 |
Kenneth Lam |
 |
Kai Man Wong |
Over the last decade, China has launched various economic and enterprise reforms to accelerate its economic development. The decentralization of control and the movement of savings into the industrial and commercial sectors were enhanced when the domestic securities markets were opened up in 1990. A landmark development in 1993 meant that the well-established State-owned enterprises (SOEs) were able to raise equity funds through overseas listings in markets such as Hong Kong, New York, Singapore, and London. In the last 10 years, over US$83 billion (HK$650 billion) was raised by enterprises incorporated in the People s Republic of China (PRC) by listing on the domestic and international stock exchanges.
This has resulted in the listing of over 1,200 PRC enterprises on the Shanghai Stock Exchange (SHSE) and the Shenzhen Stock Exchange (SZSE). The combined market capitalization of these companies in April 2001 was US$563 billion (Rmb4,700 billion). It is estimated that China has approximately 50 million stock investors, making it the world s second largest market, in terms of stock investors, after the United States. By April 2001, 52 SOEs had listed in Hong Kong (H shares), and 14 of these also issued shares to investors in the United States (N shares). In addition, there are some 46 Hong Kong incorporated listed companies, which are either controlled by Chinese ministry bodies or municipal government (Red Chip companies). H share and Red Chip companies have a combined market capitalization of approximately US$34 billion (HK$263 billion).
Resurgence of fund raising channels for PRC enterprises
Economic and enterprise reforms in China have become the driving forces behind the resurgence of fund raising channels, in particular the securities markets. This has led to the transformation of SOEs from national corporations to publicly held joint stock companies. This facilitates the separation of government ownership from the management of SOEs. Simultaneously, Chinese laws have been amended in order to bring the transformation into reality. These reforms have established a platform for the expansion and strengthening of China s securities markets.
When Deng Xiaoping was restored to power at the 11th Party Congress in 1978, China embarked on a period of experimentation and revitalization of the economy.
This period enabled the decentralization of power from the central government to the regions, paralleled by a shift of management authority from the central policy makers to working level managers.
From 1987, the process of enterprise reform and the separation of enterprise management from government ownership have accelerated. This separation has provided, to some degree, the basis for developing a joint stock company structure and has facilitated the listing of many PRC enterprises on domestic and overseas securities markets.
The emergence of domestic securities markets
SZSE and SHSE were officially sanctioned to open on December 1 1990 and December 19 1990 respectively.
Initially, the SHSE and SZSE were essentially closed markets, with only PRC domestic legal entities, enterprises and individuals allowed to participate in the markets by trading A shares, which are domestic ordinary shares denominated and traded in renminbi (Rmb).
In order to raise foreign capital a new class of share, B shares, were introduced in 1992. Only non-PRC nationals were permitted to trade in B shares until March 2001. Parties from Hong Kong, Macao and Taiwan are regarded as foreign investors for this purpose. B shares are denominated in either US Dollars if traded in Shanghai, or in HK Dollars if traded in Shenzhen.
During the first quarter of 2001, new measures and proposals are being actively considered or implemented which will have a significant impact on China s securities markets:
- From March 2001, domestic investors with US dollar funds are allowed to trade in B shares. The immediate market reaction is to re-price the B shares to a higher level, to reduce the price differentials between A and B shares. This may pave the way for the merger of A and B shares.
- The proposed establishment of a second board in Shenzhen, which aims to provide a viable channel to raise capital for start up businesses and those involved in high technology sector. Proposed amendments to the Securities Law and the Companies Law, along with the drafting of relevant listing rules and disclosure requirements are in progress.
- The suggestion that following the introduction of the second board, the main board in Shenzhen may merge with the board in Shanghai to form a single main board.
- The proposed measures to release two-thirds of the non-negotiable shares of listed companies held by the State have been widely discussed among the regulatory bodies and in academic circles. A suggested option is to group all of the non-negotiable shares into a portfolio of indexed funds to be traded on the domestic securities markets. In association with the economic development of western China, it is expected that the domestic securities markets will play a crucial role in meeting the increased capital requirements in China.
Raising capital through overseas securities markets
In 1993, selected SOEs were given the green light to list their shares on overseas markets, including Hong Kong. Following the 1993 listing of Tsingtao Brewery, Shanghai Petrochemical, Beiren Printing Machinery, Guangzhou Shipyard, Maanshan Iron & Steel and Kuming Machine Tool, Hong Kong s H share market sprang to life. It has been established that companies that have issued B shares cannot concurrently issue H shares, and vice versa. However, H share or B share companies can apply to issue A shares.
