China will allow some pilot companies to repay liabilities to their listed subsidiaries with holdings in them, offering a resolution to the repayment of misused funds in some listed firms by major shareholders.

The China Securities Regulatory Commission (CSRC) and the State-owned Assets Supervision and Administration Commission (SASAC) Tuesday announced they had agreed to allow some pilot companies to conduct the experiment of using equities to offset liabilities to their listed subsidiaries.

Such companies, or the major shareholders in listed firms, normally have misappropriated funds in the listed firms, but have been unable to repay the funds, eroding the interest of the listed firms as a whole and minority shareholders.

According to CSRC statistics, such a phenomenon exists in as many as 70 percent of domestic listed firms that record two consecutive years of losses. And it is also a major reason for delisted firm's operational failure.

Such firms are basically required to repay the liabilities with cash, but they can also seek innovate in terms of the repayment within the legal framework, said the bodies Tuesday.

The regulators' new move may offer a way out for some listed companies that suffer from the misconduct of major shareholders, but it has to be based on fair pricing of the equities that will be charged off, transparency during the process and protection of the interests of the small shareholders.

"For the creditors, this arrangement is not the best solution to recover their money, because they should be able to gain more if the debts are paid in cash," said Dong Chen, an analyst at China Securities Co.

"But they do not have much choice if the debtors are mired in financial problems. Finding one way to solve the debt will help improve listed firms' financial status. And that is better than doing nothing," Dong said.

According to the new arrangement, the indebted controlling firms can use the equities they own in the listed companies to offset debts they owe to the companies. Such equities will be written off later, so the actual holdings of the controlling firms in the listed companies will decline and the minority shareholders will ultimately get more equity rights.

If the controlling party is owned by the state, then it will actually reduce State holdings in the listed firms.

"But the number of such firms is limited. And that is not an overall solution to the irrational shareholding structure in domestic listed firms, which is the root of many problems in the stock market," said Dong.

The point is to avoid similar irregularities in the future and ensure the sustained profitability of the listed firms, he said.

A CSRC spokesman has said that regulators would punish those liable for the misappropriation of funds in the listed firms. And relevant listed firms and minority shareholders can launch civil lawsuits to obtain compensation.

(China Daily July 28, 2004)