As the Chinese stock market has unexpectedly rebounded over the past few weeks, many believe that a new bull market is in the making after a five-year lackluster performance following China’s stock market crash in 2015. Putting aside the question of whether such bullish sentiment is economically justified, there is no doubt that foreign investors’ interest in publicly quoted companies in China has been stimulated—driven both by the markets’ positive run and the homecoming of more and more overseas listed Chinese companies under the reformed securities law. The reality, however, is that there remain only limited routes available to foreign investors to invest in China’s A-share markets. One such route is the so-called “foreign strategic investment” governed by the Administrative Measures for Strategic Investment by Foreign Investors in Listed Companies, which was initially promulgated on December 31st, 2005, came into effect on January 31st, 2006, and was later amended on October 28th, 2015 (the “Existing Measures”). The Existing Measures sets a relatively high bar for foreign strategic investment, including investors’ qualifications, minimum investment size, lock-up period and other matters. However, all that is about to change, following the release on June 18, 2020 by China’s Ministry of Commerce (“MOFCOM”) of the Administrative Measures for Strategic Investment by Foreign Investors in Listed Companies (Draft for Comment) (the “Draft”), which seeks to attract more foreign strategic investments into China’s public companies. 1
An earlier version of the Draft for public comment had been released by MOFCOM in 2018 (the “2018 Draft”). However, the Draft did not go through the entire legislative process as MOFCOM thereafter shifted its attention to the new Foreign Investment Law which was promulgated in March 2019. The Draft largely follows the framework of the 2018 Draft in terms of easing the restrictions on foreign investors, but also reflects the overhauled foreign investment regulatory regime as reflected in the new Foreign Investment Law. Overall, the Draft, if implemented in its current form, would significantly lower the bar for foreign investors to invest into China’s public companies, but there remain some key areas that are in need of attention if foreign investors are truly to respond to the changed investment regime. Here are our observations:
The Draft stipulates the following key changes, as compared to the Existing Measures:
Qualification requirements for foreign strategic investors eased
Under the Existing Measures, in order to be eligible to make strategic investment in A-share listed companies, a foreign investor or its parent is required to own overseas assets of no less than US$100 million or have overseas assets of no less than US$500 million under management. The Draft has lowered such qualification requirement for foreign investors by stipulating that a foreign investor (acquiring a non-controlling interest) or its “sole” owner (either a foreign legal entity or an individual) is required to own total assets of no less than US$50 million or have total assets under management of no less than US$300 million. The Draft takes out the seemingly odd concept of measuring only “overseas assets” instead of “total assets.” For foreign investors acquiring a controlling interest, the monetary thresholds of US$100 million and US$500 million in the Existing Measures still apply.
In addition, subject to these same qualification requirements, foreign natural persons are for the first time allowed to make strategic investments in A-share listed companies under the Draft.
Minimum investment size lowered
The Existing Measures require one or more foreign investors making strategic investment at any one time to take at least a 10% stake of a listed company in aggregate. The Draft eliminates this minimum shareholding requirement for investment when executed by way of a new share subscription and lowers the requirement to 5% in the case of a
transfer of issued shares by existing shareholders. The 5% minimum shareholding requirement also applies to investments by way of a general tender offer. The lowered minimum investment threshold therefore affords foreign investors equal treatment with domestic players2, as well as providing them with more flexibility in deal structuring.
Lock-up period shortened
Probably the least investor-friendly clause under the Existing Measures is the three-year lock-up period imposed on foreign investors making strategic investments. The Draft proposes to shorten the three-year lock-up period to 12 months unless other applicable laws or regulations stipulate otherwise. This would offer real relief to foreign investors who are generally averse to such a long lock-up period, certainly as compared with investments in other jurisdictions.
Cross-board share swaps permitted
Cross-board share swaps, although theoretically permissible under Chinese law, are in fact rare in practice as only foreign listed companies’ shares can be swapped and used as consideration for the purchase of any China onshore shares or assets under the existing foreign investment regulatory regime.
The Draft permits shares of foreign private companies to be swapped and used as consideration for subscription of newly issued shares by a Chinese listed company or for purchase of issued and outstanding shares of a Chinese listed company in connection with a general tender offer.
