New rules herald the end of unlisted foreign-investment shares

B-shares are shares with a face value denominated in renminbi, subscribed and traded in foreign currencies and listed and traded on the Shanghai and Shenzhen stock exchanges, as compared with A-shares, which refer to shares traded in renminbi on the Shanghai or Shenzhen stock exchanges.

Scope of New Rules

The New Rules, like the Old Rules, only apply to non-listed foreign investment shares in foreign-invested companies limited by shares which have B-shares listed on the Shanghai or Shenzhen stock exchange. Can non-listed domestic investment shares in B-share companies be converted into B-shares by following the conversion mechanism provided for the foreign investment shares? It appears that while there have been several attempts under the Old Rules, no one has actually managed to obtain the green light from the approval authorities.¹ Companies that are only listed in the B-share market keep calling for a way to convert their non-tradable domestic investment shares into tradable shares, but the New Rules do not answer their request.

Approval authority

Under the New Rules, the applicant must obtain Mofcom approval through two steps: (i) preliminary review by the provincial counterpart of Mofcom; and (ii) review and approval by central Mofcom. Afterwards, the applicant must make public announcements, carry out certain formalities with the relevant stock exchange², renew the Approval Certificate for Establishment of Foreign-invested Enterprises with Mofcom, and finally apply for the relevant registration (such as amendment of its articles of association regarding the respective numbers of tradable and non-tradable shares) with the competent administration for industry and commerce.

No consideration for conversion

The New Rules only require Mofcom approval for the conversion of non-listed foreign investment shares into B-shares. Foreign investors are not required to pay consideration to holders of tradable B-shares for such conversion. This is different from the equity division reform (conversion of non-tradable shares in A-share companies into A-shares), where holders of non-tradable shares have to pay consideration for the conversion in cash or shares to holders of A-shares (the rationale being that historically, when determining the issuing price of the A-shares, non-tradable shares were supposed not to be listed and tradable on the market; in other words, conversion would result in a technical dilution effect).

Other noteworthy provisions

According to Article 3.3 of the New Rules, if foreign investors who bear particular obligations and responsibilities towards the B-share company (such as the provision of a shareholder's loan and guarantee, and technology transfer/licence) as required in the articles of association, shareholders' agreements and other legal documents of the B-share company, as well as required by applicable laws and regulations, plan to convert their non-listed foreign investment shares into B-shares, they will have to discharge such obligations and responsibilities before the B-share company makes the application. However, pursuant to Article 5.6, a foreign investor may, as an alternative, make a written undertaking to continue to perform the relevant obligations and responsibilities after the conversion, rather than having them fulfilled beforehand.

The requirements for two one-year lock-ups remain under the New Rules: (i) the foreign investors planning to convert their non-listed foreign investment shares into B-shares must have held such shares for more than one year before the application is submitted; and (ii) after the conversion, the converted B-shares held by such foreign investors are subject to a one-year lock-up from the approval date.

The differences

The New Rules essentially ease the pre-requisites for B-share conversion in the following two ways:

Approval by the China Securities Regulatory Commission (CSRC) is no longer required

This is in line with a pronouncement by the CSRC of December 18 2007 in response to the State Council's Decision on the Cancellation and Adjustment of the Fourth Batch of Administrative Approval Items, issued on October 9 2007, which provides for a lessening of CSRC approval requirements.

In 2001, the State Council decided to initiate the reform of the administrative approval system in order to reform the functions of the government, satisfy the needs of the market-oriented economy and meet new requirements following China's entry into the World Trade Organisation (WTO). Historically, the government had its functions mixed with those of state-owned enterprises and public institutions, and therefore acted both as a player and a referee. This had seriously impeded the opening-up of the market and fair competition.

During the period between China's entry into the WTO in September 2001 and the enactment of the Administrative Licence Law in August 2003, the State Council had cancelled a significant number of governmental approval requirements for market or civil activities. Correspondingly, various governmental departments/authorities under the State Council had also successfully cleaned up 2,400 relevant laws and regulations.³ The Administrative Licence Law, which was promulgated as China's fulfilment of its obligations regarding administrative licence under its WTO protocol, provides for the scope of the matters upon which an administrative licence may be imposed. It also stipulates that administrative licences are not required for matters which can be decided by individual citizens, legal persons or other institutions themselves, can be effectively regulated by the market competition mechanism, may be subject to the self-discipline administration of trade organisations or intermediary institutions, or can be solved by the administrative organs by means of supervision afterwards or through other administrative methods.

