Editorial: IPO Reform a Litmus Test for Regulators
As investors await a decision on June 20 by index provider MSCI Inc. on whether it will add mainland Chinese shares to its MSCI Emerging Markets Index — a move that could draw billions of dollars into China — another debate on how to fine-tune the mainland’s share issuance system threatens to cast a long shadow over markets. The discussion focuses on whether the securities regulator should suspend initial public offerings (IPOs) to squeeze supply and push up share prices. So far, the China Securities Regulatory Commission (CSRC) has only reduced the number of new share issuances approved each week, instead of halting IPOs, a drastic measure they had resorted to in the past.
It is laudable that the securities regulator has decided not to use an IPO suspension as the main measure to stave off decline. To really fix the problems in China’s stock market, policymakers must step up efforts to transition from the current approval-based system, which has led to wait times of more than two years, to a simplified registration system. The latter would allow stock exchanges, rather than the CSRC, to play the decisive role in the IPO process. The ongoing revision of the country’s Securities Law provides a good opportunity to promote these reforms.
For years, experts have argued that the approval system creates market distortions by restricting the supply of new shares and capping issuance prices. IPOs in China are routinely oversubscribed by hundreds of times as investors scramble to lock in arbitrage profits from huge price increases that invariably occur on the first day of trading.
Furthermore, whenever China’s stock market nosedives, there are calls to limit the number of new share offerings by those who believe an influx of new equity dilutes existing holdings and diverts funds from the secondary market. Over the past 20 years, the CSRC has suspended initial public offerings nine times. This meant that for a combined period of five and a half years, investors had no access to new stocks. However, contrary to common belief, data show that such practices hurt the market and that there is no strong correlation between IPO suspensions and stock index performance. A suspension suggests the regulator was trying to shore up confidence, but it can also fuel fears and speculation of a possible weakening of markets.
For a long time, China’s securities regulator has attached great importance to reducing stock market volatility. But the time-consuming, approval-based IPO system has weakened the stock market’s function as a fundraising platform and has pushed more companies to raise funds through alternative channels. Many companies also hesitate to make any major business changes while they spend years in line for an IPO and risk missing business opportunities.
CSRC Chairman Liu Shiyu has reiterated that regulatory efforts to maintain market stability should not compromise the main role of the capital market, which is to provide a platform for companies to raise funds. This signaled that the regulator would no longer try to close the tap on IPOs to prop up stock market performance. It marks a major shift in the CSRC’s supervisory approach — from its earlier patriarchal mindset to a service provider model.
Making this transition is not an easy task, but it is a vital part of the CSRC’s mission to strengthen the country’s capital market to fuel growth. Deregulating the process of IPO approvals, where regulators focus on ensuring proper information disclosure instead of conducting detailed evaluations of a company’s business, is the way forward. This will make sure that share issuers and investors play by the rules in a transparent market and take full responsibility for their own decisions. In a market where small retail investors account for over 80% of total investors, public opinion is a big concern for regulators. Under such circumstances, it is more practical for them to push for full disclosure while simplifying the approval process to make sure qualified companies go public without unnecessary delays.
It’s an uphill battle to replace the approval-based IPO system with a registration-based one. Inadequate laws and regulations, lack of effective arrangements to delist and low investor trust are among the complex factors that may hamper the efficient operation of the registration-based IPO system. But it will be too late for China to launch the IPO reform after its investor structure improves. Instead, the ongoing revisions to the Securities Law offer a rare opportunity to promote reform.
The establishment of a registration-based IPO system has long been delayed as it requires a coordinated effort from different financial sector regulators — who at times have conflicting views — to draft laws and regulations to support the system. A more feasible way is to outline the basic framework for such a system in the Securities Law, paving the way for China’s cabinet, the State Council, to flesh out a detailed arrangement in the future.
Regulators must also educate investors on potential risks. Minority shareholders should be better protected with improved information disclosure, carefully designed voting arrangements, effective dispute resolution methods, better compensation policies and stricter punishments for those who violate market rules. At the same time, however, the need to protect small investors must not be used as an excuse to block reform.
No matter which side of the debate you are on — whether to suspend IPOs to stabilize stock market performance or not — it’s widely accepted that the CSRC has the power to close the tap on new share issuances if and when it chooses to do so. Although this is the reality, it isn’t the best approach. In the long run, the market should play a decisive role in determining when and which companies should go public and their valuation. We should no longer discuss whether new share sales should be halted as this will not help the development of China’s securities market.
Hu Shuli is the editor-in-chief of Caixin Media.
Founder & Publisher, Caixin Media
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