Since Alibaba Group’s debut in Hong Kong in November 2019, the momentum of U.S.-listed Chinese companies (“China Concept Stocks”) turning to Hong Kong for a secondary listing is on the rise. In June 2020, the second-largest Chinese gaming company NetEase Inc and the e-commerce giant JD.com became the second and the third returning companies to finish secondary listing in Hong Kong. With the U.S. tightening its scrutiny of Chinese mainland companies trading on its stock exchanges, market analysts believe that there will be an increase of China Concept Stocks turning to Hong Kong for listing.
In the past, many Chinese new economy companies chose to list in the U.S. because Hong Kong's listing system did not fulfil the needs of new economy companies. In April 2018, the Hong Kong Exchanges and Clearing Limited (“HKEX”) introduced its biggest reform of listing rules in 25 years aiming at attracting more new economy companies to list in Hong Kong. This reform (“2018 Reform”) consists of three major measures, including: (i) allowing the listing of biotechnology companies that are yet to generate revenue; (ii) allowing the listing of giant technology companies with weighted voting right (“WVR”) structures; and (iii) accepting companies with business focus in Greater China to apply for secondary listing. As Charles Li, the chief executive of the HKEX, stated in an interview with Xinhua News Agency on 18 June 2020, Hong Kong’s listing system is now ready for the return of good Chinese companies.
In addition to secondary listing, which Alibaba Group, NetEase Inc and JD.com have chosen, there are other ways of listing which the returning China Concept Stocks may choose. We will discuss three pathways that are available to the returnees in the remainder of this article.
PATHWAY 1: DELIST FROM THE U.S. STOCK MARKETS AND IPO IN HONG KONG
Before the reform of the secondary listing requirements in April 2018, making an IPO offer in Hong Kong after delisting from the U.S. stock markets was a mainstream choice for China Concept Stocks. Companies following this pathway include Tongcheng-Elong, iDreamSky and China Feihe. In July this year, Sina Corporation, the operator of social media platform Weibo, announced that a company controlled by its chairman offered to take it private, making it the another renown China Concept Stock to consider a privatisation offer.
A U.S.-listed company considering an IPO in Hong Kong will have to first be privatized and delist from the U.S. market. After privatization, it is usually necessary to restructure the group before the subsequent listing. It is worth noting that the HKEX has stricter requirements for listed companies to adopt a contract-based structure (commonly known as a “VIE” structure) than the U.S. markets do. Under a VIE structure, the listed applicant and its subsidiaries do not have direct control of the operating companies incorporated in the PRC, but rely on the structured contracts to control it. According to the HKEX Guidance Letter HKEx-GL77-14 and Listing Decision HKEX LD43-3, the VIE structure adopted by a listed applicant must be narrowly tailored. Under this principle, the VIE structure may only be used to the extent necessary to address any limits on foreign ownership. The listing applicant must directly hold the maximum permitted interest in the operating companies unless (i) the operating company is required to obtain approval and fulfil additional eligibility standards, but the approving regulatory authority confirms that it will not or cannot give approval even if the company fulfilled the additional eligibility standards; or (ii) clear procedures or guidance from approving regulatory authority is not available. As China Concept Stocks which adopt VIE structure usually put all the operating companies under contractual control, a returning company may need to restructure the group to meet these stricter VIE structure requirements.
PATHWAY 2: APPLYING FOR DUAL-PRIMARY LISTING IN HONG KONG
The returning companies may opt for a dual-primary listing in Hong Kong. This means the company will be subject to the full compliance requirements of both HKEX and its existing market. In August 2018, BeiGene, Ltd., a Chinese biotechnology company listed on NASDAQ successfully issued new shares and primarily list in Hong Kong and the U.S.
Dual-primary listing can achieve fundraising on two stock markets while avoiding the need for financial resources to effect privatization. However, dual primary listing needs to meet the regulatory requirements of two markets, which undoubtedly increases the compliance cost for the issuers.
It is worth noting that applicants for dual primary listing are not required to meet any higher financial requirements than usual IPO applicants.
PATHWAY 3: APPLYING FOR SECONDARY LISTING IN HONG KONG
Secondary listing is an alternative to dual-primary listing which can substantially reduce the compliance costs involved in dual-primary listing. Secondary listed companies are primarily listed on another stock exchange and the majority of their securities are usually traded outside Hong Kong. As these issuers are subject to the regulation of their primary stock exchange, they can benefit from extensive waivers of compliance with the listing rules of the HKEX.
