Recently, the Shanghai Stock Exchange (SSE) has completed the drafting of the "SSE Detailed Implementation Rules for Shareholding Lessening by Shareholders of Companies Listed on SSE STAR Market through Non-public Transfer and Allotment (Draft)" (the "Detailed Implementation Rules" for short), and made them public to solicit opinions in the market. An SSE official has answered questions about the drafting background, logic and main institutional arrangements for the “Detailed Implementation Rules".
Q1: Can you brief us on the drafting background to the "Detailed Implementation Rules"?
A: The shareholding lessening system is one of the basic systems that have been improved comprehensively through establishing the SSE STAR Market and piloting the registration-based IPO reform. The "Implementation Opinions on Establishing the SSE STAR Market and Piloting Registration-based IPO System on Shanghai Stock Exchange" (the "Implementation Opinions" for short) clearly requires the establishment of reasonable lock-up periods for shares and institutional arrangements for shareholding lessening for the companies listed on the SSE STAR Market (the “STAR Companies” for short).
To explore the establishment of a market-oriented shareholding lessening system that can be carried out in a scientific and sensible manner, under the guidance of the China Securities Regulatory Commission (CSRC), the SSE has formulated the “SSE Rules for Listing Stocks on SSE STAR Market” (the “STAR Listing Rules” for short) in accordance with the characteristics of STAR Companies, so as to make institutional explorations based on current system of shareholding lessening. The “STAR Listing Rules” stipulates that in addition to current ways of shareholding lessening, shareholders of the STAR Companies can also transfer pre-IPO shares through non-public mode and allotment, and specific matters concerning the transfer such as methods, procedures, prices, proportions and follow-up transfers shall be separately stipulated by the exchange, which provides a rule basis for formulating the "Detailed Implementation Rules". The new "Securities Law" that has been formally enforced has provided that the transfer of shares by shareholders should comply with the exchange’s relevant business rules, which offers further confirmation and support.
In order to further implement the requirements in the "Implementation Opinions" and adapt to the institutional arrangements of the "STAR Listing Rules", since the SSE STAR Market launched for trading, the SSE has concentrated its efforts in carefully studying and repeatedly demonstrating the conditions, basic requirements, implementation mechanisms, information disclosure, follow-up transfers and other matters concerning the transfer of pre-IPO shares through non-public means and allotment, with the opinions solicited from some market institutions, thus having completed the drafting of the “Detailed Implementation Rules”. The “Detailed Implementation Rules” refines the provisions on the non-public transfer and allotment, providing implementation guidelines and operating specifications for the shareholders of the STAR Companies to transfer pre-IPO shares through non-public means and allotment.
Q2: As non-public transfer is an important institutional innovation for the SSE STAR Market, can you brief us on the main functions in the institutional design?
A: The institutional functions of the non-public transfer are mainly in the following three aspects:
The first function is to propel the formation of the market-based pricing constraint mechanism. Share transfer is a basic right for shareholders, but it may also affect the legitimate rights and interests of other shareholders and the normal trading order. In recent years, the CSRC and the SSE and the Shenzhen Stock Exchange have continued to improve the system of shareholding lessening, mainly imposing restrictions on the pace, proportion and size for the shareholders to reduce the pre-IPO shares through the secondary market, so as to mitigate the potential impact of the shareholding lessening on the market. The purpose for introducing the non-public transfer system on the SSE STAR Market, limiting the transferees of the non-public transfer to specialized institutional investors with professional knowledge and risk tolerance, and forming the transfer price through the inquiry, is to explore the establishment of a market-based pricing constraint mechanism characterized by the balanced game between the buyers and sellers, bring the due pricing function of the secondary market into full play, and propel the formation of a more reasonable price discovery mechanism.
The second function is to meet the demand for the withdrawal of innovation capital. Science and technology innovation requires capital. The development of high-tech enterprises is subject to significant uncertainties. As early investors the innovation capital bears high investment risks. Considering lots of venture capital have long investment periods investing in SSE STAR Market companies, , some are longer than 10 years, providing a convenient and predictable exit channel for innovation capital is in line with the operation rules of venture investment, and is conducive to improving the efficiency in the recycling of innovation capital. In the "Detailed Implementation Rules", after the expiration of the lockup period, there will be no restrictions on the volume of shareholding lessening and time of holding for the shareholders reducing their pre-IPO shares through non-public transfer, and the venture capital funds may decide for themselves the time, volume and proportion of shareholding lessening as needed.
