China is clarifying rules for overseas IPOs. Here's what we still don't know.

  • Regulators in both countries have issued clarifications this month on what's needed from Chinese companies to go public in the U.S.
  • Over the weekend, the China Securities Regulatory Commission released proposed rules for domestic companies if they want to list overseas.
  • "The details of rule enforcement still need further observation, especially the supervisory scope of other related ministry regulators, in addition to the CSRC," said Winston Ma, adjunct professor of law at New York University.

BEIJING — Half a year since the rush of Chinese IPOs to the U.S. dried up, many details remain unknown for companies wanting to pursue such international listings.

Since the fallout over Chinese ride-hailing app Didi's IPO in late June, authorities have increased their scrutiny of Chinese companies raising billions of dollars in U.S. public markets. A 10-year high of 34 China-based companies listed in the U.S. this year, but only three of the IPOs have occurred since July, according to Renaissance Capital.

Regulators in both countries have issued clarifications this month on what's needed from Chinese companies to go public in the U.S. While it's a start, many questions about implementation remain.

Over the Christmas holiday weekend on Wall Street, the China Securities Regulatory Commission released proposed rules for domestic companies if they want to list overseas. The public comment period ends Jan. 23.

The CSRC's proposed rules said an overseas listing could be stopped if authorities deemed it a threat to national security. Domestic companies need to comply with relevant provisions in the areas of foreign investment, cybersecurity and data security, a draft said, without much elaboration.

"The details of rule enforcement still need further observation, especially the supervisory scope of other related ministry regulators, in addition to the CSRC," said Winston Ma, adjunct professor of law at New York University and co-author of the book "The Hunt for Unicorns: How Sovereign Funds Are Reshaping Investment in the Digital Economy."

Companies in China are subject to the oversight of several ministries, ranging from industry-specific ones to ones focused on particular aspects of operations such as foreign exchange.

Notably, it was not the securities commission but the Cyberspace Administration of China that ordered Didi — and two other Chinese companies that recently listed in the U.S. — to stop registering new users while authorities conducted a security review. The move came just days after Didi's $4 billion IPO in the U.S., sending shares tumbling.

The cybersecurity regulator's clout has grown this year. It proposed this summer that companies with data for more than 1 million users must get security clearance before listing overseas.

In August, the regulator's vice minister Sheng Ronghua told reporters that Chinese companies wanting to go public at home and abroad need to comply with national laws and regulations, while ensuring the security of the national network, "critical information infrastructure" and personal data.

No ban on the popular VIE structure

Beijing has said for years that one of its goals is increasing access to and improving its stock market, which is only about 30 years old. Authorities have tried to make it easier for companies to raise money from the domestic stock market by gradually shifting to a registration system, from an approval system.

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The new rules for overseas listings did lay out specific requirements for filing documents, and said the securities commission would respond to filing requests within 20 working days of receiving all materials, according to a draft.

The commission also did not ban the widely used variable interest entity structure, as some had feared. The structure creates a listing through a shell company, often based in the Cayman Islands, preventing investors in the U.S.-listed stock from having majority voting rights.

"If complying with domestic laws and regulations, companies with VIE structure are eligible to list overseas after filing with the CSRC," the commission said in an English-language statement on its website. It did not specify what those laws and regulations were.

However, the amount of foreign investment allowed in Chinese VIEs will likely be reduced to match that of mainland China's A shares, said Bruce Pang, head of macro and strategy research at China Renaissance.

He pointed to an online question-and-answer article on new regulations on foreign investment out Monday from China's Ministry of Commerce and National Development and Reform Commission. The article noted existing restrictions that limit foreign ownership to 30% of a company's shares, with each foreign investor capped at a 10% stake.

U.S. ownership of Chinese stocks listed in New York is relatively low, according to Morgan Stanley data. Of those eligible for a secondary listing in Hong Kong, the median share of U.S. ownership for the top 50 names is 27%, according to CNBC calculations of the data.

Foreign financial institutions may also face greater requirements to participate in Chinese IPOs.

"The [CSRC's] proposed rule will also require international banks that underwrite a Chinese firm's offshore listing to register with the CSRC, which may create new compliance challenges to the foreign underwriters, as they might need to follow Chinese rules once they are registered with [the] CSRC," said Ma, former managing director and head of North America for China Investment Corporation, a sovereign wealth fund.

Scrutiny extends to SPACs

Meanwhile, the U.S. has been increasing its efforts in alerting investors to the uncertainties of investing in Chinese companies listed in New York.

Early this month, the U.S. Securities and Exchange Commission finalized the rules it needs to implement a law that could force Chinese companies to delist from U.S. stock exchanges. It is unclear when such delistings would begin — Morgan Stanley analysts don't expect them to occur until at least 2024.

The SEC's Division of Corporation Finance last week also released details on 15 areas in which it "encouraged" China-based listings — existing and future — to increase disclosures. One section read:

State whether you, your subsidiaries, or VIEs are covered by permissions requirements from the China Securities Regulatory Commission (CSRC), Cyberspace Administration of China (CAC) or any other governmental agency that is required to approve the VIE's operations, and state affirmatively whether you have received all requisite permissions or approvals and whether any permissions or approvals have been denied. 

The SEC statement noted that special purpose acquisition companies with significant ties to China should also disclose relevant risks. SPACs have exploded in popularity in the last two years. They bypass the traditional IPO process by using shell companies created for the sole purpose of acquiring existing private companies.

The CSRC's draft rules said that companies going to other markets via SPACs should follow the same filing requirements as overseas IPOs.

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