This entry is intended to offer a panorama of all the elements involved when buying a listed company in one of established Chinese stock markets.
There are three stock exchanges in China (if we consider Hong Kong also): (i)
Shanghai Stock Exchange
(
http://english.sse.com.cn/
) and (ii)
Shenzhen Stock Exchange
(
http://www.szse.cn/main/en/
) are in mainland China and they impose restrictions on foreign investors; (iii)
Hong Kong Stock Exchange
(
http://www.hkex.com.hk/eng/index.htm
) is not governed by China Securities Regulatory Commission and is open to foreign investors.
Just to introduce briefly the theme, the two exchanges in mainland China classify the stocks into A-share and B-share. Foreign investors take an increasingly active part in mainland China stock markets as QFIIs (Qualified Foreign Institutional Investors, see:
http://blawg.lehmanlaw.com/wordpress/?p=1840
). The Hong Kong Stock Exchange classifies the Hong Kong shares with mainland China background into H-share and Red Chip.
Chinese companies may be listed on one of China’s two national stock exchanges, namely, Shanghai, (Further information about Shanghai Stock Exchange available at:
http://chinastockventure.com/2009/12/shanghai-stock-exchange/
) and Shenzhen (Shenzhen Stock Exchange (the SSE) was established in 1990, governed by the China Securities Regulatory Commission (CSRC). (Hong Kong is considered a market apart), and there are several different types of shares, distinguished by rules governing their ownership and trading.
(The two exchanges in mainland China classify the stocks into A-share and B-share. Foreign investors take an active part in mainland China stock markets as QFIIs (Qualified Foreign Institutional Investors). In 2003, China permitted qualified foreign institutional investors to invest in listed domestic securities denominated in local currency, subject to a quota approved by The State Administration of Foreign Exchange (SAFE), China’s foreign exchange controller).
It must be stressed that the acquisition of the shares of a Chinese-listed company does not always lead to a change of control, in fact foreign investment in listed companies has traditionally taken the form of a negotiated minority stakes for the purpose of developing a strategic relationship rather than seeking operating control.
However, there are two main classes of domestically listed shares:
A-shares
and
B-shares
:
– With exceptions discussed later,
A-shares
are basically limited to domestic investors, including individuals, legal persons and the State, both denominated and treated in the local currency, i.e. the Chinese Yuan (CNY). Historically speaking,
A-shares
were further sub-divided into three sub-sets in light of the strictly defined groups of shareholders, namely: (i) state shares (
guoyou
gu
, 国有股), (ii) legal person shares (
faren
gu
, 法人股), and (iii) public shares (
shehui gongzhong
gu
, 社会公众股). Only public shares used to be freely traded on the stock exchange, and therefore were called “tradable shares,” while State shares and legal person shares were subject to severe trading restrictions, and therefore collectively called “non-tradable shares.” In the past five years, the Chinese government has completed a substantial shareholding structure reform program pursuant to which the former non-tradable shares (including those held by foreign parties) gradually becoming converted at a certain discount into tradable shares that shall be freely traded on the stock exchange at the expiration of statutory lock-up periods. (
Non-tradable shares
were created by the Chinese government in the early 1990s to prevent uncontrolled sales of SOEs to private sectors, but the system artificially distorted the functioning of the market, becoming a serious impediment to its further development. The tradable/non-tradable shares segmentation has been widely seen as the fundamental problem with the Chinese stock markets, which was also largely responsible for serious corporate governance issues).
– Listed domestically, B-shares are denominated in Chinese Yuan (CNY) but subscribed to and traded in US dollars (for those listed in Shanghai) or Hong Kong dollars (for those listed in Shenzhen). B-shares had emerged against the shortage of foreign currency and tight foreign exchange control in the early 1990s and were originally available only to overseas investors. B-shares were introduced to allow foreign (and HK, Macau, Taiwan) investors to participate upon their requests amid the open-up policy, to gain experience from western countries, and to prevent sophisticated foreign investors to exploit the inexperienced Chinese counterparts. (In November 1991, Shanghai Vacuum Electronic Devices Company Limited was the first Chinese company to issue B-shares.)
Starting from February 2001, China permitted domestic individual residents to open B-shares accounts with legally obtained foreign currency and trade in B-shares. With other forms of stocks flourishing, the importance of B-shares declined, and trading volume and market capitalization shrank. By February 2010, there were 57 B-shares listed on Shanghai and 57 B-shares on Shenzhen stock exchanges.
Foreign investors have been precluded from acquiring the largest class of listed shares (domestic A-shares) and acquiring a controlling interest in the non-tradable shares (permitted since 2003) triggered a general tender offer requirement that a foreign investor could not satisfy due to A-share ownership prohibition. Foreign investors were largely limited to acquiring listed B-shares. This class of shares, however, normally makes up only a small portion of a listed company’s equity and is generally illiquid, which precluded the change of control transactions. In principle, legal person and State shares started to open to foreign acquisition in 2002, but in a very limited number of highly regulated transactions. Now, as the economic reform proceeds, the Chinese government has been making great efforts to gradually solve the problem of market segmentation, with a view to bring the market more in line with international norms and standards, in addition to the introduction of the shareholding structure reform. Therefore, control transactions are now becoming more technically feasible. As will be discussed later, there are two main methods of takeovers in China: (1) takeover by public tender offer, which is used for tradable shares; and (2) takeover initiated by privately negotiated agreement, which was the common practice in the era of non-tradable shares. (CSRC approval in one form or another is required in both cases).
A merger of the A- and B-shares markets is also anticipated in the future as China moves to rationalize its capital markets. Consequently, the issuance of new B-shares is quite limited and such issuance and the transformation of shares into listed B-shares is not being encouraged.
This was an introduction about Stock Exchanges in China. In the next entry I will explain more in detail the characteristics and the functioning of these capital markets to better understand how to structure a takeover of a Chinese listed company.
Cristiano Rizzi
(Some of my entries are extracted from my work titled M&A and Takeovers in China, so if you are interested in this topic, please visit:
http://www.kluwerlaw.com/Catalogue/titleinfo.htm?ProdID=9041140484
).