Despite COVID-19 travel bans and tightening regulations from the U.S., more than 30 Chinese companies successfully filed for an initial public offering (IPO) in the U.S. in 2020, raising some $13.03 billion in total, a year-on-year increase of 270 percent. The IPO has rush extended well into 2021, with 20 Chinese companies debuting in the U.S. capital market in the first quarter alone. Lawyers say that while they don’t expect the ardour to subside any time soon, potential issuers should do well to weigh up the timing, as well as the pros and cons.
Most people felt pessimistic about economic growth when COVID-19 outbreak happened last year, but capital markets have turned out to be exceptionally robust. In 2020, Chinese companies brought in the largest amount of proceeds through U.S. IPOs since 2014, and the record is about to be broken this year.
As of the end of April, firms from the mainland and Hong Kong SAR raised $6.6 billion via U.S. IPOs this year, data compiled by Bloomberg show. “Chinese companies are listing in the U.S. at the fastest pace ever, brushing off tensions between the world’s two biggest economies and the continued risk of being kicked off American exchanges,” Bloomberg reported.
Many high-profile companies are expected to complete a U.S. IPO filing in 2021, and in total, about 60 Chinese companies plan to go public in the U.S. this year, said Vera Yang, chief China representative for the New York Stock Exchange, to CNBC.
“Investment banks have become increasingly concerned about issues such as tunneling among investors since 2019. We see clear increases in the frequency of communications between us and the investment banks’ compliance teams.”
一Gao Xiang, Jingtian & Gongcheng
“This is the busiest year I ever had since I started my career in 2004,” says Gao Xiang, a partner at Jingtian & Gongcheng, who was actively involved in the U.S. listings of Chinese companies such as iQiyi. “Many foreign lawyers are no longer accepting new orders, which makes 2021 a special year.”
“U.S.-listed Chinese companies should identify flaws beforehand to smooth out the IPO filing process; they also need to consider the adequacy of their operations in China, seeking to strike a balance between business operations and the U.S. sanctions.”
一Fang Liu, Clifford Chance
Fang Liu, a partner at Clifford Chance, adds: “Actually, the U.S. IPO rush as we see it today it’s already a diminished version after some companies went to Hong Kong instead of the U.S. … In view of the various external factors involved in an U.S. listing, some companies that originally planned to go public in the U.S. have recently gone to Hong Kong instead, otherwise the number would be bigger.”
“Chinese companies in general have become keener to get listed in the U.S. in spite of the mounting challenges because it provides a convenient and accommodative financing channel.”
一Shen Jun, Commerce & Finance Law Offices
As for the reasons, Shen Jun, a partner at Commerce & Finance Law Offices, points out: “Different capital markets are all financing channels for Chinese companies, and the U.S. market is no exception… Chinese companies in general have become keener to get listed in the U.S. in spite of the mounting challenges because it provides a convenient and accommodative financing channel.”
Compared with the other capital markets, such as the ones in mainland China and Hong Kong, Fang notes, the U.S. market has two advantages. Firstly, “there is a predictable IPO timeline and process in the U.S.,” as IPO filing approval is largely focused on information disclosure. Also, filings are more or less reviewed once they are submitted, so it is much more predictable than the A-share and H-share markets.
The other advantage is the fact that “as the largest capital market in the world today, the U.S. market has greater liquidity, and a large number of investors and funds interested in investing in ‘new economy’ companies, so for these companies, a U.S. IPO is a better choice in terms of investor base, liquidity and stock valuations,” Fang elaborates.
Speaking of the recent changes in regulatory policies for Chinese companies seeking an IPO in the U.S., all the three lawyers emphasise the ramifications of the Holding Foreign Companies Accountable Act (HFCA) in the U.S.
The HFCA bill was unanimously passed by the U.S. House of Representatives in December 2020, followed by the endorsement of the final amendment in March this year; it went into effect 30 days after it was released for comments. The act requires companies listed in the U.S. to allow the Public Company Accounting Oversight Board (PCAOB) to check their audit papers – companies failing to do so for three consecutive years may be delisted. However, Chinese laws prohibit Chinese companies from supplying such papers.
“It poses a threat hanging over Chinese companies like a sword of Damocles,” says Fang of Clifford Chance. “The measures adopted by the Trump administration gave rise to doubts as to whether the trend toward listing in the U.S. will last. It has been several months that the Biden Administration took over office, and we believe that the tightening regulation of Chinese companies will not ease off under the new presidency.”
