Touchdown: Full Implementation of Registration-Based IPO System

On February 17, 2023, the China Securities Regulatory Commission (the “CSRC”) promulgated relevant rules regarding the expansion of registration-based initial public offering (“IPO’) system, representing a firm step into the deep-water zone of PRC capital market reform. Major stock exchanges including Shanghai Stock Exchange (the “SSE”), Shenzhen Stock Exchange (the “SZSE”) and Beijing Stock Exchange (the “BSE”, together with the SSE and SZSE, each stock exchange is separately referred as “the Stock Exchange” hereafter) also released their supporting business rules and guidance on the same day to reflect the amendments respectively (collectively, “the New Rules”). The swift promulgation of the New Rules right after the lapse of public consultation period is indeed rarely observed for such a high-level reform.

The essence of the registration-based system reform is to “leave the choice to the market，strengthen disciplines from the market and the established rules”, said the CSRC in the press release earlier on February 1, 2023, adding that the review process is transparent and open for social supervision[1]. The CSRC also noted that the reform will optimize registration procedures, unify registration systems nationwide and fine-tune the supervision mechanism. With the establishment and improvements of regulatory schemes almost completed, the reform will cover all national securities exchanges and public offerings of all types of stocks, including preferred stock, convertible corporate bonds and depositary receipts.[2]

The PRC government and its leadership had repeatedly stressed the importance of capital market as “bedrock” in the financial sector and expected that a modernized capital market would be the ignitor for steady market growth in the long run.[3] This article will provide an overview of significant amendments made in the New Rules regarding IPO. We will further share our views on other amendments under the New Rules regarding refinancing, stock placement and M&A in separate articles.

1. History and Present – The Time Has Come

In fact, whether or not to, and how to implement the registration-based system reform has been taken deep dive in the PRC for many years. In November 2013, at the Third Plenary Session of the 18th Central Committee of the Communist Party of China (CPC), the implementation of the registration-based IPO system in the PRC was proposed for the first time. However, it was not until the proposed revision of the Securities Law in 2015 that the registration-based system reform was brought up under the judicial spotlight. On December 27, 2015, the Standing Committee of the National People’s Congress temporarily delegated its legislative power to the State Council, thus providing legitimacy to the supreme administrative body for formulating the regulatory scheme and instructing the registration-based system reform[4].

On November 5, 2018, President Xi Jinping announced at the opening ceremony of the first China International Import Expo that the STAR Market will be established on the SSE and pilot the registration-based system reform. In 2019, the STAR Market of the SSE officially opened and the first batch of issuers had been successfully listed on the STAR Market in July 2019.

On March 1, 2020, the revised Securities Law came into effect, which established the legal framework of the registration-based system reform for the PRC capital market.

In April, 2020, the registration-based system reform was introduced to the ChiNext Market of the SZSE and the first batch of issuers had been successfully listed on the ChiNext Market in August, 2020. The BSE, which established in 2021, also adopted the registration-based system. Only the Main Boards of the SSE and SZSE did not adopt such mechanism yet back then.

The experience of those pilot programs had laid the foundation for the full implementation of registration-based system reform. The CSRC reviewed the experience in the past four years, and pointed out that the registration-based system was in line with market practice. With the establishment and improvements of regulatory schemes almost completed, the pilot regulatory programs of the registration-based system had withstood the market’s test and brought benefits to all participants in the market. Therefore, the full implementation of the registration-based system was literally a matter of time[5].

The table below compares the major differences between the approval-based system and registration-based system:

2. Positioning and Perception – Find Your Path to the Capital Market

The full implementation of the registration-based system completes the multi-level capital market in which different stock exchanges are developed to serve various purposes and objectives and interact to one another with collaboration and synergy.

The Main Boards of the SSE and SZSE have been positioned to highlight the “large-cap blue-chip” characteristics, mainly supporting representative high-quality enterprises with mature business models, stable operation and relatively larger size in business scale and scope.

The SSE STAR Market aims at the frontier in the global science and technology sectors, the major battlefield of the economies, and the major needs of the country.[6] It highlights “hard-core tech” nature and supports enterprises that possess core technologies, outstanding innovation capabilities and stable business models with strong growth potential, and have high market recognition and good public image.

The SZSE ChiNext Market supports the integration of traditional industries with new technologies, new industries, new economy and new business modes. It focuses on the national innovation-driven development strategy and prioritizes supporting the IPO of excellent innovative venture enterprises.

The BSE and NEEQ mainly serve innovation-oriented emerging enterprises with relatively smaller size in business scale and scope.

