3 there is a whole set of rules facilitating the investment. Art. 3.8 says that in the FDI, the company in the FTZ can cross border receipt without the prior permission. Art 3.9 says that the individual can pay debt across border and lend money across border. Art. 3.11, it says that the company in the FTZ can borrow money from overseas. |
In the Qianhai district, the Notice on Cross Border Lending(关于印发《前海跨境人民币贷款管理暂行办法》的通知 深人银发【2012】173号) sets the ground rules for the cross border lending. In Art.2 it says that the cross border RMB lending means that the company in the Qianhai area can borrow money from the Hong Kong bank. Art. 11 says that the borrower should open account at the clearing bank in Qianhai. The account should only be used to receive money from Hong Kong bank. In Art. 8 and 9 it says that the interest rate and amount should be determined by the borrowers and lenders themselves. |
From the regulation we can see that the cross border RMB lending means that borrowing money from Hong Kong bank. It is an offshore RMB lending. Secondly, the Qianhai bank acts as the clearing bank. Normally there are two operating models in the business. The first one is that the Hong Kong bank takes the responsibility, it checks the credit of the borrows and monitor the borrowers behavior, while the Qianhai bank only acts as the clearing bank. The second one is that the Qianhai bank is responsible for the due diligence check and earns intermediate charging from it. [132] |
In the offshore lending we can see that not only the foreign currency control is eased, moreover, the interest rate is also liberalized and determined by the market. This is not the only thing that changes the interest rate control. Another movement is to allow the private companies and persons to start building banks. |
As the previous theory predicts, the small banks will focus on the small companies and if they focus on the small business and refine their business model, it will earn profits. And in turn it will spur the large banks to enter into this market and lay the ground for the interest rate reform. In July 25, 2014, there private banks are allowed to be established. They are Webank in Qianhai, the Wenzhou Commercial Bank in Wenzhou, Zhejiang, and the Tianjin JINCHEN Bank in Tianjin. In allowing those banks to operate, the China Banking Regulatory Commission (CBRC) says that the applicant has to have posited themselves differently. It is so called ‘One Bank One Policy’.[133] The Webank will focus on the individual finance and internet finance, the Wenzhou Commercial Bank will focus on the micro and small companies, and the Tianjin JINCHEN Bank will only handle the business from the corporate customers, and there is no individual finance.[134] |
9. Conclusion |
There are many problems for the companies to raise funds in domestic market. First of all, in the domestic direct financing, the standard to list on the domestic stock exchange is extremely high due to the substantive approval system. Second in the foreign direct financing, because of the “456” rules, and the substantive approval from the CSRC, direct listing overseas is also very hard. Thirdly, the bond market favors for the big companies, because the separation of the different markets and the low varieties of investors and investment tools. Fourthly, in the indirect financing, the interest rate is tightly controlled, and the market is monopolized by the big state owned banks, so they do not have incentives to lend money to the small companies. Fifthly, the control of the foreign currencies make the foreign investment not easy and the offshore structure has to be used. So in the end the company has to use the method of indirect method to list overseas. |
There regulations in the indirect listing are like the following. The first one is called the reverse merger. However, because of the ‘97 red chip guide’, this method is banned. After that the business begin to use individual to register companies overseas, however not for long the no action letter stops this method. After the abolishment of the no action letter, not for many years, the No.11 and No.29 Orders are issued, the cumbersome procedures stop the overseas listing. 1 year later, the No.75 Orders passed, the situation is easier to some extent. However on the next year, the No. 10 Order finally breaks the last hope of people, because the overseas listing involves the approval of 3 minister level agencies, the MOFCOM, the SAFE and the CSRC. |