PRC enterprises can also raise capital in the United States by issuing N shares, where the enterprises can either issue ordinary shares or American Depository Receipts (ADRs). The latter option is the more common form as it is more flexible. Examples of PRC enterprises that have issued ADRs include PetroChina, Sinopec Shanghai Petrochemical, Qingling Motors, and Shandong Power.
As an alternative to issuing A, B, H and N shares, PRC enterprises can raise capital via Red Chip companies. PRC enterprises can obtain a listing in Hong Kong as a Red Chip company by directly listing the new shares of its Hong Kong incorporated subsidiary companies, or by acquisition of Hong Kong listed companies through restructuring. Examples of successful Red Chips include China Merchants, China Overseas, CITIC Pacific, China Resources and COSCO Pacific.
Considerations for a PRC enterprise prior to listing
Domestic and overseas securities markets are attractive to potential listing issuers for different reasons. If a PRC enterprise decides to list, various factors may affect the decision to list on an overseas or domestic market. These include:
- Historical trading patterns of PRC enterprises with dual listings in China and overseas securities markets
- Attractiveness of the securities markets to investors
- Benefits of overseas listing vs. domestic listing
- Challenges for a PRC enterprise seeking an overseas listing
- Is the timing right
Historical trading patterns of dual listed PRC enterprises
In order to understand the trading pattern of PRC enterprises in domestic and overseas securities markets, a brief comparison of the P/E ratio, liquidity ratio and funds raised for enterprises that issue both A and H shares needs to be examined.
P/E ratio and liquidity
Table A - P/E ratio A & H shares as at April 19 2001
Range of P/E ratio at April 19 2001 | A | H |
| No. of companies | |
No P/E provided | 2 | 2 |
Below 20 | 0 | 12 |
21 to 600 | 14 | 3 |
601 to 1000 | 0 | 2 |
1001 to 5000 | 3 | 0 |
Total number of enterprises with dual listing in A and H shares | 19 | 19 |
[Source: Bloomberg]
Table B - Liquidity ratio A & H shares as at April 19 2001
| No of companies with concurrent listing as at April 2001 | Average number of tradable shares on issue (million) (From April 2000 to February 2001) | Average of the average daily trading volume of shares (From April 2000 to February 2001) | Liquidity ratio | |
|
| (A) | (B) | (B)/(A) |
|
|
|
|
|
China A | 19 | 259 | 5,304,605 | 0.020 |
Hong Kong H | 19 | 658 | 10,095,440 | 0.015 |
[Source: Bloomberg]
Table C Funds raised A & H shares up to April 19 2001
No. of companies with concurrent listing as at April 2001 | Funds raised up to April 19 2001 | |
China A | 19 | USD 2,027 million |
Hong Kong - H | 19 | USD 3,327 million |
[Source: Bloomberg]
Tables A and B show that 17 out of 19 A share companies have a P/E ratio of over 20, while 12 out of 19 H shares have a P/E ratio of lower than 20, and the liquidity ratio of A shares is approximately 1.3 times that of H shares.
A number of academic studies have tried to explain this. The argument put forward is that the A share market is a closed market which is restricted to domestic enterprises and nationals, whereas, H shares are traded in Hong Kong which is open to global investors. The overall price sensitivity of A shares is less than that of H shares. Other arguments are available to explain why the P/E ratio of A shares are much higher than that of H shares, some of which are following:
- Shortfall of available shares to domestic investors together with high demand cause the market prices of A shares to have a higher premium. In contrast, international investors generally enjoy a wider range of investment opportunities across stock sectors and countries.
- Existence of exchange controls which limit domestic investors to invest in SHSE and SZSE only.
- The effects of high savings ratios in China, approximately 40% of GDP, cause strong price support in the securities markets of the PRC.
Table C shows that funds raised through H shares exceed those raised through A shares by 64%. This is the result of the larger volume of H shares in the initial listing. The larger volume of H shares satisfies the demand of global institutional investors who have access to a global or regional distribution network.
Which securities market is attractive to investors
Investors like to invest in securities markets with a well-established corporate governance regime, a high degree of transparency and good investor protection regulations. Freedom of capital inflow and outflow from the economy and the stability of the currencies in which the shares are denominated are factors to be considered by investors.
For domestic markets, foreign investors have concerns over issues such as insider dealings, price manipulation and insufficient corporate governance. Chinese authorities have recognized these issues and have tried hard to improve the legal and regulatory measures, such as the enactment of a Securities Law which became effective in July 1999, along with the introduction of accounting standards which are closely modeled on the International Accounting Standards.