Considering the facts that (1) both STAR Market and ChiNext Market have detailed supporting rules elaborating the criteria for the positioning of the respective market and, (2) there are market rumors over the Main Boards indicating that authorities may prohibit or restrict certain candidates’ listing endeavor, further guidance may be on its way to clear the mist over the Main Boards’ positioning.

3. Unity Throughout – One Capital Market, Similar Rules

The A-share market established a two-track system since the launch of the STAR Market in 2019. After several years of practice, STAR Market and ChiNext Market are favored by the domestic issuers for their more transparent and trackable review systems, higher efficiency and certainty.  

Under the New Rules, the CSRC integrates regulations of different stock markets and unifies securities regulatory system that is applicable to not only the Main Boards, but also STAR Market and ChiNext Market. The Main Boards leverage the successful experience of the STAR Market and ChiNext Market. Except for the differences in the market positioning and financial requirements for the issuers, the Main boards, STAR Market and ChiNext Market, unify the listing requirements, such as legal incorporation and due existence, sound financial management and effective internal control, business compliance and qualified senior management and etc., which generally apply to all issuers. The CSRC further simplifies and integrates the guidance and Q&As issued by different authorities into several unified guidance letters, making it more convenient for all market participants to comprehend, thus providing transparency and certainty.

The full implementation of registration-based IPO system unifies the listing procedures across the Main boards, STAR Market and ChiNext Market as well. The New Rules further delegate different responsibilities between the Stock Exchanges and the CSRC. In brief, the Stock Exchange will serve as the full-spectrum reviewer, while the CSRC will be the registrar and “fail safe”:

i. The Stock Exchange Level

Issuers shall prepare the application documents in accordance with the New Rules and submit to the targeted Stock Exchange. An independent listing review division and listing review committee under the Stock Exchange shall review the application documents and make inquiries to determine (1) whether issuers satisfy the requisite requirements for listing; and (2) whether issuers make sufficient disclosures in the application documents.

If, during the review process, the Stock Exchange discovers anything below, it shall promptly report to the CSRC for further instructions:

(1) Critical sensitive matters

(2) Critical situation without any precedent

(3) Critical public affairs or

(4) Clues that lead to critical illegal activities

If it is determined that certain issuers are suitable for listing, the Stock Exchange shall make a decision and submit to the CSRC for registration. Meanwhile the CSRC will simultaneously focus on whether the business of issuer is compliant to the national industrial policies and whether the issuer is suitable for listing in accordance with such stock market’s positioning.

The listing review committee under the Stock Exchange stands in the very center of the registration-based system, deciding an issuer’s fate. The CSRC demonstrates its determination to reform the listing review committee, polishing rules regarding its composition, tenure, duties and review procedure. As the “gatekeepers” of the market, CSRC not only intends to set higher requirements for committee members on their political awareness, professional background, and working ethics, but also to increase the ratio of full-time members and strengthen their disciplinary constraints[7].

When the SSE STAR Market and SZSE ChiNext Market respectively formed their first listing review committees, except for members from respective stock exchanges and the CSRC, they recruited external members from various intuitions, including industry associations, colleges, insurance asset management institutions, mutual funds, listed companies, law firms and accounting firms, with the hope that external members could use their expertise to provide solid review opinions. However on Dec 23, 2022, both the SSE and SZSE promulgated New Rules on regulating the listing review committee and subsequently announced a new group of candidates[8]. It is observed that all the candidates are from the CSRC and the Stock Exchange, and no members from private sectors are selected, which indicates a huge shift on how the CSRC perceive the functioning of committee members from private sectors.

ii. The CSRC Level

The CSRC shall decide, within the statutory limit, on whether to execute the registration procedure after receiving the decision and supporting materials from the Stock Exchange. However, if the CSRC discovers facts that may affect listing requirements of the issuer, it may direct the Stock Exchange to make further inquiries and form a supplemental opinion on such facts.

The CSRC may request the issuer to suspend or terminate the listing process if it discovers material facts that may affect the issuer’s proposed listing or such facts may question the suitability of the issuer for listing.

4. Main Board Listing Reform – High Qualification, Higher Expectation

Since the promulgation of Administrative Measures for Initial Public Offering and Listing of Stocks in 2006, listing requirements for the Main Boards Listing have been unchanged for 16 years. As mentioned above, the Main Boards emphasize on “large-cap blue-chip” characteristics, and the New Rules reflect such emphasis by optimizing financial requirements accordingly.

The table below summarizes the amendments to the financial requirements of the Main Boards listing and compares with the financial requirements prior to the New Rules:

The New Rules introduce several major amendments:

(1) The New Rules abolish no-accumulated-loss requirement and eliminate limitation on the intangible assets;

(2) The New Rules retreat from the profitability requirement by introducing multiple standards;

(3) The financial requirements for Main boards listing are drastically increased.

