China: New Regulations Open Door To Acquisition Of China Listed Companies By Foreign Investors

Last Updated: 22 November 2006
Article by Kevin Ban

I. Introduction

Recent regulatory changes for the first time allow foreign investors to directly acquire shares in a company listed in a Mainland China stock exchange. This expands further the investment opportunities for foreign strategic and financial investors.

On December 31, 2005, the Measures on Administration of Strategic Investment by Foreign Investors in Listed Companies ("Measures") were jointly issued by the Ministry of Commerce ("MOFCOM"), the China Securities Regulatory Commission ("CSRC"), the State Administration of Foreign Exchange ("SAFE"), the State Administration for Industry and Commerce ("SAIC") and the State Administration of Taxation ("SAT").

The Measures, which took effect on January 31, 2006, allow foreign investors, through so-called strategic investments (the "Strategic Investments"), to acquire A-shares of a PRC company listed on either the Shanghai Stock Exchange or the Shenzhen Stock Exchange provided that such company (i) has completed the reformation of the split equity structure (the "Split Shares Reform") as required by the relevant PRC laws1 after becoming listed on a PRC stock exchange or (ii) is listed on a PRC stock exchange after the promulgation of the Split Shares Reform Measures.2

II. Requirement of a strategic investment

A Strategic Investment pursuant to which a foreign investor may acquire A-shares of a PRC listed company under the Measures is an investment that meets the following criteria as set forth under Article 5 of the Measures:

  1. The investment may be made in separate transactions to be consummated over an unspecified period of time provided that the percentage of shares acquired by the foreign investor pursuant to the first of such series of transactions shall be no less than 10% of the aggregate issued and outstanding shares of the listed company in question (the "10% Threshold"), unless provided otherwise in rules or regulations applicable to the particular industry in question or as otherwise approved by a competent PRC governmental authority;
  2. To the extent that investment in the PRC by foreign investors with respect to certain industries are restricted or prohibited by other rules or regulations of the PRC, such other rules or regulations shall be observed notwithstanding the Measures;3
  3. The A-shares acquired by the foreign investor shall not be transferred for a period of three (3) years;
  4. The acquisition of the A-shares in question must be effectuated through a transfer of issued and outstanding shares pursuant to private contract with an existing shareholder of the company, a private offering of new shares by the listed company in question, or such other methods as may be permitted under the relevant laws and regulations of the PRC; and
  5. If the proposed investment by the foreign investor involves state-owned shares in the listed company in question, any applicable requirements as set forth in the relevant provisions pertaining to the administration of state-owned assets shall be satisfied.

III. Qualifications of a Foreign Investor Proposing to Undertake a Strategic Investment

The Measures also impose the following requirements with respect to the foreign investor proposing to undertake a Strategic Investment in the A-shares of a PRC listed company:

  1. The foreign investor must be a foreign corporate or other entity which is established and operated according to law, in stable financial condition, with sound credit and reputation, and be staffed with an experienced management;
  2. The foreign investor must (a) own assets located outside of the PRC with an aggregate value of no less than US$100 million; (b) manage assets located outside of the PRC with an aggregate value of no less than US$500 million; or (c) be the subsidiary of an entity that satisfies either the foregoing clause (a) or clause (b);
  3. The foreign investor must have established in place a sound corporate governance structure, internal control procedures, and operating procedures; and
  4. The foreign investor (nor any entity of which it is a subsidiary) shall not have been, within the previous three-year period, subject to any material penalty or fine imposed by any regulatory body either within or outside the PRC.

The Measures provide that any foreign investor which itself satisfies the criteria described in the preceding paragraph may undertake – through its wholly owned subsidiary organized under the laws of a jurisdiction outside of the PRC – a Strategic Investment under the Measures to acquire the A-shares of a PRC listed company, so long as such subsidiary submits to the MOFCOM an irrevocable commitment letter under which the foreign investor undertakes joint and several liability for the liabilities of the subsidiary arising in connection with the proposed Strategic Investment.

