Updated: Mar 2
Wall Street © Monica Volpin/ Public domain/ Pixabay
Financial news outlets’ headlines reported worldwide Didi’s decision to delist from the New York Stock Exchange at the end of 2021. This decision marked the end of a standoff between the ride-hailing company and the Chinese government that began with Didi’s Initial Public Offering in June, just one week before the Chinese Communist Party (CCP) celebrated its centennial. While the gravity of the decision to delist was apparent to all, not everybody could grasp the technical aspects of it. Inspired by genuine debate among European Guanxi’s members, the article aims to provide readers with some technical knowledge on why and how Chinese companies look for financing overseas (mainly in the US) and on the latest policy developments in China.
Equity financing – the one employed by Didi – is one way for rapidly growing start-ups to raise capital. Companies sell shares to investors, who gain ownership rights and possible financial returns through price appreciation and dividends in exchange for capital. The Initial Public Offering (IPO) marks the first time that a company raises capital from public investors. Companies must comply with stock exchanges requirements to hold an IPO, which differ across exchanges. Famous exchanges include the New York Stock Exchange (NYSE), the London Stock Exchange (LSE), and the Hong Kong Stock Exchange (HKSE).
Selecting an exchange entails advantages and disadvantages, which helps explain why some Chinese companies choose to hold an IPO overseas. There are various reasons why a Chinese company makes the choice to list in the US rather than in China. These are the main ones (Calhoun, 2020; Kwan, 2016). First, rapidly growing companies cannot go public in China unless they register a profit for 3 years in a row. To the contrary, in the US high growing companies or companies that are leaders in their sector can file an IPO, as was the case for Amazon and Tesla. Secondly, the financial sector in China tends to significantly favour companies that are able to grant a collateral (assets owned by the borrower that, if he defaults, lenders can seize and sell to recoup some or all of its losses). This is notably harder for start-ups to grant than for well-established businesses and SOEs. Third, investors might be willing to invest more capital in the US than in China because of higher liquidity, meaning that investors can buy and sell shares more easily and faster, and with a greater certainty on their price. Finally, listing in the US can also be a badge of honour for Chinese companies.
To make things harder, listing in the US for Chinese companies is not unequivocally legal. The Chinese government divides its companies into categories. Some are allowed to offer ownership to foreign investors, others face restrictions or prohibition, such as companies operating in the internet sector. Since 2000, when the Chinese-language media company Sina’s IPO took place, companies used the Variable Interest Entity (VIE) structure to bypass restrictions, and the government never opposed nor endorsed it (O'Melveny & Myers, 2011). Companies were operating as a matter of fact in a legal grey zone. The VIE structure requires a shell company to be established – normally in a tax haven such as the Cayman Islands or the British Virgin Islands – which serves as a vehicle for the direct listing. This structure allowed Chinese companies such as Alibaba, Baidu, JD.com and Weibo to access foreign investments and rank among the most valuable companies worldwide.
In the summer of 2021, the Chinese government took an unprecedentedly aggressive stance against a Chinese company listing overseas, the ride-hailing group Didi Chuxing. Didi counts more than 377m users and 13m drivers annually active in China and concerns exist about the data handled by the company. At the end of June, the company completed a $4.4bn IPO, second largest only to 2014 Alibaba’s IPO, the week before the CPC centennial. The fact that Didi proceeded with its IPO without addressing all concerns related to data security angered government and party officials. Two days after the IPO, the Cyberspace Administration of China initiated a coordinated investigation on Didi involving the police, tax authorities, the market competition regulator, as well as industry regulators for natural resources and transport (Yang, 2021). Didi was requested to stop signing up new users and Chinese app stores removed more than two dozen of the company’s services. After losing 6.3$bn in less than one year (McMorrow, 2021), in December 2021 Didi finally came to the decision to delist from the NYSE and switch to the HKSE (McMorrow, Yu & Mitchell, 2021). Following these events, the Chinese government announced that rules on overseas listing would have been strengthened. Curbing VIE from foreign listings would be coherent with other measures taken by the Chinese government to rein in the reckless expansion of private capital (Ellena & Migliore, 2021).
The new rules were released by the China Securities Regulatory Commission (CSRC) on Friday December 24, when US markets were closed for Christmas holidays, (CRSR, 2021a), by the National Development and Reform Commission, the state’s economic planning agency, on the 27th of December (The State Council, 2021), and by the Cyberspace Administration of China (Creemers & Webster, 2022). Under the new rules, an overseas listing could be stopped if authorities deemed it to be a threat to national security, specifically in the fields of foreign investment, cybersecurity, and data security. In addition, firms in industries with restrictions on foreign investments would have to seek a waiver from relevant authorities before proceeding with overseas IPOs. Investors of such a company would face a 30 per cent cap on their holdings, with a single investor holding no more than 10 per cent, and would be banned from operating and managing it. The new rules would not be retroactively applied, safeguarding the ownership structure of companies that went public overseas in the past. Moreover, as of 15 February 2022, companies processing data for more than 1 million users should undergo security clearance before listing overseas. In spite of the increased scrutiny over overseas listing, Chinese authorities stopped short of outlawing the VIE structure, thereby continuing to allow companies to list overseas in the future, subject to the approval by regulators (CSRC, 2021).
Besides issuing new restrictions on overseas investments, the Chinese government also eased conditions for innovation-oriented small and medium enterprises (SME) to raise funds in China. A newly-established bourse in Beijing aimed at Chinese SME started trading on 15th November 2021 (Xinhua, 2021). The mainland Chinese financial market landscape now includes the Shanghai Stock Exchange (SSE), Shenzhen Stock Exchange (SZSE) and the Beijing Stock Exchange (BSE). Whether this new stock exchange will lure Chinese companies away from overseas listing remains open for debate (The Diplomat, 2021).
Giacomo Migliore is a Master graduate in International Business. His thesis compared Chinese and Italian users' behaviour in respect to ePayment. He worked in a finance and tax consultancy in Shanghai. He completed an internship at the United Nations Economic Commission for Europe and is currently working as a Blue Book trainee at the European Commission. You can find him on LinkedIn.
The opinions expressed here are those of the writers and do not represent the views of European Guanxi.
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