China Reopens its Doors to the IPO Market

Under the IPO Measures, the issuer must be a joint stock company, established either by way of an incorporation as a joint stock company or conversion from a limited liability company. Generally, the PRC Company Law (Amended) (Company Law) specifies two ways of incorporating a joint stock company: (i) by promotion, where the promoters subscribe for all the shares, or (ii) by share offering, where the promoters subscribe for not less than 35% of the total shares while the public subscribes for the balance.

However, to qualify for an IPO, the IPO Measures stipulate that incorporation may be conducted through share offering but only in the event of a conversion from a limited liability company into a joint stock company; and such incorporation through share offering must be approved by the State Council.

Establishment approval

The provincial government's approval, which was previously required for establishing a joint stock company, is no longer necessary under the Company Law.

Nevertheless, the establishment of a foreign invested joint stock company remains subject to the approval of the Ministry of Commerce. The establishment of a joint stock company with State-owned shares remains subject to the approval of State Council State-owned Assets Supervision and Administration Commission or its competent local delegates.

Registered capital and minimum public float

The New Listing Rules of both the Shanghai and Shenzhen Stock Exchanges maintain the old registered capital requirement of Rmb50 million (US$6.25 million), which, under the IPO Measures, must be paid-up before the listing.

As for a minimum public float, the New Listing Rules maintain the old standard of 25% of the issuer's total issued share capital, but reduces the standard for issuers with a total issued share capital of more than Rmb400 million from 15% down to 10% of the issuer's total issued share capital.

Operating and track record

The IPO Measures state that a qualified issuer must be a joint stock company that has been operating for at least three years. For a joint stock company that has been converted from a limited liability company, the three years may be calculated from the date on which the company was incorporated as a limited liability company. However, the State Council may make exceptions to this three-year operating record requirement.

It is a requirement under the IPO Measures that during the three-year track record period that there have been no significant changes to the issuer's core business or management and there has been no change of the actual controller.

Issuer independence

The IPO Measures adopt a high standard of issuer's operation independence, providing that an issuer must possess an integral business system and legitimate ownership of operating assets.

Also, the issuer must be independent from its controlling shareholder and companies controlled by such a shareholder, in respect of its business, organization, financial system and personnel including the following:

i. the issuer's senior officers must not take positions other than a directorship or a supervisory role with the issuer's controlling shareholder or companies controlled by such a shareholder;

ii. the issuer's financial personnel must not keep any concurrent post with the issuer's controlling shareholder or companies controlled by such a shareholder;

iii. the issuer must not share the same bank account with its controlling shareholder or companies controlled by such a shareholder, and

iv. the controlling shareholder or companies controlled by such a shareholder must not own or operate any business competing with the issuer.

Corporate governance

An issuer must have a sound corporate governance and internal control system. In particular, a person in any of the following situations will be disqualified from his/her capacity as a director, supervisor or other senior officer of the issuer if that person is:

i. subjected to a market-entry ban penalty imposed by the CSRC;1

ii. subjected to administrative penalties by the CSRC within the most recent 36 months, or a public reprimand by the stock exchanges within the most recent 12 months, or

iii. suspected of crimes and subjected to on-going criminal investigation, or suspected of irregularities and subjected to the CSRC's on-going investigation.

Other irregularities may cause the controlling shareholder to be subjected to a market-entry ban penalty by the CSRC. During the ban, a controlling shareholder will not qualify for an IPO. As a consequence, the issuer may need to reorganize its business structure/management, while bearing in mind that it is a requirement under the IPO Measures that during the three-year track record period there should be no change of the actual controller.

In addition, the issuer will not be qualified for an IPO if it:

i. within the most recent 36 months, made a public offering of securities without approval;

ii. within the most recent 36 months, was subjected to administrative penalties due to material violation of laws governing taxation, land use, environmental protection, customs and other similar penalties;

iii. within the most recent 36 months, made materially defective submissions, obtained approval for IPO by cheating or committed otherwise inappropriate behaviour during the application process; or

iv. is suspected of crimes and subjected to on-going criminal investigation.

