Caixin
Apr 29, 2020 06:52 PM
OPINION

Opinion: Many Doubts About ChiNext’s Registration-Based IPO Reform Are Unnecessary

Although this reform was anticipated, many unanswered questions remain after the announcement.
Although this reform was anticipated, many unanswered questions remain after the announcement.

The reform on Shenzhen’s ChiNext board introducing a registration-based IPO system was officially unveiled by authorities on Monday evening.

The main points include:

• Promoting the ChiNext registration system with information disclosure at the core, and institutional set-up in line with that of Shanghai’s STAR Market registration system;

• Introducing trading thresholds for individual investors on ChiNext;

• No limit for price gains or drops in the first five days of listing, and then the limit will be only 20%;

• A negative list specifying which companies cannot list on ChiNext.

Although this reform was anticipated, many unanswered questions remain after the announcement. In the dead of night, I kept receiving questions from investors about the reform, reminding me of the inception of the STAR Market in 2019.

Now, let me address several market doubts here:

(1) Concern about diversion of funds from the market under the registration system. This makes the least sense. It is hard to imagine that a liquidity crunch would arise when the market is worried about excessive printing of money and the ballooning size of the People’s Bank of China’s balance sheet, which nears the U.S. Federal Reserve’s. China’s central bank has continuously lowered policy interest rates. Coupled with downward pressure on inflation in the future, market interest rates should trend down further. These circumstances indicate that liquidity is not a major issue at this stage.

(2) Concern about excessive valuation of new listings and thus investor losses under the registration system. This concern was even more serious when the STAR Market was introduced. However, any market-oriented reform is meant to allow the market to decide which companies can be listed and at what prices. If the market believes that a price is too high, post-listing market valuations will correct.

When the STAR Market was introduced, some companies raised deep market concerns as their initial profits were limited, with price-to-earnings (P/E) ratios at elevated levels. But when did we start to value emerging growth companies with P/E ratios? If the same logic is applied to the Nasdaq market in the U.S., investors would surely miss the growth of emerging companies such as Amazon, Netflix and Tesla.

(3) Concern about shrinking valuations of shell companies in the market. The registration system allows the market to determine which companies meet the conditions for listing and can be listed, which will ultimately shorten the timeline for companies to list and reduce listing costs. Therefore, listed companies that refuse to delist in order to stay as shell companies may see their valuations shrink significantly. If so, this is precisely the success of market reforms.

Shrinkage in the valuations of shell companies will free up funds locked in these companies and redistribute them to more valuable ones in the market. Market leaders do not face such delisting risks, and their valuations have not factored in shell company value. After the funds from shell companies are freed up, we can expect them to be reallocated towards quality, leading players in the market.

(4) Concern about unqualified companies cashing in on listings under the registration system. This concern is applicable to any market, including in the U.S. However, these companies will eventually be exposed even if they pass the listing mechanism, such as the U.S. blood-testing company Theranos and Luckin Coffee. The key to managing this risk lies in information disclosure requirements and severe penalties for violators. References to these risk management regulations were made in the Monday news on the ChiNext reform and the news that the China Securities Regulatory Commission’s audit department is investigating Luckin Coffee.

(5) Concern about the timing of ChiNext registration reform, given potential global market depression and high volatility. This worry stems essentially from the desire to time the market reform. This habit to time is common among market participants. However, any time is the best time for reform. Short-term market fluctuations should not hold back the pace of long-term reforms.

Against consensus, I made a contrarian call last year to recommend STAR Market opportunities. It is gratifying that many of those who followed this call should have made handsome gains. We hope that this ChiNext registration reform will deliver investment opportunities for everyone.

Hong Hao is managing director and head of research at Bocom International Holdings Co. Ltd., a Hong Kong-based subsidiary of Bank of Communications Co. Ltd.

This article has been edited for length and clarity.

Contact editor Yang Ge (geyang@caixin.com)

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