So in order to avoid the No.10 orders, the business come up with three solutions. The first one is change the national identity of owner, because the No.10 Order only regulated the action of the Chinese citizenship. The second one is use the VIE structure， not using the shares but the contract to control the companies. Because the No. 10 Order only regulates the merger and acquisition of the domestic company by the foreign SPV. The third one is to use the method of selling and buying strategy to avoid the affiliate transaction. |
In order to tackle these problems, merely stoping the companies from going overseas is not an option. The development of the domestic financial market is the real solution. First of all, the registration system and multilayer market should be built, in order for the domestic exchange to meet different needs of the companies. Second of all, the bond market should be expanded, so the domestic companies can have another mean to raise money instead of listing. Thirdly, the banking system should be reformed, and the interest rate should be liberalized, so that more small companies can borrow money from banks, in order to do that the private bank is introduced and the cross border RMB started. Fourthly, the procedures of the direct and indirect listing should be eased, the “456” rules should be abolished and the foreign currency registration should be easier, now the No. 37 rule ease the foreign registration system. Fifthly, the exchange rate should also be liberalized, so that the company can enjoy the investment from overseas and to support the foreign SPV, so now the No. 36 Order is issued and several experiments on the cross border RMB lending and investment are conducted. |
Now the reform in the Chinese financial market has only started, in the foreseeable future, I believe the problems bothering the companies today will disappear. |
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[2] Tang Yingmao, 私人企业为何去海外上市[Why the Private Companies Choose to Get Listed Overseas], Tribute of Political Science and Law, Vol.28, No.4, 161,161(2010) |
[3] See WU XIAOBO, THE REVOLUTIONARY 30 YEARS, Vol.1, 33 (2008) |
[4] See the list of all the Central Enterprises, available at http://www.sasac.gov.cn/n1180/n1226/n2425/ (visited at January 17, 2014) |
[5] Wang Qiupin, 利用离岸公司进行红筹上市研究 [Use the Offshore Companies to Get Listed Overseas], Zhejiang University of Technology, 1, 13 (2012) |
[6] Fu Jun, ON THE LEGAL SYSTEMS OF OVERSEAS INDIRECT LISTING (1st ed. 2010 ) |
| [7] Investopedia, available at http://www.investopedia.com/terms/b/bluechip.asp and NYSE Group available at http://www1.nyse.com/content/faqs/1042235995602.html?cat=Listed_Company___General (visited July 15, 2014) |
[8] YUEG CHUL PARK and HUGH PATRICK, HOW FINANCE IS SHAPING THE ECONOMIES OF CHINA, JAPAN AND KOREA, 107-110 (2013) |
[9] Li Yi, 境内企业境外直接上市：亟需明晰的监管框架和明确的监管标准[The Standard of Overseas Listing Needs to be Clarified], Studies of International Finance, 46,49, Vol.10, 2010 |
[10] Li Hongji，红筹股公司监管争议的商榷[Rethinking the Regulations of Red Chip Company], CAPITAL MARKET, 19, 19, Vol.7 (1997) |
[11] Zhang Meiyuan，中国境外上市法律问题分析[The Analysis of Law Issues about Chinese Companies Overseas Listing], 1,21, Fu Dan University (2012) |
[13] See Notice of the State Administration of Taxation on the Interpretations and Implementation of Some Clauses in the Arrangement between the Mainland of China and Hong Kong Special Administrative Region on the Avoidance of Double Taxation and Prevention of Fiscal Evasion with Respect to Taxes on Income and Closer Economic Partnership Arrangement with Hong Kong |
[14] See Gaoyan，我国红筹上市法律监管问题研究[On the Issues of Regulation of Laws in Red Chip Mode]，JINLIN UNIVERSITY (2013) |
