Nov 23, 2018 09:11 PM

In Depth: Chinese Investors May Finally Taste Forbidden Fruit

The Shanghai Stock Exchange on July 12. Photo: VCG
The Shanghai Stock Exchange on July 12. Photo: VCG

Tencent Music Entertainment (TME) is China’s answer to Spotify. But when the music streaming service goes public later this year, almost none of its 800 million users will be able to buy its shares. That’s because TME is conducting its initial public offering (IPO) 13,000 kilometers (8,060 miles) away on the Nasdaq stock exchange in New York.

The Shenzhen-based company can’t list on either of China’s two stock exchanges — in Shanghai and Shenzhen — because of a myriad of regulatory barriers and legal constraints that have shut it out of the domestic market. The country’s top food delivery service app, Meituan Dianping, which raised $4.2 billion in one of the top five global IPOs this year, faced the same problem and chose to float its shares in Hong Kong.

The list of homegrown Chinese start-ups, unicorns and established companies who are shunning the domestic stock markets in favor of Hong Kong and New York just keeps expanding. It now includes rising stars such as parenting website BabyTree, travel website Tongcheng E-long Holdings, e-commerce app Pinduoduo, and cancer drug developer Innovent Biologics Inc. Even state-owned mobile infrastructure operator China Tower chose to list in Hong Kong.

The trend underscores the failure of Chinese regulators to dismantle the barriers they have built over the years that have forced domestic companies in fast-growing industries to list overseas. In March they sought to address the problem with a plan to set up a Chinese depositary receipt (CDR) program that would allow tech giants such as Baidu, Alibaba, Tencent,, Xiaomi and Ctrip (collectively known as BAT-JMC) to trade their shares at home. But the program collapsed in June after smartphone-maker Xiaomi shelved plans to offer receipts at the same time as its Hong Kong IPO, ostensibly because of disagreements with regulators over the pricing of the shares.

Political task

Now President Xi Jinping has weighed in. In a speech on Nov. 5 in Shanghai, he made a commitment to set up a new science and technology innovation board that will become a testing ground for a long-touted IPO mechanism based on a registration system rather than regulatory approval, a transformational change that could finally force the China Securities Regulatory Commission (CSRC) to relinquish control over the IPO process.

Xi did not elaborate, but his intervention emphasizes how important the stock market and access to capital has become for the leadership, especially amid government efforts to boost access to funding for startups and fast-growing companies in strategic or emerging industries. Such a board could also become an additional attraction for foreign investors who are being encouraged to pour money into the domestic stock market.

The two initiatives aren’t just the latest short-term quick fixes to improve sentiment and stem this year’s hemorrhage in the stock market, they are policies that have been touted for years by the financial authorities but have never managed to get past the drawing board. With the country’s top leader putting his name to the changes, they have become a political task that must be carried out.

Within hours of Xi’s remarks, the CSRC and the Shanghai Stock Exchange (SSE) responded with statements vowing to actively work on details to get the program off the ground.

“The fact that the establishment of the science and technology innovation board and the trial of the registration-based IPO system were announced by the supreme leader indicates that IPO reform will definitely happen,” a source close to top policymakers, who spoke on condition of anonymity, told Caixin.

“People who resist the overhaul on the grounds that it could impact the stock indexes, and bureaucrats who have a vested interest (in maintaining the status quo) must change their mindset and understand that reform is the only cure for stock market crashes,” he said.

As policymakers see it, these much-needed changes can no longer be delayed because the stocks rout this year, which saw a plunge of as much as 25% in the benchmark Shanghai Composite Index to a four-year low, has underscored the urgency of fixing the fundamental distortions in the A-share market, the source said.

Rigged market

China’s stock markets are burdened with problems. They are prone to speculation and insider dealing and are heavily controlled by regulators in many ways, including the length of trading suspensions, caps on daily share price movements, caps on IPO prices, and a ban on dual-class share structures that offer preferential voting rights to some shareholders.

The current IPO system, which is based on an approval process where the CSRC vets applications, is a major roadblock. It is unpredictable, lengthy, and prone to corruption because of the power it gives officials to approve or reject applications. A number of CSRC officials in charge of IPO approvals have been jailed for accepting bribes over the years including Yao Gang, who spent his career at the commission and rose to become its vice chairman. In September, Yao was sentenced to 18 years in prison for taking bribes and for insider trading.

