China’s tech-focused startup board, ChiNext Index, implemented new rules in August aimed at further liberalising the country’s equity markets. Under the arrangement, companies planning to go public no longer require approval from the China Securities Regulatory Commission (CSRC).
Instead, companies are now vetted by the Shenzhen exchange based on disclosure requirements. The revision moves away from a burdensome administrative process and towards one that reflects broader demand-supply dynamics.
ChiNext’s new format is already used on the Shanghai STAR market and practiced in the US. The amendments follow other initiatives in recent months. The Hong Kong exchange altered rules to permit companies with weighted voting rights to list, setting a path for Alibaba’s secondary listing last year.
At the end of July, the NEEQ Select equity market for small and medium sized enterprises (SME) was launched. Earlier this year, the Hang Seng Index revised eligibility criteria to include secondary listed and weighted voting rights companies into their composite, and commenced those changes in September.
Chinese investors have shown sufficient liquidity depth, supporting more than $10 billion in initial public offerings (IPOs) raised over the first seven months of this year on the Shanghai STAR market. With China’s technology innovators seeking institutional investors to expand their businesses, bourses are amending rules to attract local capital and reduce the appeal to seek overseas investors.
“The ChiNext reform is a significant part of China’s grand competition strategy with the United States,” noted Hao Hong, head of research at BOCOM International. Secondary listings in Hong Kong underline this trend. JD.com and NetEase together accumulated $7 billion in secondary offerings this past June while Yum Brands plans a $2 billion offering later this year.
BROADER IMPLICATIONS
The updated procedures carry two implications. First, the revision expands regulatory support for technological innovation. By overlapping with Shanghai’s STAR market, listing discrepancies are removed, encapsulating an easier onboarding process which is characterised by a shorter and more transparent IPO practice.
Notable floats in Shanghai support this view. China's largest chipmaker Semiconductor Manufacturing International Corporation (SMIC) raised nearly $8 billion in July. Currently, bankers are preparing for Ant Group’s upcoming $30 billion dual listing, with Reuters reporting the deal flow to lean more towards Shanghai than in Hong Kong.
Second, the new rule serves as a litmus test whether other mainland A-share bourses will also adapt the registration-based process, specifically ones that host SMEs. This channel would help Beijing move more capital towards private companies, as well as reduce outstanding debt accumulated during the Covid-19 shutdowns.
Utilising equity markets alleviates the burden taken from the banks, where China’s four largest state banks reported double-digit drops in first half profits due to provisioning. China’s banking and insurance regulator noted that the banking sector has indirectly sacrificed more than RMB 870 billion in net profits over the first seven months of the year from a combination of reduced fees, loan moratoriums and restructuring.
VOLATILITY CONCERNS
Besides changes to the approval process, ChiNext’s new rules removes daily price limits for debuting shares while also widening the stock price trading bands for listed companies. Daily price movement now allows 20% in either direction, from the previous 10% limit.
On the first day under the revised scheme, the share price for the 18 companies listing their IPO surged by an average of above 200%. Trading volumes from August 27 to September 2 were up 23% against the prior five-day cycle.
“We believe the wider trade limit range may in the near-term trigger bigger stock price moves, however, should lead to more efficient pricing in the long-run, and therefore reduce speculative activities and market volatility,” according to a research note by Morgan Stanley.
Over the medium term, this view is expected to be challenged as “Chinese markets will remain volatile on global events and retail buying on margin. Additionally, shorter holding periods and more frequent trading still account for most of the activity,” says Neil Mascarenhas, Fund Manager for Hamon Investment Group speaking to FinanceAsia.
“Institutional investors will continue to focus on fundamentals, but momentum is hard to ignore,” explains Mascarenhas.
In addition to trading momentum, money managers are also contending with expensive earnings multiples for Chinese technology stocks. At the end of August, the ChiNext traded at 37x forward earnings, compared to 14x on the CSI 300 index, pushing the technology premium higher that could lead to sudden profit taking in the market.
MANAGED RISK
Bolstering the role of equities corresponds to other policy changes and new regulatory oversight. Among these, China’s Ministry of Commerce said that the government had expanded its list of technologies subject to export controls while regulators plan to tighten supervision over financial holding companies.
China’s plan to nurture the Shenzhen Stock Exchange into a leading capital hub coincides with ambitions to develop the Greater Bay Area and the neighbouring region. While securities regulators have cited zero tolerance for misbehavior under the revised listing regime, they will unlikely interfere with normal trading activity.
The implication here is an inherited tolerance for oscillating price swings, where “falling stock prices, instead of rising, should be the sign of whether such market reform is successful," according to Hong.
But concerns are muted as risk appears managed. More than half of the announced second quarter earnings for Chinese equities have beat expectations, according to Morgan Stanley. Additionally, with China’s 10-year yields sitting at 3%, real rates (nominal borrowing costs minus inflation rates) remain positive, which disincentives risky speculative investments.
China’s markets have risen in tandem with a pickup in margin finance, reporting a five-year high of RMB 1.4 trillion at the end of August. But current levels are 40% below China’s stock market correction in 2015. Memories of this event remain fresh not only for Beijing’s policy makers, but Chinese households as well.