Data shows that, approximately 63% of the enterprises currently listed on the Main Boards would satisfy the market capitalization test set out in Standard 2, and only approximately 44% of the enterprises currently listed on the Main Boards would satisfy the capitalization test set out in Standard 3[9]. It is foreseeable that the Main Boards will focus on soliciting the top-tier enterprises in the business with high profile, and those emerging enterprises that seek listing on the Main Boards need to revisit their proposed listing arrangements.

The New Rules further integrate shattered Red-Chip enterprises listing guidance into the Main Boards Listing Rules. The table below summarizes the financial requirements for Red-Chip enterprises that seek listing on the Main Boards:

However, subject to the Notice of the General Office of State Council on Forwarding the Opinions of the CSRC on Launching the Pilot Program of Offering Stocks or Depositary Receipts in China by Innovative Enterprises (Guo Ban Fa [2018] No.21) and other applicable rules, the Red-Chip enterprises that may seek listing on the Main Boards shall be selected as pilot enterprises, namely reputable enterprises that not only match national strategies and own core technologies, but also specialize in high-tech industries and/or strategic emerging industries, such as the Internet, big data, cloud computing, artificial intelligence, software and integrated circuits, high-end equipment manufacturing, biomedicine, next-generation information technology, renewable energy, new materials, new energy vehicles, environmental protection, aerospace and marine equipment.

Hence it remains unsolved that how the Main Boards will align with the STAR Market and ChiNext Market on the Red-Chip enterprise admissions, since the eligible pilot Red-Chip enterprises are natural matches for STAR Market (e.g. SMIC, CR Micro, Megvii) or ChiNext Market (e.g. CIMC Tianda) from the perspective of positioning and the Red-Chip enterprises are in a better position to seek listing on those markets. We will follow on whether further guidance is on its way to harmonize such mismatch.

Another highlight of the New Rules is that the Main Boards accepts issuers with weighted voting rights arrangements, which is not permitted prior to the promulgation of the New Rules. The table below summarizes the financial requirements for such issuers:

Weighted voting rights arrangements, or commonly referred as super voting rights, are introduced to founders when they demand absolute control. Founders can use a class of super-voting shares to maintain control without retaining a proportional economic interest. Such arrangements are often observed and bargained in fundraising activities of Red-Chip enterprises. Meanwhile, scenarios where a domestic issuer could establish such mechanism are rare, which specifies that the issuer must be a “technological innovative enterprise”, along with other conditions[10].

The draft revisions to the PRC Company Law in progress, however, proposed that, companies limited by shares may issue different classes of shares, with different preferential rights (such as liquidation preference) and voting rights attached, in accordance the company’s articles of associations. Combining with the proposed amendments, we might witness an expansion of utilization of the weighted voting rights arrangements within domestic issuers.

5. Pre-Profit Enterprises on ChiNext Market – New Road Ahead

When the registration-based system reform was introduced to ChiNext Market in 2020, in accordance with the arrangements of the CSRC and considering the market status at that time, the relevant rules for pre-profit enterprises, although in place, were temporarily suspended.[11]

After two years of testing and in response to the growing market demands, the CSRC grants the permission to officially activate the rules for pre-profit enterprises, which provides a more inclusive environment for certain issuers to fulfil their funding requests. The table below summarizes the key requirements:

6. Transition Period – Stability and Order

To secure a steady and smooth transition, the CSRC, the SSE and the SZSE have all released notices on the arrangements for the transition period. The table below briefly summarizes the transitional arrangements:

Within 10 working days from the promulgation date (from Feb 20, 2023 to Mar. 3, 2023) of the New Rules, the Stock Exchange will only accept applications from the Main Boards issuers currently under review. From March 4, 2023, the Stock Exchange will accept applications from new issuers.

In accordance with the notice of the CSRC, the issuers that have submitted the application for listing on the Main Boards to the CSRC before February 1, 2023, are allowed to apply the financial tests prior to the New Rules. However such issuers but must fulfill other listing requirements under the registration-based system.

In addition, after the promulgation date of the New Rules, the issuers currently under review by the STAR Market and the ChiNext Market shall submit special explanations and verification opinions within 15 working days, stating that issuers are in compliance with the relevant New Rules, and renew their application documents upon the next round of feedback or update of financial data.

7. Conclusion

Within only a few years, the registration-based system reform pilot programs has attracted many high-quality enterprises to the PRC capital market. With full implementation of the reform and a more unified and developed regulatory scheme, a new page of the PRC capital market is right ahead.

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