The China Securities Regulatory Commission (CSRC) is in the process of drafting the code of corporate governance. For listed companies in China, the concept of corporate governance may not be widely accepted and adopted. Existing listed companies on the two exchanges in China only issue one-third of their shares as negotiable shares. The other two-thirds of their shares are those non-negotiable shares held by the founders of the enterprises, other SOEs or quasi-governmental bodies. Such shareholding structures tend to focus on the maintenance of the status quo instead of generating profits and maximizing shareholder value.
Certain commentators see that the value of the Hong Kong market lies in its provision of a more advanced environment of corporate governance. This increases the transparency of listed companies and the protection offered to investors. In the absence of exchange controls in Hong Kong, funds are freely convertible and freely remittable. With a well-established legal framework and accounting system, and the concentration of fund managers and analysts on Chinese enterprises, institutional investors are more willing to invest in the Hong Kong market.
Additional benefits for a PRC enterprise seeking an overseas listing
There are other reasons why an international listing may be more attractive to PRC enterprises. These include:
- Raising capital in foreign currency
The volume, breadth and sophistication of major international markets make them an ideal place to raise capital in foreign currency.
- Diversification of the shareholder base
Listing in the international securities markets gives PRC enterprises a chance to broaden their non-PRC shareholder base. This may complement their domestic listing.
- Enhance share values
A large, more liquid trading environment may enhance share values in the domestic and global securities market. This could substantially decrease a company s cost of capital and facilitates other forms of financing such as debt financing in international financial markets. An offering in the international securities markets gives access to a pool of sophisticated investors that may give the company a more favourable rating than it has in its domestic market.
- Product marketing
A presence in the international securities markets provides international exposure for a company s name, services and products. This exposure may help a company to enhance its export base and earnings of foreign exchange.
- Reputation
Listing on an international market is a good way to raise the profile of a PRC enterprise.
- Expands business relationships
The publicity generated by a public company brings it to the attention of prospective suppliers and distributors, potential partner companies for joint ventures, or inventors that have marketable ideas. Such relationships, existing or future, are strengthened by the confidence that stems from the knowledge that the company has met stringent listing and reporting requirements of international securities markets.
- Flexibility in issuing share options as remuneration for management and employees
Red Chip companies enjoy the flexibility to issue share options. These share options can be used as part of a remuneration package to motivate the performance of management.
- Flexibility in issuing shares as consideration for acquisition of investments
Red Chip companies generally enjoy the flexibility to issue shares for the acquisition of investments without having to pass through the bureaucratic process that many SOEs experience.
Challenges for a PRC enterprise seeking an overseas listing
Overseas listings also mean additional challenges:
- Costs of maintaining investor relations
Investor inquiries, investment community presentations and periodic financial reports require a significant time commitment by management. These efforts have costs and may require additional internal resources or expensive external assistance.
- Demanding reporting requirements
The enterprise must satisfy the ongoing information needs of overseas investors and regulators. In particular, it will be required to prepare financial statements in accordance with, or reconciled to, International Accounting Standards or the accounting standards and practice of the country where the listing is sought. If the PRC enterprise also lists its shares in the domestic securities market, dual corporate and financial reporting will be required.
- Increasing demand for transparency and corporate governance
Usually international securities markets demand a higher level of transparency and require extensive corporate governance practices and disclosure requirements. There are additional costs and time in meeting such disclosure requirements.
- Significant listing and ongoing costs
Listing on international securities markets generally involves more significant listing and ongoing costs such as the initial and annual listing fees, the underwriting commission, marketing expenses, professional consultation and assistance.
Is the timing right?
The performance of the securities market is often one of the most unpredictable factors in choosing whether to raise capital at a particular point in time. Key elements affecting market performance include general market sentiment and the prevailing political and economic climate.
It is easier to ensure that the company is ready for listing and then look for the right timing in the market.
The following are some of the positive characteristics that the investment community will be looking for:
- Demonstrated profitability
- Experienced management team
- Highly visible products and services
- Purpose of the listing
- Significant and sustainable revenue growth rate
- Clear corporate structure
- The ability to produce reliable financial reports in accordance with internationally accepted standards
Which overseas securities market should a PRC enterprise choose?
Once a PRC enterprise has decided to list its shares overseas, which overseas securities markets should it choose? As most PRC enterprises are listed in Hong Kong and the United States, a brief analysis of the listing requirements in these two jurisdictions is set out in Appendices 1 and 2. Most sponsors will be able to assist management in making the appropriate choice.
