China: Legal Update - Red Chips Return To China´s Capital Market

Last Updated: 20 July 2007
Article by Leigh Brown, Sebastian Hempel and Lawrence Lu

In a move to increase share supply to help deflate the Shanghai and Shenzhen stock-exchange bubble, China's securities regulator, CSRC, has finalised provisional rules for Hong Kong-listed red chip enterprises to return home and list on the A-share market. A-shares refer to those issued in China by domestically listed firms for Chinese local investors.

What are red chips?

'Red Chip' is terminology used to describe a certain type of listed company on the Hong Kong capital market. A red chip company is a China-invested enterprise incorporated and listed overseas, mostly on the Hong Kong Stock Exchange, with the business and net profits being generated from mainland China. The concept of red chip came into being on the Hong Kong Capital Market in the early 1990s.

As China is commonly referred to as 'Red China' on the international stage, Hong Kong people call these China-related shares 'red chips'.

At present, most red chips are state-owned or state-controlled enterprises. The top red chip companies, and their listing date in Hong Kong, are:

  • China Mobile Communications Corporation (23 October 1997)
  • CNOOC Limited (28 February 2001)
  • Bank of China – Hong Kong (25 July 2002)
  • China Unicom (22 June 2000)
  • China Netcom Group Corporation (Hong Kong) Limited (17 November 2004)

Background of red chips' return

Red chips' eagerness to return to the home market is inspired by a 127% main index growth in Shanghai in 2006, and also encouraged by the successful dual listing model of blue chips such as the Industrial and Commercial Bank of China.

The increased sophistication of the mainland's capital market and a flood of funds into Shanghai and Shenzhen's bourses are also creating good conditions for red chips to list at home market.

The current listing regulations for red chips

According to the Company Law and Securities Law of China, to list on the domestic A-share market, the companies have to be incorporated in the mainland of China for at least three years and have a record of profit-making in the past three consecutive years.

As red chips are not incorporated domestically, they are regarded as foreign companies. As such they have so far been barred from launching A-share initial public offerings (IPOs) at home, as Chinese regulations forbid foreign companies from going public on the A-share markets. Therefore, listing regulations currently do not allow overseas incorporated companies to directly list on the mainland.

CSRC new rules to clear the legal obstacle

CSRC has recently started soliciting views from some securities companies on the new rules for Hong Kong-listed red chips wanting to issue A-shares.

But the rules are applicable to Hong Kong-listed red chips only. This is because most of the red chips listed in the United States and Singapore are privately run high-technology or Internet-related firms. Also, Hong Kong has seen many successful cases of mainland-incorporated H-share companies returning to the mainland stock market.

According to the draft rules, a red chip company aiming to return to the domestic market is required to have:

  • been listed on the Hong Kong stock exchange for at least one year
  • a market capitalisation of HK$20 billion (US$2.56 billion) or more
  • made net profits of HK$2 billion or more over the previous three years
  • at least half of its operating assets or earnings being generated from China mainland
  • The rules also allow a red chip to issue A-shares if its parent or subsidiary firm is already listed on the domestic market.

Impact of the proposed CSRC rules

The above requirements are aimed at attracting the return of large, good-quality red chip companies. Based on recent Hong Kong Stock Exchange data (31 May 2007), of the more than 89 red chips, 22 will be eligible for listing under those criteria, such as China Mobile, CNOOC (China National Offshore Oil Corp), Bank of China (Hong Kong), China Unicom, China Netcom, and China Merchants International. The total market capitalisation of these two dozen red chips is more than HK$2 trillion, with the capitalisation of China Mobile alone exceeding HK$1 trillion.

The market capitalisation of A-shares on the mainland now is about 16 trillion yuan (US$2.1 trillion) and it would increase by more than 10% with the return of these red chips, which would bring in two trillion yuan Renminbi. Thus, the success of the move will be sure to increase the share supply to cool down the red-hot A-share markets by direct intervention of the Chinese authorities.

While on the other hand, if the current ban on overseas-incorporated companies from going public on the A-share markets is lifted to facilitate the return of red chips, other Hong Kong companies could also launch A-share IPOs. We can imagine that in the near future, foreign giants such as HSBC will be selling A shares in Shanghai.

Latest process

The soliciting period with those securities companies will normally last for one month. According to the Chinese media, CSRC is estimated to formally launch the rules by the end of July 2007, while the first red chip is expected to list between August and September, and then the door for red chips to issue A-shares will officially open.

The following red chips are likely to be among the first batch to sell A shares in mainland of China:

  • China Mobile – top global wireless firm
  • CNOOC – mainland China's biggest offshore oil producer
  • PetroChina – the world's fourth-largest company by market value
  • China Construction Bank – top bank
  • China Shenhua Energy – China's largest coal miner
  • China Telecom – China's largest telecommunications operator
  • Lenovo Group – the world's third-largest personal computer maker
  • GOME – top retailer

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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