23 October 2016
IPOs are in short supply and tend to be heavily oversubscribed, tying up investors' cash for a while. Photo: Xinhua
IPOs are in short supply and tend to be heavily oversubscribed, tying up investors' cash for a while. Photo: Xinhua

Market turbulence on reopening of IPOs likely only temporary

Chinese authorities announced Friday the restarting of initial public offerings in the A-share market.

As investors can easily secure high profits by subscribing to new shares, large amounts of money are likely to be pulled out from the market and locked up for IPO subscriptions.

Many are concerned this may hurt the mainland stock market, which has just recovered a little from the crash in the summer.

Last week, market transactions were more active.

Mainland brokers were the biggest winners in this round of the rebound.

The strong performance of brokers fueled share prices in the entire financial sector, leading to an 11 percent increase last week.

Although the market may experience short-term turbulence after the reopening of IPOs, the move is good news for brokers.

So, even if the market corrects this week, I think prices of brokerage firms’ shares will remain relatively stable.

In early June, there were 25 IPO that raised 41.4 billion yuan (US$6.47 billion).

Those IPOs were heavily oversubscribed, with locked up funds amounting to an incredible 5.69 trillion yuan.

The mainland media tried to determine whether the IPOs were to blame for dragging down the market.

They found that of the eight periods when the authorities halted IPOs, the stock market rose during five and fell in the other three.

In addition, the market rose in three of the eight post-reopen periods.

So, in fact, the IPO effect never really influenced the macro market trend.

Although the lock-up period for IPO subscriptions is not long, it will create a negative impact on investors’ sentiment, which may lead to short-term volatility.

The regulatory authority has been trying to fix this.

It recently announced several optimization measures for the IPO subscription rules.

One of the adjustments is to allow investors to pay up only after they are confirmed as winners of the IPO lottery.

At present, investors need to prepay for the new shares they intend to subscribe for, and their money will be returned if they don’t get them.

The new rule can reduce the amount of money locked up and thus reduce the potential market impact.

However, some investors may apply for a bigger amount of new shares that they won’t be able to afford.

In this case, the underwriters will have to sell those surplus IPO shares.

It’s easy to sell these shares under current market conditions.

But once the IPOs are no longer in short supply, brokers will have to shoulder a bigger risk.

In addition, if the prepayment rule is removed, the brokers will lose some income from margin financing for IPO subscribers.

The new rule will have limited benefit for brokers.

But I believe the fear of the IPO effect may be relieved, and the uptrend will continue despite short-term turbulence caused by the reopening of IPOs.

This article appeared in the Hong Kong Economic Journal on Nov. 9.

Translation by Myssie You

[Chinese version中文版]

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a columnist at the Hong Kong Economic Journal

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