No.75 Order Art.1“Return investment” as mentioned in this Notice shall refer to the direct investment activities carried out inside China by a domestic resident via a special purpose company, including but not limited to the following ways: acquisition or exchange of the stock rights of the Chinese party to a domestic enterprise… |
No. 10 Order Art. 21 Where a foreign investor merges a domestic enterprise by equity merger, it shall, pursuant to the total investment amount of the foreign investment enterprise under planned establishment, the type of the enterprise and the industry it engages in, submit the following documents to the approval authority with the corresponding approval power in accordance with the laws, administrative regulations and departmental rules on establishment of foreign investment enterprises |
[15] Yan Fengxia, 特殊目的公司_我国境内居民境外融资工具[Special Purpose Vehicle: A Means to Raise Funds Overseas for Chines Domestic Companies], Southeast Justice Review, Vol.00,195,197 (2011) |
[17] Wang Jing, 仰融案中的豁免与诉讼[On State Immunities in Yang Rong Case], Hebei Law Science,Vol.4, 25 (2006) |
[18] Art. 3 “…the internal enterprise or the share-holding unit(s) inside the country of the Chinese shareholder(s) should obtain in advance consent from the provincial people’s government or the competent department under the State Council based on its subordination thereto” |
[19] Art.2 “For domestic assets in its possession for not more than three years, the company shall not apply for share issuance and listing overseas. In the case of special requirements, a report thereon shall be submitted to the China Securities Supervisory and Regulatory Commission for verification and then subject to the examination and approval of the State Council Securities Commission. ” |
| [23] Trend Associates, The report of the era of ‘no action letter’ (Mar. 30, 2009) , available at http://www.trendlaw.com/newsView.asp?classID=267&infoid=1606( visited at Jan. 17, 2014) |
[27] CHEN YONG JIAN,中国私募股权[CHINESE VENTURE CAPITALS AND PRIVATE EQUITIES], 73 (2008) |
[28] YE JUN, BAO ZHI：外资并购法律分析[LEGAL ANALASIS OF FOREIGN CAPITALS MERGER AND ACUISATIONS], 374 (2008) |
[29] Today because China has made commitments to the WTO so in principle foreign companies are not forbidden to own shares in the telecommunicate industry and only need to satisfy one condition: the shares owned by foreign companies can not exceed. However whether the foreign companies will be allowed to invest in the companies is at the full discretion of the authorities. See TMT lawyer, Qiu Xiaoyu, 外资被竞争进入ICP 吗？[Are the Foreign Investment Banned From Entering in to ICP?]available at http://www.zhihu.com/question/20674110 |
[30] Wang Wei，境外上市协议控制研究[Overseas Listing and Contract Control], FU DAN UNIVERSITY (2012) |
[31] FASB, Definition of VIE, available at http://www.fasb.org/pdf/aop_FIN46R.pdf,(visited August 7, 2014) |
| [38] Ying Ye, CIL Group Ltd, 为什么设置两层香港公司[Why Set Up 2 layers of Offshore Companies?] http://www.zhihu.com/question/19869835/answer/19747958 (visited August 7, 2014) |
[42] Li Xiao Yu，VIE模式境外上市风险与防范[Risk in the VIE and its Prevention], Financial Law Forum, Vol.2 (2013) |
[44] General Principle of Civil Law (2009), Art. 58 Civil acts in the following categories shall be null and void:… (7) those that performed under the guise of legitimate acts conceal illegitimate purposes. And Contract Law of People’s Republic of China, Art. 52: A contract shall be null and void under any of the following circumstances:… (3) an illegitimate purpose is concealed under the guise of legitimate acts. |
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[46] SHI SHANG KUAN，民法总论[ GENERAL PRINCIPLES OF CIVIL LAW], 333 (2001) |
[47] Lu Chen, VIE 法律效力分析[Legal Basis of VIE], Financial Law Forum, Vol. 2 (2013) |
[49] Qiu Xueting，失控的协议控制-对“支付宝股权转让纠纷案”的法律评析[The lost Control of VIE-Legal Analysis of the Alipay Case], Company Law Review，Vol.00 (2012) |
| [52] Ma Xiaoqian, 双威教育:控制权争夺引发VIE资产转移及退市[China Cast Education: Fight Over the Control of the Company],available at http://learning.sohu.com/20130327/n370610541.shtml (visited August 7, 2014) |
[54] V&T Law Firm, Ways to Circumvent the No.10 Order, available at http://www.vtlaw.cn/content/2013/06-04/173840120.html (visited August 7, 2014) |
