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China Unveils Sweeping Rules for Foreign IPOs in Didi’s Wake

(Bloomberg) — China has unveiled sweeping rules for the sale of shares abroad by the country’s companies, taking one of its biggest steps to tighten controls on international debuts in the wake of Didi’s controversial listing Global Inc.

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The regulations, issued last week by the country’s securities watchdog, the Department of Commerce and the top economic planning agency, sowed more uncertainty over the prospects for foreign IPOs that had gone virtually unchecked for two decades. The Nasdaq Golden Dragon China Index fell 1.1% overnight despite a new all-time high for US equities, while the Hang Seng Tech Index fell a whopping 1.6% during trading in Hong Kong Tuesday, swept by losses in Tencent Holdings Ltd. and Meituan.

Chinese companies in industries excluded from foreign investment will have to apply for an exemption from a negative list before proceeding with share sales, the National Development and Reform Commission and the Commerce Ministry said in a statement Monday. Foreign investors in such companies would be prohibited from participating in management and their total ownership would be limited to 30%, with a single investor owning no more than 10%, according to the updated list effective Jan. 1.

Meanwhile, the China Securities Regulatory Commission on Friday proposed that all Chinese companies seeking initial public offerings and additional share sales abroad must register with the securities regulator. Any company whose listing could pose a threat to national security would be banned from proceeding.

The review represents an important step Beijing has taken to tighten controls on foreign listings, after ride-hailing giant Didi went ahead with its New York IPO despite concerns about the security of its data by regulatory authorities. While regulators lifted a ban on IPOs by companies using the so-called Variable Interest Entities (VIE) structure, the new rules would make the process more difficult and expensive.

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It means that Chinese companies seeking to list abroad through VIEs may need to complete compliance process with the Ministries of Trade and Economic Planning in addition to a cybersecurity investigation before being allowed under the CSRC’s proposed registration process, said Winston Ma, deputy deputy chief executive officer. professor at NYU. Law School and author of “The Digital War – How China’s Tech Power Shapes the Future of AI, Blockchain and Cyberspace.”

The new edicts on VIEs and lists indicate that China’s efforts to curb its massive internet sector are not waning. After cracking down on areas from e-commerce to fintech, after-school education, gaming and online content, Beijing has focused on the risks posed by tech startups seeking access to foreign capital in an effort to expand. In addition to the new rules for VIEs, regulators had previously proposed that companies with at least one million users undergo a cybersecurity assessment before going abroad.

“The Ministry of Commerce, as the enforcement agency for foreign investment laws and the lead ministry for the existing VIE rule enacted a decade ago, could become a key regulator for Chinese VIEs seeking offshore IPOs said Mom.

VIEs have been a perennial concern for global investors. Pioneered by Sina Corp. and its investment bankers during an IPO in 2000, regulators have only started acknowledging their existence in a series of rulings and new regulations in the past year, though it’s still unclear whether Beijing sees them as legal.

Nevertheless, VIE’s have allowed Chinese companies to circumvent foreign investment rules in sensitive sectors, including the Internet industry. The structures allow a Chinese company to transfer profits to an offshore entity – registered in places such as the Cayman Islands or the British Virgin Islands – with shares that foreign investors can then own. The new rules may now make them less relevant, as there will also be oversight of any indirect mentions.

The requirements apply to new stock listings and do not affect foreign ownership of companies already listed abroad, the Department of Commerce and NDRC said.

Companies using the VIE structure would be allowed to pursue foreign IPOs after meeting compliance requirements, the securities regulator said Friday, without providing further details. Foreign securities firms that insure the foreign stock sales of Chinese companies are required to register with the CSRC and submit an annual report on the companies.

That “could create new compliance challenges for the foreign insurers, as they may have to follow Chinese rules once registered with CSRC,” Ma said.

It’s all part of a years-long campaign to curb the breakneck growth of China’s internet sector and what Beijing has called a “reckless” expansion of private capital. Reducing VIEs from foreign exchanges would close a gap that has been used by tech giants Alibaba Group Holding Ltd for two decades. to Tencent to circumvent restrictions on foreign investment and to list offshore.

Days after Didi’s $4.4 billion mega IPO, China shocked investors in July by announcing that it was investigating the company and ordering that its services be pulled from Chinese app stores, exposing the ridehailing’s shares. company were refueled. Didi said earlier this month it would remove its US deposit shares from the New York Stock Exchange and pursue a listing in Hong Kong.

Didi’s shares plunged 5.4% in US trading Monday after the Financial Times reported that the company has banned current and former employees from selling their shares indefinitely.

A lack of clarity on the listing rules has hampered the ability of startups and their large investors to capitalize on their growth. Following the blockbuster debut of companies like Kuaishou Technology at the beginning of the year, several startups expected to enter the market have canceled or postponed their IPO plans.

Podcast App Ximalaya Inc. and lifestyle platform Xiaohongshu have been among companies that have given up on their preparations to sell shares in the US, while ByteDance Ltd., the owner of the popular TikTok and Douyin apps, the world’s most valuable startup, has tried to spark fervent speculation. of its own listing plans.

The tightened scrutiny by Chinese regulators was echoed by their US counterparts. The Securities and Exchange Commission this month announced its final plan to enact a new law that would require foreign companies to open their books to U.S. scrutiny or risk being thrown off the New York Stock Exchange and Nasdaq within three years. China and Hong Kong are the only two jurisdictions to refuse the inspections, despite Washington demanding them since 2002.

For companies looking to list under the VIE structure, the stricter oversight could affect their decision to choose the listing destinations, said Xia Hailong, a lawyer with Shanghai-based law firm Shenlun.

“They used to have no barrier to foreign listing, but now they will definitely be controlled much more closely and the road to foreign IPOs will be much more difficult,” said Xia.

(Update stock prices in second paragraph)

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