China CDR Listing Pilot Program

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Background

Late on Friday, March 30th 2018, the State Council of the People's Republic of China released a statement (in Chinese., English) on its page referring "Several Opinions" (in Chinese) from the Securities Regulatory Commission regarding its pilot program for domestic companies currently listed overseas issuing China Depositary Receipts. The statement gives the underlying basis for the program(s):

The "Several Opinions" require that the Party's Nineteenth National Congress should be fully implemented, guided by the socialist ideology of Chinese characteristics under the new era of Xi Jinping, and deepen reforms in the capital market, expand openness, and support innovative companies in the domestic capital market in accordance with the requirements for high-quality development. The issuance of listed securities will help promote the development of China's high-tech industries and strategic emerging industries, and promote the transformation of economic development quality, efficiency, and power....

Pilot enterprises should be high-tech industries and strategic emerging industries that are in line with national strategies, have mastered core technologies, and have a high degree of market recognition. They are Internet, big data, cloud computing, artificial intelligence, software and integrated circuits, high-end equipment manufacturing, and bio-pharmaceuticals. And reached a considerable scale of innovative companies.

The guidelines, first published on March 22nd and made public Friday March 30th 2018, took effect immediately, and they make it clear that China wants to take the winners. The various comments from thinktanks, media, and brokerages which came after Premier Li Keqiang's press conference on March 20th focussed quite clearly on the ability for the CDR process to effectively allow market forces to do the work of valuation and support while profitability and/or revenue stability criteria would allow unlisted internet+ unicorns to come to market.

The Several Opinions

The important points arising from these Several Opinions are

1. Companies wishing to take advantage of the pilot program to issue Depositary Receipts in the case of overseas-listed red chips, or domestic "innovative companies" have to be big.
   • Red-chips which may issue Depositary Receipts must have a Market Value of RMB 200bn or more.
   • Unlisted innovative companies looking for pilot listing must have had Operating Income greater than RMB 3bn for the previous year, and a valuation of more than RMB 20bn.
2. The companies must be in sectors in line with national strategies.
   1. They need to have strong core competencies and be recognized by the market as such.
   2. The chosen sectors are; Internet, big data, cloud computing, artificial intelligence, software and integrated circuits, high-end equipment manufacturing, and bio-pharmaceuticals.
3. While unstated, the avenue for private tech/etc companies to list domestically using standard procedures effectively guarantees them "priority access" to an IPO, where the review would take "months" rather than 2-4 years normally expected (note that Foxconn Industrial Internet Co., a subsidiary of Foxconn Technology Group, was able to complete its IPO prospectus filing and update in two weeks in February.
4. Previously ineligible-for-China-listing VIE structures are now allowed.
5. Voting Rights: While local rules ban weighted voting rights, it is clear through the statement that the CSRC would be able to waive that rule as long as the difference was clearly explained in the prospectus.
6. Everything else is pretty much par for the course. Importantly, the CSRC's opinions state that the entire thing can be accomplished in the existing legal framework. It seems to suggest a new committee will be established to screen such companies, but it is not clear it would do much work, because the Issuance Audit Committee already does the heavy lifting.
7. The last opinion is about legal liability. This suggests that companies or directors who incur the wrath of Chinese authorities in ways which would not be illegal in the market where they are listed can be held liable. While not overly surprising, the extra-territoriality implied is, well, what is is.

Developments

On Friday May 4th, the China Securities Regulatory Commission released a Draft Document (CSRC link, Chinese only) called "Administrative Measures on Depository Receipts Issuing and Trading" (存托凭证发行与交易管理办法). At a press briefing, Chang Depeng, spokesman for the China Securities Regulatory Commission, said the CSRC was soliciting public comment for a period of one month, noting, according to a Reuters story, that it would "lay the foundation for innovative companies to return to the domestic capital markets via the issuance of CDRs."

According to multiple media sources, the spokesman also noted that the establishment of the CDR program would allow for a Shanghai-London Stock Connect program to start with reciprocal listing of DRs. The launch of that program is expected later in 2018, however I expect it will have to be more like a HK-Shanghai Connect model than just purely reciprocal DRs because most UK-listed companies will not have the strong desire to deal with the contents of the Several Opinions and the Administrative Measures described below just to get a number of mainland retail investors on the register.

In addition, the CSRC approved the launch of six mutual funds that are able to become "strategic investors" in the CDRs. The maximum size of each fund will be about Rmb50bn.