[57] Zhou Jun, 要给证券市场正确定位[Reposition of the Financial Market], Journal of Zhongnan University of Finance and Economics, No.4 (2005) |
| [58] Shenzhen Stock Exchange, History of Shenzhen Stock Exchange, available at http://www.szse.cn/main/aboutus/bsjs/bsjj/index.shtml (visited August 7, 2014) And Overview of Shanghai Stock Exchange, Shanghai Stock Exchange, available at http://www.sse.com.cn/aboutus/sseintroduction/introduction/ (visited August 7, 2014) |
[59] 中石油市值[ Market Value of China Petrol]，available at http://finance.sina.com.cn/stock/s/20071106/10554143128.shtml (visited August 7, 2014) |
[60] Jiang Daxin，隐退中的权力型证监会[Strengthen the Power of CSRC], Law Review, Vol.2 (2014) |
| [61] 追问IPO 堰塞湖[ Question to the IPO blockade] available at http://finance.people.com.cn/stock/GB/217390/353190/ (visited August 7, 2014) |
[62] A股IPO 正式重启[ Reopen the IPO of A shares] available at http://finance.ifeng.com/stock/special/IPO2013/ (visited August 7, 2014) |
[64] IPO 该不该暂停[Should IPO be Stopped], available at http://money.163.com/special/ipozanting/, (visited August 7, 2014) |
[66] 《关于企业申请境外上市有关问题通知》[CSRC Notice on Domestic Enterprises Listing Overseas] No.83 (1999) |
[67] 《境内企业申请到香港创业板上市审批与监管指引》[CSRC Notice on Procedures to Listing on Hong Kong GEM board] No.126 (1999) |
[69] See Art.16 -17 Securities Law of the People’s Republic of China (2013) and Order of China Securities Regulatory Commission (No. 49) 2007 |
[70] Notice of the State Council on Issues Concerning Strengthening the Management of Local Government Financing Platform Companies(2010 No.19) |
[71] Hong Yanrong，我国企业债券融资的制度困境与变革[ Difficult Situation in the Bond Market ] Company Law Review, Vol.00 (2010) |
[72] Xu Min，进一步完善公司债券市场的法律制度[ Refine the Bond Market Regulations], Securities Law Review, 23, 28, Vol.6 (2012) |
[74] Securities Law of the People’s Republic of China (2013 Amendment) Art.10 paragraph 5 “For any securities that are not issued in a public manner, the means of advertising, public inducement or public issuance in any disguised form shall not be adopted thereto.” |
[75] Wang Yuwei, 私募股权基金退出法律机制研究[Exit Mechanism Legal Research of Private Equity Funds], Jilin University (2011) |
[76] Wang Huaxiu，Wang Ruichao, 我国私募股权基金法律制度障碍及其完善 [Perfect the Laws Governing the Private Equities], Journal of Chongqing University of Science and Technology(Social Sciences Edition), No. 1 (2014) |
| [77] Yicai, 中概股IPO背后整体惨淡：每投资一年平均亏损1%[Winter in IPO], available at http://capital.chinaventure.com.cn/11/7/1401078772.shtml, (visited August 7, 2014) |
[78] Shezhen Stock Exchange Listing Standard, available at http://www.szse.cn/main/nssqyfwzq/fxssxz/sstjzy/ (visited August 7, 2014) NASDAQ Listing Standard, available at https://usequities.nyx.com/listings/list-with-nyse/listing-standards?quicktabs_24=1#quicktabs-24 (visited August 7, 2014) |
[79] The Law Of The People’s Republic Of China On Chinese-Foreign Equity Joint Ventures (2001 Amendment)Article 8 After payment, pursuant to the provisions of the tax laws of the People’s Republic of China, of the joint venture income tax on the gross profit earned by the joint venture and after deduction from the gross profit of a reserve fund, a bonus and welfare fund for staff and workers, and a venture expansion fund, as provided in the articles of association of the joint venture, the net profit shall be distributed to the parties to the joint venture in proportion to their respective contributions to the registered capital. |
And Company Law of the People’s Republic of China (2013 Amendment) Article 168 The company’s common reserves shall be used for making up losses, expanding the production and business scale or increasing the registered capital of the company, but the capital common reserve shall not be used for making up the company’s losses. |
And Company Law of the People’s Republic of China (2013 Amendment) Article 34 Shareholders shall be distributed with the dividends based on the percentages of the capital that they actually contributed. When a company is going to increase the capital, its shareholders have the preemptive right to subscribe to the new capitals based on the same percentages of the old capital that they contributed. The exception shall be given if all shareholders agree that they will not be distributed with the dividends or have the preemptive right to subscribe to the new capitals based on the percentages of the old capital that they contributed. |