The system imposes stringent requirements on companies and gives them little control over the offer price of their shares. It also forces applicants to wait for months, possibly years, for approval and then requires them to list within six months of the go-ahead, limiting their ability to respond to changes in market sentiment. Onerous criteria, such as the need for a three-year track record of profitability, effectively shut the door to hundreds of young, high-growth companies because they are money-losing and push them to list on overseas markets.

The regulation on profitability has hit the booming peer-to-peer (P2P) lending sector particularly hard, although not all were losing money when they listed. There are now at least a dozen P2P platforms listed in the U.S., including Pintech Technology Holdings, which went public in October, and X Financial, which floated in September. That compares with zero in China.

There are also legal barriers to foreign investment and ownership in many sectors including value-added telecommunications services, and internet businesses. These laws have become obstacles to many Chinese companies that have brought in foreign investors during early rounds of fundraising and have forced tech firms such as Alibaba and Tencent to set up complicated legal structures called variable interest entities to get around the rules. But these structures, which are tolerated by the government, mean the companies are seen as foreign firms and as such are barred from carrying out their IPOs on either of China’s two stock exchanges — which between them have around 145 million share-trading accounts.

Chinese investors have grumbled for years about their lack of access to China’s best companies and about the dysfunctional IPO system. In response, regulators have come up with various plans to allow foreign firms to list in China and give access to the stock market to companies with strong growth prospects but no profits.

Discussions have also taken place for years about shifting to a registration-based IPO system similar to those used in developed economies such as the U.S. where the market, investors and the companies themselves make the decisions on valuations, the amount of money to be raised, the IPO price, the timing of the share sale, and the importance of profitability. The listing process is simpler, more flexible and puts far greater emphasis on information disclosure.

Nevertheless, there has been little progress. That’s partly due to policymakers’ concerns, based on bitter experience, that the prospect of such huge changes will exacerbate stock market volatility as investors dump shares in hundreds of underperforming companies to buy profitable foreign blue-chip stocks and high-growth businesses of the future.

As recently as February, CSRC Chairman Liu Shiyu said the time was not yet ripe to implement a registration-based IPO system, citing concerns such as the immaturity of the market and its inability to properly price new-share offerings.

Favorable environment

Testing a registration-based IPO system on the new high-tech board reflects the government’s intention to minimize any potential impact on the broader stock market, the source close to policymakers told Caixin. Ironically the coordinated efforts by government agencies to stem the recent rout in the stock market have created a favorable environment for the reforms because “the stock indexes are likely to stay relatively stable,” he said.

It’s still early days and details about the proposed science and technology innovation board and the IPO registration system have yet to be announced. But the CSRC’s statement (link in Chinese) on Nov. 5 appeared to acknowledge the shortcomings of the current IPO system. The commission said the authorities will “set out more appropriate, customized requirements on the profitability, shareholding structure and other aspects” of qualified companies to “improve the inclusiveness and compatibility” of the high-tech board.

Analysts and stock market professionals expect that the thresholds could be similar to those laid out in the CDR rules, with requirements on some issues such as price-earnings valuations likely to be further loosened.

A source close to the SSE, who declined to be named, told Caixin that biotech companies and semiconductor manufacturers will be among the main targets policymakers will try to woo as the mainland seeks to match the Hong Kong Stock Exchange’s revised rules to allow pre-profit biologics firms and companies with a dual-class share structure to list.

“What’s upsetting the market at the moment is that many biopharmaceutical companies have chosen to list in Hong Kong,” the stock exchange source said. “Therefore biopharmaceutical firms, manufacturers of chips and integrated circuits will probably be the focus of this round of changes.”

A key requirement for the regulators will be to ensure the new board has a broad spectrum of companies including blue-chip heavyweights to create stability and prevent the market from becoming yet another vehicle for speculators, investors have told Caixin.


The fixation with speculation and turning a quick profit is one of the main problems besetting the domestic stock market but it’s the hardest to solve, said Kevin Qi, the founder of Merger China Group, a Beijing-based investment services firm.