IV. Advantages over prior QFII regime

Prior to the Measures, the only investors that were permitted to purchase A-shares listed on the PRC stock exchanges were qualified foreign institutional investors ("QFII") pursuant to the Interim Measures for the Administration of Securities Investments by Qualified Foreign Institutional Investors in China promulgated by the CSRC and the People’s Bank of China on November 5, 2002 (the "QFII Measures").4

The Measures significantly reduce the entry barriers for foreign investors planning to acquire A-shares of listed PRC companies. Some of the major differences between the requirements imposed under the Measures and those under the QFII Measures are set forth below.



QFII Measures

Investor Qualifications

Any foreign entity that meets the requirements as set forth in Section III of this Memorandum.

Offshore financial institutions meeting certain specified criteria.5

Type of Investment and Trading Restrictions

Investments are limited to A-shares listed on the PRC stock exchanges. The manner of acquisition of such A-shares is limited to the types of transactions set forth in Section II (iv) of this Memorandum. No acquisitions on the open market are allowed.

A QFII is entitled to invest in any RMB denominated security listed in China, including both equity and debt instruments,as well as the acquisition of A-shares on the open market.

Limitations on Capital Inflow

No limits on the amount of capital inflows for the purpose of making Strategic Investments under the Measures.

Each QFII is allocated an investment quota which represents the maximum amount of capital that the QFII may remit into the PRC for investment purposes.

Restrictions over Foreign Investment

No provision under the Measures which impose ownership restrictions with respect to foreign investors.

Shares held by a single QFII in any one listed company may not exceed 10% of the total share capital of the listed company.

Lockup Period

Shares acquired by the foreign investor are subject to a three-year lockup period.


Restrictions on Capital Outflows

No specific restrictions relating to flow of capital out of the PRC.

The original invested capital may be remitted out of the PRC on an installment basis to begin no earlier than one year after the date on which such original invested was fully paid into the PRC, provided that each installment remitted out of the PRC may not exceed 20% of the principal fund and the installments shall be at least 3 months apart.6

V. Significant restrictions still remain

As discussed above, the acquisition of A-shares contemplated under the Measures must be accomplished through (i) a transfer of issued and outstanding shares pursuant to private contract with an existing shareholder of the company, (ii) a private offering of new shares by the listed company in question, or (iii) such other methods as may be permitted under the relevant laws and regulations of the PRC.

Such limits on the types of transactions pursuant to which A-shares may be acquired by a foreign investor may cause difficulties for a foreign investor who proposes to acquire a controlling block in the target company. Under the Split Shares Reform Measures, A-shares that were non-tradable A-shares prior to the completion of the Split Shares Reform shall not be transferred for a period of twelve months following the Split Shares Reform. To the extent that a significant block of the outstanding shares of the target company were non-tradable A-shares, a foreign investor may have to patiently wait out the lock-up period mandated under the Split Shares Reform Measures before proceeding with a Strategic Investment under the Measures for a controlling block of the target company.

With respect to the permitted acquisition of shares via a private offering of new shares by the listed company, the CSRC recently issued the Measures for the Administration of the Listed Company Issuing Securities (the "Issuing Measures"), which took effect on May 8, 2006. The Issuing Measures impose additional thresholds that must be satisfied for the undertaking of a Strategic Investment. For example, the subscription price paid by a foreign investor in connection with the private offering of newly issued A-shares shall be no less than the amount equal to 90% of the average value of the closing price for such stock for the twenty preceding trading days. In addition, the Issuing Measures mandate that a company proposing to issue new A-shares in a private offering shall not have any current directors or members of senior management who have been subject to any administrative penalties by competent authorities of the PRC for the preceding three years.

Furthermore, Article 14 of the Measures provides that the consideration with respect to a Strategic Investment must be paid in foreign exchange. This position is a pronounced departure from the usual practice, in contexts other than the Measures, of allowing foreign investors to contribute to the registered capital of foreign invested enterprises by way of foreign currency, tangible assets, intangible assets, RMB-denominated profits or RMB dividends. In addition, the foreign investor must commence its Strategic Investment within fifteen days after the foreign exchange to be used for the purpose of effectuating the Strategic Investment has been converted into RMB, and within 180 days after receipt of the approval by the MOFCOM regarding the proposed Strategic Investment.