Furthermore, the issuer must have a stringent funds administration system that prevents impropriety by the issuer's controlling shareholder or companies controlled by such a shareholder. The issuer's articles of association must clearly specify the approval authority and procedure for external security so as to prevent any irregular provision of security to the issuer's controlling shareholder or companies controlled by such a shareholder.

Financial requirements

According to the IPO Measures, the issuer must have good financial status. Within the most recent three accounting periods, the issuer must have reported profits in each year, totalling Rmb30 million and have a cash flow produced in its operation totalling Rmb50 million or an operation income totalling Rmb300 million. Before the IPO, the issuer must have a total share capital of not less than Rmb30 million. At the end of the most recent audited financial year, the issuer's value of intangible assets (excluding land use rights, water breeding rights and mining rights) must not be more than 20% of the net assets value and the issuer must be free from all of its major indebtedness.

An issuer must not be characterized by any of the following situations that may adversely affect its continuous profitability:

i. material changes of its business model or structure of its products or services or such potential changes;

ii. material changes of its market position or the business environment or such potential changes;

iii. substantial reliance on its connected parties or its uncertain important customers in the production of its operation income or net profits of the most recent accounting year;

iv. its net profits of the most recent accounting year being mainly from the returns of investment that has not been consolidated into its financial statements, or

v. risk of material adverse changes in relation to its important intellectual property rights.

Use of proceeds

The IPO Measures provide clear guidelines for the use of proceeds from new share sales and prohibit non-financial companies from using the proceeds to invest, either directly or indirectly, in companies mainly engaging in securities trading. The IPO Measures also highlight the ban on non-financial firms using the proceeds to trade, lease or consign financial assets for profits.

In addition, the IPO Measures remove the previous restriction that IPO proceeds must not exceed twice the issuer's net assets value. At the same time, it requires that the issuer must open a special account for depositing the proceeds and that the proposed proceeds amount must conform to the issuer's objective circumstances, such as its business scale, financial status, technological level and management capacity.

Lock-up undertakings by shareholders

Following the amendment of Company Law and the PRC Securities Law, the IPO Measures abolish the requirements for a one-year tutorial by a sponsor and the ban on private placements, within 12 months, prior to the IPO.

The New Listing Rules extend the one-year lock-up period for general shareholders to a 36-month lock-up period particularly for: (i) the controlling shareholder, commencing from the listing date, and (ii) shareholders who acquire shares within 12 months prior to the IPO, commencing from the date on which such shareholders were registered as shareholders of the issuer. To obtain an IPO approval, the aforementioned shareholders must sign an undertaking in relation to the lock-up requirement.

Offering Better protection to investors

The implementation of the IPO Measures and the New Listing Rules indicates that the CSRC is moving in the right direction to better protect investors' rights and interests by tightening the IPO and listing requirements and emphasizing the issuer's internal control, financial performance and corporate governance, as well as sponsor's liability and information disclosure.2

However, tougher listing requirements do not necessarily guarantee better performance of listed companies, particularly in a market without a deep-rooted culture of creditability and strict enforcement of legal liabilities for irregularities. In any event, it remains to be seen whether the quality of the listed companies will be markedly improved.

Endnotes

1 On June 7 2006, the CSRC promulgated the Provisions for Prohibition from Access to the Securities Market (Provisions), which will become effective as of July 10 2006. According to the Provisions, if directors, supervisors or other senior officers of the issuer violate applicable laws, regulations or rules and thereby are imposed a market-entry ban penalty, the issuer must, upon such imposition by the CSRC, dismiss those facing the penalty. Depending on the severity of their acts, the relevant individuals may face a ban of three to five years or five to 10 years, or be permanently expelled from the market.

2 On May 18 2006, the CSRC promulgated the revised disclosure guidelines (Guidelines for the Contents and Formats for Information Disclosures by Companies That Offer Securities to the Public (No.1): Share Prospectuses and Guidelines for the Contents and Formats for Information Disclosures by Companies That Offer Securities to the Public (No.9): Application Documents for Initial Public Offerings of Shares and the Listing Thereof) to standardize the IPO submissions. On May 26 2006, the CSRC issued Circular on Issues Relevant to Strengthening the Administration of Subscription with Capital and the Underwriting Business for IPO underwriters aiming to avoid a repeat of trading scandals by tightening underwriter's liabilities.