“The HFCA act indeed has a psychological impact on issuers, because they don’t want to face such political uncertainties after the share offering,” Gao of Jingtian & Gongcheng admits. “However, the act is not that frightening if viewed from a different angle. Firstly, the China Securities Regulatory Commission has always been open-minded regarding the issue of audit papers, and we believe financial professionals will be able to figure out solutions that meet the U.S. regulatory requirements, and serve China’s economic sovereignty interests at the same time. Furthermore, from the perspective of financial interests, if Chinese companies were delisted resulting from the HFCA act, it would ultimately cause losses to American investors, so I don’t think it’ll materially affect listings of Chinese company stocks in the U.S.”
In fact, the audit papers are not the only contentious issue. “As China’s new Securities Law came into force, the ban on organizations and individuals in China from supplying documents and materials related to securities activities to overseas authorities has attracted the attention of foreign stock listing regulators, and we have received specific inquiries in some projects,” Shen of Commerce & Finance points out.
Shen attributes issues related to offshore listings to “differences in regulatory rules across national borders and possible conflicts arising from them.” As global tensions may increase the frequency of such conflicts, he thinks that it “requires that lawyers sharpen their understanding of the legislative intent and their ability to clarify such differences and solve practical issues – especially when it comes to responding to regulatory inquiries. The lawyers’ work is no longer limited to superficially handling individual cases in isolation. Instead, they need to acquire an understanding at a deeper-level so as to work out highly practical solutions.”
Shen finds that in the face of challenging uncertainties, his clients now “take extra caution when planning an IPO in the U.S., and consider the feasibility of and route to recapitalization as a contingency measure, including carrying a secondary share offering on another capital market, and listing a business segment as a spinoff. Apart from traditional factors such as valuation and liquidity, security has become an increasingly important consideration in selecting the IPO location.”
For example, a total of $17 billion was raised via secondary listings of U.S.-traded Chinese companies in Hong Kong last year, and such listings have fetched over $8 billion this year as of the end of April, Bloomberg data shows. Companies like DiDi, Xpeng Motors, Nio and Li Auto are seen in the list of the reported secondary offerings.
“It might gradually become the norm going forward,” says Fang, who was recently involved in the Hong Kong secondary listings of JD.com and Bilibili. “The HFCA act laid down the ‘three consecutive non-inspection years’ rule, and the HKEx requires that the issuer of a secondary IPO should have been listed on the primary market for at least two full fiscal years, which dovetail exactly with the HFCA timeframe. May Chinese companies seeking a U.S. IPO will consider filing for a secondary listing in Hong Kong two years afterwards, such that they can make Hong Kong the primary location in the event of a delisting in the U.S. They say that it’s like buying insurance – if the situation in the U.S. doesn’t improve, at least we’ll have a backup plan.”
In addition to the tightening regulation, the lawyers have seen increasingly strict regulatory requirements adopted by investment banks in recent years, which as had a more direct impact on legal service providers.
“In the U.S., IPOs are mostly led by investment banks. They have become increasingly concerned about issues such as tunneling among investors since 2019, and thus ask the lawyers to conduct more thorough due diligence investigations,” Gao says. “Some legal matters were only required to be disclosed in the past, but now in-depth discussions and analysis are conducted regarding the relevant background information and the potential implications. We see clear increases in the frequency of communications between us and the investment banks’ compliance teams, and they have started ask questions similar to those raised by the regulators.”
But he welcomes such changes. Gao thinks “it is very helpful on risk control – that is, when the market is overheating and the agencies are very busy, if the investment banks’ compliance teams don’t set any mandatory requirements, lawyers may indeed perfunctorily perform their duties.”
On the other hand, as the banks’ Chinese lawyers need to explain certain matters concerning the Chinese companies to "help them get a better understanding of the actual situation and legal system in China, so the banks’ Chinese lawyers are playing an increasingly important role.”
“In the past, people thought of underwriters’ Chinese lawyers merely as makeweights, but our role has improved substantially in the past couple of years, and we have even increased charges on complex projects,” Gao says. “The pandemic has made it impossible for the American lawyers of some underwriters to travel to the mainland, so the underwriters have to count more on their Chinese lawyers to take care of the many overlapping tasks.”
Will it lead to increased competition between the Chinese lawyers? Gao doubts the conclusion. “There’s only a very limited number of law firms and lawyers capable of serving the underwriters,” he admits. “The investment banks require the lawyers to satisfy basic qualification criteria, and have a sound track record. They rank the lawyers based on such information and select the lawyers on a case-by-case basis. Even with the panel firms, the banks determine the most suitable law firm according to the exact business area involved in the case.”
“I have gone through something like this myself: the investment bank thoroughly approves of my and my law firm’s professional competence, but they think that another lawyer is more experienced in the specific industry, so they chose the other lawyer,” he adds.
