Beijing's heavy hand on offshore route puts kink in IPO pipeline

STOCK EXCHANGES WORLDWIDE, not the least of them Hong Kong's, have been enjoying a robust flow of initial public offerings by privately owned mainland enterprises over the past two years. This may soon come to a halt.

The Ministry of Commerce has recently ordered provincial governments to freeze applications for the sale of privately owned enterprises to offshore holding companies.

This will have a significant impact on overseas listings of most such firms, since in the typical deal, owners sell their stake to an offshore company owned by them, which in turn sells shares in an overseas initial public offering.

Mengniu Dairy, for example, raised $1.58 billion in 2003. And property developer Greentown China Holding just started marketing its $2.1 billion share offering.

The current system is attractive to foreign investors in a fledgling mainland firm because it gives them a relatively easy way to cash out their investments without all the complications involved if the companies remain mainland-domiciled or sell H shares.

For the entrepreneurs, it brings freedom and profit. In one fell swoop, the firm becomes a foreign enterprise, free from mainland restrictions such as prior state approval for a share placement. The new firm also enjoys various advantages that can halve its tax bill. Moreover, it removes the usually unspoken fear of arbitrary state intervention or even confiscation that lurks in the hearts of many mainland entrepreneurs.

State control over this arrangement - nicknamed the red-chip scheme by bankers - has been relatively light. Provincial governments are empowered to vet applications. Since their interests are often intertwined with those of the private sector, provincial authorities have often been eager to grant approval. Indeed, the system has proved so successful that some investment banks now offer bridge loans to private owners to facilitate the transfer of shares.