The third function is to introduce incremental funds for shareholding lessening. Investors have been concerned about the "blood loss" effect possibly caused by shareholding lessening. Non-public transfers occur between shareholders and professional institutional investors, and the subscription capital mainly comes from incremental funds, which is conducive to reducing the liquidity risk that may result from the shareholding lessening. At the same time, the "Detailed Implementation Rules" has designed diversified suitability arrangements for institutional investors, and all the eligible public funds, private funds and insurance funds can participate. The institutional investors have different shareholding purposes, investment strategies and shareholding periods, which can alleviate to a certain extent the problems such as transferees’ subsequent convergence in selling and affecting the market stability.
In addition, the "Detailed Implementation Rules" also stipulates that the shareholders can sell through allotment their pre-IPO shares to other existing shareholders of a STAR Company, who can decide for themselves whether to participate in the allotment according to the price and volume arrangements provided by the transferors. The main purpose of allotment is to protect the trading right of existing shareholders and provide more options of modes for reducing the pre-IPO shares.
Q3: Institutional investors are important participants in non-public transfers, and have an impact on whether the objectives of the non-public transfer system can be achieved. Can you brief us on the provisions and requirements for the institutional investors in the "Detailed Implementation Rules"?
A: An important objective of the system of non-public transfer is to further strengthen the market-based pricing constraint mechanism for shareholding lessening. To this end, the "Detailed Implementation Rules" makes it clear that the transferees should be professional institutional investors with corresponding pricing capabilities and risk tolerance, mainly including two groups: the first group includes the offline IPO investors on the SSE STAR Market stipulated in the "SSE Implementation Measures for the Issuance and Underwriting of Stocks on the SSE STAR Market"; the other group includes the private equity fund managers registered in accordance with the "Measures for Registration of Managers and Filing for Private Equity Investment Funds (for Trial Implementation)", with the relevant products used for the transfer of shares already filed. In addition, the "Detailed Implementation Rules" also allows industrial capital to participate in the non-public transfers through private equity funds and other means, so as to facilitate the STAR Companies’ introduction of strategic investors through non-public transfers and create effective industrial synergy.
At the same time, to prevent the potential "crossing bridge" transfers and ensure the fairness and effectiveness of inquiry and pricing for non-public transfers, the "Detailed Implementation Rules" focuses on regulating the requirement for the independence of institutional investors and prohibits affiliated parties from participating in non-public transfers. That is to say, institutional investors having an affiliate relationship with the pre-IPO shareholders and intermediary institutions that plan to transfer the shares shall not participate in the non-public transfers. Such provision aims to prevent both sides of the transfer from damaging the fairness and justness of the non-public transfer and the functioning of the system through entrusted shareholding by affiliated parties and other means.
In addition, to avoid short-term arbitrage, the "Detailed Implementation Rules" provides that the transferee shall not retransfer the shares transferred through non-public means within 6 months after the transaction.
Q4: The price formation mechanism is the core part of the non-public transfer system. Can you brief us on the provisions of the “Detailed Implementation Rules” regarding inquiry and pricing?
A: The principle for design of "Detailed Implementation Rules" is a market-oriented price formation mechanism for non-public transfers, focusing on reflecting the true price expectations of both sides, ensuring the necessary trading efficiency, and avoiding interference in the stable operation of the secondary market.
First of all, the transaction shall be conducted by the market itself. Non-public transfers are mainly organized by intermediaries such as securities companies or other entities entrusted by the pre-IPO shareholders, with the participation of the pre-IPO shareholders and institutional investors; the market entities shall independently complete the processes such as transfer entrustment, determining inquiry targets, sending subscription invitations, collecting subscription quotes, confirming the transfer results and declaring the transfer.
Secondly, there should be full game in pricing. After the completion of the subscription quotation by the institutional investors, the intermediary conducts cumulative statistics on the effective subscriptions, determines the transfer price according to the principles of price preference, quantity preference and time preference, and initially confirms the transferees and the transfer quantities. The lowest quotation of the inquiry targets with the shares allotted shall be the transfer price; if the subscriptions are not sufficient, additional subscriptions can be made at the determined transfer price.
Thirdly, the floor transfer price should be set. In order to avoid the extreme prices in non-public transfers that may disrupt the normal trading in the secondary market, the floor transfer price shall not be less than 70% of the average price of the company's stock in 20 trading days before the date of sending out the subscription invitations.
Fourthly, trading efficiency should also be taken into account. Considering that there are costs in the organization and implementation of non-public transfers, in a single non-public transfer, the total number of the shares to be transferred by a single or some pre-IPO shareholders shall not be less than 1% of the total number of the company’s shares, so as to ensure the market efficiency in the non-public transfers.
