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In recent years there has been an explosion of foreign private equity investments in Chinese companies. Many of these investments are now maturing to exits in public markets. With a global investor base and traditional markets becoming less “issuer friendly,” many companies are turning to nontraditional markets for listings. My firm, Preston Gates & Ellis, recently assisted Xinhua Finance Limited in its listing on the Mothers Board of the Tokyo Stock Exchange (TSE), the first primary listing by a foreign company and the first listing by a Chinese company on that exchange. The listing of Xinhua Finance is a reflection of the ascendancy of Chinese capital markets. The company is in the business of providing financial news, indices, investor relations and ratings focused on the rapidly growing financial markets in China. It provides investors with international standards of access to, and analysis of, Chinese equities and bonds. It has offices and news bureaus around the world, including substantial operations in the United States. More recently, we saw the opening of the Chinese capital markets to foreign investors under the Qualified Foreign Institutional Investors (QFII) program. Under this program, foreign investors are permitted to invest in the same market of publicly traded shares (known as A shares) previously reserved for domestic Chinese investors. Historically, foreign investors were only permitted to invest in a separate pool of shares (B shares), which traded at a discount and with lower liquidity than the A shares of the same company. Already, more than $3 billion has been invested under the QFII program, with many more applications for qualification and quotas waiting to be processed. That said, for companies seeking to list, access to capital might not be the most important criteria in deciding to tap foreign markets. More than ever before, the domestic Chinese markets are awash in capital. However, tapping domestic capital markets in China can only generate renminbi, the Chinese currency, which is not freely convertible into foreign exchange. A foreign listing provides access to foreign exchange, which companies can then use for acquisitions, expanding their distribution network or for other expenses that may be incurred overseas. As a result, a listed company’s shares and the foreign exchange proceeds from the listing can provide true liquidity for overseas expansion and operations. Secondly, an overseas listing is often seen as providing a greater level of credibility for the issuer and its management. Compliance with regulatory requirements associated with going public is a challenge for any company, including those in China. An overseas listing can provide investors with added comfort relating to financial and other reporting by the company, making it easier for the company to raise additional funds. For the company, a listing is often used as a catalyst to improve management discipline and financial accounting and transparency. The underwriting, audit and legal sign-off by internationally recognized investment banks, auditors and lawyers can add considerably to the credibility of the management team and the business. In general, China’s laws lag behind the rapid liberalization of investments, trade and commerce. Restrictions remain on foreign ownership and control of certain businesses and assets. As a result, lawyers will often have to resolve ownership and control issues for the Chinese components of the business. For U.S. investors, making an investment in the first place must be contingent on having an achievable and suitable exit strategy. Surprisingly, many foreign investors still do not take this critical preparatory step. Despite the opening of China’s domestic markets through the B-share market and the QFII program, domestic listing in the Chinese markets (with the exception of Hong Kong) provides limited or no exit opportunity for foreign investors due to currency and market restrictions. When Xinhua Finance made the decision to pursue a listing, it considered several different markets. The company’s legal structure allowed it to list in many jurisdictions. This is not unusual for many Chinese companies that are looking for an IPO in international markets. Xinhua is incorporated in the Cayman Islands with headquarters in Hong Kong and subsidiaries in China, the United States and several other jurisdictions. It has a diverse base of institutional and private investors from the United States, China and Japan. While a listing in Japan may seem like an odd choice for a company that, prior to the IPO, had only limited operations in Japan, the choice becomes more obvious when one looks at the attributes of the Tokyo markets. Officials from stock exchanges around the world now put on road shows in different markets to lure companies to list on their exchanges. China has been a frequent stop on many of these tours due to the rapid growth in both size and sophistication of Chinese private enterprises. Significant amounts of private equity have been invested in many of these companies for years, and they are now ripe for listing. State-owned enterprises continue to be privatized. In short, China has become a hotbed for IPO candidates. What separates Tokyo from many other exchanges is size. In terms