Walter Hutchens’ Blog

With PRC stock markets trading near 8-year lows, China has begun experimenting with making all shares of some listed firms tradeable. Initially, four companies were chosen for experimentation.

Prior to these experiments, only a minority of shares in each PRC listed firm have normally been liquid shares (liutong gu). These liquid shares, tradeable on either the Shenzhen or Shanghai stock exchange, normally comprise only a third of a firm’s shares. The other two-thirds of a listed firm’s shares are typically divided into various classes of non-tradeable shares (fei liutong gu). These non-tradeable shares include state-owned shares (guo you gu) and legal person shares (fa ren gu).

In late April the China Securities Regulatory Commission (CSRC) announced it would allow experiments that make all the shares of some listed firms tradeable. The CSRC picked four firms for initial experiments in complete liquidity (quan liutong).

On June 31, the CSRC issued a new notice about its planned experiments, indicating it will pick a second group of listed firms for complete liquidity experimentation. However, no specific firms or time frames for this next round of experimentation were announced.

Characteristic of many PRC regulations, the new notice has an ungainly title: Notice Concerning Issues Related to Completion of Work on the Second Batch of Experiments in Reforming the Division of Share Rights in Listed Companies (关于做好第二批上市公司股权分置改革试点工作有关问题的通知, 证监发[2005]42号, or Guanyu zuohao di er pi shangshi gongsi guquan fenzhi gaige shidian gongzuo you guan wenti tongzhi).

The Notice is addressed to listed firms, their guarantors, the Shenzhen and Shanghai stock exchanges and China’s securities clearing corporation. It states that given that experiments with the first batch of four listed firms are preceding smoothly and in keeping with the spirit of the original Notice Concerning Several Issues Related to Experiments for Reforming the Division of Share Rights in Listed Companies (关于上市公司股权分置改革试点有关问题的通知, 证监发［2005］32号, Guanyu shangshi gongsi guquan fenzhi gaige shidian you guan wenti de tongzhi), a second batch of firms will be chosen for further experiments with complete share liquidity.

A quick paraphrse of the main provisions of the notice follows.

1. Experiments must be strictly carried out per the previous notice on these experiments.

2. Firms must select a guarantor (baojian jigou) with good internal controls, standardized operations and at least three qualified guarantors on staff.

3. A law firms must provide a legal opinion.

4. A confidentiality agreement must be entered into, providing that the firm, holders of its illiquid shares, guarantors and their representatives, and retained lawyers will not reveal matters related to the reform experiments before the firm is confimed as an experimental one. [This confirmation is not defined, but presumably in means before CSRC approva].

5. Firms cannot be in the second experimental batch if:

• CSRC is currently investigating them for suspicion of illegal activity
• there is suspicion that the firms shares are being traded by insiders or manipulated
• there are other irregular matters with respect to the firm’s shares

6. On the basis of its due diligence investigation and in accordance with the intention of the holders of non-tradeable shares to conduct a reform experiment, guarantors shall give materials recommending firms for experimental status to the CSRC.

These materials include: the guarantor’s opinion, confidentiality agreement, reform plan, and a unanimous agreement of holders of non-tradeable shares endorsing the firm’s complete liquidity experiment. If the approval of other relevant departments is required concerning the handling of the non-tradeable shares, the opinions of such departments shall also be provided. The specific time frame for providing documents to the CSRC shall be provided elsehwere.

7. Experimental firms shall allow enough time between announcing their intention to reform their shareholding system and convening a board of directors meeting for communications and negotiations between holders of liquid and illiquid shares, including through means such as meeting with shareholdrs, media and institutional investors; on-line road shows; and solicitation of opinions by letter. They shall also make available a telephone hotline and accept faxes and email to collect the opionions of of holders of tradeable shares and build broad support for the the reform plan.

8. The prospectus of an experimental company should explain the impact of the conversion to completely tradeable shares on the firm’s governnance and future development. The holdings of liquid shares by controlling shareholders and affiliated persons as of the day before the board’s public announcement of the reform experiment shall also be disclosed, along with any trading activitity of those persons with respecting to liquid shares within the last six months.

9. Guarantor organizations and representatives must conduct a due diligence investigation. If the guarantors supply disclosure documents with misrepresentaitons or material omissions or if they instigate, participate in or or abet insider trading, market manipulation or other fradulent acts, the CSRC may remove the guarantor form the list of guarantors and otherwise impose liability as legally provided.