26 April 2019
IPO activity will strengthen in China if more reforms are carried out with regard to the listings approval process. Credit:
IPO activity will strengthen in China if more reforms are carried out with regard to the listings approval process. Credit:

Regulatory changes needed to revitalize China IPO market

China had for many years relied on credit expansion to drive economic growth. But that strategy has begun run out of steam now.

Credit expansion has led to rising bad loans in the banking sector, while corporate earnings increased only by single-digits in percentage terms. Meanwhile, local governments’ debts are piling up.

Against this backdrop, the government needs to open up the stock market to help more qualified companies get listed or issue debt, a move that will help cut financing costs for businesses and also further the cause of market reforms. 

Investors will determine whether a firm’s price-to-earnings ratio is sensible, rather than have the China Securities Regulatory Commission (CSRC) control the number of listings and distort the share supply.

The distorted IPO market has to be corrected. Huge amount of capital has chased small IPOs in the past, leading to a situation where some junk-grade companies were listed at over 10 times P/E ratio.

And mainland retail investors have been obsessed with new listings regardless of the company quality. That’s because the stock price always paid off, which has created trouble for future capital market development.

Amid this situation, the CSRC intends to move toward a registration-based system for IPOs from June, according to a Caixin report. If it is true, the new system will expedite the approval process and pump up new share supply. That could exert a lot of pressure on the market, but it will help the firms that are currently struggling to raise funds.

The registration system may have some adverse impact on the stock market in the short term, in particular on small-cap plays. However, in the long run, it will help reduce transaction costs and regulate the A-share market. Meanwhile, the new listings will provide a booster for investment banks and securities brokerages.

Investors should take advantage of market corrections to place some bets on related stocks.

Authorities have to safeguard the market as they try to widen the door. Else, the bull market can quickly turn into a bearish zone. 

It remains unclear whether the CSRC will give up listing approval powers completely. Listing approval is a fairly lucrative business, as IPO candidates have to pay significant sums in fees. 

If the power is passed on to the stock exchanges, will the market culture change and will more companies get listed?

With reforms, some new listings may, meanwhile, see their shares plunge below the offer prices. That will teach mainland individual investors a good lesson that not all IPOs will yield instant big returns.

This article appeared in the Hong Kong Economic Journal on March 5.

Translation by Julie Zhu

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Founder and Managing Director of Pegasus Fund Managers Ltd.

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