Switching to Hong Kong stocks, H-shares or red chips? (Next article)

LABEL： Financial institution , Securities and Capital Markets ,

introduction

Against the backdrop of favorable policies for listing on the Hong Kong stock market, companies need to combine their own actual situation and choose the appropriate listing mode in accordance with regulatory requirements to complete their journey in the Hong Kong stock market. Continuing from the previous section of this article (see "Diverting Hong Kong Stocks, H-Shares or Red Chips? This article will further interpret the specific differences in securities issuance and circulation, foreign investment access, foreign exchange management, and control rights recognition between the two common modes of domestic enterprises going public on Hong Kong stocks (i.e. H-share mode and red chip mode). This article will further compare the two modes in terms of standardized operation, liquidity, and exit after listing, and further explore with readers.
1、 Standardized operation of listed companies
1. Use and retrieval of raised funds

According to the listing rules of the Hong Kong stock market, Hong Kong listed companies should disclose the "total amount of funds to be raised and the proposed use of proceeds", and must disclose and regularly update "reasonable and detailed" information on the use of proceeds in their interim and annual reports. Therefore, both red chip companies and H-share companies using the funds raised through listing must comply with their disclosed purposes of use.

In practice, most of the main business and core assets of red chip companies and H-share companies are located within China. The primary issue faced by companies after listing is how to repatriate the raised funds for domestic use. The path for listed companies to repatriate the funds obtained through financing under the H-share model is significantly different from the path for listed companies to repatriate the funds obtained through financing under the red chip model. The funds obtained from the listing and financing of H-share companies need to go through specific foreign exchange procedures in accordance with relevant regulations before they can be returned to RMB accounts for use. For red chip companies, the listed financing entities are overseas entities, and the flexibility of fund repatriation methods and procedures is higher. For example, WFOE can inject financing funds into domestic entities through capital increase.

According to current laws and regulations, as well as our past project experience, the requirements for the repatriation of H-share financing funds mainly include foreign exchange registration requirements, usage requirements, and the need to open a dedicated account. In terms of foreign exchange registration, H-share companies should complete the relevant foreign exchange registration as required within 15 working days from the date of completion of overseas listing and issuance. In terms of usage purposes, if applying to transfer or pay funds from a special account within the country, proof materials related to the consistency between the use of funds and the use of funds for repatriation and foreign exchange settlement in the overseas listing public disclosure documents must be provided to the account opening bank.

At the same time, the H-share financing funds need to be remitted back to China by opening a "Special Foreign Exchange Account for Overseas Listing of Domestic Companies" (foreign exchange account) for fund exchange and transfer services such as initial public offering (issuance) and repurchase. At the same time, a corresponding foreign exchange payable account (RMB account) needs to be opened at the bank where the account is opened to store RMB funds (including RMB funds obtained from foreign exchange settlement, overseas listed fundraising funds returned in RMB form, and funds remitted in RMB form for repurchasing overseas shares and returning surplus funds from repurchasing).
2. Continuous compliance in corporate governance of listed companies

Under both modes, Hong Kong listed companies need to comply with the local applicable laws and regulations of the listing entity to meet the requirements of continuous compliance. For example, H-share companies should formulate their articles of association in accordance with Chinese laws and regulations such as the Company Law of the People's Republic of China ("Company Law") and the Guidelines for the Articles of Association of Listed Companies. Red chip companies (usually Cayman companies) should also formulate their articles of association documents in accordance with the local applicable laws and regulations of overseas listed entities. If the laws and regulations of the jurisdiction of each listed entity are adjusted, Hong Kong listed companies also need to make adaptive adjustments. For example, the Company Law was revised and passed on December 29, 2023, and officially implemented on July 1, 2024. H-share companies that have completed listing should make adaptive adjustments to their articles of association. Based on our recent project experience, some market supervision and management departments have required limited liability companies to submit their articles of association for filing that comply with the requirements of the Company Law, otherwise they will not be filed.

At the same time, the Hong Kong Stock Exchange requires Hong Kong listed companies and their directors to assume ongoing responsibilities under two modes, mainly including general disclosure obligations, compliance with the Corporate Governance Code, disclosure of the use of proceeds from listed financing, arrangement of annual general meetings and board meetings, disclosure of financial information, disclosure of major transactions, etc. From this perspective, there is no significant difference between the two modes in terms of standardized operation of Hong Kong stocks.
2、 Liquidity and exit after listing

There are differences between the two models in terms of the lock up period for shareholder exit after listing, the convenience of the circulation of held shares, and the return of realized funds
1. Lock in period

According to the Company Law, shares issued by a company before its public offering shall not be transferred within one year from the date when the company's stock is listed and traded on the stock exchange; According to the main board listing rules of the Hong Kong Stock Exchange, the lock up period for shares held by controlling shareholders and cornerstone investors is six months after listing.

