On 17 February 2023, China’s securities market watchdog, the China Securities Regulatory Commission (the CSRC), published the long-awaited rules (the New Rules), effective from 31 March, regulating China-based issuer’s listing in overseas capital markets, including the US capital market. For decades, Chinese companies had managed to circumvent the PRC regulations’ limitation on foreign investment and enjoyed freewheeling access into the US capital market. Such US listing path taken by Chinese companies was ground to a halt by Chinese regulators due to the listing by Didi Global Inc. on 30 June 2021 which Beijing sees as a threat to its data and national security. The crackdown on Didi by the Chinese regulators plunged Didi’s stocks and also led to the SEC’s enhanced disclosure scrutiny on China-based issuers. On 20 December 2021, in reaction to the Didi event, the SEC released the Sample Letter to China-Based Companies (the Sample Letter) setting forth its expected disclosures to be made by Chinese companies, particularly those related to relevant PRC regulations. Since then, the regulatory uncertainties together with the diplomatic and trading disputes between the US and China have nearly frozen Chinese companies’ access to the US capital market.

After a thorough review of the New Rules, it can be said that the News Rules are trying to accommodate the US IPO process, to pave a clear path for Chinese companies to go abroad and to ease the SEC’s concerns reflected in its Sample Letter. The New Rules may be regarded as a starting point by the market to resolve the key issues raised by the SEC in its Sample Letter and may revive the US market’s enthusiasm towards Chinese investment targets with high growth potential.

CSRC’s filing process – aligning with the SEC’s confidential submission mechanism

Under the New Rules, the CSRC is empowered to vet offshore listing applications which are required to be submitted to it by the issuer and the lead underwriters within three business days after listing applications filed with an overseas capital market. After confirming all materials required are submitted, the CSRC is obliged to process and complete the issuer’s filing request within 20 business days and publish the filing information on its official website. However, if the issuer’s listing application to an overseas capital market is submitted to overseas securities regulators in secret, the CSRC will only post the filing information on its website after being notified by the issuer that it has published its listing application in the offshore capital market.

The SEC permits all issuers to submit draft registration statements relating to IPOs for review by the SEC staff on a confidential basis. This confidential submission process is intended to give issuers more flexibility to plan and adjust their offerings and limit potential exposure that can adversely affect their business operation and offering plan. Most Chinese companies choose to file their registration statements with the SEC on a confidential basis to take advantage of these merits. The New Rules accommodate the SEC’s confidential submission mechanism and allow no publication of the filing results until the registration statement filed with the SEC goes public.

According to the Sample Letter, the SEC stated that the issuer is required to disclose in the “Summary” section of the prospectus whether it is required to obtain permission from CSRC for its US listing and, if required, whether it has obtained such approval. In order to align the New Rules’ filing requirement with the SEC’s disclosure, the China-based issuers will need to disclose in their initial confidentially submitted registration statement to the SEC that they are required to obtain the CSRC’s approval and are in the process of filing their listing applications with the CSRC. Within three business days after its SEC confidential submission, the issuer will file its overseas listing with the CSRC. The issuer will then keep updating the disclosure related to its CSRC filings in the registration statement according to its progress with CSRC until the approval of its filing by CSRC.

CSRC’s overseas listing suitability standard

According to the New Rules, among others, issuers with circumstances below are prohibited from conducting public offerings and listings overseas: (i) issuers in the industries not allowed to offer securities to the public according to the laws and regulations; and (ii) issuers’ overseas public offering constituting a possible threat to China’s state security according to the relevant state council departments’ review results.

Didi’s US listing without any approval from the Chinese authorities can be seen as a violation of what is listed above. Didi, which offers a wide range of online taxi-hailing services in China, gathered vast amounts of real-time users and mobility data used for its business operating and marketing purposes. Before its listing, the Chinese government has been beefing up its data protection regime and also introduced several data protection and security laws to regulate data collection, storage and use by companies like Didi. Soon after its US listing, the Cyberspace Administration of China (the CAC) announced its investigation into it in the name of national security and public interest protection. CAC’s review found Didi to be in breach of China’s data and cybersecurity laws and led to a freefall of its stocks and its final delisting from the US stock exchange.

In reaction to such law enforcement actions by the CAC, the Sample Letter issued by the SEC specifically requests China-based issuers to disclose whether they have received all required approvals from CAC and other governmental agencies and whether the CAC’s regulation will affect the issuers’ business and whether the issuers already comply with the regulation. According to the CAC’s latest regulations and SEC’s disclosure request, it is advisable for a Chinese issuer with more than one million Chinese users’ information to go through a cybersecurity review with the CAC and get its approval before submitting or filing its registration statement with the SEC. According to the disclosure by an internet services provider which was listed on NASDAQ recently, it applied for and completed a cybersecurity review with the CAC before its offering and listing. According to the disclosure, it seems the CAC does not give a formal notice after the review regarding whether it is satisfied with the issuer’s data protection and cybersecurity measures and it does not see the issuer’s US listing as a threat to China’s state security. It is just disclosed that the issuer was not notified of any material adverse findings by the CAC during the review. This issuer’s offering and listing happens prior to the News Rules coming into force and, as such, it still remains to be seen whether the CSRC is fine with approving an issuer’s filing without a formal green light from the CAC if the issuer engaged in an industry required to go through cybersecurity review before listing.

