China’s SSE Issues New Rules for Red-Chip Companies to List on STAR Market

On 5 June 2020, the Shanghai Stock Exchange (“SSE”), with approval from the China Securities Regulatory Commission (“CSRC”), promulgated the Circular on Matters concerning Applications Filed by Red-Chip Companies for Issuance and Listing on the SSE STAR Market (“Circular”). In order to address certain issues identified during SSE’s vetting of IPO applications by red-chip companies, the Circular provides guidance on share issuance and disclosure requirements for red-chip companies applying to list on the Science and Technology Innovation Board (“STAR Market”). The Circular is drafted based on a series of previous regulations and rules promulgated by the CSRC and the SSE regarding the listing of red-chip companies[1] on the domestic capital market. The key takeaways of the Circular are: (i) arrangements for preferred rights of investors; (ii) specific criteria for using rapid growth in business turnover to satisfy listing requirements; and (iii) adjustments to certain listing conditions and delisting circumstances.

Arrangements for preferred rights of investors

The Circular stipulates that an issuer and its investors must agree and undertake not to exercise the preferred rights of preferred shares during the process of IPO application, and instead to terminate such preferred rights, and to convert the preferred shares into ordinary shares prior to the listing. A significant clarification provided by the Circular is that the converted ordinary shares will not be deemed to be new shares, which would normally trigger a three-year lock-up period if issued shortly before an IPO; instead, any lock-up period applicable to investors is to be determined based on the date the investors obtained their preferred shares. The Circular reflects the SSE’s recognition and provision for the foreign practice of converting investors’ preferred shares into ordinary shares prior to listings of red-chip companies on overseas stock exchanges.

In addition, the SSE requires an issuer to disclose certain information in the prospectus, including but not limited to subscription information relating to preferred shares (including numbers of shares, name of investors, etc.), rights attached to the preferred shares, arrangements on conversion and changes in shareholders’ rights as well as the impact of such conversion on the issuer’s share capital, corporate governance, and financial statements, and lock-up arrangements and undertakings. The SSE also requires the issuer to disclose risk factors connected with the aforementioned.

Specific criteria of “rapid growth in business turnover”

Prior to the Circular, the Rules of the SSE for the Listing of Shares on the STAR Market (“Listing Rules”) and the Rules of the SSE for the Review and Approval of the Issuance and Listing of Shares on the STAR Market (“Review Rules”, together with the Listing Rules, “Rules”) provided that a red-chip company which had not yet been listed overseas could use “rapid growth in business turnover” to satisfy the market value and financial indicator requirements for listing on the STAR Market, i.e. (i) its estimated market value is not less than RMB 10 billion, or alternatively, (ii) its estimated market value is not less than RMB 5 billion and its business turnover in the most recent year is not less than RMB 500 million. However, those Rules did not specify the standard for what constitutes rapid growth in business turnover. The Circular provides the following specifics on the rapid growth in business turnover that red-chip companies must show to satisfy the market value and financial indicator requirements:

• The business turnover of the issuer in the most recent year must be more than RMB 500 million, and the compound growth rate of its business turnover in the last three years must be higher than 10%.
• The business turnover of the issuer in the most recent year can be less than RMB 500 million, provided, however, that the compound growth rate of its business turnover in the last three years is higher than 20%.
• An issuer in an industry that is experiencing overall downward adjustments due to factors such as industrial periodic fluctuation does not need to meet the minimum business turnover  threshold if the compound growth rate of its business turnover over the last three years is higher than the average growth rate of comparable companies in the same industry during the same period.
• Red-chip companies that are at R&D stage or that are otherwise significant to the national innovation-driven development strategy do not need to meet any of the aforesaid criteria of rapid growth in business revenue.

Adjustment to listing conditions and delisting circumstances for red-chip companies

Given that red-chip companies and domestic stock companies differ in terms of corporate structure, par value of shares, and share capital requirements, and that such differences are within the scope of corporate governance, the Circular has made corresponding changes to certain provisions regarding listing conditions and delisting circumstances for red-chip companies to address such differences.

For instance, the Circular has amended the listing condition of the total share capital after the offering being not less than RMB 30 million to the total number of shares after the offering being not less than 30 million.  The Circular also revised the delisting condition of the share closing price, from delisting if it has remained below par value for 20 consecutive trading days to delisting only if it remains below RMB 1.00 for said period.

Conclusion: practice and prospects of red-chip companies listing on the STAR Market

Regulators are constantly exploring listing rules and regulatory requirements suitable for red-chip companies, and have been improving and refining the rules relating to domestic issuances and listings of red-chip companies.[2] Following the promulgation of relevant listing rules concerning red-chip companies, several red-chip companies have applied to list on the STAR Market. For instance, on 27 February 2020, China Resources Microelectronics Co., Ltd became the first ever red-chip company with a shareholding structure[3] to be listed on the STAR Market; on 1 June 2020, the application for listing submitted by SMIC International Integrated Circuit Manufacturing Co., Ltd., a company listed on the Hong Kong Stock Exchange, was accepted by the SSE; and on 12 June 2020, No. 9 Robot Co., Ltd., a red-chip company with a VIE structure[4], was approved by the SSE. With the implementation and refinement of relevant rules and regulations, we believe that an increasing number of red-chip companies will have their IPOs or dual listings on the domestic capital market.

[1] Red-chip companies refer to companies that are incorporated outside mainland China and carry out principal business activities within mainland China.

[2] The evolution of such rules and regulations has gone through the following phases: (i) an overall pilot scheme for domestic listing and issuance conditions for red-chip companies was established by the promulgation of the Circular of the CSRC on Several Opinions on Launching the Pilot Program of Domestically Issuing Stocks or Depository Receipts by Innovative Enterprises on 30 March 2018, with the CSRC providing guidance on listing conditions and requirements for sale of overseas pre-IPO shares on the domestic capital market by the promulgation of the Implementation Measures for the Regulation of the Pilot Scheme of Enabling Innovation-Oriented Enterprises to Issue Stocks or Depository Receipts and Be Listed Domestically on 6 June 2018; (ii) the SSE STAR Market Listing Rules was issued on 1 March 2019 to specify the listing conditions and disclosure requirements for red-chip companies to be listed on the STAR Market; and (iii) on 30 April 2020, the Announcement on Arrangements for Domestic Listing of Innovative and Pilot Red-Chip Companies was promulgated, lowering the conditions for the domestic issuances and listings of red-chip companies that have been listed overseas and clarifying the foreign exchange matters concerning the domestic sale of pre-IPO shares of red-chip companies yet to be listed. The promulgation of the Circular further clarifies the threshold for red-chip companies to IPO.

[3] Shareholding structure refers to an investment structure whereby a red-chip company exercises equity control over a domestic operating entity.

[4] VIE structure refers to an investment structure whereby a red-chip company exercises de facto control over a domestic operating entity through contractual arrangement.