Towards a Diversified Capital Market System: A Brief Review of the Proposed Regulatory Reform in China on IPO
Authored by Dr Chi Zhang Shu-Chien Chen
The Key of the Capital Market in China: Liberalization
The capital market in China is a relatively young market, being developed around only 40 years. The keyword to describe the development process is “liberalization”. The process of liberalization has to strike a subtle balance between the enterprises and state interests. Therefore, liberalization of the capital market in China is not streamlined, but demonstrates various different attempts.
In China, there are two public stock exchange markets:
Shanghai Stock Exchange (the “SHSE”) and Shenzhen Stock Exchange (the “SZSE”). In addition to the main board, SZSE has the SME board and the ChiNext board, which serve the needs of SMEs and innovative and fast-growing enterprise1.
In 2018, SHSE has also adopted the similar tunnel, as discussed in the next sections. Theses sub-boards have less restricted list requirements, and aim to provide an exchange platform for smaller-size enterprises. As to attract international capital, SHSE and SZZE have established “Shanghai-Hong Kong Stock Connect” and “Shenzhen-Hong Kong Stock Connect” programs, under which investors in each market may trade shares on the other market using their local brokers and clearing houses.
The relevant laws and regulation regarding IPO in China involve2 the Company Law, the Securities Law, and other specific rules and requirements. As to listing requirements in SHSE and SZSE, Administrative Measures for Initial Public Offerings and Listings of Share are applicable. From the perspective of liberalization, the supervision regulations of the Chinese capital market are developed “from a merit-based regulation towards a disclosure-based regulation”.3 The disclosure-based system is also known as the registration system, which requires “adequate disclosure with respect to the transaction and imposing sanctions for false or misleading statements” and the regulatory authorities would only conduct a limited review. On the contrary, the merit-based system emphasizes “protection of investors”, so the regulatory authorities would conduct a substantial review on the listing applications and have the right to approval as the final say. Before 2015, China adopted the merit-based system and after 2015, China has changed to adopt the disclosure-based similar to that of the USA.4 Such change also reflects the liberalization process in the Chinese capital market.
While being optimistic to the various liberalization developments, including the latest tech-board in SHSE, readers should still be aware of criticisms5 and reflections on corporate governance. In this field of capital market in China, the practice seems always ahead to the law. When the law development has embraced the goal of facilitating trading shares and financing opportunities, the side effects on the other stakeholders including investors would also be, monitored closely.
Plight of Financing for Private Economy
If it is said that petroleum is the ‘blood’ for industry, capital can also be assimilated as the ‘blood’ for enterprises. There are currently four main sources providing the finance for Chinese companies to expand their businesses, namely (i) loans from banks, (ii) the private lending market, (iii) the public stock market and (iv) the debt market. First of all, as regards loans from commercial banks, considering most commercial banks in China are owned by the state, Chinese commercial banks prefer to lend money only to the SOEs or medium to large enterprises with a good reputation and clean credit record6. For start-ups, without stable cash flow or adequate collateral, however, lending from commercial banks is quite difficult.7 The second source is private lending, which may be more flexible for small and medium enterprises (SMEs). However, private lending is also not reliable for most private enterprises in China, because the risk of illegal fund-raising and interest rates are very high.8 Thirdly, nevertheless the public stock markets regulated by the China Securities Regulatory Commission (CSRC) can provide a safer source of finance, for most private firms, however, the high requirements of listing have, in fact, blocked their access to China’s stock market. As a consequence, at present nearly 75% of the companies listed on China’s domestic stock exchange are SOEs.9 In parallel, the debt market in China also extraordinarily prioritizes SOEs, whereas the bonds issued by the SMEs only constituted 10% or less of the bond market in the past five years.10 Overall, the existing mainstream financial sector in China can hardly meet the demands of SMEs for financing.
Technology Innovation Market As a New Financing Tunnel for SMEs
During the First China International Import Expo in Shanghai, State President Xi Jinping announced that The Shanghai Stock Exchange (SHSE) proposes to establish a new securities dealing platform for small hi-tech companies, namely the “technology innovation market”. At the same time, the SHSE will also make a pilot system that tests out a new and deregulated mechanism for initial public offerings (IPOs). The so-called 'registration system' will be an alternative regulatory approach to the 'approval system' which is the current mainstream IPO approval system in the two stock exchanges located at Shanghai and Shenzhen. The CSRC's listing rules have led to a long queue of companies waiting for IPOs. What's more, such a very costly and inefficient IPO approval system creates strong motivations for corruption among officials with approval authority. As early as 2014, the CSRC has previously promised to move towards a registration system for IPOs, aiming at essentially cut off SMEs' transaction cost in the process of financing. Due to a series of political and economic factors, however, such reforms have been delayed for more than three years. Based on President Xi’s above statement, the P.R.C securities regulator (CSRC) may improve its listing rules for the proposed Technology Innovation Market aiming at providing “appropriate and differentiated standards” regarding the profitability and some other compliance issues of firms that plan to list on stock exchanges. Particularly, the proposed new listing system tends to allow those corporations with dual-class share structures to conduct IPOs, because the regulators has recognized that super-voting system is a popular and necessary legal technique for IT and hi-tech companies in global market, however, such companies are currently prohibited from floating on the mainland stock markets in Shanghai and Shenzhen. Overall, it can be imagined that establishing a technology innovation market and testing the registration IPO system is an important reform to increase the market’s ability to serve innovative start-ups and strengthen the Chinese stock market’s inclusiveness.
CECCA's Comments
The year 2018 is the Forty Year Anniversary of the Opening-up Reform of China, our financial market has been much more closely connected with the global economy than ever before. The new reform of the domestic stock markets will definitely fuel the Chinese economy. In the upcoming year, we believe that the development of the P.R.C stock market will be quite promising, as both the Shanghai- London Stock Connection Scheme and the Technology Innovation Market of Shanghai Stock Exchange will be launched shortly. Therefore, domestic companies especially the SMEs in China will be able to finance more economically, at the same time, investors in China and the United Kingdom can be also directly benefited from the stock exchanges in the two countries.
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