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October 20, 2019

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Building Shanghai into a financial center that serves as the leader in innovation

According to the “Statistical Report on Internet Development in China” published by the China Internet Network Information Center, the number of Chinese listed Internet companies totaled 120 at the end of 2018. Of this, 46 were in Shanghai and Shenzhen (38.3 percent of the total), 26 in Hong Kong (21.7 percent), and 48 in the US (40.0 percent). Compared to the end of 2017, Shanghai and Shenzhen remained flat and the US increased by 7 to 41 in terms of the number of Chinese listed Internet companies.

In order to realize its potential as an international financial center, Shanghai should take the lead in China in setting up fund raising markets for innovative businesses, and aim to become an international financial center with easy access for innovation-driven companies by making the cross-border transfer of funds easier.

Financial intermediation through direct financing is indispensable in transforming China into the innovation-led growth model. Shanghai has some of the largest financial markets in the world and it should aim to become an international financial center by developing a multi-layered primary market for securities, collaborating with foreign companies, developing high-quality office space, and driving fundraising for companies through innovation.

Shanghai’s strengths lie in concentration of financial institutions and institutional investors (mutual funds, private funds) that have entered the China market over the years, and the market size of its stock exchange, which have become one of the largest in the world. While nurturing new industries and reorganizing existing ones, Shanghai has a potential advantage as the platform for sourcing funds for growth industries.

In recent years, innovation-driven companies have been leveraging Internet based business models and rapidly promoting integration with the manufacturing industry as represented by Internet of Things. It is important for Shanghai to establish a new board to support the financing of small- and medium-sized venture companies that promote innovation in China in order to attract venture companies aspiring to list their shares and to promote diversification of financial performance of listed companies in the medium- to long-term.

In response, at the first China International Import Expo held in Shanghai in November 2018, President Xi Jinping announced a plan to establish a new market in Shanghai called the STAR Market. As innovation-driven companies often offer new technologies and business models, they often raise funds from overseas investors relying on their astute business judgment. In many cases, these companies focus on global expansion from the beginning, rather than developing technologies and business models that target the domestic markets.

The establishment of the STAR Market will not only support the issuance of shares by innovation-driven companies, but also offer a great opportunity for Shanghai to become an international financial center by attracting foreign investors. Joint-venture securities companies to be newly established in Shanghai are also expected to contribute in underwriting shares and attracting foreign investors, leveraging their global franchise.

The new feature of the board is the introduction of the “share issue registration system” for the first time, under which the initial listing examination is conducted by the Shanghai Stock Exchange. Thanks to this feature, it is expected that start-up companies can complete the whole listing process from application submission to listing of shares on the STAR Market within a shorter period than on the main board.

However, in the initial introduction of the STAR Market, there will be a dual registration system where stock issued will be registered with the China Securities Regulatory Commission in addition to the Shanghai Stock Exchange. The timing of a public listing is also important for recovering the funds invested and sourcing the funds required for the next business expansion. It will be necessary to unify issue registration in the Shanghai Stock Exchange at an appropriate time in order to ensure that a more flexible listing mechanism can be put in place, although we also need to wait and see how the registration system of the new board actually works.

The development of primary securities markets should be carried out in combination with efforts to attract foreign investors as it is important for investors with diverse perspectives to act as astute judges, evaluating financing proposals made by Chinese innovation-driven companies. There are also opportunities for Shanghai to play a sufficient role in strengthening connectivity with neighboring East Asian countries.

Shanghai also has opportunities to create a platform to strengthen collaboration with Japanese companies and to promote joint research and business matching between them and companies, universities, and research institutes based in Shanghai. It could be possible that, as a result of such collaboration, there will be companies in Shanghai, whether Chinese companies based in Shanghai or local subsidiaries of Japanese companies that will be future potential users of the primary securities markets in Shanghai.

When using existing commercial facilities as part of urban redevelopment, there is still room in China not only to increase the floor area ratio, but also to promote fund-raising that takes into account the post-redevelopment future cash flow of those projects. At the 2018 IBLAC, Nomura proposed the introduction of real estate investment trusts (REITs) from the viewpoint of strengthening the function of the Shanghai Stock Exchange. In 2019, we recommend the introduction of publicly offered REITs, in particular to procure funds for urban redevelopment in Shanghai.

In China, the financial authorities and the housing construction sector have been conducting research to prepare for the introduction of REITs. It is considered that behind this, the real estate developers aim to correct distortions in the financial intermediation function in the real estate market and avoid over-dependence on specific financing routes such as bank loans and securing new financing routes through the capital market that are smaller and more diversified.

In the past, certain products have been developed and established on a pilot basis in relation to REITs, but they were mostly privately offered asset-based securitization, which were structured using securitization. Shanghai should take the initiative in directly introducing REITs in as a publicly offered equity product to which preferential tax treatment is applied.


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