Prior to the 2018 Reform, companies with their “centre of gravity” in Greater China (“Greater China Issuers”) were regarded by the regulators as not suitable for secondary listing. This position was stated in the Joint Policy Statement regarding the Listing of Overseas Companies issued by the Hong Kong Securities and Futures Commission (“SFC”) and HKEX on 27 September 2013. However, as part of the 2018 Reform, a Chapter 19C - Secondary Listing of Qualifying Issuers was added to the Main Board Listing Rules of the HKEX, opening the door for Greater China Issuers to start secondary listing in Hong Kong.
Under Chapter 19C, the New York Stock Exchange LLC, Nasdaq Stock Market and the Main Market of the London Stock Exchange plc (and belonging to the UK Financial Conduct Authority’s “Premium Listing” segment) are regarded as "Qualifying Exchanges". An issuer primarily listed on a Qualifying Exchange is regarded as a “Qualifying Issuer”. A Qualifying Issuer may apply for secondary listing if the following conditions are met:
- The issuer must be eligible and suitable for listing. The suitability issue has been addressed in the HKEx Guidance Letter 94-18 “Suitability for Secondary Listing as a Qualifying Issuer under Chapter 19C”. To be suitable for secondary listing, the HKEX normally requires the issuer to be an “innovative company”. That is, a company with two or more of the following characteristics:
- its success is attributable to the application of new technologies, innovations, and/or a new business model to its core business, which differentiates the applicant from existing players;
- research and development (R&D) significantly contributes to its expected value and comprises a major activity and expense;
- its success is attributable to its unique features or intellectual property; and/or
- it has an outsized market capitalisation/intangible asset value relative to its tangible asset value.
- The issuer must have a track record of good regulatory compliance of at least two full financial years on a Qualifying Exchange;
- A Greater China Issuer must have a market capitalisation of at least HK$40 billion at the time of listing; or a market capitalisation of at least HK$10 billion at the time of listing and revenue of at least HK$1 billion for the most recent audited financial year; and
- Its constitutional documents must meet the standards of shareholder protection required by Appendix 3, Appendix 13 and/or Rule 19C.07 (where applicable) of the Main Board Listing Rules.
In addition, if a Greater China Issuer was primarily listed on a Qualifying Exchange on or before 15 December 2017, it is regarded as a "Grandfathered Greater China Issuer" and may benefit from the following concessionary arrangements:
- It is not required to amend the constitutional documents to meet the requirements of Appendix 3 and Appendix 13;
- It can retain the existing VIE structure even though the existing VIE structure does not meet the narrowly tailored principle;
- It can retain the existing WVR structure and do not need to comply with the ongoing WVR investor protection requirements under the Main Board Listing Rules 8A.07 to 8A.36, 8A.43 and 8A.44;
- It is not subject to the application of the Codes on Takeovers and Mergers and Share Buy-backs (“Takeovers Code”). The Takeovers Code has been updated with effect from 30 April 2018 to reflect the new position of the HKEX in secondary listing. A note has been added to Rule 4.2 of the Takeovers Code stating “A Grandfathered Greater China Issuer within the meaning of Rule 19C.01 of the Listing Rules with a secondary listing on the Stock Exchange will not normally be regarded as a public company in Hong Kong under this section 4.2. Where the bulk of trading in the shares of a Grandfathered Greater China Issuer migrates to Hong Kong such that it would be treated as having a dual-primary listing in Hong Kong pursuant to Rule 19C.13 of the Listing Rules, the Codes will apply to it.”
When compared with the dual-primary listing, secondary listing can substantially reduce compliance costs for the issuers. Moreover, for the Grandfathered Greater China Issuers, the cost of implementing various changes to the current structure of the group due to the different regulatory requirements in Hong Kong and the U.S. are evaded. Hence, secondary listing could be a more popular option for sizable innovative companies.
This year, we have seen an acceleration of China Concept Stocks returning to the Hong Kong stock market irrespective of their pathways. With continuous reform efforts, Hong Kong shall inevitably stay as one of the top international financial platforms in fundraising.