of market cap, it is roughly the same size as Nasdaq, one-quarter the size of the New York Stock Exchange and double the size of the London Stock Exchange. In comparison to other markets is Asia, the Tokyo exchange is more than three times the size of the Hong Kong Stock Exchange, which is the next largest market, and larger than all other major Asian markets combined. In terms of liquidity, the average daily volume of trades on the TSE exceeds $11 billion. The TSE is divided into four sections. The first is made up of large cap companies and the second one contains smaller or mid-cap companies. All companies are reviewed each year based on a number of criteria to determine whether they should move from one section to the other or be delisted altogether. There is also a Mothers board for new and high-growth companies. Lower thresholds for track record, profits and revenues are among the benefits to listing on Mothers. Finally, there is a section for foreign companies that have a primary listing elsewhere. The Tokyo exchange provides an excellent platform for Chinese companies to list. Japanese investors, by and large, are familiar with the Chinese market and business environment. Many Japanese companies were early investors in China, first using and then buying and building low-cost manufacturers. Foreign investors constitute approximately 20 percent of the market, and the major U.S. brokerages, including some discount brokerages, have the capability to trade on that exchange. Perhaps most importantly, it is not unusual for a company on the TSE to trade at 20+ times its price-earnings ratio. This is the case even for many companies on the Mothers board. This is a significant premium over what is often available on the Hong Kong or Singapore exchanges. An interesting quirk of the Tokyo exchange is that it is not unusual for the price of each share to be in the hundreds or thousands of dollars. The notion of “penny stocks” applies in Japan but, like everything else in that country, operates on an inflated scale. The liquidity is generally higher for higher priced shares than those priced in the range of a few dollars. In helping the first foreign company to have a primary listing on the TSE, Preston Gates & Ellis worked with the underwriters, global syndicate, the Japan Securities Settlement & Custody Inc. (JSSC) and its custodian to devise a settlement system that allowed Japanese and foreign investors to clear and settle their trades. Under the Tokyo exchange system, JSSC acts as the central depository and settlement agent. Listed foreign companies must have the shares deposited with the custodian appointed by the JSSC, and brokerages with an account with the JSSC can trade the stock within the system. Depending on the underwriters and the syndicate involved, a company may face settlement and liquidity issues if its shareholders cannot access accounts with brokers registered with the JSSC. In the Xinhua Finance listing, we assisted in qualifying the Mothers board as a designated offshore securities market (DOSM) for purposes of the Securities Act of 1933. Though the Tokyo exchange was already a DOSM, Xinhua’s listing marked the first time that was required for the Mothers board. Our work with Xinhua should pave the way for more listings on the TSE of companies with U.S. shareholders. U.S. investors often will negotiate registration rights agreements, which are premised on a listing in the United States. The U.S. securities regime involving registration statements is often not applicable to other markets. In many jurisdictions, all of the shares of a company will be freely tradable after the listing has been approved by the relevant authorities. For companies with dual listings in an Asian market and in the United States, the securities traded in the United States generally have lower liquidity. Depending on the business, a listing in the United States may not be the most attractive option. As companies go public in other markets, agreements providing for exit or liquidity rights should be sufficiently broad to take into account these opportunities and markets. Xinhua Finance made the decision to list on the Tokyo exchange in March 2004 and the listing was completed by October. The speed with which we were able to accomplish a listing within such a short time is a credit to Xinhua Finance’s management team and the advisers involved. In addition to the issues outlined above, there were many hurdles that were encountered for the first time. The Tokyo Stock Exchange was exemplary in facilitating the listing while ensuring the integrity of the process. Completing the listing on that tight schedule took a lot of creativity, cooperation, perseverance and appreciation of the different cultures involved. As more Chinese companies seek listings overseas, the number of viable markets where a listing can occur has increased. Investors do not need to restrict exit mechanisms to U.S. markets. On the contrary, markets in Hong Kong, Singapore and Tokyo can offer better exits for American and other foreign investors as well as a higher valuation and a more liquid and knowledgeable market for the issuers. Clifford Ng is a partner in Preston Gates & Ellis’ Hong Kong office, where his practice focuses on cross-border transactions.

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