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China has quietly taken a critical step in enticing foreign strategic investment in listed companies by allowing long-term investors to buy tradable shares listed on the Shanghai and Shenzhen stock exchanges. Previously, strategic investors from other countries were allowed to buy only nontransferable shares when investing in state-controlled companies listed on the two bourses. The only exception until now has been a program for qualified foreign institutional investors, or QFIIs, who are fund managers allowed to buy freely traded shares in listed Chinese companies through a quota system. The new rules “could have a drastic impact,” said Lan Xue, head of China Research at Citigroup Inc. “Strategic investors would be allowed to invest in listed Chinese companies, using the QFII format. It would help the government to liquidate its portfolio to invest in pension funds and reduce [selling] pressure on the secondary markets.” The China Securities Regulatory Commission and Ministry of Commerce on Oct. 26, with immediate effect, jointly issued the new rules for foreign strategic investors who purchase significant holdings in companies to have a say in how they are run. The statement encourages more foreign strategic investment in listed Chinese companies, which has happened infrequently. For example, British brewer Scottish & Newcastle plc bought a 19.51 percent stake in Shanghai-listed Chongqing Brewery Co. Ltd. for $63 million in November 2004, and Eastman Kodak Co. bought a 20 percent stake in Shanghai-listed Lucky Film Corp. for about $100 million in February 2004. The new foreign strategic investment rules apply to all listed companies whose controlling state shareholders have completed a compensation reform program by issuing bonus shares to minority shareholders in exchange for the right to float their state-held holdings, which were previously blocked from trading. About two-thirds of China’s 1,200-plus listed companies’ shares are locked in nontradable shares the state holds. So far, fewer than 200 of them have completed the compensation reform program, but analysts expect the remaining thousand to freely float their state-owned shares by first quarter 2007, allowing all of them to qualify for foreign strategic investment thereafter. The new rules will allow companies that sell stakes of more than 25 percent to foreign strategic investors to receive generous tax breaks, similar to those offered foreign-invested enterprises. They would keep this special status as long as foreign strategic investors continue to hold more than a 10 percent stake in the company. Working details of the new rules have not been issued. Lawyers and analysts said the actual implementation of the rules will be crucial, as broad policy guidelines in China can be altered when the government actually puts the rules into effect. Copyright �2005 TDD, LLC. All rights reserved.

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