What preparation work needs to be done before listing?
If the objective of management of the PRC enterprise is to go public, timing is the most critical factor in achieving that objective.
Forming an internal IPO committee
The initial task is to form an internal initial public offering (IPO) committee (committee) that normally consists of members from the management, chief executive officer, chief financial officer, and company secretary. The committee will be responsible for liaising with the external IPO team and should consider the following:
- Prepare timetable for the complete IPO process
- Formulate business strategy
- Consider group and business restructuring
- Consider availability of resources
- Evaluate the existing information technology infrastructure for reporting and operational purpose
- Review the existing internal control procedures
- Review the existing corporate governance regime
- Consider the relevant application procedures for an overseas listing
- Consider the post IPO remuneration plan, particularly for senior management
- Redefine the employment title and role of those senior management who hold positions in governmental bodies to ensure a proper separation of government ownership from the management of the company
- Assist in finalizing the listing documents
- Assist experts in finalizing their expert reports, for example the accountants report and valuation reports
- Prepare and file the listing application form
- Price the offering
- Prepare for the road show and hearing
Selection of an external IPO team
The selection of an experienced external IPO team can facilitate the listing process and will ensure that the listing is carried out in the most cost efficient and effective manner. An external IPO team will normally involve some or all of the following parties:
- Sponsors
- Underwriters
- Legal advisers
- Merchant bankers
- Public relations firm
- Reporting accountants
- Valuers
- Printers
- Share registrar
- Translator
Group and business restructuring
Part of the business of an enterprise may not be suitable for listing. The enterprise needs to conduct an overall review of its business and group structure, taking into account the following:
- Merging those companies with overlapping or competing businesses
- Deciding which part of the business, if any, should continue to be held privately
- Deciding whether to establish a holding company abroad
- Tax planning and preservation of tax assets
- Clarifying the ownership of tangible and intellectual properties
- Deciding which company is going to bear the costs that are of continuing nature, for example housing subsidies and redundancy costs
- Clarifying the social responsibilities
- Considering the impact on the morale of staff
- Considering any potential and contingent liabilities or commitments
Future development
The development of the securities markets in China over the next decade is expected to be as rapid as the development of the markets over the previous decade. The main focus will be on the consolidation of the regulatory and supervisory controls within the markets, and the adaptability of the markets to the ever-changing international and domestic economic climate, particularly following accession to the World Trade Organization. The seeking of an overseas listing status and the access to international capital will continue, particularly in Hong Kong. The healthy development of securities markets in both China and Hong Kong will be mutually beneficial, with the funds raised used to further enhance the growth of the PRC economy.
Appendix 1
A brief summary of the listing environment in Hong Kong and United States relevant to PRC enterprises
Hong Kong | United States | |
Regulatory authority |
| The Securities and Exchange Commission (SEC) |
Markets |
|
|
Principal governing rules |
|
|
Usual form of securities used by PRC enterprises for overseas listings |
- Rights issue |
|
Methods for raising capital | Mainly
| Mainly
|
Basic requirements for listing | Refer to Appendix 2 | |
Content of listing documents / particulars | The listing rules prescribe the information to be disclosed in the listing document. This information may include the following:
Additional information required for listing on GEM:
| The content of registration statement (Form 20-F) include:
|
Cost of obtaining a listing | Depending on the complexity of the exercise, the estimated minimum cost for obtaining a listing ranges from 8% to 13% of the funds raised. The estimated cost includes the following fees:
| Depending on the complexity of the exercise, the estimated minimum cost for obtaining a listing ranges from 9% to 14% of the fund raised. The estimated cost includes the following fees:
|
Appendix 2:
Overview of listing requirements in Hong Kong and certain US exchanges relevant to PRC enterprises
Hong Kong | United States | |||||
| Main Board | GEM | NYSE (Note 1) | Nasdaq National Market | ||
Alternative for non-US companies | Option 1 | Option 2 | Option 3 | |||
Operating history | 3 years (Note 2) | 2 years (Note 2) | N/A | N/A | 2 years | N/A |
