Time to rethink China's NSSF free shares rule
An attempt by a Chinese state-owned enterprise to seek a waiver of the requirement to hand over 10% of any public equity offering to the country's pension fund has put the spotlight on a rule that looks increasingly hard to justify. Exempting offshore deals would be a good step forward.
Shanghai-listed Industrial Securities attracted attention recently for lobbying the China Securities Regulatory Commission (CSRC) to waive the requirement that it cede 10% of the shares from the brokerage’s planned Hong Kong listing to China's National Social Security Fund (NSSF).
The free shares rule, which has been in place for several years, was intended to give a China’s underfunded pension system a leg-up as the country's population gets older.
When money is raised in a public offering by a Chinese state-owned enterprise (SOE), either the company or its shareholders are compelled to contribute 10% of the stock in the deal to the NSSF.
But the rule has become outmoded. Companies frequently get around it, if they can, by selling shares via private placements, where between six and 10 investors are targeted.
Those looking after China’s pension system will doubtless find little reason to entertain the waiver request. The NSSF already has big holes to plug, given its low replacement ratio and future liabilities that economists see posing a threat in 20 years.
In addition, China’s desire to keep any dilution of its stakes to a minimum has led to the current requirement of what is effectively a 10% tax on Chinese firms conducting public offerings.
But any social welfare benefits to the NSSF from this piece of regulation are starting to be outweighed by the advantages of a more liberal financial regime that would place no artificial limits on capital raising.
Seize the moment
Implementing a change now would be good timing. China has been keen to push its homegrown companies to raise capital offshore and shift risk away from the banking system.
Its brokerage houses, many of them in the throes of the most exuberant A-share rally in years, have responded in droves. Just last week GF Securities clinched $3.6bn in a hotly-received Hong Kong IPO that investors unabashedly pile into, paving for the way others to follow.
HTSC and Guolian Securities Co have recently filed to list in Hong Kong. Citic Securities and China Galaxy Securities are also planning to hit the market, but because of the 10% free share rule, they have opted for private placements.
That China Inc is hungry for capital, and lots of it, is a given. Removal of the 10% tax would create, then, a fresh incentive for Chinese SOEs looking to raise funds.
Without their hands tied by the rule, companies could go to the offshore market for larger amounts and a broader set of investors than the maximum of 10 allowed under private placements.
It will also give Chinese SOEs the investor diversification they so crave — fitting hand in glove with the government’s aim to reform its state enterprises and further open up its capital market.
Moreover, such a process allows for true price discovery in a market-based bookbuild. Investors, once they don’t have to cough up the extra 10% that ultimately goes to China’s pension pot, will be more than happy to participate in new offerings.
And by doing away with the free share contribution at the time of an H-share deal — after a company has already completed a similar donation when it was first listed in the mainland — would alleviate the double-whammy burden.
The NSSF is already losing out because of companies going down the private placement route in Hong Kong. And those companies are also hampered by the restrictions placed on them when they avoid the rule.
In any case, rather than relying on an endless stream of donations from SOE public offerings offshore as well as onshore, the focus for the NSSF ought to be on improving the returns from the trillions of yuan it holds in its books.
China had originally included H-share offerings in the scope of the free NSSF shares rule with good intentions. But the authorities would now be wise to take a hard look at what is an increasingly ineffective policy tool.