Little red-chips get an overseas opening
May 09, 2009 | BY
clpstaff &clp articles &China's M&A Rules effectively blocked domestic Chinese companies from raising money on overseas capital markets. But recent Ministry of Commerce guidelines may have provided a way out. By Zhou Jiaxing, Or & Partners, Hong Kong.
Before the promulgation of China's M&A Rules in 2006, the so-called Little red-chip model was a common way used by private Chinese companies to seek listing on overseas stock exchanges.
In this model, the owner of the private Chinese company sets up a special purpose company in a tax-haven country, such as the British Virgin Islands (BVI). The BVI special purpose company then sets up a subsidiary in Cayman or Bermuda. The Cayman or Bermuda special purpose vehicle (SPV) then acquires the shares of the Chinese company with the result that it becomes the holding company of the Chinese company. Finally, the Cayman or Bermuda SPV seeks listing on an overseas exchange.
The M&A Rules – formally the Provisions for the Acquisition of Domestic Enterprises by Foreign Investors (关于外国投资者并购境内企业的规定)– have made this model unworkable. According to Article 11 of the M&A Rules, where a foreign company established or controlled by a domestic company, enterprise or natural person intends to take over its domestic affiliated company, it shall be subject to the examination and approval of the Ministry of Commerce (Mofcom). The parties concerned can not get round these requirements by making investments within China through a foreign-funded enterprise, or other means.
The M&A Rules also require that domestic companies or individuals have to apply to Mofcom for permission before they can incorporate special purpose vehicle companies abroad. When the SPV companies acquire domestic companies, they again need to seek approval from the Ministry. If Mofcom grants the approval, it will issue a new business licence to the acquired domestic company specifying: Controlled by Overseas Special Purpose Company and Valid for Only One Year. If the listing cannot be completed within one year from the grant of this business licence, the shareholding structure will be restored to its original situation. Furthermore, Article 40 of the M&A Rules provides that the transaction for the overseas listing of a special-purpose company shall be subject to approval of the China Securities Regulatory Commission (CSRC).
Since the M&A Rules came into effect on September 8 2006, Mofcom has not approved a single Little red-chip company's overseas listing.
The global financial crisis has changed the economic environment for domestic private companies. The CSRC has stopped approving new listings for the A-share market completely. Although domestic banks have been instructed to increase loans granted to enterprises, most loans are given to state-owned or state-controlled companies. Domestic private companies desperately need capital in order to survive the financial crisis. It is against this background that the Guidance Handbook for Administration of the Entry of Foreign Investment (外商投资准入管理指引手册) was issued by Mofcom in December 2008.
Section 5(1) of Part 4 of the Guidance clarifies the scope of application of the M&A Rules in respect of foreign-funded companies in China. It provides that the M&A Rules do not apply to the acquisition of the equity of Chinese shareholders by foreign shareholders of established foreign-funded companies, no matter whether the Chinese shareholders are affiliated with the foreign shareholders. It then reiterates that the M&A Rules only apply to domestic companies.
This rule has clarified or, to be exact, restricted the scope of application of the M&A Rules. It is possible for a domestic enterprise to make use of the Little red-chip model by turning itself first into a foreign-invested enterprise. This can be achieved by the domestic shareholder selling more than 25% equity in the domestic enterprise to a SPV set up by the strategic investor or the financial investor of the domestic enterprise. After the domestic enterprise is turned into a foreign-invested enterprise, the foreign shareholder of the foreign-invested enterprise can then acquire the rest of the equity of the enterprise to make it a wholly foreign-owned enterprise. At the same time, the domestic shareholder subscribes for the equity in the foreign shareholder. In the last step, the foreign shareholder, which is usually incorporated in Cayman or Bermuda, is listed on an overseas stock exchange.
The chart below shows how a domestic company may make use of the opening in the Guidance to get listed as a Little red-chip company.
It should be noted that Section 5(1) of Part 4 of the Guidance applies to “established foreign-funded companies”. It is not clear whether this refers to those foreign-funded companies which were established at the time of the promulgation of the Guidance or at the time of the promulgation of the M&A Rules. There are PRC lawyers who take the view that the Guidance allows foreign-funded companies established after the promulgation of the M&A Rules but before the publication of the Guidance to follow the Little red-chip model. So far, Mofcom has not confirmed whether this view is correct.
It seems that, until a domestic company gets listed on an overseas exchange through the Little red-chip model, no one knows whether or not the door for domestic companies seeking overseas capital is really open.
This premium content is reserved for
China Law & Practice Subscribers.
A Premium Subscription Provides:
- A database of over 3,000 essential documents including key PRC legislation translated into English
- A choice of newsletters to alert you to changes affecting your business including sector specific updates
- Premium access to the mobile optimized site for timely analysis that guides you through China's ever-changing business environment
Already a subscriber? Log In Now