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When Chinese automaker Brilliance China Automotive Holdings Ltd. listed on the New York Stock Exchange in 1992, it was the first of many Chinese companies to list on an international market. Recent headlines have been filled with billion-dollar-plus listings of major Chinese banks and state-owned enterprises. As the Chinese economy continues to liberalize, an unprecedented number of Chinese companies are tapping public markets, with listings on the New York, London, Tokyo, Singapore and Hong Kong exchanges. Among these are notable listings of private companies such as Focus Media Holding Ltd. and Baiou.com Inc. Chinese businesses often list on foreign capital markets at the urging of private equity investors seeking exits and returns on their investments. Listing can provide foreign exchange for overseas expansion of the business, and listed shares can provide currency for mergers and acquisitions. However, China-based businesses seeking listings overseas face unique challenges and choices. Listing successfully requires a combination of business and financial performance, corporate management, governance, compliance and investment banking, accounting and sound legal counsel. For Chinese companies deciding on the venue for listing overseas, there are major issues to consider: Market conditions in China as well as those in the listing venue. Level of interest and understanding of investors in the listing venue of China. Perception of the sector involved-for example, which markets are more receptive to technology, mining or manufacturing companies. Nature of the revenues of the business, from domestic sources or foreign exchange, and currency exchange fluctuations. The likelihood of trade disputes or sanctions and other geopolitical issues. China’s ascendancy in economic importance makes some of these issues loom especially large for Chinese companies as they consider listing on foreign exchanges, many beyond a company’s control. Clearly, a successful listing of a Chinese business is no small feat. At the most fundamental level, Chinese business organizations are structured to facilitate the regulation of the ownership of the business by foreign shareholders. Listings on foreign markets often take place with the transfer of the Chinese business or its economics to an offshore company that does not restrict or regulate shareholding. That offshore company becomes the listing vehicle. Listings in Hong Kong generally are permitted only for companies incorporated in China, Hong Kong, Bermuda and the Cayman Islands. For initial public offerings in the United States, the Cayman Islands seem to be the jurisdiction of choice, with the depository receipts being listed in the United States. For listings in Singapore, Bermuda and the Cayman Islands seem to be more favored. The right jurisdiction Selecting the jurisdiction of the listing vehicle is a function of maximizing flexibility for the listing venue. In the prelisting reorganization, perhaps in the early rounds of financing, British Virgin Islands (BVI) companies often are used as the foreign vehicle holding for controlling the Chinese business. In the reorganization for the listing, a Cayman or a Bermuda company would be inserted into the chain to be the listing vehicle. All of these jurisdictions are tax-neutral to the issuer. However, the cost of incorporating and maintaining a BVI company is a fraction of that of a Bermuda or a Cayman company, and the procedures for incorporating much simpler. Before there is the certainty of a listing, most businesses would opt to use a BVI and then do a share swap for a Cayman or Bermuda company for listing. There is limited choice over the jurisdiction of the listing vehicle for reverse takeovers (RTO) in the United States. Nearly all available shells are U.S. companies. One critical factor to consider for a company seeking to list in the United States through an RTO is the tax implication of being a U.S. company. Chinese companies often have tax incentives that play an important factor in their financial performance, and the use of a U.S.-listed vehicle, and resulting U.S. tax exposure, may nullify any tax incentives available in China. Management may consider this loss too high a price for a listing and choose to delay the process until the incentives are no longer available. China’s shift from controlled to market economy poses unique challenges for a company seeking to list in public markets. The rapid change to capitalism often means that laws lag market conditions and practices. As one example, China controls foreign ownership of certain industries it considers sensitive. This is no different and, arguably, more transparent and predictable than the restrictions imposed by the United States on sectors such as telecommunications and oil and gas. Foreign ownership restrictions in China are gradually being reduced through the auspices of the World Trade Organization and generally as the market opens. However, certain sectors, notably Internet content providers and most forms of media, still face restrictions. Despite this, some companies in these sectors have structured their holdings to facilitate listings on Nasdaq and other public markets. Without changes in the law, there are inherent risks in these structures and, for these companies and the market, it is very much the case of “no news is good news.” It takes time for both the administrators and those affected to interpret and implement new laws. Administrative bodies sometimes have overlapping jurisdictions or interests and may have different views on how matters should be dealt with. How new laws are applied and enforced differs from province to province. Because of local conditions, some administrative bodies may offer incentives to persuade certain businesses to locate within their jurisdiction. These may result in noncompliance with some laws of general application. It should also be noted that strict compliance may not be the market practice for certain industries. Companies that comply could find themselves being uncompetitive in the market. As one recent example of policy change, the Chinese State Administration of Foreign Exchange (SAFE) last year issued Circular 75, which imposes a new registration process for Chinese residents, including noncitizens, transferring businesses in China to offshore companies. Circular 75 was issued to clarify two SAFE circulars issued in early 2005 that caused uncertainty and concern in the investment community. State Administration of Foreign Exchange, Circular on Issues Relating to Improving the Administration of Foreign Exchange in Mergers and Acquisitions by Foreign Investors, Jan. 24, 2005, Huifa [2005] No. 11; Circular on Registration of Overseas Investment by Domestic Resident Individual and Foreign Exchange Registration Related Merger and Acquisitions by Foreign Investors, April 8, 2005, Huifa [2005] No. 29. For most of 2005, private equity and listing transactions were put on hold as parties considered the effect of the initiatives. In the end, Circular 75 requires residents of China transferring businesses located in China to offshore structures, including companies and