Therefore, for red chip companies, the shares held by their controlling shareholders and cornerstone investors are subject to a lock up period of six months after the company's listing. Other pre listing shareholders, except for the controlling shareholders and cornerstone investors, do not have lock up requirements at the regulatory level. However, in practice, for the sake of maintaining market stability, other pre listing shareholders, including directors, executives, and employee stock platforms, will also adopt voluntary lock up arrangements. For H-share companies, all shareholders before listing will face a mandatory one-year lock up period after listing, which is longer and wider than the lock up period for shareholders of red chip companies.
2. Convenience of circulation

For shareholders of red chip companies, after the listing is completed and the lock up period expires (if any), they can normally reduce their holdings and exit the secondary market of Hong Kong stocks; For shareholders of H-share companies, their domestic unlisted non tradable shares held before listing cannot be directly reduced and withdrawn from the secondary market. Circulation needs to rely on the "full circulation" channel and complete the corresponding "full circulation" filing procedures (which can be applied for simultaneously with listing or separately after listing).

In addition, "full circulation" also needs to consider foreign investment access restrictions (if involved) to ensure that the proportion of foreign shares after "full circulation" continues to meet relevant requirements. For red chip enterprises, they have already planned these matters at the beginning of the establishment of the red chip structure and do not need to consider them again during the exit stage.

From this perspective, due to the additional "full circulation" procedures, the liquidity of H-share companies' shares is slightly inferior to that of red chip companies' Hong Kong stocks.

It is worth mentioning that after red chip companies and H-share companies are listed on the Hong Kong Stock Connect, if they meet the relevant requirements of the "Hong Kong Stock Connect" and are included in the scope of the "Hong Kong Stock Connect", qualified domestic investors who have opened accounts on the Shanghai Stock Exchange or Shenzhen Stock Exchange can apply to obtain trading authorization for the Hong Kong Stock Connect and purchase "Hong Kong Stock Connect" stocks, which is one of the channels for the circulation of stocks of Hong Kong listed companies.
3. Return of funds obtained from shareholders' reduction of holdings

According to applicable laws and regulations such as the Notice of the State Administration of Foreign Exchange on Relevant Issues Concerning Foreign Exchange Management of Overseas Listed Companies, the funds obtained by domestic shareholders of overseas listed companies from reducing their holdings of shares in overseas listed companies should be promptly transferred back to China, and relevant procedures should be carried out in accordance with relevant foreign exchange and settlement requirements. For non domestic individuals or enterprises who do not have the requirement or demand for funds to be transferred back to China, regardless of whether they obtain funds through reducing holdings in H-share companies or red chip companies, they can arrange for overseas transfer on their own.

For H-share companies, according to the "Guidelines for Foreign Exchange Business under Capital Accounts (2024 Edition)", their domestic shareholders should go to the local foreign exchange bureau within 20 working days after reducing their holdings to register their domestic shareholders' shareholding. After completing the registration, they should receive the business registration certificate, hold the domestic shareholders' shareholding business registration certificate to the domestic bank to open relevant accounts, and after reporting the funds and foreign exchange information to the securities company and the securities company reporting such information to China Securities Depository and Clearing Corporation, they should make deposits and withdrawals of the funds obtained.

For red chip companies, the funds obtained by their domestic shareholders from reducing their holdings of shares in overseas listed companies should still use the No. 37 document and ODI registration processed at the time of investment as a compliant channel for the flow of funds both domestically and internationally. In practice, there are cases where some domestic shareholders temporarily retain the reduced funds overseas based on special considerations. At the same time, some domestic shareholders of red chip enterprises (especially VIE structured enterprises) have made commitments to regulatory authorities to repatriate the reduced funds.

Overall, whether it is an H-share company or a red chip enterprise, its domestic shareholders need to go through certain procedures to transfer the funds obtained from reducing their holdings back to China, and there is no significant difference in advantages and disadvantages. The main consideration should be the tax procedures and costs related to the transfer back to China. From the perspective of tax burden, whether it is an H-share company or a red chip enterprise, if shareholders return investment income for domestic use, they must pay corresponding taxes and fees on personal/corporate income in accordance with Chinese laws and regulations. However, under the red chip model, enterprises and shareholders can choose regions with simple tax systems and low tax rates to build their structures. Through compliant tax planning methods, they can more flexibly handle arrangements such as fund repatriation time, and use bilateral tax agreements to reasonably and compliantly reduce tax burden costs.
epilogue

When Chinese domestic enterprises formulate their Hong Kong stock listing strategies, the H-share model and red chip model each have their own advantages and limitations. When making decisions on the listing path, enterprises need to comprehensively consider various factors such as regulatory rules, corporate governance, market preferences, and tax planning, and weigh and choose based on their own situation and capital operation planning. With the continuous updating of regulatory policies and changes in market environment, enterprises need to closely monitor regulatory trends and flexibly adjust their listing strategies to achieve optimal results in stable operation and capital operation within the compliance framework. The country currently encourages and supports mainland industry leaders who meet the conditions to go public in Hong Kong. We also look forward to more mainland companies choosing suitable listing models to go public in Hong Kong and achieve long-term development.