Investors in China’s equity markets have gained risk-free profits amid government regulations that force companies launching initial public offerings to sell their shares at a discount to market prices.
However, the rules has also led to distortions in the market as well as lost funds for issuers and lower fees for underwriters, the Financial Times said.
At the end of 2013, the China Securities Regulatory Commission (CSRC) issued new rules aimed at promoting more reasonable pricing as it prepared to end a 15-month freeze on domestic IPOs.
Technically, the rules do not cap IPO prices but companies are required to issue a “special risk notice” if they offer shares at a price/earnings ratio higher than the market average for industry peers. For issuers, this means IPOs that are priced too high will not be approved.
The current system “has caused market inefficiency as investors flock to IPO subscriptions to benefit from the valuation gap” between primary and secondary markets, HSBC equity strategist Steven Sun wrote in a recent report.
And as regulators step up the pace of IPO approvals, more fund products focused on new shares have proliferated.
Mutual fund managers, who enjoy preference in IPO subscription lotteries, like the current system.
“The new issuance system has been effective at restraining the problem of high IPO prices, while also leaving the secondary market considerable space for profit-taking,” said Zhou Ping, who manages an IPO-focused fund at GTJA Allianz Funds, a German-Chinese fund house.
But the system has also led to distortions in other parts of the financial system, the newspaper said.
Short-term interest rates normally jump before a big IPO is launched as investors borrow funds to join the lottery.
Orient Securities’ 10 billion yuan (US$1.6 billion) IPO was 90 times oversubscribed, which meant more than 900 billion in funds were frozen for about a week, FT said.
Those who were lucky to obtain the shares were richly rewarded. On its first-trading day on Monday, the shares rose 44 percent, following by 10 percent increases on Tuesday and Wednesday, the post-debut daily limit.
That’s a more than 60 percent return for investors in just three days. According to HSBC, this year’s 75 or so deals rose by an average of 178 percent in the first 10 trading days, according to HSBC.
Under the previous system, IPO approvals were restricted but pricing was free. But this also created distortions.
The IPO restrictions only whetted investors’ appetite. And as a result, news shares were issued at high prices, then rose further in the first few days of trading, only to drop below their issue price within the next few months as bleak conditions in the broader market replaced the initial upbeat mood.
There were also concerns that small companies, having raised more money than they could invest in their core businesses, channel the funds to real estate and lending through the shadow banking system.
There are hopes that the system will improve. At the annual session of the National People’s Congress earlier this month, Premier Li Keqiang vowed to pursue reforms that would allow market forces to determine which companies can sell shares and at what price.
The CSRC has also pledged to relinquish its approval authority and allow stock exchanges to manage a streamlined registration process, in which the timing and pricing of IPOs will be left to the market.
Local media have reported that the registration system could be introduced later this year.
“A registration system is the clear direction policy makers have set, but there’s going to be a transition period,” Xiao Shijun, Beijing-based equity strategist at Guodu Securities, told the newspaper.
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