Post-transaction information reporting replaces pre-transaction approval
So long as none of the businesses conducted by the target listed company falls within the so-called “negative list”, which sets out the industries and sectors where foreign investment is either restricted or prohibited, the Draft stipulates that post-transaction information reporting, instead of pre-transaction approval with MOFCOM, is required. Technically, the Provisional Measures on Administration of Recording-filing for Incorporation and Change of Foreign Invested Enterprises (the 2017 amended version) have already abolished the pre-transaction approval requirement stipulated in the Existing Measures, and the Draft merely formally documents this important regulatory change.
The scope of strategic investment is yet to be clarified
Under the Draft, contractual transfers, private placement, general tender offers and other methods permitted by applicable laws and regulations are the permitted routes for foreign strategic investment. However, what“other meth- ods” permitted by relevant laws and regulations are remains unclear. We are of the view that it is very important for the new measures to specifically list other available or permissible methods, such as rights offering, purchase of convert- ible bonds and exchangeable bonds and block trade. Permitting foreign investors to make investment through all the legitimate routes available should be in line with the legislative purpose behind the Draft.
Lock-up period targeting foreign investors is inconsistent with the national treatment principle
The lock-up period imposed on foreign investors is significantly shortened (from 36 months to 12 months). We are of the view, however, that this “special” lock-up targeting foreign investors should be lifted entirely as there are still various lock-up requirements already applicable in different scenarios (e.g. private placement, contractual transfer, significant shareholder holding 5% or more, among others) under the current regime. Moreover, the lifting of such lock-up would deliver a clear message that the Chinese government is determined to open its market to foreign inves- tors with national treatment, even for public equities in China.
Restrictions on cross board share swaps still remain
As mentioned above, shares of foreign private companies can be used as consideration for subscription of newly issued shares by a Chinese listed company or for purchase of issued and outstanding shares of a Chinese listed compa- ny in connection with a general tender offer. But it is unclear to us why the Draft does not allow shares of foreign private companies to be swapped cross board as consideration for the purchase of the outstanding shares held by current shareholders of the A-share listed company by way of a private agreement.
We consulted on this point with a senior official at MOFCOM and were advised that the limited expansion of cross board share swaps as reflected in the Draft is already a significant breakthrough thanks to the efforts on the part of MOFCOM, and it is not realistic to achieve further relaxation due to complexities of inter-ministerial coordination or, frankly, different policy goals or interests of the multiple ministry level agencies involved. Our speculation is that the underlying logic for limited relaxation is to enable or encourage A-share listed companies to use newly issued shares to pay for overseas acquisitions of businesses and assets, while not affording the same option to existing shareholders of listed companies, which essentially is a new channel to move assets offshore.
Applicability on existing strategic investments to be clarified
The Draft remains silent on whether the draft will apply to strategic investments made before the effective date. For example, do existing foreign strategic investors enjoy the shortened lock-up period?
As explained by the authorities3, the Draft purports to deal with issues under the Existing Measures that obstruct foreign strategic investments in listed companies by broadening the scope of permitted investment methods, lower- ing the investment qualification requirements, shortening the lock-up period, providing more flexibility on cross board share swaps, implementing a simplified post-event reporting procedure, and other measures. If finally imple- mented without substantially changes, we believe the new administrative measures will be welcomed by the more sophisticated foreign investors who have their eyes on China’s public companies.
However, other than the few issues discussed above where further clarity and guidance will be needed, the more critical question is the coordination (or the lack of it) of different government agencies involved in the investment process, including MOFCOM, SAMR4, SAFE5, stock exchanges, stock depositary and clearing houses and banks handling account opening and cross-border capital transfers to make sure that the entire process is straightforward and deal structuring can operate as it should, in a user-friendly way. For example, the Draft has replaced the pre-deal approval with post-deal information reporting as a major step forward to streamline the process of investment. The post-deal information reporting is supposed to be the last step of the investment process. However, one important step in the process is the opening of a stock account with China’s stock depositary and clearing house so that the shares of a public company in which the foreign investor has invested can be properly booked under the investor’s name. What documentary proof will the clearing house need in order for the foreign investor to open a stock account in its capacity as a “foreign strategic investor” as opposed to an investor in the secondary stock market ,which falls into another regulatory category? Which agency will be taking up the role of vetting the qualification of the foreign inves- tor? Bear in mind that unlike a private company, the stock clearing house—instead of SAMR—is playing the role of maintaining a register of shareholders holding what number of shares (in most cases). We can foresee that the clearing house may in practice require the foreign investor to complete the information filing first and use that proof to open a stock account. Questions like these seem to be procedural in nature, but bear critical importance in terms of fulfilling the legislative purpose of the Draft—to attract more foreign strategic investment in China’s pubic companies.