Statistics indicate that by the end of 2007, the State Council had cancelled or adjusted 1,992 administrative approval items (including 109 items requiring CSRC approval), according to public announcements made by the State Council. The cancellation of the CSRC approval for B-share conversion was just another demonstration of the State Council's continuous efforts to lessen the government's over-regulation of market activities.

A senior official of the CSRC, quoted in the China Securities Journal on January 20 2008, stressed that with the gradual development of the capital market and the growing prominence of the market mechanism, it was necessary to implement the reform of the administrative approval system in light of market discipline and rule of law and to take steps to reduce excessive administrative approval items. In order to achieve this goal, the CSRC would further change its way of thinking, keeping the examination and approval of matters which may contain significant market risk while lessening regulation over the activities of market players. In the meantime, the CSRC would strengthen administration over market participators through reinforcement of daily inspection and intensification of post factum punishment.

No requirement for the applicant to be profitable for each of the two years before the application

The New Rules alternatively set forth the requirement on the applicant having a clean operational record (that is, the applicant has engaged in normal production and operation activities within the business scope as set out in its business licence) and a requirement of the normal trading of its shares. The New Rules fail to further clarify what the “normal trading of its shares” means.

In light of such changes, the applicant will not need to submit to Mofcom, among other things, audit reports and tax receipts as evidences of the applicant's profitability for each of the two years before the application.

The impact

The New Rules offer simplified approval procedures and less substantive application conditions for conversion of non-listed foreign investment shares into B-shares. In the current circumstances, the practical impact of the New Rules, however, is anticipated to be somewhat limited. Since the promulgation of the Old Rules, most B-share companies having non-listed foreign investment shares have had their non-tradable foreign investment shares converted into tradable shares (A- or B-shares) through either of the following two ways:

Conversion into B-shares under the Old Rules

According to a May 2005 report from the China Securities Journal, there were 29 B-share companies having non-listed foreign investment shares (of which 21 were listed on the Shenzhen Stock Exchange and eight on the Shanghai Stock Exchange) in 2000. In 2001, Wuxi Little Swan became the very first company to convert its non-listed foreign investment shares into B-shares. Until the commencement of the equity division reform in 2005, 23 B-share companies had obtained the approvals to convert all or part of their non-listed foreign investment shares into B-shares. Only 12 B-share companies still had non-listed foreign investment shares then, of which 10 companies were A + B-share companies and the remaining two were pure B-share companies.

Since 2005, B-share companies might still apply for conversion of their non-listed foreign investment shares under the Old Rules, while A + B-share companies were granted another option to convert non-listed foreign investment shares into A-shares.

Conversion into A-shares under the Equity Division Reform

In April 2005, the CSRC, by issuing the Issues Relevant to Pilot Reform Projects Regarding the Separation of Equity Ownership and Trading Rights of Listed Companies Circular (关于上市公司股权分置改革试点有关问题的通知), kicked off the reform of equity division. Equity division refers to that part of the shares of a listed company which were listed and tradable in the stock market while the remainder (mainly, domestic and foreign investment legal person shares) were not listed or tradable in the public market. This was incurred due to various historical factors. The equity division reform aimed to convert all non-tradable shares into listed and tradable shares and eliminate the systematic differences between listed shares and non-tradable shares in respect of pricing and transfer mechanism in the A-share market.

By adopting the equity division reform plan, foreign legal person shares in A + B-share companies could be converted into A-shares. For instance, when Shanghai Yaohua Pilkington Glass adopted its equity division reform plan in 2006, its foreign investor, Pilkington International Holdings, participated into this plan and converted its foreign investment shares in Shanghai Yaohua Pilkington Glass into A-shares.

Conclusion

Thanks to the two mechanisms available for conversion of non-listed foreign investment shares mentioned above, most of these shares have been converted into tradable shares (either A-shares or B-shares). It is estimated that among the 109 B-share companies listed on the Shanghai or Shenzhen stock exchange, there are less than 10 companies which still have non-listed foreign investment shares. With the simplified procedures provided by the New Rules, non-listed foreign investment shares in these companies may become a thing of history in the near future.

Endnotes

¹ See China Securities Journal, July 3 2006.

² This may refer to the classification of the foreign investment shares into B-shares in the exchange's systems.

³ See National Resource Economics of China, October 2006.

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