China should fulfil reform promise with Star
China’s Star board, the local version of the US Nasdaq, has great potential to highlight the country’s move towards reforming its IPO market — if it’s done right.
IPOs in China have long needed some shake-up. For years, the China Securities Regulatory Commission (CSRC), the country’s securities regulator, has kept a tight grip on the quality of potential issuers, giving listing approvals only to top-notch companies. It also barred firms from pricing their listings above 23 times earnings — a restriction that played a role in forcing many technology giants to list abroad.
In response, China established two stock boards with looser rules to make the IPO process more market driven. But both, the OTC market and the Shenzhen Stock Exchange’s ChiNext, faded from view after their launches.
Needless to say, when the Star Market — dubbed as China’s version of Nasdaq — kicked off in July, analysts predicted that it may also end up having the same fate as its predecessors.
But early signs seemed to suggest that the Mainland authorities had finally hit jackpot. Investors’ frenzy during the Star’s first days indicated how much hope they had on the board’s success.
For instance, the first batch of 25 companies was listed by July 22 with an average price-to-earnings ratio of 49.16 times. The firm with the highest valuation, semiconductor manufacturer Advanced Micro-Fabrication Equipment, saw its price spring up to a jaw-dropping 171 times earnings. More importantly, despite their lofty valuations, the share prices of the 25 companies still rose to 140% of their IPO prices on the first day of trading.
That’s not all. In the first week, the firms saw their trading volume hit Rmb142bn ($20bn), buoyed in part by speculative investors. Thanks to that, analysts reckoned there will be more than 100 companies listed on the board by the end of 2019.
But the market has seen a big U-turn recently. Last week, trading volume slumped to Rmb29.5bn — one-fifth of the first week.
The pace of approvals has also slowed significantly. The CSRC took only a month to register the first 28 companies, but in the next two months, it only registered eight. As of Wednesday, there are only 30 companies listed on the board.
To make matters worse, the IPO pipeline is dwindling. By July 18, 149 companies had applied to list on the board. But two months later, only 11 more applied. In addition, 12 companies either terminated their applications, or they were cancelled by the regulator.
That raises some serious concerns about whether the Star market can be a sustainable listing venue in the long run.
From a regulatory perspective, the Star board offers some perks. The board, for the first time, adopts a registration-based instead of an approval-based IPO system. Further, the regulator scrapped the 23 times earnings limit for IPO valuation. These mean that, at least theoretically, the regulator has little say over where the issuers are valued or when they are listed.
But this appears to be the case only on paper. While the listings are based on registration, they still need to be registered with the regulator, which has to go over the documents. Onshore bankers told GlobalRMB that the regulator is increasingly reluctant to fasten the pace of IPO registration. Instead, the CSRC is of the view that now that the first 30 companies have traded successfully, it can turn its focus to picking “winning” companies, or the stronger names, for IPOs, said bankers.
This change in tack was, to some extent, expected by bankers in China, who point out that all innovative stock boards launched by the government have shared similar fates.
But now more than ever, China should aim to make a difference with the Star board.
Competition to woo technology IPOs is rising. The Hong Kong Stock Exchange has made a number of tweaks to its listing regime to attract such companies. The Singapore Exchange, the Korea bourse and the Japanese exchange are all also hoping to entice high-growth companies to list on their respective markets.
Additionally, if the US decides to bar Chinese issuers from listing on its exchanges, or delists already listed firms, those companies will have no choice but to look at the potential of Asian exchanges. Star should set itself up to leverage on those opportunities.
Of course, with the US-China trade war, a slowing economy, and pressure on the banking sector causing headaches, it is easy to put the market reform agenda on the backburner.
But the Mainland authorities would be remiss in doing so. Now is the time for them to act and make the Star board a robust and viable listing avenue. That positioning will only pay off in the longer run.