The ‘Singapore Solution’ to China’s Stock Woes?

The ‘Singapore Solution’ to China’s Stock Woes
Allowing companies to list directly overseas is good for regulators and investors.
PAUL GILLIS
March 19, 2014 11:34 a.m. ET
Alibaba has finally announced its plan to list its shares in New York, after months of speculation about the location. This is a blow to Hong Kong, which had courted the Chinese tech company but was unwilling to change its rules to allow founder Jack Ma to keep control of the company after the listing. But this is also a blow to Chinese investors, who will yet again be denied an opportunity to invest in one of their country’s most successful firms.

The problem is that so many Chinese companies are forced to list overseas because it is still so difficult to win permission to issue shares on the mainland. That makes the deals a lose-lose for investors everywhere. Chinese citizens can’t buy offshore shares because of the mainland’s capital controls. Meanwhile, foreign investors technically don’t buy the company, either. To circumvent foreign-ownership restrictions, Chinese firms use the so-called variable-interest entity (VIE) structure. With the VIE structure, offshore shell companies have contractual claims to the revenues from, but no actual ownership of, the Chinese firms.
Fortunately, a solution is finally coming into sight, from an unexpected quarter: Singapore. The China Securities Regulatory Commission (CSRC) in November reached an agreement with Singaporean authorities to allow Chinese companies to list directly in the Lion City without first setting up an offshore holding company. If this becomes a template for other jurisdictions—and a seed of further reforms in China—investors everywhere stand to benefit.
The Singapore Solution addresses several serious flaws with the VIE overseas-listing model. First and foremost, it clarifies regulatory authority over the listed companies by specifying that the CSRC will retain jurisdiction. A major problem with overseas listed Chinese companies is that because they are neither wholly Chinese nor wholly foreign, regulators have struggled to determine whose laws the firms must follow and who will enforce them.
The offshore holding companies are not subject to Chinese regulation, and Beijing has been slow to cooperate with foreign regulators investigating Chinese companies that it considers domestic. Because the Singapore Solution makes it a requirement under Chinese law that companies comply with the laws of the jurisdiction where they list, this method also resolves the thorny sovereignty issues that arise when foreign regulators try to enforce foreign laws against Chinese companies on Chinese soil.
Another flaw with the VIE model is that the domestic Chinese company and the overseas-listed entity are technically not the same enterprise, and are only tenuously connected. This makes it impossible to do a traditional secondary listing onshore, leaving domestic investors permanently cut off from the opportunity to buy the shares.
By allowing the Chinese enterprise to list abroad without a VIE, the Singapore Solution opens the door to secondary listings on China’s stock exchanges. This would finally allow local investors to benefit from the growth of domestic companies. Indeed, this could open the door to the eventual “return” of such firms to China if, as the domestic financial markets grow, it becomes possible to use the proceeds of local share issues to buy out foreign investors.
The challenge now is for authorities in China and the main overseas listing venues for Chinese companies in Hong Kong and the U.S. to find ways to apply the basic Singapore model to their own markets. This will not necessarily be easy, but it is certainly achievable.
China could start by allowing Chinese companies to list directly overseas after gaining approval from CSRC. The vetting process could take account of Beijing’s traditional concerns about overseas listing of companies possessing state secrets or with disreputable management.
The heart of the Singapore Solution is to make the CSRC the primary gatekeeper and regulator of overseas listed Chinese companies, charged with the responsibility to ensure that these companies comply with Chinese and foreign laws. The CSRC might ask foreign authorities such as the U.S. Securities and Exchange Commission and Public Company Accounting Oversight Board to help them meet their responsibilities, including sending inspectors to work with the CSRC to regulate these companies. Chinese regulators will likely reserve the right to punish miscreants, and the SEC and PCAOB should be happy to let them do so if the result is that American standards are met.
Other reforms might be more difficult. Beijing needs to allow a greater number of companies to accept foreign investment. The Third Plenum reforms last year promised liberalization in the rules on foreign investment in e-commerce and education, two of the most popular sectors that use the VIE structure. Premier Li Keqiang reiterated the commitment in his remarks to the National People’s Congress on March 5. Allowing foreign investment in e-commerce and education would remove the need for the VIE structure for companies in those industries.
The Singapore Solution will require some attitude adjustment from regulators all around. But the alternative—booting Chinese companies off foreign exchanges while denying them the opportunity to list at home—is no alternative at all. After a troublesome several years concerning these listings, regulators should seize on the most promising model to date for how to move forward.
Mr. Gillis is a professor at Peking University’s Guanghua School of Management.