Q5: What requirements for information disclosure should the shareholders and STAR Companies abide by when transferring the pre-IPO shares through non-public means?
A: The shareholders holding pre-IPO shares, especially the controlling shareholder and the actual controller of a listed company, are usually able to participate in the company's daily operations and influence the company's major decisions, so they have certain information advantages. How to ensure that non-public transfers are implemented in an environment with relatively fair information is a key consideration for the “Detailed Implementation Rules”. At the same time, as the transaction price, quantity and other information about the non-public transfer provide the small and medium-sized investors in the secondary market with reference in judging the investment value of a STAR Company, it is necessary to disclose the information in a timely manner.
On one hand, it is necessary to reiterate the requirements for information disclosure by controlling shareholders and actual controllers. If the controlling shareholder or the actual controller participates in the non-public transfer, the STAR Company shall additionally disclose the major matters such as whether the core competitiveness and operating activities have or face major risks, whether there will be a significant decline in performance, and whether the control power may be changed. In addition, if a STAR Market company has not disclosed periodic reports during the disclosure period, the controlling shareholder and the actual controller shall not carry out the non-public transfer.
On the other hand, it is necessary to specify separate requirements for information disclosure before and after the non-public transfer. Before the transfer, the transferring shareholder should present the transfer intention and transfer plan, and disclose the number of the shares to be transferred, the reason for the transfer, the floor transfer price and other information, so as to settle the market expectations. After the transaction is concluded, the transferring shareholder should publish the report on the transfer, and announce the transfer results and the inquiries, and the intermediary should express the opinion on the compliance for the transfer.
Q6: Can you brief us on the considerations and arrangements for the share allotment system?
A: To diversify channels for capital exit and provide existing shareholders with the options for pre-IPO allotment, with reference to market practice of allotment, the “Detailed Implementation Rules” stipulates that shareholders can transfer the pre-IPO shares to other shareholders through allotment, so as to lessen their shareholding. In terms of the specific requirements, first of all, to improve market efficiency and operability, the number of the shares for allotment shall be no less than 5% of the company's total shares; secondly, the allotment price shall be no less than 70% of the market price; thirdly, specific arrangements for allotment and transfer shall follow the share allotment practice of the STAR Companies; fourthly, the shareholder participating in the allotment should disclose the allotment plan and allotment report .
Q7: Can you brief us on the arrangements for the regulation of non-public transfers and allotments in the “Detailed Implementation Rules”?
A: To ensure compliance in non-public transfer and allotment, the "Detailed Implementation Rules" makes regulatory arrangements for transferring shareholders, transferees, intermediaries and self-regulation.
First of all, the circumstances in which the shareholders are not allowed to carry out non-public transfer or allotment are stipulated. The shareholders who are not allowed to reduce their shares according to the existing shareholding lessening system shall not carry out the non-public transfer or allotment. At the same time, to prevent the company's internal personnel from using information advantages to transfer shares, the controlling shareholder, the actual controller, the directors, supervisors and executives and the core technical personnel shall not conduct non-public transfer or allotment within the "window period" before the announcement of the periodic reports.
Secondly, the prohibited behaviors for both sides of transfer are stipulated. The "Detailed Implementation Rules" requires that the transferring shareholders should follow the principles of fairness and justness to carry out transfer according to law, the transferees should follow the principles of honesty, trustworthiness, independence and objectivity to conduct subscription rationally, and there should be no behaviors that may affect the fairness and justness in the non-public transfer and allotment, such as improperly influencing the subscription quotations, colluded quotations, false quotations and profit delivery.
Thirdly, duties of intermediaries are tightened. In multiple processes of the non-public transfer and allotment the "Detailed Implementation Rules" requires securities companies and other intermediaries to strictly perform their duty of verification and ensure compliance. Specifically, intermediaries should formulate and implement the internal control systems related to businesses of non-public transfer and allotment; they should comprehensively verify whether both sides of the transfer meet the eligibility requirements; and they should also urge both sides to obey laws and rules in the non-public transfer or allotment.
Fourthly, the self-regulation is stipulated. In addition to the regular supervision of information disclosure, the "Detailed Implementation Rules" also provides for the regulatory measures and disciplinary actions against the violations of all participants in the non-public transfer and allotment, and specifies that the exchange can conduct on-site inspections of the businesses of non-public transfer and allotment offered by the intermediaries such as securities companies. When necessary, the exchange will file the cases to the CSRC for official investigation, so as to ensure the regulated operation of the non-public transfer and allotment system.