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Second Board Rules

On March 31 2009, the China Securities Regulatory Commission (CSRC) promulgated the Tentative Administrative Measures for IPOs and Listing on the Second Board (Second Board Rules), which are scheduled to take effect on May 1 2009. The promulgation of the Second Board Rules is a milestone in developing a multi-level capital market in China.

The purpose of the second board market is to target "self-innovation" and "growth" enterprises (definition of both of these categories is to be made by the CSRC) and offer an avenue for them to capitalise on their growth opportunities if they cannot fulfill the profitability and track record requirements for the IPO and listing on the main board.

The Second Board Rules are composed of six chapters and 58 articles. Similar to the rules under the Administrative Measures for IPOs and Listing (Main Board Rules), the Second Board Rules also require that the issuer satisfy the requirements on qualifications, independence, formalised operation, finance and accounting, and the use of the proceeds. However, there are still substantial differences in certain offering conditions between the Second Board Rules and the Main Board Rules.

On financial qualifications, the thresholds set by the Second Board Rules are lower than those under the Main Board Rules. The Second Board Rules prescribe two sets of criteria, that the issuer should (a) have made a profit for the recent two consecutive years with the accumulated net profits of at least Rmb10 million ($1.46 million) and be in continuous growth; or (b) have made a profit in the most recent year with the net profit no less than Rmb5 million and revenues being no less than Rmb50 million, and the annual revenue growth shall not be less than 30% in the most recent two years.

Furthermore, the Second Board Rules do not set requirements on cash flow, nor do they require that the ratio of intangible assets to net assets in the last financial statement is not be higher than 20%. The requirement that "the assets and liability structure shall be reasonable" as set forth under the Main Board Rules is also not applicable in the Second Board Rules.

On business operation, the Second Board Rules require that the issuer focus on one business, while the Main Board Rules do not have such limitation.

And with respect to stability, the Second Board Rules require that there shall not be substantial changes in the issuer's main business, actual controlling person and senior management personnel in the most recent two years, which is one year shorter than that under the Main Board Rules.

Finally, the Second Board Rules have set stricter requirements on the controlling shareholder and actual controlling person of the issuer. For example, they shall not be involved in any major illegal activities that are detrimental to the lawful rights and interests of investors and the public in the past three years.

Although some offering conditions under the Main Board Rules have not been included in the Second Board Rules, they do deserve attention in the application for the second board listing. These conditions include, but are not limited to: i) accounting policy shall be consistent; ii) price of related transactions shall be fair; iii) investment in projects using the proceeds shall comply with the laws and government policies; and iv) no new competition shall occur between the issuer and its controlling shareholder and actual controlling person.

Other than above differences in offering conditions, the following regulations stipulated in the Second Board Rules should also be noted: i) the CSRC will set up a special "examination and approval committee" to examine and approve the applications for the IPO and listing on the second board; ii) an investor entry system matching the risk-bearing capability of the investors will be built up by the CSRC, while the listing, trading and delisting rules fitting for the second board market will be established by the stock exchange; and iii) more responsibilities of the controlling shareholder and actual controlling person of the issuer have been added as they are required to endorse on the prospectus.

Notwithstanding the promulgation of the Second Board Rules, the acceptance of application by the CSRC is subject to the publication of auxiliary regulations such as listing rules, stock trading rules, requirements on contents and formats of the application documents, working rules on examination and approval of the applications, rules on sponsoring. However, it is expected that the second board market will be opened before the end of 2009.

It is reported that more than 300 enterprises are ready to submit their applications. The second board market will create a recognised avenue for domestic and international investors, especially those venture capital investors, to get exit from the enterprises they invested. Thus, it will stimulate the venture capital investment in China.

Shao Chunyang

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