[80] Article 20 The shareholders of a company shall abide by the laws, administrative regulations and bylaw and shall exercise the shareholder’s rights under the law. None of them may injure any of the interests of the company or of other shareholders by abusing the shareholder’s rights, or injure the interests of any creditor of the company by abusing the independent status of legal person or the shareholder’s limited liabilities. |
And Article 21 Neither the controlling shareholder, nor the actual controller, nor any of the directors, supervisors or senior management of the company may injure the interests of the company by taking advantage of its connection relationship. |
| [82] King & Wood Melleson,海富投资案：解读最高法院再审判决及对PE投资者的启示 [The Analysis of the SPP ruling On VAM], available at http://www.chinalawinsight.com/2012/12/articles/corporate/%E6%B5%B7%E5%AF%8C%E6%8A%95%E8%B5%84%E6%A1%88%EF%BC%9A%E8%A7%A3%E8%AF%BB%E6%9C%80%E9%AB%98%E6%B3%95%E9%99%A2%E5%86%8D%E5%AE%A1%E5%88%A4%E5%86%B3%E5%8F%8A%E5%AF%B9pe%E6%8A%95%E8%B5%84%E8%80%85%E7%9A%84/ (visited August 5, 2014) |
[83] Contemporary Economics Dictionary, Direct financing, available at http://xuewen.cnki.net/R2006061250005675.html and Indirect Financing available at http://xuewen.cnki.net/R2006061250002399.html (visited August 7, 2014) |
[84] See Manning Gilbert Warren III，Reflections on Dual Regulation of Securities: A Case Against Preemption，B． C． L． REV．Vol． 25 ( 1984) ; Manning Gilbert Warren III，Reflections on Dual Regulation of Securities: A Case for Reallocation of Regulatory Responsibilities, 78 Wash.U.L.Q.497 ( 2000) . Available at: http://digitalcommons.law.wustl.edu / lawreview / vol78 / iss2 /6 (visited August 1, 2014) |
[85] See Shen Chaohui, 流行的误解: “注册制”与“核准制”辨析[ Misrepresentation of Registration System and Substantive Approval System], Securities Market Herald, No.9 (2012) |
[88] See Daniel J. Morrissey，The Road Not Taken: Rethinking Securities Regulation and the Case for Federal Merit Review，U. Rich. L. Rev. Vol. 44 |
[89] Securities Law of the People’s Republic of China (2013 Amendment) Article 13 An initial public offer (IPO) of stocks of a company shall meet the following requirements:…(2) Having the capability of making profits continuously and a sound financial status. |
[90] Ronald J. Colombo，Merit Regulation Via The Suitability Rules，J. Int＇l Bus. & L. Vol. 12，(2013) . |
[92] SEC Powers and Functions, available at http://www.sec.gov.ph/aboutsec/powerandfunction.html (visited August, 2014) |
[93] NTSE bought AMEX and Pacific Stock Exchange in 2008, NASDAQ bought Boston Stock Exchange and Philadelphia Stock Exchange, Direct Edge bought Cincinnati which moved to Chicago and was renamed to National Stock Exchange, available at http://www.csrc.gov.cn/pub/newsite/ztzl/yjbg/201406/t20140610_255813.html (visited August 7, 2014) |
[94] Liu Yan, Ding Ning, 美日多层次资本市场的发展、现状及启示[The Experience of US and Japan Multilayer Market and its Enlightenment to China], Finance & Trade Economics, No.10 (2007) |
| [95] 纳斯达克中国首代郑华：VIE上市不应被堵死 _纳斯达克OMX交易所 （NDAQ） _i美股[NASDAQ First Representative Zhen Hua: The IPO of VIE should not be banned] available at
http://news.imeigu.com/a/1317024251187.html. For the non-US listing companies, there are two sets of standards, the worldwide and domestic standard. In the domestic standard, the criteria is 10 million dollars and 2 million dollars. And https://usequities.nyx.com/listings/list-with-nyse/listing-standards?quicktabs_24=1#quicktabs-24 |
[98] CAI Shuang-li ZHANG Yuan-ping, The Construct of OTC Market on the Basis Multilevel Capital Market: The American Practices and the China Reference, Journal of Central University of Finance & Economics, No.4 (2008) |
[99] Listing Standard of SEM board, available at http://www.szse.cn/main/nssqyfwzq/fxssxz/sstjzy/ (visited August 7, 2014) |
[102] Zhou Wenyuan, Yu Xiaomeng, 中小企业私募债的现状、特点及发展模式展望[The Future and Characteristics of Small Companies Bond] available at http://www.chinabond.com.cn/Info/14514450 (visited August 7, 2014) |