Data from Deloitte reveal some major changes in the types of businesses operated by Chinese companies listed in the U.S. in the first quarter of 2021. During the same period of 2020, U.S.-listed Chinese companies specializing in healthcare/pharmaceutical, real estate and financial services obtained the largest amount of proceeds from their U.S. IPOs, but the top three sectors have changed to TMT, consumer goods and healthcare/pharmaceutical this year.
“Over the past decade, the Chinese companies listed in the U.S. were mostly TMT companies – among them internet companies, in particular – but things have changed in the last couple of years,” Fang says.
He divides the most popular areas into four categories. The first is internet infrastructure companies within the TMT industry, including physical infrastructure developers such as data centres, as well as Cloud Computing companies that build virtual infrastructure facilities. Kingsoft Cloud and China Data are some of the most recent examples. “These companies are kind of hard tech companies, and they represent the ‘technology’ element of TMT,” Fang points out.
The second category includes “new types of internet-related businesses that emerged amid the continuous expansion of the internet and internet business models,” such as residential community-based group buying and live-stream shopping. The third category comprises “‘consumption upgrading’ businesses. Perfect Diary, a Chinese start-up that sells cosmetics online, for example, specializes in consumption upgrading businesses.”
The last one refers to the “digital currency market represented by bitcoin, an industry that combines the internet and fintech.” Fang notes. “It’s a contentious business and only a few companies have been floated on the stock market. It remains to be seen how this market will evolve in the future.”
SERIOUS ABOUT SPAC
Special purpose acquisition companies (SPACs) have been a growing trend in U.S. capital markets in recent months. Some 298 SPAC IPOs were filed in the U.S. in the first quarter alone this year, raising $87 billion in total, statistics released by PwC show. By contrast, the quarter only saw 91 conventional IPOs, which raised $38 billion.
“The SPAC phenomenon allows the companies to consider with a new perspective when planning an IPO in the U.S.,” Gao elaborates. “Now, SPAC has become an increasingly serious option for Chinese companies seeking a U.S. listing.”
For Shen of Commerce & Finance, the SPAC fever has started to cool off under the pressure from the U.S. Securities and Exchange Commission. “But on the other hand, the Singapore Exchange has just completed formal consultation on SPAC listings, and the HKEx is also considering SPAC as a listing method, and is reportedly planning to greenlight SPAC IPOs by year’s end.” Therefore, law firms need to prep themselves for this new business, he says adding that Commerce & Finance has “taken part in some SPAC listings, including the one for Meten, a chain English education school in China.
Gao believes that for Chinese lawyers, SPAC listings “also involve setting up a red-chip or VIE structure, so there’s not much difference.” In Fang’s opinion, however, American lawyers consider SPAC deals to involve “both M&A and stock listing elements…on the one hand, it involves conducting negotiations between the blank check company and the acquisition target to conclude the deal, which is typical of M&A projects; on the other hand, the acquisition target needs to transform from a ‘shell’ into a normal public company, which is subject to regulatory review similar to the IPO filing process.”
Fang tells ALB that Chinese clients considering a SPAC listing tend to “have flaws for a separate IPO, or tend to be medium-sized companies.” But he also warns against over-generalization, because “shell company deals are conducted for different purposes – some companies want to get listed on the stock market through such deals, while others seek to sell themselves rather than get listed, and SPAC deals can also cater to such business needs.”
For those who are still interested in listing in the U.S., lawyers share some suggestions about how to respond to the subtle changes in IPO policies.
Shen first points out that “window and timing is very important for companies seeking a U.S. listing.” Although there is a certain degree of uncertainty, one should not throw away the apple because of the core, he adds. “For the companies that are still planning to go public in the U.S. this year, they need to do the right thing at the right time.”
Fang’s suggestion is that in view of the changes in Sino-U.S. relations and the sanctions that the U.S. have successively imposed on Chinese companies, “companies planning to get listed in the U.S. should examine, in the due diligence process, if their business operations involve any transactions with any company sanctioned or blacklisted by the U.S. government, and then screen related transactions, assess their impact on the stock listing, and ensure effective information disclosure at later stages.”
But he also points out that in today’s challenging world, U.S.-listed Chinese companies should possess not only strong business capacities but also business wisdom. They need to “identify flaws beforehand to smooth out the IPO filing process; on the other hand, they also need to consider the adequacy of their operations in China, seeking to strike a balance between business operations and the U.S. sanctions, instead of being totally servile to the U.S. regulators,” he advises.
To contact the editorial team, please email ALBEditor@thomsonreuters.com.