China has its eye on overseas listings

Craig Coben is a former senior investment banker at Bank of America and now a managing director at Seda Experts, an expert witness firm specialising in financial services.

“Don’t forget it’s me who put you where you are now,” sings Philip Oakey in Human League’s 1981 hit Don’t You Want Me. “And I can put you back down too.”

The lyrics occurred to me when I read last Friday about the long-awaited new rules issued by the Chinese Security Regulatory Commission. These relate to overseas listings of companies incorporated outside the People’s Republic of China (PRC) but whose main operations are on the mainland.

Heralded as “reopening the avenue of fundraising after a 20-month obstruction,” the package of measures starkly reminds companies and banks just who the ultimate gatekeeper is. The CSRC announcement gives multiple government watchdogs much leeway to decide which companies can access foreign markets and under what conditions. And it piles on extra procedures and approvals that hadn’t been required before. Unlike China’s December pivot from zero Covid, the CSRC is not letting overseas IPOs “rip” without tight control and surveillance.

In other words, this is less a U-turn and more a reassertion of state power.

Until 2021 China had enjoyed an active period of blockbuster IPOs in the US and Hong Kong. In July 2021, however, Chinese authorities clamped down on foreign listings purportedly to strengthen data security and ordered ride-hailing firm Didi to take down its app just days after its $4.4bn Nasdaq IPO, eventually forcing it to delist from the NYSE. Overseas IPOs screeched to a halt, with amounts raised by Chinese companies from US listings collapsing by 98 per cent from 2021 to 2022. Hong Kong IPOs from mainland-operating companies tumbled by over 70 per cent in the same period.

But recently China has shown signs of opening up again to foreign capital. In a major concession aimed at avoiding delistings, China agreed last December to allow the US Public Company Accounting Oversight Board “complete access” to the audit papers of US-listed Chinese companies. And now the CSRC has created a road map for listing abroad.

Under the new rules, non-PRC companies operating primarily in China must file with the CSRC to list offshore. The rules apply to so-called “red chip” offerings in Hong Kong and the “variable interest entities” (VIEs) that have been widely used to list tech companies in the US and Hong Kong. Foreign listings will also need the approval of other supervisory agencies, such as the Cybersecurity Administration of China, especially if they implicate such areas as national security or data management. Companies already listed abroad now have to register with the CSRC, too.

This marks a change from earlier practice. Before the government froze foreign listings in mid-2021, only PRC-incorporated companies had been required to file with the Chinese regulator CSRC to list overseas (known as “H shares” on the Hong Kong Stock Exchange). If a mainland company created an overseas entity, it was largely free to list abroad without needing to apply for domestic approvals.

The CSRC announcement now means that Xi Jinping’s China has gone from turning a blind eye to foreign listings to placing them “under his eye”.

The new regime means stricter scrutiny for bankers as well. Underwriters will now be required to report every year to the CSRC their activities on Chinese overseas listings.

In sum, there is a path to resume foreign listings. But it’s more arduous than before. No one knows how smoothly the process of securing approvals from different regulatory bodies will operate in practice. Some companies are rumoured to be quietly exploring whether — like fast-fashion retailer Shein — they can move their headquarters and a critical mass of operations to Singapore and thus bypass these rules altogether to list overseas.

The big news for global investors is that the rules don’t ban offshore listings of so-called variable interest entities. A VIE is an overseas (usually Cayman) holding company that enters into a complex web of contracts with a mainland operating company to replicate the economics of a shareholding. Ever since the Nasdaq IPO of Sina.com in 2000, VIEs have been used by hundreds of Chinese companies to sidestep foreign investment restrictions in sensitive sectors such as ecommerce, media and telecoms. Household Chinese internet firms such as Alibaba, JD.com and Baidu have all gone public via VIEs.

The legality of VIEs has never been made clear. This strategic ambiguity gives wriggle room for authorities and still allows foreign capital to flow to growth sectors. When regulators started cracking down on tech companies, it reawakened latent fears about their legitimacy.

No one expected China to invalidate VIEs, but the “existential risk” couldn’t be entirely disregarded. In late 2021 Bloomberg reported that China was planning to ban companies from going public abroad via VIEs, while the SEC started warning that VIE owners could lose everything:

Further, the Chinese government could determine that the agreements establishing the VIE structure do not comply with Chinese law and regulations, including those related to restrictions on foreign ownership, which could subject a China-based Issuer to penalties, revocation of business and operating licenses, or forfeiture of ownership interests.

The new package mostly allays these fears. The CSRC says it will support VIE listings if they “stay compliant with local regulations”. VIEs will be allowed to offer shares abroad “under consultation with departments in charge.” That is at least implicit recognition of the VIE structure.

Nevertheless, authorities could sanction VIE entities in future if they fall afoul of whatever official policy is later interpreted as being. And now that VIEs need approval for the first time, it’s unclear how that process will work in practice. In short, Chinese regulators “can put [VIEs] back down too”.

Even with the semi-reassurance around legality, Chinese IPOs on offshore exchanges are a hard sell right now. Geopolitical tensions with the US weigh on sentiment, notwithstanding the recent recovery, and the carnage resulting from China’s crackdown on tech companies is still seared into the collective investor memory. Unexplained disappearances of prominent Chinese business figures such as Bao Fan also rattle investor nerves more than they used to.

The market isn’t closed. But absent a very compelling equity story and valuation, investors may shoot down a Chinese company IPO in New York faster than the Air Force did to a Chinese spy/weather [delete as appropriate] balloon drifting over the US. Overall, it’s not back to business as usual.

It used to be straightforward to list overseas, but companies and advisers now have to first navigate a route through different Chinese government departments. The bottom line is that China wants its companies to have access to foreign capital, but on its own terms, with strict controls on who raises what and under what conditions.