* Alibaba, Xiaomi furthest along the CDR planning path - sources
* Beijing may also drop rules on pricing to attract CDRs -sources
* CDR cornerstones may see lock-up period of at least 1 yr-source
By Julie Zhu and Shu Zhang
HONG KONG/BEIJING, May 25 (Reuters) - China plans to use cornerstone investors to help its overseas-listed tech giants such as Alibaba and Xiaomi to sell shares at home, on worries the size of the deals could overwhelm mainland markets, three sources said.
This departure from norm by China, where equity offerings are typically sold without such strategic investors, comes at a time when the country is looking to tempt its offshore-listed tech behemoths into secondary listings using the planned Chinese depositary receipts (CDRs).
Beijing could also rip up its unwritten rules on pricing caps to make way for these blockbuster deals, said the sources who have direct knowledge of the matter, adding that Alibaba and Xiaomi were furthest along the CDR planning path.
Selling CDRs equivalent to say about 1 percent of Alibaba's market capitalisation would mean raising $5 billion in Shanghai or Shenzhen, marking what would be China's largest share sale on the open market since 2009, according to Thomson Reuters data.
While such deals would allow mainland investors to benefit from any further share price rally, the securities regulator is worried they "will take up too much liquidity in the secondary market, which may lead to a drop in the main indices", one of the sources told Reuters.
Cornerstones would help ease such concerns of liquidity drain as they take a large allocation of shares in return for their holdings being locked up for a set period.
CDR cornerstones will likely be subject to a lock-up period of at least one year, the source said.
Smartphone maker Xiaomi declined to comment when contacted by Reuters on Friday, while the China Securities Regulatory Commission (CSRC) and Alibaba did not respond to requests for comment.
Cornerstones are viewed as a mixed blessing in other markets including Hong Kong. Once a means of using marquee-name investors to encourage others to sign up, they have in recent years been increasingly used to support large deals that might otherwise have struggled to generate enough interest.
Chinese regulators are currently testing a version of the practice with the $4.26 billion Shanghai IPO of Foxconn Industrial Internet, a unit of the world's largest contract manufacturer Foxconn.
FII plans to sell 30 percent of its IPO, the biggest Chinese listing in almost three years, to a group of strategic investors whose holdings will be locked up for one-three years.
Meanwhile, to attract CDRs, China could also break away from the pricing rules it applies to A-shares by dropping the unspoken, but always observed limit of pricing deals at a maximum of 23 times historical earnings.
The cap will not apply to CDRs, the sources said, as some candidates trade at a hefty premium such as Alibaba at 51 times its 2017 earnings and Tencent, another potential CDR issuer, at 39 times, Reuters Eikon data shows.
Exact pricing rules are still to be decided, they added.
The CSRC had planned to implement CDR rules by end-June, but given disagreements between the regulator and the would-be issuers over details such as the requirement for information disclosure, the rules are subject to changes and could take longer than expected to be finalised, the sources said. (Reporting by Julie Zhu in HONG KONG and Shu Zhang in BEIJING; Additional reporting by Cate Cadell in BEIJING; Editing by Jennifer Hughes and Himani Sarkar)