Guidelines on the Regulated Operation of Companies Listed on ChiNext

Issuing Body: Shenzhen Stock Exchange
Issuing Date: October 15, 2009
Effective Date: October 15, 2009

Last fall, as the Shenzhen Stock Exchange was preparing to launch its much-anticipated Nasdaq-like sister board, ChiNext, exchange officials issued the Guidelines on the Regulated Operation of Companies Listed on ChiNext (ChiNext Company Guidelines) in an attempt to improve the quality of ChiNext companies and protect investors. Known during its decade-long development as the Growth Enterprise Market or Growth Enterprise Board, ChiNext was developed to fill an important gap in China's capital markets by enabling relatively small, innovative companies to raise funds through public offerings—offerings that are inherently riskier than investments in more established companies.

Because ChiNext was designed to attract fast-growing, innovative companies, those listed on the new exchange will have a fairly short development history—and in many cases, relatively weak corporate governance structures and internal controls. The ChiNext Company Guidelines require ChiNext companies to establish normative corporate governance systems and sound internal controls involving the establishment of power and balance mechanisms among the general meeting of shareholders, board of directors, board of supervisors and management. Such mechanisms would regulate the behavior of directors, supervisors and senior managers and require the performance of safeguards such as proper information disclosure.

Corporate Governance

Like companies listed on the Shenzhen Exchange's main board, ChiNext companies adhere to a system in which decision-making power, business management power and supervisory power are separately assigned to the general meeting of shareholders, the board of directors, and the board of supervisor, respectively.

In accordance with the ChiNext Company Guidelines, the general meeting of shareholders should establish a practical and effective operating mechanism to guarantee the legal rights and interests of shareholders, and minor shareholders in particular.

A ChiNext company should establish a venue for its general meeting of shareholders in the form of on-site meeting, though it may also provide Internet or other alternative channels for shareholders to monitor. If certain matters of a ChiNext company, such as a restructuring of material assets, the disposal of material assets, or repayment of the company's debt with stock and the public placement of additional shares, are discussed at the general meeting of shareholders, the company must arrange an Internet voting system to allow minor shareholders who cannot attend in person to vote upon such matters.

The board of directors of a ChiNext company should treat all shareholders fairly and pay attention to the legal rights and interests of all stockholders. The powers of the board of directors should be executed by the board collectively, and any change in or deprivation of the powers through amendments to the company's Articles of Association or a resolution of the board is proscribed.

The board of supervisors of a ChiNext company is accountable to all shareholders, and is responsible for oversight and supervision of the company's financial affairs and assuring compliance and the performance of duties by directors and senior managerial personnel. The board of supervisors should execute its oversight and supervisory powers independently and effectively. The board of supervisors should issue an opinion in writing on the accuracy, truthfulness and completeness of the company's periodic reports.

Management of Capital Raised by a ChiNext Company

The ChiNext Company Guidelines require every ChiNext company to establish a bank account or accounts specifically for capital raised in a stock offering; other capital cannot be deposited in such accounts. The number of accounts designated for such capital cannot be more than the number of investment projects in which the capital will be invested. If the amount of capital actually raised exceeds the amount the company planned to raise, the excess portion of the capital should also be deposited in such an account.

Except for financial institutions, ChiNext companies cannot invest capital raised in a stock offering either in financial investments such as stocks, bonds and mutual funds or in companies whose main business is securities trading.

Under limited conditions, a ChiNext company may temporarily use idle capital raised in a stock offering to supplement its working capital, but the idle capital can only be used in production and operations related to the main business of the company. Usage of idle capital must be approved by the company's board of directors and reported to the Shenzhen Stock Exchange within two trading days.

Excess capital raised by a ChiNext company in a stock offering likewise cannot be used in securities investments, derivatives or venture capital investments. The use of excessive capital must also be approved by the board of directors or the general meeting of shareholders, and must be disclosed to the public in a timely manner.

Internal Controls of a ChiNext Company

The ChiNext Company Guidelines require ChiNext companies to establish vertical control structures to guarantee that every order communicated by the board of directors and senior managers can be strictly enforced. ChiNext companies must also set up horizontal power and balance mechanisms as well as oversight and supervision among different departments and positions. The ChiNext Company Guidelines provide detailed requirements on various aspects of internal control systems, including control over the company's controlled subsidiaries, related transactions, external security, major investments and information disclosure.

Conclusion

ChiNext trading is expected to be volatile—and indeed early trading in the board's first months was even more volatile than predicted. The ChiNext Company Guidelines reflect the Shenzhen Stock Exchange's intention to strictly regulate and supervise companies listed on ChiNext, and to provide ChiNext companies with guidelines related to corporate governance, capital management, internal control and other matters. But improved legislation and more effective enforcement is needed if ChiNext and ChiNext companies are to grow in a healthy manner.