The dangerous game of floating by China’s new rules

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Craig Coben is a former global head of equity capital markets at Bank of America and now a managing director at Seda Experts, an expert witness firm specialising in financial services.

Back in February bankers rejoiced when China announced new rules for overseas listings, hoping it would reopen the flow of IPOs into the Hong Kong and New York markets after a 20-month freeze. “The rules,” wrote Bloomberg, “could revive a wave of IPOs.”

But the rules were never going to offer an easy ride. Gone were the carefree days of creating a Cayman Islands entity and listing abroad; now companies first need the blessing of the Chinese Security Regulatory Commission and other domestic regulators. Indeed, Chinese companies have gotten bogged down in a bureaucratic quagmire, and none have yet gone public overseas under the new regime. But at least banks had a roadmap to list a Chinese company on an overseas exchange, even if they had more hoops to jump through. 

Now comes news that last week the CSRC told lawyers to downplay China-related risk factors in share offering prospectuses. This guidance may make it much more complicated for global banks to underwrite overseas share offerings, a hitherto lucrative business.

As Reuters reports:

Beijing has asked law firms to tone down the language used to describe China-related business risks in Chinese companies’ offshore listing documents, warning failure to do so could cost them regulatory green light for the IPOs…

The China Securities Regulatory Commission (CSRC) on July 20 met with local lawyers and asked them to refrain from including negative descriptions of China’s policies or its business and legal environment in companies’ listing prospectuses . . . 

Chinese companies planning overseas share offerings would typically list changes in China’s changing economic, political and social conditions as well as changes in government policies and regulations and trade tensions with the United States among business risks, their public disclosures showed.

The Chinese law firms acting as IPO advisers have been asked to drop such boilerplate risk disclosures . ..

The CSRC guidance arises in response to an attempted workaround. The offshore listing rules, which went into effect on March 31, prohibit “securities firms” from “misrepresenting or disparaging the law and policies, business environment, or judicial situation of China” in listing documents. So lawyers devised a standard list of risk factors, hoping to satisfy both Chinese and overseas rules. However, according to law professor Henry Gao, “this has caught the attention of the top CCP leadership, who ordered the CSRC to summon the firms and [tell] them to stop this or face penalties”.

At one level, there is something appealing about the CSRC’s position. The “Risk Factors’‘ section of a share prospectus contains a mixture of alarmist legal jargon and boilerplate gobbledegook more suited to shielding issuers and underwriters from liability than to informing investors. Indeed, American and European regulators have sought from time to time to encourage issuers to spell out the specific risks and not regurgitate prefab risk disclaimers. 

But the CSRC’s initiative is more geared towards controlling the narrative than streamlining prose. It is part of a broader Chinese campaign to play by its own rules, free from the binds of Western norms. Like Napoleon Dynamite, the Chinese authorities insist on dancing to their own beat.

And this puts international investment banks in a quandary. 

This is not because toned-down warnings will leave investors in the dark. High-profile Chinese government crackdowns have wiped out billions of equity value in such sectors as gaming, ride-hailing and tutoring. Fund managers are already acutely aware of the damage that policy changes can inflict on their Chinese investments. 

The real problem lies in how to navigate between the CSRC’s instructions and the SEC’s call for “more specific and prominent disclosure about material risks related to the role of the [Chinese] government . . . in the operations of China-based companies.” This could make it challenging for international banks to underwrite a share offering for a Chinese company in the US. Issuers and banks are just the latest in a long line of entities struggling to manage conflicting diktats of Chinese and American officials. And watered-down risk factors could leave banks exposed to a class-action lawsuit.

Even if a Hong Kong listing could be an alternative, the situation remains sticky and tricky for international banks. The so-called bulge bracket strive for consistent IPO standards worldwide — based on American/Western practice and regulation — regardless of differing rules in each country. For example, Goldman Sachs and Bank of America reportedly withdrew from the $2.5bn IPO of Adnoc Gas due to the lack of an audit opinion from a Big Four firm, even though it was not required under Abu Dhabi regulations. Listing a company in Hong Kong with disclosure that wouldn’t pass muster with the SEC creates reputational risks for these banks, especially if something were to go wrong after the IPO.

The stakes are high for global banks. A significant chunk of their Asian investment banking revenues comes from Chinese share offerings on overseas exchanges. That business has gone from bonanza in 2021 to basket case today, and the recent CSRC guidance has made life a lot harder.

Further reading:
— China has its eye on overseas listings (FTAV)