In order to eliminate the adverse effects of non-tradable state-owned shares in the corporate governance of listed companies and the entire security market, Chinese securities regulators have started to adjust the stock market by conducting transfer of stated-owned shares since 1995 on a pilot basis. However, it is not until the introduction of share splitting of the securities market which started in 2005 that substantial progress has been made. On the condition of avoiding the loss of state-owned assets and for the purposes of further improving the mechanism of circulation of state-owned shares, promoting the standardization and improvement of the securities market, the authorities promulgated two regulations, namely the Interim Measures for the Administration of the Transfer of Shares of Listed Companies by State-Owned Shareholders (“Regulation No. 19”) and the Implementing Measures for the Transfer of Some State-owned Shares from the Domestic Securities Market to the National Social Security Fund (“Regulation No. 94”). These regulations have solved the problems of state-owned shares to some degree.
According to Article 5 of the Regulation No. 94, the term “transfer of state-owned shares” refers to the transfer of 10% of the actual amount of initial public offering (IPO) stocks of joint stock limited companies ofstate-owned shares in listed companies to the National Council for Social Security Fund at the time of listing. The Regulation further provides clearer codes of conduct and guidance on the application of transfer of state-owned shares in relation to the proportion, ways, procedure and etc. However, the definition of the state-owned shares remains uncertain. According to Article 2 and Article 4 of Regulation 94, State-owned shares refer to shares of listed companies held by state stockholders identified by the State-owned Assets Supervision and Administration organization. The wording “identified by the
state-owned asset supervision and administration” is too general that it doesn’t contribute to a well-defined concept of the state-owned shares in the aspects of its constitution. The ill-defined concept of state-owned shares will directly affect the category of the state-owned shares needed to be transferred and the information needed to be disclosed by listed companies. As such, it also leads to imperfect corporate governance structure of listed companies, insufficient supervision of state-owned shares and other problems that affects the administration of state-owned assets and the development of securities market. The following analysis focuses on the application of the abovementioned regulations coupled with our practical experiences.
Firstly, according to Article 217 (2) of the Company Law, "controlling shareholder" shall refer to two situations: 1) a shareholder whose shares account for 50 percent or more of the total share capital of a company limited by shares, i.e. absolute holding; or 2) a shareholder whose voting rights corresponding to the capital contribution or shares thereof are sufficient to exert a material influence on the resolutions of the shareholders' meeting or the general meeting, i.e. relative holding, despite the fact that the shareholder's capital contribution or shares account for are less than 50 percent of the total capital or total share capital. Nonetheless, as far as the unique criteria of state-owned shares is concerned, the law is not clear on whether the identity of state-owned shareholders shall include absolute holding or relative holding.
Secondly, only the absolute holding is identified as the state-owned holding in most of the related regulations and documents on the state-owned shares. Such regulations include:
- the Provisions of the Supreme People’s Court on Issues Concerning Freezing or Auction of State-Owned Shares and Social Corporate Shares of Listed Companies;
- the Opinions of the Ministry of Finance on the Determination of State-owned Enterprises;
- the Interim Provisions on the Labeling and Management of State-Owned Shareholders in Listed Companies (“Regulation No. 108”); and
- the Reply of the State-owned Assets Supervision and Administration Commission of the State Council on Issues concerning the Implementation of the "Interim Provisions on the Labeling and Management of State-Owned Shareholders in Listed Companies (“Regulation No. 80)".
According to the Regulation No.80, shareholders of listed companies who must be marked as state-owned shares in accordance with Regulation No. 108 include: 1) government agencies, departments, institutions, wholly State-owned enterprises, or limited liability companies or joint stock limited companies whose investors are all wholly State-owned enterprises; 2) incorporated enterprises in which the above-mentioned entities or enterprises exclusively hold more than 50% of the shares; incorporated enterprises in which the above-mentioned entities or enterprises aggregately hold more than 50% of the shares, one of which is the first largest shareholder; 3) subsidiaries at all levels, in which the enterprises mentioned in item 2) hereof maintain absolute shareholding relationship; and 4) affiliated entities or wholly-owned subsidiaries of all the above-mentioned entities or enterprises. It should be noted that Regulation No.108 was promulgated at the same time as Regulation No. 19. The State-owned Assets Supervision and Administration Commission of the State Council later released “Issuing the Several Opinions on Regulating the conduct of State-owned Shareholders of Listed Companies” in which it was stated that Regulation No.108 is an integral part of the administrative regulations. In other words, the definition of the concept of state-owned shareholders should also be applicable to Regulation No. 19. Regulation No. 80 shall have same effect as it provides specific rules for the implementation of Regulation No.108 despite the wordings of “only applicable to the Labels of Listed Companies' State-owned Shareholders”.
In addition, the reference of Regulation No.108 and No.80 in the application of Regulation No. 94 has been tested in many cases. To be specific, it is not necessary to fulfill the obligation of transfer under the situation of relative holding. Some example cases are as follows:
- In the IPO of Beijing Beilu Pharmaceutical Co. Ltd (“Beilu”), Regulation No. 108 and No. 80 were adopted by SASAC to decide whether Chongqing Sanxia Paint Co. Ltd (“Sanxia”), a shareholder of Beilu company, should be identified as state-owned shareholder and thus should fulfill the obligation of transferring its state-owned shares to Social Security Fund. In this case, Chongqing Chemical and Pharmaceutical Holdings (Group) Co. Ltd, i.e. the major shareholder of Sanxia, is a state-owned corporation invested by the SASAC of Chongqing. However, it is not recognized as state-owned shareholder of Sanxia for the reason that its proportion of shareholding is 40.53% and does not reach or exceed the requirements of 50% shareholding according to the Reply of SASAC & MOF. Furthermore Sanxia is not required to perform the duty of transferring state-owned shares.
- The same situation happened in the progress of the IPO of Hiconics Drive Technology Co., Ltd (“Hiconics”). Legend Holdings Limited which owns 3% shares of Hiconics was not identified as state-owned shareholder or not required to perform the duty of transferring state-owned shares because the proportion of shares held by major shareholder, Chinese Academy of Sciences Holdings Co., Ltd ("CAS HOLDINGS"), was less than 50%.
- According to the prospectus of Beijing Ultrapower Software Co. Ltd. (“Ultrapower”), no shareholders were obliged to transfer state-owned shares to the Social Security Fund. Gold Stone Investment Limited, as one of its shareholders, is a wholly-owned subsidiary of CITIC Securities Co. Ltd. (“CITIC Securities”) and the major shareholder of CITIC Securities is CITIC Group Corporation, i.e. a State-owned corporation. According to the Annual Report of CITIC Securities in 2009, CITIC Group Corporation’s holding ratio of 23.69% shares of CITIC Securities is considered as relative holding and thus CITIC Securities is not considered as State-owned shareholder of Ultrapower during its IPO.
In conclusion, whilst waiting for more specific definition of state-owned shares of listed companies by relevant regulators, Regulation No.108 and No.80 have actually provided more practical rules for defining the concept of State-owned Shares from the perspective of shareholders holding ratio. As a result, these two regulations may be applied as reference for Regulation No. 94 in deciding whether a shareholder should be identified as State-owned shareholder and be obliged to transfer its shares to the Social Security Fund during a company’s IPO process.