To satisfy the SEC’s disclosure requirement, China-based issuers will have to disclose (i) in the “Summary” section of the prospectus that they either have obtained the approval from the CAC or do not have to apply for it and the consequences of failure to receive or maintain the approvals or required to obtain the approval after approval; and (ii) in the “Risk Factors” section of the prospectus, how the CAC’s oversight will impact the issuers’ business and their public offerings and whether they are in compliance with the regulations. According to the Sample Letter, the SEC only requires detailed disclosure and has not explicitly stated that it will not approve any registration statement which discloses that the issuer’s US listing shall be a violation of the CAC’s regulations. Even if with all adverse consequences of such violations fully disclosed in the prospectus, it is hard to tell whether the SEC will approve the registration statement and the US exchanges will approve the listing applications considering that the listing will end up as a violation of the CAC regulation, as well as the New Rules.

CSRC’s clarified attitude towards the VIE structure

For decades, the VIE structure is used to access foreign capital by Chinese companies engaged in industries which restrict foreign investment according to the relevant PRC laws. After the Didi event, there have been rumours in the market that the Chinese authorities may choose to ban companies with VIE structure to go public in an overseas capital market. However, the New Rules and CSRC’s remarks eased such concerns and suggested that Beijing will not shut down this financing loophole and see it as a viable channel for its companies to access foreign capital. According to the New Rules, companies with VIE structure are required to report to the CSRC in their filing the reason for the setup of the VIE, relevant risks related to the structure and any measures taken to mitigate the risks. The PRC counsels of the issuers are also required to review and opine whether foreign investment is restricted or prohibited into industries of the issuers. While no outright ban, it can be seen that VIE structure will face detailed scrutiny under the New Rules by the CSRC and there is a chance that the CSRC may not approve an issuer’s filing if it is not comfortable with foreign investment into the issuer. Considering the recent trading and diplomatic row between China and the US, it is not surprising that listings in the US through VIE structure may be subject to harsher security scrutiny than listing applications to other overseas markets like Hong Kong. Chinese companies, particularly those tech and internet services firms, out of concerns over CSRC’s questioning of its VIE structure, may favor non-US capital markets for their future offering and listing venue.

According to the Sample Letter, SEC requested a China-based issuer with VIE structure to (i) disclose prominently its VIE structure and explain the reason for using this VIE and how cash is transferred within the issuer’s group under the VIE arrangement; and (ii) disclose in detail in the “Risk Factors” section the various risks of the VIE structure under Chinese regulations. In terms of the risk factors to be disclosed, according to the prospectus of an issuer getting listed in the US after the SEC’s Sample Letter, it disclosed various legal and operational risks and uncertainties related to its corporate structure, including the uncertainty of the status of VIE and the enforceability of the VIE under Chinese law. After the New Rules come into force, in addition to submitting these VIE-related risks to the SEC for review, the issuers also have to submit the same to the CSRC with their other filing materials within three business days after their SEC submission. It can be predicted that the CSRC may frown upon these risk factors disclosed related to the VIE structure under the PRC law and may request to downplay these risks with which the SEC shall probably disagree. It remains to be seen how the issuers can adjust their disclosures in the prospectus to accommodate comments from both capital market regulators.

CSRC’s request for lead underwriters in the overseas offerings

According to the filing materials list provided under the New Rules, the lead underwriters of the overseas offerings are required to undertake to the CSRC as at filing that they (i) conduct due diligence and review of the filing materials; (ii) confirm that what is provided in the filing materials is true, accurate and complete, without any misrepresentations, misleading statements and material omissions; and (iii) take full legal responsibility for the filing materials. It is not market practice in a typical US IPO for US underwriters to give any undertakings referred to above to any regulators. It is not surprising that this undertaking requirement by the CSRC will give the US underwriters a hard time to comply.

In a typical US IPO, the underwriters will request the US counsels to address to them 10b-5 letters which state that, under certain assumptions and qualifications, no facts have led them to believe the prospectus contains any untrue statement of a material fact or omits to state a material fact necessary to make the statements not misleading. With this New Rules coming into force, if the underwriters may, as a reliance of their undertakings to the CSRC, require legal counsels to issue some undertaking/confirmation to them like the 10b-5 letters at the time of submitting filing materials to the CSRC.

In addition, a typical 10b-5 letter issued by US counsel would only cover the information provided in the prospectus, but the CSRC requests underwriters to undertake the information contained in the filing materials. It is worth mentioning that what is covered in the filing materials may not be included in the prospectus. For example, the News Rules require full disclosure of the principal shareholders (their criteria are different from US securities laws), any entrusted shareholding arrangement (normally only principal shareholding required of such disclosure in the prospectus), all pre-IPO investors during the past 12 months, and details about any ESOPs in place including their price fairness and executing procedure. Other than the times of 10b-5 issuance, the legal counsels may also be requested to expand what is covered under their typical 10b-5 letters to also include such information in the filing materials. It remains to be seen whether the US counsels in the market could accept such extra risks, even with generous legal fee compensations.

In summary, against the backdrop of the deadlock between the Chinese and US capital market regulators after the Didi event, the New Rules can be seen as an intention by the Chinese regulators to break the deadlock for Chinese companies’ access to liquidity overseas. “Offshore listing is a key component of the opening up of China’s capital markets,” the CSRC said in a statement. “The New Rule’s issuance shows China will not change its direction of reforming and opening up amid growing uncertainly in the world,” it added. Even if as described in this article there are still outstanding issues lying ahead, the introduction of these fleshed-out New Rules underlines Beijing’s attitude and intention to continue supporting its companies’ overseas financings in the US capital market.