New Regulations on State-owned Assets Transfer

On August 25 2004, the State Council State-owned Assets Supervision and Administration Commission (SASAC) issued the Issues Relevant to Assignment of Enterprise State-owned Assets and Equity Circular (国务院国有资产管理委员会关于企业国有产权转让有关问题的通知)(the Circular). The Circular is intended to clarify certain issues in connection with the implementation of regulations on the same subject released by the SASAC together with the Ministry of Finance in late 2003, the Administration of the Assignment of Enterprise State-owned Assets and Equity Tentative Procedures (the Tentative Procedures).

What's New

Specifically with respect to any transfer of equity interests that will trigger "change of nature" of a PRC listed company's state-owned shares, the Circular has imposed some new requirements for regulatory compliance. Change of nature of state-owned shares usually means that the assets or equity interests in question will be transferred to entities other than an SOE and therefore become non-state-owned. For this reason, transfer involving such a change of nature will require the SASAC's or its local counterparts' approval. Furthermore, pursuant to the Tentative Procedures, the transferor is required to make a disclosure at the asset exchange institution in order to widely solicit potential transferees, and the listed company is required to make a disclosure on the same matter no later than such transferor's disclosure.

After having obtained approval, the transferor will need to obtain a "certification" of the transfer at a designated asset exchange institution by submitting the approval document together with the full payment certificate of the purchase price. Subsequently, both transferor and transferee need to file for recording at the relevant "Securities Registration and Settlement" institution to reflect the change of the state-owned equity interests in the listed company.

The Circular has also stipulated some general provisions that apply to all transfers of state-owned equity interests regardless of whether they involve any listed companies. For instance, the Circular has expressly provided that the transferor may hire professional firms for advice and assistance on the proposed equity interests transfer. This is reportedly the first official endorsement on obtaining external financial, legal and other professional advisors for SOEs.

Further to the existing rules and regulations on transfer processes, more details have been given on the mechanics of making disclosures and public announcements. For instance, a soliciting announcement of the proposed transfer must be properly publicized by the asset exchange institution and kept for at least 20 business days. The asset exchange institution is also required to appropriately register and record all interested potential transferees.

Implications for Foreign Investors

The Circular is intended to make the relevant equity interests transferring procedure more transparent and fair in order to protect state-owned assets and interests. The impact on foreign investors might be mixed. The good news is that transactions will hopefully be carried out on a more level playing field for all potential buyers. But ironically, the Circular's lack of clarity seems to be adding more questions than answers.

One looming question relates to the wording "full payment certificate" of the purchase price, without which neither the transaction "certification" nor the change of recording can be processed at the asset exchange institution and the "Securities Registration and Settlement" institution, respectively. Does this imply that full payment must be made at the transaction completion stage, thus ruling out the possibility of instalment payments? If so, this is at odds with the Normalizing the Reform of State-owned Enterprises Circular issued by the SASAC itself on December 16 2003 and the Acquisition of Domestic Enterprises by Foreign Investors Tentative Provisions (外国投资者并购境内企业暂行规定)(issued on March 7 2003), both of which expressly allow purchase price payment in instalments. Potentially, this could considerably impact mergers and acquisitions of SOEs involving listed companies in China, as such a payment method serves as a crucial mechanism that not only provides more financial flexibility but also helps shield the buyer from the target company's hidden or contingent liabilities after the deal is closed. In other words, the buyer can use future payment instalments to set off any indemnification claims it may have against the seller. But this may not work from now on due to the new regulation.

Another puzzle arises from the wording in Article 3, "transfer of state-owned equity interests involving the change of nature of a listed company's state-owned shares". Is it related to a listed company transferring its own state-owned shares, or a listed company's parent company selling its own shares? Both possibilities are plausible. A more confident guess is that Article 3 of the Circular does not apply to listed companies transferring their state-owned shares to non state-owned entities. The existing law and common practice of transferring listed company shares suggest that such transfers take place in securities exchanges rather than those "asset exchange" institutions. And so far those transfers have been done by private negotiations only. If the Circular, however, does apply to the transfer of a listed company's state-owned shares, this would be a major policy shift.