Beijing overhauls rules on companies seeking an overseas IPO, including banning any listing deemed a national security threat

December 28, 2021, 3:49 AM UTC

China has unveiled sweeping regulations governing overseas share sales by the country’s firms, taking one of its biggest steps to tighten scrutiny on international debuts in the wake of Didi Global Inc.’s controversial listing.

The regulations, issued by the country’s securities watchdog, commerce ministry and top economic planning agency over the past week, cast more uncertainty over the prospects for overseas initial public offerings that had proceeded virtually unchecked for two decades. The Nasdaq Golden Dragon China Index dropped 1.1% overnight despite another all-time high for U.S. shares, while the Hang Seng Tech Index slipped as much as 1% in early trading Tuesday.  

Chinese firms in industries banned from foreign investment will need to seek a waiver from a negative list before proceeding for share sales, the National Development and Reform Commission and the Ministry of Commerce said in a statement on Monday. Overseas investors in such companies would be forbidden from participating in management and their total ownership would be capped at 30%, with a single investor holding no more than 10%, according to the updated list effective Jan. 1.

Meanwhile, the China Securities Regulatory Commission proposed on Friday that all Chinese companies seeking IPOs and additional share sales abroad would have to register with the securities regulator. Any company whose listing could pose a national security threat would be banned from proceeding.

The overhaul represents a major step taken by Beijing to tighten scrutiny on overseas listings, after ride-hailing giant Didi proceeded with its New York initial public offering despite regulatory concerns over the security of its data. While regulators stopped short of a ban on IPOs by companies using the so-called Variable Interest Entities (VIE) structure, the new rules would make the process more difficult and costly.

It means Chinese firms seeking to list abroad via VIEs may need to complete the compliance procedure with the commerce and economic planning ministries in addition to a cybersecurity review, before getting the clearance under the CSRC’s proposed registration process, said Winston Ma, adjunct professor of NYU Law School and author of “The Digital War – How China’s Tech Power Shapes the Future of AI, Blockchain and Cyberspace.”

The new edicts on VIEs and listings indicate China’s efforts to rein in its massive Internet sector isn’t abating. After cracking down on areas from e-commerce to fintech, after-school education, gaming and online content, Beijing’s attentions have turned to the risks posed by tech startups as they seek access to foreign capital in a bid to expand. In addition to the new rules on VIEs, regulators had previously proposed that firms with at least a million users undergo a cybersecurity review before going public overseas.

“The Ministry of Commerce, as the enforcement agency for foreign investment-related laws and the leading ministry for the existing VIE rule issued a decade ago, may emerge as an important regulator for Chinese VIEs seeking offshore IPOs,” said Ma. 

VIEs have been a perennial worry for global investors given their shaky legal status. Pioneered by Sina Corp. and its investment bankers during a 2000 IPO, the VIE framework has never been formally endorsed by Beijing. It has nevertheless enabled Chinese companies to bypass rules on foreign investment in sensitive sectors, including the Internet industry. The structure allows a Chinese firm to transfer profits to an offshore entity—registered in places like the Cayman Islands or British Virgin Islands—with shares that foreign investors can then own.

The requirements apply to new share listings and won’t affect the foreign ownership of companies already listed overseas, according to the Ministry of Commerce and NDRC.

Companies using the VIE structure would be allowed to pursue overseas IPOs after meeting compliance requirements, the securities regulator said on Friday, without providing further details. Foreign securities firms that underwrite Chinese firms’ overseas share sales are required to register with the CSRC and submit an annual report on the businesses.

That “may create new compliance challenges to the foreign underwriters, as they might need to follow Chinese rules once they are registered with CSRC,” said Ma. 

It’s all part of a yearlong campaign to curb the breakneck growth of China’s Internet sector and what Beijing has termed a “reckless” expansion of private capital. Curbing VIEs from foreign listings would close a gap that’s been used for two decades by technology giants from Alibaba Group Holding Ltd. to Tencent Holdings Ltd. to sidestep restrictions on foreign investment and list offshore. 

Days after Didi’s mega $4.4 billion IPO, China shocked investors in July by announcing it was investigating the company and ordered its services be taken off Chinese app stores, tanking the ridehailing firm’s shares. Didi said earlier this month that it would remove its American depositary shares from the New York Stock Exchange and pursue a listing in Hong Kong. 

Didi’s stock tumbled 5.4% in U.S. trading Monday after the Financial Times reported that the firm has barred current and former employees from selling their shares indefinitely.  

A lack of clarity on listing rules have hobbled the ability of upstarts and their marquee investors to cash in on their growth. After the blockbuster debuts of companies like Kuaishou Technology at the start of the year, several startups expected to come to market have scrapped or put off their listing plans. 

Podcast app Ximalaya Inc. and lifestyle platform Xiaohongshu were among companies that had abandoned their preparations to sell shares in the U.S., while ByteDance Ltd., the owner of the hit TikTok and Douyin apps that’s the world’s most valuable startup, has sought to douse fervent speculation of its own listing plans.

The heightened scrutiny by Chinese regulators has been echoed by their U.S. counterparts. The Securities and Exchange Commission this month announced its final plan for putting in place a new law that mandates foreign companies open their books to U.S. scrutiny or risk being kicked off the New York Stock Exchange and Nasdaq within three years. China and Hong Kong are the only two jurisdictions that refuse to allow the inspections despite Washington requiring them since 2002.  

For companies that seek to list under the VIE structure, the tougher oversight may affect their decision as to choosing the listing destinations, said Xia Hailong, a lawyer with Shanghai-based Shenlun law firm. 

“They used to have no obstacle to overseas listing, but now they’ll surely face much tougher scrutiny and the path to overseas IPOs will be much more difficult,” Xia said. 

Negative list for foreign investment (2021)

  • Agriculture, forestry, farming, fisheries industries: includes specific foreign capital limits on the wheat and corn sectors; ban on investment in genetically modified crops
  • Mining: foreign investment in rare earths and tungsten is banned
  • Manufacturing: cap on foreign shareholding in publishing; ban on investment in traditional Chinese medicine
  • Power, heating, gas and water generation and supply: foreign shareholder limits on the building and operating of nuclear power stations
  • Wholesale and retail: ban on foreign investment in tobacco
  • Transportation, storage and postal services: limits on foreign shareholders in waterway transportation, airlines, civilian airports; ban on investments in postal, courier firms
  • Information transmission, software and information technology services: limits on foreign investment in telecommunications, e-commerce; bans on investment in Internet news services, online publishing, online audio-visual programs, Internet cultural services etc.
  • Leasing, commercial services: ban on investment in legal, market surveying firms
  • Scientific research, technical services: bans on investment in stem cell, gene therapy, social science research, marine surveying, mapping etc.
  • Education: limits on foreign participation in pre-school, K9 education services
  • Health and social services
  • Culture, sports and entertainment: bans on investment in news services, book publishing, broadcasting, TV and movie production etc.

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