| [104] Chinese Financial Dictionary, Liberalization of Interest Rate, available at http://epub.cnki.net/kns/brief/default_result.aspx (visited August 7, 2014) |
[105] Ba Shusong, Hua Zhongwei, Zhu Yuanqian 利率市场化的国际比较：路径、绩效与市场结构[The approach to the Liberalization of Interest Rate-A comparative Analysis], Journal of Huazhong Normal University (Humanities and Social Sciences, No.5 (2012) |
| [107] 中国人民银行决定进一步推进利率市场化改革[The PBOC Decision on Further Liberalize the Interest Rate], available at http://www.pbc.gov.cn/publish/goutongjiaoliu/524/2013/20130719184316951612816/20130719184316951612816_.html (visited August 7, 2014) |
[108] The low limit is used as a competitive tool for attracting client, and the bigger the companies are, the greater the negotiating power therefore the lower the lending interest is. The trend in the loan interest rate in Chinese market is going downward, suggesting the micro and small companies become harder to get money from banks. See. Ba Shusong Yan Min Wang Yuexiang, 我国利率对商业银行的影响分析[The Impact of Liberalization of Interest Rate on Commercial Bank] Journal of Huazhong Normal University (Humanities and Social Sciences), No.4 (2013) |
[111] Li Xing, Zhao Xuri, 富国银行小微企业贷款模式的经验及借鉴[Fargo Wells Experience on Micro loans], Financial Management and Research, No.4 (2012) |
[113] Notice of the General Affairs Department of the State Administration of Foreign Exchange on the Relevant Operating Issues concerning the Improvement of the Administration of Payment and Settlement of Foreign Currency Capital of Foreign-funded Enterprises Art. 3-4 |
[114] Nie Weidong, Gong Mulong, Wang Lixin, Cao Yanhua, 返程投资外汇进入2.0时代[Return Investment 2.0]，Journal of KWM China ( July 7, 2014) |
[116] Art.7 says that Where a special purpose company meets with a major capital modification event such as capital increase or decrease, stock right assignment or exchange, merger or division, investment with long-term stock rights or credits, provision of guaranty to a foreign party, etc., and is not involved in return investment, the domestic resident shall, within 30 days as of the major event, apply to the foreign exchange office for going through the procedures for modification or archival filing of the foreign exchange registration of the overseas investments. |
[118] 国务院关于进一步促进资本市场健康发展的若干意见[State Council Opinion on Facilitating the Capital Market], available at http://www.gov.cn/zhengce/content/2014-05/09/content_8798.htm (visited August 7, 2014) |
[119] Liu Fei, 我国多层次资本市场转板机制的设计与实施[The Design of Multilayer Market and Transferring between Different Levels], Shanghai Securities Times, A04 (February 27, 2014) |
[122] NEEQ, Statistics of Listing Companies, available at, http://www.neeq.com.cn/index |
|
[124] See Notice of the State Administration of Foreign Exchange on Relevant Issues concerning Foreign Exchange Administration for Domestic Residents to Engage in Financing and in Return Investment via Overseas Special Purpose Companies(No.75) |
[129] Notice of the General Affairs Department of the State Administration of Foreign Exchange on the Relevant Operating Issues concerning the Improvement of the Administration of Payment and Settlement of Foreign Currency Capital of Foreign-funded Enterprises Article.III |
| [130] Richard Madison, RMB ranks 7th in the World as a Payment Currency, http://cn.wsj.com/gb/20140327/bch073218.asp (visited August 7, 2014) |
| [131] MOFCOM, 人民币海外清算行共有10所[10 RMB Clearing Banks Overseas], available at http://www.mofcom.gov.cn/article/i/dxfw/gzzd/201407/20140700673998.shtml (visited August 7, 2014) |
| [132] Lu Litao, 银行、券商布局忙：前海隐现跨境金融机遇[New Business in Qianhai Cross Border RMB], available at, http://www.yicai.com/news/2014/04/3703506.html (visited August 7, 2014) |
| [133] Zhang Wei, 民营银行首批五家试点 拟用四种模式尝鲜[Different Models of the Private Banks], available at http://finance.sina.com.cn/money/bank/bank_hydt/20140312/020218478292.shtml (visited August 7, 2014) |
[134] Xinhua Net, 中国首批试点三家民营银行获准筹建 [Three Private Banks Approved by the Authority], available at http://news.xinhuanet.com/fortune/2014-07/25/c_1111803929.htm (visited August 7, 2014) |
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