The incentive for the pilot program is to make sure that China's capital markets include China companies which had previously only been able to list overseas. A set of comments by CSRC chairman Liu Shiyu mid-March are telling:

Noting that Chinese investors haven’t been able to profit from the share gains of some foreign-listed companies that he didn’t identify, Mr. Liu called it “a pity, a real pity” and said this “cannot happen again.” (WSJ)

Latest Updates

On 6th June 2018, The CSRC announced new rules on its website. The rules are effective immediately.

• The "CSRC said it will strictly control the number of enterprises and volume of funding for the pilot CDR program, and properly arrange the timing and pace of CDR issuance." (xinhua.net)
• Requirements which were basically insinuated in the rules and adjustments/comments but codified were that companies must have normal accounting practices (and standards), must show strong internal controls, and that directors and execs must have good reputations (one wonders if there will be a 'Social Credit' aspect here) and no significant black marks on their records.
• There was an announcement of the standardization of information disclosure and financial reporting
• The REALLY interesting one is that there will be a simplified approval procedure for companies who only sell CDRs to Qualified Investors. This means that it will be much easier for companies to raise capital through private placements.

• The CSRC announced a package of measures to support "innovative firms" in domestic stock issuance or CDR issuance. Those companies can submit applications to the CSRC for CDR issuance starting today. Separately announced was the regulations regarding due diligence by sponsors.
• The CSRC also announced new measures to manage IPOs

The CSRC is also, it seems, practically pleading that investors do not chase. The goal of cornerstone investors was to be able to lock people into their investments, and therefore have them consider the longer-term.

The CSRC also approved six listed open-ended funds (LOFs) to be able to purchase up to RMB 300 billion of CDRs (they can raise at least RMB 5bn each, but not more than RMB 50bn each, and investors are limited at RMB 500,000 per investor per fund). This is a lot because Bloomberg data shows total IPOs in mainland China last year was just over RMB 210bn, and the run-rate this year is lower as a huge number of IPO applicants have pulled their applications or had them rejected.

These LOFs will have three-year lockups, which as discussed in the offering rules (noted above in the small type) allows pre-IPO CDR issuance at different prices than the public offerings as long as the institutional investors are subject to a lockup, and allows them to act as cornerstones in public offerings. The six companies are (with linked approvals) China Southern, China AMC, E Fund, Harvest, China Universal, and China Merchants Fund.

The six LOFs will be distributed through Industrial Bank of China, Bank of China, China Construction Bank, Agriculture Bank of China, Bank of Communications, and China Merchants Bank (SCMP)

Impact

Preparations for CDRs have dragged on. But the programme is important. This is a big step in China’s push to bring some of the world’s biggest technology firms back home. After what was a lackluster Q1'2018 in mainland China IPOs (35 IPOs, down 74% from last year) due to several significant rejections, limited application acceptances, and much stricter reviews, the launch of CDRs is expected to represent a significant flow event.

• This Administrative Measures announcement and document clears the path for the CSRC and exchanges to start accepting applications for CDR issuance in early June and companies such as Alibaba Group Holding Ltd (BABA US), which has reportedly hired CITIC Securities to prepare, and JD.com Inc (ADR) (JD US), which has reportedly hired Huasheng Securities and China Securities, are expected to apply as soon as possible, and possibly list as early as mid-summer.
• Other possible issuers include Baidu Inc (ADR) (BIDU US), NetEase Inc (ADR) (NTES US), Tencent Holdings Ltd (700 HK), as well as possibly China Mobile Ltd (941 HK) and China Telecom Corp Ltd (H) (728 HK).
• For the currently unlisted companies, an SCMP article amended this weekend said that up to 30 currently unlisted "unicorns" would be eligible to list CDRs based on a joint study of 164 China "unicorns" worth a combined US$628.4bn conducted by a Ministry of Science and Technology affiliate and a Beijing -based consultancy.
• Mainland media groups have suggested a 2018 total issuance of RMB 250 billion or more. Xiaomi's HK IPO is scheduled to be on the order of US$10 billion, but CDR issuance this year could be multiples of that.
• These CDR issuances are likely to be big events. And could change the flow patterns of mainland Chinese investors. They could also, if big enough, introduce the possibility of a massive short-term monetary squeeze as retail investors deposit monies in their account to be able to bid on the IPOs of the CDRs. The CSRC and PBOC will time it so it is not done at month-end or quarter-end I expect.

References

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