trusts in a financing transaction, to make a filing with SAFE that includes the business plan and a plan for repatriating financing proceeds to China. Because some shareholders may wish to reinvest their proceeds of refinancing overseas without repatriating funds into China, these requirements have caused some concern. Chinese residents are also required to report to SAFE any subsequent changes in the structure of the financing vehicle, creating an ongoing compliance obligation on the part of Chinese residents. Against this background, a record of strict compliance with all laws at all times can be a challenge for companies. Some companies seeking to list have to re-evaluate their operations and change their practice for a period of time in order to ensure a clean bill of health for a listing. Some common issues or challenges for Chinese clients include title and ownership of real estate in China, tax and employee benefits matters. When these issues have a direct impact on financial performance, as may be the case for tax or where financial penalties may be involved, the quantum involved may jeopardize the listing. In other cases, the issues involved may bar a listing completely. The obligations and responsibilities of management following listing and the company’s ability to meet these are important factors to consider, especially for legal advisers. Compliance costs for listing in the United States can and have caused many companies, even those already listed in the United States, to reconsider that venue. The extensive ongoing disclosure and compliance requirements, including the Sarbanes-Oxley requirements, can make the United States prohibitively expensive for smaller companies. In addition, U.S. securities laws impose heavy civil and criminal liabilities on the directors and officers of listed companies. Compounding this is the reputation of U.S. markets being more litigious than others from both shareholders and regulators. Asia’s pros and cons In light of these issues, some companies are opting for other markets that both lower the listing and compliance costs and mitigate the compliance and litigation exposure. Exchanges closer to China are often viewed as more logical venues. Hong Kong is the obvious choice, given the location and the depth and experience of the capital market and availability of professional advisors familiar with China. Major investment banks, accounting firms and law firms, including American firms, are all well represented in Hong Kong. Some of the U.S. law firms are active on local listings. If there is a strike against Hong Kong, it is that the size of the market is small compared to the overall markets in the United States or even Japan. However, with the major Chinese banks listing primarily in Hong Kong, its market cap is increasing steadily. Singapore has emerged in recent years as a potentially valuable venue for certain sectors. However, the low number of Chinese companies currently listed in Singapore has resulted in low volume of trade for these businesses. The Tokyo Stock Exchange has been actively seeking listings from China recently. Certain sectors, such as retail, media and telecom, have a strong following in Japan. Japanese investors have a good understanding of these businesses and sectors and many Japanese companies have already invested heavily in China. Companies will find the valuations on the Tokyo exchange very attractive compared to other regional exchanges and even the U.S. exchanges. However, the requirement for filings to be in Japanese, financial statements to follow Japanese generally accepted accounting practices (GAAP) and some level of presence in Japan can be a significant impediment for some companies. From a practical perspective, Hong Kong and Singapore offer compatibility in language that other markets do not offer. In ongoing compliance and disclosure, language can significantly increase delays and costs and can cause compliance complications as requirements, issues and facts literally get lost in the translation. The number of U.S. securities lawyers proficient in the Chinese language and dialects is already low, and that number may be even lower for those who understand Japanese or English securities laws. The requirement for local accounting standards is also a filter in determining the listing venue. Chinese businesses must follow local accounting requirements. For overseas listings, businesses will have to duplicate accounting and financial reporting under standards for the foreign market. U.S. GAAP and financial reporting standards are not often used outside the country, unless the company happens to be a reporting issuer in the United States or its subsidiary or affiliate, and the effort and expense of restating financial statements in compliance with them can be significant. A company wishing to maximize options in listing venue may decide to rely on international accounting and financial reporting standards that can be used in Hong Kong, Singapore, London and other markets and not make a single bet on using U.S. GAAP for the U.S. market. A listing by a company in a mature economy is and should be driven by market and commercial factors such as profit-to-earnings ratios, investment interest for that business, liquidity in that market and size of the offering. In a developing market like China, we are seeing more of these decisions take into account legal considerations. Status factor fades When the first listings of Chinese companies on Nasdaq became successful in 2000, it became a matter of status to list in the United States. Founders and senior executives proudly proclaimed their companies’ U.S.-listed status. Little differentiation was made whether the company was listed on the New York Stock Exchange or over the counter. As the market has matured, the cost in monetary terms and management time needed to comply with the heavy requirements is beginning to sink in. In addition, the requirements are sometimes viewed as overreaching and the litigation risk, especially for smaller companies and smaller amounts raised, unjustified. On the other hand, Chinese businesses are in the unique position of having a number of listing venues offering to help them list on these exchanges. Each listing venue has its focus, advantages and disadvantages, and there are a myriad of factors the companies themselves must consider in this decision. As the China market continues to define its own form of capitalism, it will find the markets that best meet the needs of its businesses. Chinese businesses looking for a listing venue will not depend solely on one market. The United States remains the largest capital market in the world and will play an important role in the continuing development of Chinese businesses and the Chinese economy. The cost and effort required to list and maintain a listing in the United States will limit it to larger and more sophisticated Chinese businesses. In the end, that may be the best result for all involved. Clifford Ng is a partner in the Hong Kong office of Seattle-based Preston Gates & Ellis and heads the firm’s Asia practice group. He can be reached at [email protected].

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