Late last month, China decided to resume initial public offerings (IPOs) in January after a freeze of more than a year. Along with the decision were new listing rules.
The rules establish an IPO registration system, breaking with the previous approval regime.
The China Securities Regulatory Commission (CSRC) will be responsible for examining applicants’ qualifications, leaving investors and the market to make their own judgment about the company’s value and the risks of buying its shares.
Previously, listing hopefuls would go through a complicated application process that could take multiple reviews and several years before approval by the CSRC. The approval system mainly focuses on the profitability of the applicant.
The new measures are in line with China’s decision to let market forces play a more “decisive role” in its economic reform. With the registration system, the government turns from manager to regulator.
Other changes include more freedom to issuers and underwriters to negotiate IPO prices, allowing retail investors to invest in popular IPOs and checking excessively high valuations.
These measures are positive but more is needed to make sure the changes yield the expected results.
China’s stock market has many problems but the root cause is the poor quality of listed firms.
A huge majority of these companies treat the stock market as a capital pool or private coffers for their executives, or both. They draw funds from the pool by launching IPOs and selling new shares, or converting stakes in companies into personal fortunes by selling shares.
Investors, on the other hand, have very few choices. Investment channels remain limited for Chinese people who are not allowed to freely invest in stock markets overseas.
This partly explains why China’s stock market continues to see large turnover despite being one of the world’s worst performers in the past two years.
To solve the problem, a combination of “bringing in” and “kicking out” strategy might help.
Bringing in means introducing more quality companies. From that perspective, an international board should be considered.
The idea of an international board was hotly discussed a few years ago but it was shelved after policymakers decided it was more important to reform the market first.
But these two moves — deepening stock market reform and launching a third board — are not mutually exclusive. An international board could help China press ahead with market reform.
A number of vibrant global companies such as HSBC, McDonald’s and Coca-Cola have expressed interest in a China listing. They could perk up the market and, more importantly, offer good returns to investors.
The best catalyst for revitalizing the market is competition. Pressure from rivals could give listed Chinese companies a kick in the rear. That would bring about the desired level of performance, or they’re out of the game.
The second approach is to kick out unqualified companies.
In this sense, the listing system urgently needs a revamp. At present, it is focused on profitability. This policy encourages listed companies to try to use all means necessary to polish their bottom line.
As long as a company can make profit by accounting standards, it can remain listed. That’s why China’s bourses have a lot of companies that have stopped operation but are waiting to be sold as shell businesses.
In foreign bourses, profitability is not the only yardstick. Other criteria such as revenue, shareholder numbers and dealers are equally important. Under this combination of criteria, if a listed company is not performing well or not actively trading, it faces the risk of delisting.
The difference between these systems has produced a big disparity in delisting ratios. In China, the delisting ratio is 1.8 percent. It’s 8 percent in NASDAQ, 6 percent in the New York Stock Exchange and 12 percent in London’s AIM.
Without a sound elimination mechanism, the overall quality of China’s stock market will deteriorate. That is the reality now.
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