VI. FIE Status of the Listed Company after the Strategic Investment

After the consummation of the Strategic Investment, the MOFCOM shall issue to the target company an approval certificate for foreign invested enterprises (the "Approval Certificate") on which shall appear the notation that the company in question is a foreign invested enterprise ("FIE") by acquisition of A-shares. In the event that the Strategic Investment in question involved (i) an acquisition by the foreign investor of no less than 25% of the total outstanding shares in the target company and (ii) a commitment by the foreign investor to the MOFCOM that such foreign investor shall maintain its ownership in the company to no less than 25% of the total outstanding shares for a period of 10 years, then the Approval Certificate shall bear the notation that the company in question is an FIE by an acquisition of A-shares of at least 25%.

It is unclear at this point what purpose those notations on the Approval Certificates are intended to serve. Although 25% ownership by foreign investors in an FIE is usually the threshold that must be crossed in order for the FIE in question to claim certain preferential tax treatment, the Notice of the China Securities Regulatory Commission, the Ministry of Finance, the State Economic and Trade Commission in respect of Issues of Transferring the State-owned Shares and Legal Person Shares in the Listed Companies to the Foreign Investors dated as of November 1, 2002 (the "Transfer Notice") would suggest that the conversion of a listed company into an FIE through the transfer of shares to foreign investors would not entitle such resulting FIE to the various preferential treatment accorded to other FIEs.

VII. Opening of China’s Capital Markets

The Measures are expected to serve as yet another stimulant to China’s stock markets following the QFII Measures and will undoubtedly be welcomed by foreigners seeking investments in A-shares of listed companies. The Measures further represent a significant breakthrough that will encourage increased M&A activity involving PRC listed companies. Moreover, the Measures—by offering a more level playing field for foreign investors in the Chinese capital markets—are designed to attract acquisitions by foreign companies looking to make longer-term strategic investments in A-share companies, and are deemed a signal to China’s further liberalization of its stance toward the acquisition of Chinese assets by foreign investors.


1. The Administrative Measures on the Split Share Structure Reform of Listed Companies promulgated on September 4, 2005 by the CSRC (the "Split Shares Reform Measures") mandated the elimination of the distinction between tradable A-shares of a PRC listed company and the non-tradable A-shares of a PRC listed company. Prior to the advent of the Split Shares Reform, the A-shares issued by a PRC listed company would be categorized as either (i) A-shares held by shareholders who acquired such shares prior to the listing of the company in question, which A-shares are not freely tradable on the open market under PRC law for an unspecified period of time after the listing of the company; or (ii) A-shares held by shareholders who acquired such shares upon or after the listing of the company in question, which A-shares are freely tradable. As part of the required procedures for the Split Shares Reform, holders of the non-tradable A-shares and the tradable A-shares are to agree on arrangements pursuant to which holders of the non-tradable A-shares would make financial payments to the holders of the tradable A-shares as the consideration in exchange for the tradable status of such shares. One rationale offered unofficially for the payment of such consideration is that such payment compensates the holders of the tradable A-shares for the dilution they will suffer when the non-tradable A-shares convert into tradable A-shares after the elimination of the above-described split share structure.

2. The A-shares of a company that becomes listed on a PRC stock exchange after the promulgation of the Split Shares Reform Measures would all be tradable A-shares.

3. The Catalogue for the Guidance of Foreign Invested Industries (2004 Revision) (the "Foreign Investment Catalogue") identifies most of the various industries with respect to which prohibitions or various restrictions regarding foreign investment are applicable, as well as setting forth the applicable percentage restrictions. In addition to the Foreign Investment Catalogue, specific regulations applicable to certain enumerated industries may also contain further prohibitions or restrictions regarding foreign investment.

4. Non-QFII foreign investors were only permitted to acquire the A-shares of PRC listed companies by purchasing non-tradable shares pursuant to private agreements rather than on the open market.

5. Only the following types of offshore financial institution are eligible as QFIIs: foreign fund management institutions, insurance companies, securities companies and asset management institutions. And to qualify as a QFII, the offshore financial institution in question must further satisfy minimum capital and asset holding requirements which are much more stringent than those applicable under the Measures. Lastly, a foreign investor must receive approvals from the CSRC and SAFE in order to qualify as a QFII.

6. It should be noted that only the original invested capital is subject to such outflow restrictions. The gains derived by the QFII within the PRC based on the original invested capital amount may be remitted out of the PRC free from such restrictions.

* Kevin Ban’s practice focus is private equity and M&A.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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