Pre-tax income | HK$20 million for the most recent year and HK$30 million for aggregate of the first two years (Note3) | N/A | US$100 million cumulative pre-tax income for the last three fiscal years, with no less than US$25 million in each of the two most recent years Or For companies with not less than US$500 million in worldwide market capitalization and US$200 million in revenue for the most recent 12 months: US$100 million aggregate cash flow for the last three years and with no less than US$25 million in each of the two most recent years Or For companies with not less than US$1 billion in total worldwide market capitalization and not less than US$100 million in revenue for the most recent fiscal year, there are no additional financial requirements | US$1 million in latest fiscal year or two of last three fiscal years | N/A | N/A |
Hong Kong | United States | |||||
| Main Board | GEM | NYSE (Note 1) | Nasdaq National Market | ||
Alternative for non-US companies | Option 1 | Option 2 | Option 3 | |||
Balance sheet | N/A | N/A | N/A | US$6 million net tangible assets | US$18 million net tangible assets | N/A |
Minimum number of investors | Three holders for each HK$1,000,000 with a minimum of 100 holders | 100 holders | 5,000 each holding 100 or more shares | 400 each holding 100 or more shares | 400 each holding 100 or more shares | 400 each holding 100 or more shares |
Minimum shares to be held by the public | If there are existing issued securities of the PRC issuer other than H shares:
| If there are existing issued securities of the PRC issuer other than H shares:
| 2.5 million worldwide | 1.1 million | 1.1 million | 1.1 million |
Hong Kong | United States | |||||
| Main Board | GEM | NYSE (Note 1) | Nasdaq National Market | ||
Alternative for non-US companies | Option 1 | Option 2 | Option 3 | |||
Minimum shares to be held by the public (continued) | If there are no existing issued securities of the PRC issuer other than H shares: 25% of the issued share capital or 10% of the issued share if market capitalization exceeds HK$4 billion | If there are no existing issued securities of the PRC issuer other than H shares: 20% of the issued share capital (15% of the issued share if market capitalization exceeds HK$1 billion and at least HK$200 million worth of shares are held by the public)
| ||||
Total market value of public shares | Not less than the higher of HK$50 million; or the expected initial market value of the applicable minimum prescribed percentage noted above
| Not less than the higher of HK$30 million; or the expected initial market value of the applicable prescribed minimum percentage noted above | US$100 million worldwide (Note 4) | US$8 million | US$18 million | US$20 million |
Minimum bid price | N/A | N/A | N/A | US$5 | US$5 | US$5 |
Number of market makers | N/A | N/A | N/A | 3 | 3 | 4 |
Notes:
- Non-US companies may elect to qualify for listing under either the alternate listing standards for non-US corporations or the NYSE's domestic listing criteria. However, an applicant must meet all of the criteria within the standards under which it seeks to qualify for listing. The table highlights the alternative listing standards for non-U.S. corporations.
- The Exchange may accept a shorter period for infrastructure and natural resource companies.
- The Exchange may vary or waive the above profit requirement for infrastructure and natural resource companies.
- While greater emphasis is placed on market value, an alternate measure is equity for certain issuers whose market value of public shares is no more than 10% below US$60 million or US$100 million, as applicable.
- The table highlights the listing requirements in NSYE and Nasdaq National Market, as they are the most common U.S. markets where PRC enterprises seek listing in United States. Apart from NSYE and Nasdaq National Market, there are also AMEX and Nasdaq small cap markets in United States.
Sources:
- Rules governing the listing of securities on the Stock Exchange of Hong Kong Limited
- Rules governing the listing of securities on the Growth Enterprise Market of the Stock Exchange of Hong Kong Limited
- Listing standards set out in the website of NYSE as of April 2001
- Listing requirements set out in the website of Nasdaq as of April 2001
Exchange rates:
HK$/US$ - 7.8
RMB/HK$ - 1.07
Sources:
Figures quoted on page 1
- Bloomberg
- Website of The China Securities Regulatory Commission
Figures quoted on pages 4 and 5 (Tables A, B and C)
- Bloomberg
Listing requirements set out in Appendices 1 and 2
- Rules governing the listing of securities on the Stock Exchange of Hong Kong Limited
- Rules governing the listing of securities on the Growth Enterprise Market of the Stock Exchange of Hong Kong Limited
- Listing standards set out in the website of NYSE as of April 2001
- Listing requirements set out in the website of Nasdaq as of April 2001
Acknowledgement
The authors express their sincere thanks to Rebecca C. C. Chan and Rita S. S. Chan of PricewaterhouseCoopers, Hong Kong, who have provided valuable input in developing the chapter on issues relating to their expertise on laws and regulations in Hong Kong and the PRC.
Kai Man Wong, Partner, Assurance & Business Advisory Services, PricewaterhouseCoopers
Email: [email protected]
Kenneth Lam, Partner, Assurance & Business Advisory Services, PricewaterhouseCoopers
Email: [email protected]
Note: This article was first published in a book called "Structuring for Success"
