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July 6, 2015

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Reform of IPOs goes on back burner amid market turmoil

China’s attempts to revamp its much-vilified system of initial public offerings suffered another setback amid a stock market crash that has resulted in a renewed halt to IPOs.

Before the market rout, government regulators were poised to introduce new measures aimed at improving transparency, lowering fundraising thresholds and strengthening the role of market forces.

But now IPOs are in limbo again, taking part of the blame for a market crash that lopped almost 30 percent off the value of the Shanghai Composite Index in three weeks.

IPOs resumed late 2013 after an earlier halt aimed at shoring up sagging markets was lifted.

The proposed IPO reform would move to a registration-based system from the current regulatory approval system.

At present, approval of new listings on China’s stock market rests with the Issuance Review Committee of the China Securities Regulatory Commission -- a group with 25 members and absolute power over who can go public.

The system has long been criticized for its inefficiency and its secrecy.

Under the proposed changes, the Shanghai and Shenzhen stock exchanges would be in charge of reviewing of IPO documents, according to Huang Wei, assistant chairman of the regulatory commission.

“The vetting process would focus on information disclosure, which is the foundation of stock trading and ultimately decides the efficiency of resource allocation,” Huang told a recent financial forum.

Under the change, stock exchanges would be empowered only to ensure that IPO documents are complete, consistent and understandable to general investors. Underwriters would be responsible for the veracity of information in the documents, Huang said.

The reform is also expected to ease requirements on the profitability of companies seeking to list. In the past, many non-traditional companies that were unprofitable but had high growth potential were forced to list overseas.

“The new system would allow companies at different stages of development to raise funds by selling shares,” said Huang.

Wang Hong, deputy general manager of Shenzhen Stock Exchange, told the forum that the bourse would scrap the requirement that an IPO candidate show three years of profit in order to list on the exchange’s ChiNext, a Nasdaq-style board for start-ups and growth enterprises.

The proposed reforms aim to reduce regulatory interference in the process of new-share sales.

Under the present regime, China’s top securities regulator not only decides which companies can go public but also sets guidelines for the size and pricing of new offerings.

The regulator has required IPO applicants with price-to-earning ratios of 25 percent higher than their listed industry peers to explain the basis of their pricing and disclose possible risks to investors.

None of nearly 200 companies that went public in the first half of this year set a price higher than 23 times PE ratios. It’s an unspoken rule that companies need to keep their PE ratios low if they want share-sale approval.

In the past, the regulator suspended new share sales several times when stock markets were slumping and additional listings threatened to roil prices further. That left many companies waiting years for approvals.

The review of IPOs under the new registration-based system would have to be completed within a specified timeframe, and companies would be allowed to go public as long as their IPO documents meet requirements, according to Huang.

“It would make the listing process more predicable,” said Liu Xin, vice president of Guotai Jun’an Securities. “That is one of the biggest changes the new system will bring. Predictability means that companies can determine the timing of their listings according to market conditions and offer prices will be decided by market supply and demand.”

IPO underwriters and investors would have to adapt to a new framework.

Under the current system, IPOs are eagerly sought by investors in the secondary market because of controls limiting supply and price in the initial offer.

So far this year, all new shares hit the limit-up of 44 percent on their first day of trading, followed by several daily limits-up of 10 percent.

Under the new system, listings would no longer be so scarce and only high-quality companies would presumably be more popular.

IPO managers would have to give greater scrutiny to documentation in order to mitigate underwriting risks.

“The registration system requires investment banks to have better capabilities in research, pricing and distribution of new shares and risk control,” said Wang Kaiguo, chairman of Haitong Securities.

For investors, jumping into new listings would no longer guarantee profits. As regulators no longer could pass judgment on the profitability and investment value of issuers, investors would have to evaluate risks and make their own investment decisions based on available information.

“That should promote more rational investment,” Wang said.

Wang suggested that the securities regulator should also tighten its monitoring of post-flotation performance and impose strict penalties when irregularities are uncovered.

Most analysts praise the proposed changes.

“Taking the Taiwan market as a reference, its stock market rallied when it shifted from an approval system to a registration system,” said Ha Jiming, vice chairman and chief investment strategist of the Investment Strategy Group at Goldman Sachs Private Wealth Management. “Market performance should be decided by fundamentals.”

Robin Soong, president of TS First Fortune Asset Management Co, said a registration-based IPO system would be conductive to market stability in the long run because it will improve the quality of listed companies.


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