Over-the-Counter Stock-Trading Platform Building Tiers to Boost Transactions

(Beijing) — China’s New Third Board has helped more than 10,000 small- and medium-sized companies raise hundreds of billions of yuan since launching as China's over-the-counter market five years ago.

Now, in a bid to boost trading and attract new listings, the board’s operator National Equities Exchange and Quotations (NEEQ) has proposed creating a special category for stock in elite companies with strong growth prospects.

The proposal is currently being reviewed by the China Securities Regulatory Commission (CSRC), Caixin has learned from people familiar with the matter.

NEEQ wants to distinguish elite stocks by calling the proposed category a “select tier,” and setting these stocks apart from those currently divided into the trading platform’s “base tier” and “innovation tier” categories. The existing tiers were created in June to help stock traders choose between innovators in their respective business sectors and other companies.

The CSRC’s review of the third-tier proposal is set against the backdrop of an annual government report released at the recent National People’s Congress, the country’s top legislature, by Premier Li Keqiang. The report stressed the government’s interest in building “multiple-layer” capital markets. The goal is to ease the funding difficulties facing companies too small to qualify for the Shanghai and Shenzhen stock exchanges.

NEEQ launched the two-tier system in hopes of generating more trades among the board’s 10,805 listed companies, which as of last year reported a combined market capitalization of 4.28 trillion yuan ($619 billion).

But those hopes have apparently fallen short of expectations, prompting NEEQ to pursue the plan for a third tier, which would include newly listed companies as well as some of the 949 companies currently positioned on the innovation tier.

The two-tier system has spurred a surge in new company listings, but so far has failed to light a fire under monthly trading activity.

Tide Turner?

OTC listings jumped more than 170% to 10,837 today compared to about 6,349 one year ago. Companies last year raised a combined 143 billion yuan, up 16.3% from the 2015 funding total.

Nevertheless, stock market turnover — a ratio of traded stock value and total market capitalization that gauges how often stocks change hands — fell to 0.37% in February from 0.45% in May 2016.

The NEEQ Component Index, a benchmark of market performance, has yet to recover since falling from its April, 2015, peak of 2,075. The index dipped to 1,148 in August, and in early March was hovering around 1,220.

The NEEQ Market Making Component Index, which measures the value of stocks traded through market makers, hit 1,147 on March 9 after sliding from a high of 2,503 in April 2015.

Market makers have also hit a rough patch. Securities brokers told Caixin that most New Third Board market makers barely broke even last year as stock supplies often surpassed demand.

It’s hoped the tide will turn for the OTC trading deck if CSRC approves NEEQ’s request to create a select tier, which analysts say would include at most 500 companies. Only companies with strong financials, good growth prospects, a competitive edge and effective corporate governance would be allowed to join. Rules for select tier membership would complement existing criteria for companies in the base and innovation tiers.

“It’s not difficult for the NEEQ to further classify companies, as it already has prior experience,” Yuan Ji, chief manager of securities research at Guangzheng Hang Seng Securities, told Caixin.

“The New Third Board should play a role in seedling growth,” CSRC Chairman Liu Shiyu said at a February news conference. “Those companies considered more competitive, creditworthy and with more potential to grow should be allowed to go public, if possible.”

No Panacea

Adding a third tier to the OTC deck also might support a CSRC effort to accelerate approvals for initial public offerings, and thus help work off what’s now a huge backlog of IPO applicants seeking regulatory approval. So far, the regulator’s backlog-fighting efforts have focused on reforming the IPO registration system.

But building a third tier of companies within the OTC trading framework may not be a panacea, as some New Third Board problems have been linked to its rule structure and broader market issues.

One reason cited for the platform’s recent history of light trading is the New Third Board’s investor capital limits. An individual investor must have in an account at least 5 million yuan worth of securities at the end of a previous trading day to qualify for buying stock through the OTC market.

Another perceived shortcoming centers on the fact that OTC shares can only be traded through agreement-based transfers and market-making.

Even the tier system itself has been faulted. Many investors say the innovation tier created last year has been more flash than results because it lacks the kind of open, price-bidding process that could spur capital inflows and increase OTC trading liquidity.

“The creation of the innovation tier failed to make a splash,” said a securities firm manager. “Maximizing profits by gearing up for an IPO may be the best move at present.”

“People think it may take a very long time to address all of the problems on the New Third Board,” said the chief manager at a security firm’s OTC department. He’s calling for “a tremendous breakthrough in terms of (government) policy, as financing, low liquidity and low market valuation difficulties are intertwined.”

Contact reporter Dong Tongjian (tongjiandong@caixin.com)