The new high-tech board will be vulnerable if it is stuffed with small startups whose prices are easily manipulated because of their relatively small market capitalization, he said. The board should include not only innovative startups with high growth potential but also industry behemoths already listed overseas that are harder to manipulate, he said, pointing to the BAT-JMC group. Their overseas share prices will provide a reference for domestic investors, and they have better disclosure that makes their operations more transparent, he added.

“If these companies are allowed in, the odds will be stacked more heavily against the speculators and Chinese individuals will be provided with the opportunity to do long-term value investing,” he said.

Barriers to entry

But even if they want to, not all Chinese investors will be allowed to trade directly on the proposed new board. Still wanting to exert control over the market, the regulator has indicated investors will have to meet certain criteria such as a minimum asset requirement, and have their risk tolerance profile vetted. As a result, many small investors will only be able to access the market through mutual funds sold to the public.

This continues the tradition of regulators erecting barriers to access for all stock-related trading platforms other than the two main boards in China out of concern they are too risky for unsophisticated investors and those without a certain cushion of assets.

Changing the IPO system is not without risks either. Investors have traditionally flocked to new issues because their offer prices are capped by regulators during the approval process. On their first day of trading IPO, stocks are exempt from the usual daily 10% limit on gains or declines and almost without exception prices soar, netting speculators a tidy profit.

The stringent approval system also gives investors the impression that companies who get the green light to go public are of good quality. But this implicit endorsement will disappear once the approval process is replaced by the registration-based system and investors will have to rely on company disclosures, particularly the prospectus, to make their own judgment on the firms’ financials, investment value and growth prospects.

The market is now debating what kind of registration system the CSRC will adopt. Under a previously discussed plan, the power to vet IPO applications was to be given to the two stock exchanges who would submit their approval to the CSRC for a final review.

Qi from Merger China Group said the power of the stock exchanges should be limited to checking the veracity, accuracy and completeness of candidates’ disclosures rather than allowing them to judge their suitability and quality in order to discourage rent-seeking.

The new system is also likely to involve scrapping the cap on IPO pricing, which is currently set at a maximum of 23 times a company’s earnings per share, a valuation criteria that is often irrelevant or inappropriate for high-growth companies — and impossible to calculate for firms that are money-losing because they have no earnings.

Although President Xi’s announcement has given new impetus to the introduction of a high-tech board and a new IPO system and put regulators under pressure, the changes could still take months if not years.

Exodus continues

Xi’s pledge to trial a registration-based IPO system was made almost five years to the day that the policy was written into a key document issued by the ruling Communist Party setting the framework for the country’s development through 2020 and pledging to give the market a decisive role in the allocation of resources.

In March 2015, then CSRC chairman Xiao Gang said that regulators would implement the change that year. But the stock market crash that unfolded in June 2015 brought a sudden halt to the plan. Many investors blamed the rout partly on fears that the new arrangement would trigger a huge sell-off of shares to free up funds to pour into IPOs.


A girl tries out biometric "face scanning" payment technology in Hangzhou, East China’s Zhejiang province, in October 2016. Photo: VCG

In December of that year, the standing committee of the National People’s Congress, the country’s legislature, gave the State Council a two-year mandate to do the preparatory work to trial the new system, which has implications for the Securities Law. But in February 2018, the committee gave the State Council a further two years to finalize the plan because of the slow progress to date and the complexities involved.

In the meantime, the steady exodus of companies to overseas stock markets has continued apace — in September, seven Chinese firms went public in the U.S., taking the total for the first nine months of 2018 to 23, more than any full-year total since 2010, according to an October report by Renaissance Capital, an IPO investment adviser based in Greenwich, Connecticut. The list was dominated by fast-growing, money-losing tech companies including Pinduoduo and video-streaming platform iQiyi.

Waiting in the wings are some of China’s biggest and most innovative private companies including ride-hailing app Didi Chuxing and Ant Financial, the online payment giant affiliated to billionaire tech entrepreneur Jack Ma’s Alibaba. Ant Financial is currently valued at around $150 billion, double the market capitalization of U.S. investment bank Goldman Sachs.

The question now is whether China’s regulators can make the new high-tech board and IPO system attractive enough to lure these potential hot stocks back home.

Contact reporter Fran Wang (

You've accessed an article available only to subscribers
Share this article
Open WeChat and scan the QR code