Queue-jumping initiative | China Accounting Blog | Paul Gillis

Queue-jumping initiative

Reuters has an interesting report that says Chinese regulators plan to allow some of China’s largest tech firms to jump the queue to list in China.

The largest Chinese tech companies have mostly listed in the United States. This was for several reasons. Initially Chinese markets were used mostly for state owned enterprises. That changed with the opening of the SME Board in Shenzhen and especially with the 2009 launch of ChiNext, China’s NASDAQ. Listing offshore also provided an exit for foreign venture capital investors, who otherwise faced restrictions in investing and currency controls made it difficult to convert proceeds from exits.

Most listings went to the US where both NASDAQ and NYSE competed aggressively for the listings. Initially this was because of a perception that US markets had more liquidity and a better understanding of tech. As the Hong Kong and China markets matured and grew in size, the listings mostly continued to go to the US. A major reason was that the US allows control structures (like two classes of shares) that enable founders to stay in control of companies despite selling down most of the shares. Hong Kong and China do not permit control structures, and the Hong Kong Stock Exchange's unwillingness to change this rule cost them the Alibaba IPO. Nevertheless, a few tech companies, notably Tencent, have listed in Hong Kong (without control structures).

Recently we have seen many companies undertaking going private transactions to delist from US exchanges with the intent to relist on China’s stock exchanges. Since the IPOs of these companies, the Chinese stock exchanges have grown significantly and offer potentially higher valuations. These going private transactions have been criticized over their arguably unfair treatment of minority shareholders, who are typically offered a price far below the expected value when the company is relisted.

Chinese tech companies often also faced restrictions against foreign ownership. That should have blocked foreign venture capital investments and foreign IPOs, but a workaround was developed. The workaround was the variable interest entity (VIE), which enabled the listing of companies controlled through contracts instead of ownership. VIEs have been a source of pain for many investors, since the contracts proved difficult to enforce and control through contracts proved to be vastly inferior to control through actual ownership.

A few formerly US listed companies have succeeded in relisting in China. Before doing so they needed to restructure to get rid of the VIE structures and offshore structures (and control features) that had been put in place for the US listings.

The Reuter’s article points to three companies that may be the initial beneficiaries of the queue-jumping initiative - Ant Financial, the world's most valuable financial technology company, Zhong An Online Property and Casualty Insurance, and security software maker Qihoo 360 Technology Co. Ant and Zhong An would be doing IPOs, while Qihoo went private in 2016 and would be relisting in China.

It is not known whether China plans to change its rules to facilitate control structures. Ant is owned by Jack Ma and his associates. Jack Ma insisted on a control structure for Alibaba. It would also appear that it will be difficult for foreign investors to participate in these transactions, since foreigners can only purchase shares on the Chinese exchanges through the Qualified Foreign Institutional Investor (QFII) programs or the Hong Kong Connects.

I have been hearing rumors that China soon plans to announce that the VIE structure will no longer be tolerated for foreign investment, while at the same time grandfathering existing VIE structures. China had earlier proposed to change the foreign investment rules to exclude companies that were controlled by Chinese from restrictions, effectively encouraging the control structures, but these rules were not adopted when the foreign investment rules were modified last year.

If VIEs are banned (and the rules are actually enforced), it would likely mean the end of new US listings of Chinese tech (and other restricted sectors such as education and finance) companies. The queue-jumping program might foreshadow that announcement. The big losers would appear to be US venture capital firms and US investment banks.

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