May 15, 2018 03:41 PM

Regulator Sees Speculation Looming in China Depositary Receipts

China’s securities watchdog has proposed revising share offering rules to reduce potential speculation on the issuance of China depositary receipts (CDRs), as it paves the way for the stocks of overseas-listed tech giants such as Alibaba to be traded on domestic bourses.

The China Securities Regulatory Commission (CSRC) published eight revisions (link in Chinese) to the Measures for the Administration of Securities Issuance and Underwriting for “the appropriate arrangements of the domestic offering of stocks or CDRs by innovative companies,” the agency said in a statement (link in Chinese) Friday. The public can file their comments online by June 10.

Companies may choose to set their initial public offering (IPO) price directly with their underwriters or by making inquiries with institutional investors about their demand even if the number of shares they are issuing is fewer than 20 million, according to the statement. Currently the price inquiry system, or “book building,” only applies to IPOs larger than that amount.

The proposed lowering of the threshold aims to “improve the pricing flexibility” for innovative companies and make their price-discovery process more efficient, as their valuation is generally difficult due to their often new business model, the statement said.

At present, institutional offering will be reduced to expand the amount of retail offering, a mechanism known as “clawback,” if the retail demand is substantial. If the retail tranche is more than 50 times oversubscribed, 20% of the total IPO shares will be taken from the institutional tranche to replenish the retail offering. The ratio increases to 40% and to at least 90% when the retail oversubscription exceeds 100 times and 150 times, respectively.

Under the revised version of the rules, when the retail offering is oversubscribed by 150 times or more, the clawback mechanism can be suspended if a lockup period — or the minimum time investors must hold stocks — is set for the institutional tranche.

The revision is aimed at curbing speculation to ensure market stability while making institutional investors more accountable for the IPO prices they help determine.

In another policy intending to deter speculation, companies offering CDRs will be permitted to sell some shares to strategic investors before the IPO regardless of the total number of shares they issue, the CSRC said. It also proposed granting the underwriters of CDR issuances the right to exercise an overallotment option, which normally allows the sale of up to 15% more shares than the original IPO plan. At the moment, only IPOs offering more than 400 million shares are allowed to use the two tools.

Given that the traditional indicator of price-to-earnings ratio is not suitable for valuing innovative companies — as many of them have yet to make a profit — the CSRC plans to ask the firms going public to disclose substitute gauges such as price-to-sales ratio and price-to-book ratio, which compares a firm’s share price to the book value of its equity, it said in the statement.

At the end of March, China published the listing criteria for companies eligible for the CDR trial, which is aimed at luring home overseas-listed high-tech companies, such as Alibaba Group Holding Ltd., Inc. and Baidu Inc. Earlier this month, the CSRC published draft rules on the issuance and trading of CDRs.

The program, modeled after U.S.-listed American Depositary Receipts, will allow overseas-listed Chinese companies to transfer part of their shares to banks to circumvent barriers that discourage IPOs on the A-share market. These barriers include restrictions on weighted voting rights — which tech and family-owned companies favor to keep control — and requirements on profitability.

Contact reporter Fran Wang (

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