【New Stock IPO】CSRC: Removal of VIE Structure by Individual Red-Chip Enterprises is a Normal Regulatory Requirement and Should be Correctly Interpreted (Second Edition)

It is rumored that mainland China is tightening restrictions on red-chip companies listing in Hong Kong. Bloomberg reports that regulatory authorities have recently suggested that companies planning to go public should dismantle their red-chip structures and switch to domestic entities for listing in Hong Kong. Otherwise, they must explain and prove the necessity of using red-chip structures, aiming to prevent capital outflows. The China Securities Regulatory Commission (CSRC) responded to Bloomberg, stating that some red-chip companies have recently received notices to dismantle their structures, which is a normal regulatory requirement and should be correctly interpreted.

CSRC: Some red-chip companies have low equity transparency and higher compliance risks

The CSRC said that some red-chip companies have low equity transparency and relatively higher compliance risks. Both domestic and foreign regulatory agencies and supervisory departments are paying close attention to these compliance risks.

The authorities emphasized that they always actively support companies to comply with laws and regulations when listing in Hong Kong and other overseas markets, making good use of two markets and two resources for financing and development. The Hong Kong Stock Exchange did not comment on market rumors.

The CSRC stated that according to the “Interim Measures for the Administration of Securities Issuance and Listing by Domestic Enterprises Abroad,” regulatory agencies and supervisory departments generally focus on the necessity and compliance of establishing red-chip structures, especially after the implementation of new regulations.

What is a red-chip structure?

A red-chip structure refers to a company registered overseas, with offshore funds as the main operation, but with its main business and assets in mainland China. This model has been common in industries such as technology, new consumption, and biopharmaceuticals, including companies like Tencent (00700), Meituan (03690), and others.

Red-chip structures also facilitate early investors’ exit. Bloomberg indicates that the new regulatory trend has begun to generate some reactions among listed companies, investment banks, intermediaries, and overseas investors. Dismantling a red-chip structure means transferring control of the domestic operating entity back to mainland China, which involves high costs.

For investors, dismantling the red-chip structure may reduce their equity and flexibility in share reduction. Foreign and private equity fund investments in domestic entities will face strict approval processes when exiting in the future, as funds need to be transferred out of domestic entities, making the process more complex and involving longer lock-up periods.

Corporate Financing Lawyers: Converting to H-shares Will Face Large Capital Gains Tax

A lawyer specializing in corporate financing told this newspaper that dismantling a red-chip structure and converting to H-shares usually takes about 3 to 6 months. However, time is not the biggest cost; the process involves share transfer and offshore tax issues.

The lawyer bluntly said that in the past, companies chose red-chip structures mainly to avoid higher taxes. Once converting to H-shares for listing, they will face significant capital gains taxes, greatly increasing tax costs.

Deng Haowei, founding president of the Hong Kong Sponsor Association, believes that once the policy is implemented, it will have the greatest impact on red-chip companies using VIE structures. He also thinks that regulators prefer H-shares because they offer higher transparency in information disclosure and taxation after listing. In fact, “capital outflow” may not be the primary concern.