Rebalancing China’s IPO Market

New rules will lift a freeze on IPOs and aim to punish corruption | “It looks like Xiao is willing to take bold measures”

Bloomberg News


Four months after taking over as China’s top stock market regulator, Xiao Gang showed up at a government meeting in July with flashes of gray hair on his temples. The salt-and-pepper look quickly sparked a debate on China’s Sina Weibo microblog service. Commentators wondered if the challenges of reforming Asia’s worst-performing major stock market had aged him or if he’d simply stopped dyeing his hair. One blogger chimed in with an attempt at poetry:

A-share market keeps falling,

Chairman Xiao’s hair turning white.

Can’t anger the companies,

And the institutions won’t be disciplined.

Sad, sad, sad.

Xiao, who turns 55 this month, is trying to reconcile conflicting goals: clean up corruption in the nation’s capital markets as President Xi Jinping has pledged, and enable companies to raise money through the stock market. Last October the Chinese government banned initial public offerings because of volatility in the stock market and investor concerns about the financial reporting of newly listed companies. As the chairman of the China Securities Regulatory Commission (CSRC), Xiao is in charge of drafting rules to curb misconduct. The CSRC is also seeking to penalize investment banks that underwrite IPOs of companies that provide false information. Only when the rules are in place will the IPOs of more than 700 companies clamoring to list their shares in the equity market be allowed to resume.

While bankers and companies had expected the freeze on initial offerings would end in July, tightening credit markets led to a stock selloff in June. Concerns about China’s slowing economy have pushed the Shanghai Composite Index down 24 percent since July 2010, including 12 percent this year, making it the worst-performing among 13 emerging and developed markets in Asia. A sudden rush of new stock offerings could drive the market even lower and end up irking investors who have already taken big losses. The 83 companies whose IPO applications have been reviewed by the CSRC and are awaiting final approval may raise a combined 55.8 billion yuan ($9.1 billion), according to June estimates from Ernst & Young. Those include Shaanxi Coal & Chemical Industry Group and China Postal Express & Logistics, according to the securities regulator’s website. “He has to walk on a tightrope to balance it out,” says Fang Fang, JPMorgan Chase’s head of investment banking for China. “There’s fear that these listing candidates could potentially flood the market.”

The draft rules would impose penalties on banks and their employees for including inaccurate information in a prospectus and not fully disclosing risks. Bankers could be penalized when the companies they underwrite post a drop of more than 50 percent in profit in the first year after going public. The regulator could suspend securities firms from equity underwriting, and bankers could be barred from filing new applications for as long as a year. Legal advisers and auditors also could be held accountable. “It looks like Xiao is willing to take bold measure,” says Zhang Qi, a Beijing-based analyst at Zero2IPO Group, which provides research and data on China’s venture capital and private equity industries. “Investment banks will need to be even more scrupulous and cautious, and their costs may increase as bankers will need to put in more time and effort.”

The IPO suspension has disrupted the fundraising plans of China National Nuclear, budget carrier Spring Airlines, and more than a dozen regional lenders. “Dragging on with the IPO halt will affect companies’ expansion plans, because they’ll run out of money to fund growth,” says Wei Tao, an analyst at China Securities in Beijing. “It’s especially bad in new industries, where companies don’t lack demand for their products but have no money to invest.”

The new-listing ban has been a blow to investment banks, whose revenue soared as China became the world’s biggest market for initial offerings in 2010 with $71 billion raised, surpassing the U.S.’s $54 billion that year and Hong Kong’s $53 billion, according to data compiled by Bloomberg. In 2010 securities firms collected $2.49 billion in fees from underwriting IPOs in China, a threefold increase from 2009, according to New York-based research firm Freeman & Co. That was a boon for state-backed China International Capital and Citic Securities, since foreign investment banks are barred from managing IPOs in China without a local partner. Fundraising from IPOs in China fell to $40 billion in 2011 and $14.4 billion last year, data compiled by Bloomberg show, as plummeting share prices, poor financial results, allegations of falsified data, and incomplete risk disclosure spooked investors.

About half the 870 companies that have gone public in China since June 2009 now trade below their offering price. The worst performer is Sinovel Wind Group, whose stock has dropped 82 percent from its IPO price after the wind turbine maker raised $1.42 billion in China’s second-biggest new-stock offering of 2011. In March, Sinovel revised down its 2011 reported earnings by 22 percent, citing an accounting error. In May the company said it’s being investigated by the CSRC for suspected misconduct, including inflating earnings and revenue. In June, Sinovel was charged by U.S. prosecutors in federal court with stealing trade secrets from its former U.S. supplier. Sinovel didn’t respond to requests for comment.

A crackdown under Xiao’s predecessor, Guo Shuqing, has led to more than a dozen bankers, auditors, lawyers, and executives being barred from China’s securities industry since May. That month, the CSRC fined Ping An Securities 76.6 million yuan and suspended the Shenzhen-based firm’s underwriting license for three months. Ping An says it’s taken steps since 2011 to beef up internal controls, including revising its compensation system, hiring external experts for a panel that screens offerings, and committing more people and time to conducting due diligence.

Some bankers say they’re concerned the crackdown may go too far. The prospect of tighter rules has prompted 200 companies to withdraw IPO applications since October. Ding Xiaowen, the Beijing-based co-head of investment banking at UBS’s China securities unit, says banks shouldn’t be held responsible for verifying the financial information reported by companies. “The primary responsibility in accounting fraud should lie with auditors,” he says. “Fraud must be punished, but fluctuations in a company’s financial performance due to unexpected circumstances should be given tolerance.”

Edmond Chan, a partner at PricewaterhouseCoopers in Hong Kong, says tighter rules are crucial to restoring investor confidence in China’s domestic stock market. He estimates 50 to 60 companies may go public this year if the IPO suspension is lifted by the end of September.

Among analysts, the hope is that Xiao will end the IPO freeze by yearend at the latest. “You have to go through this painful process to come to a more orderly market,” says JPMorgan’s Fang. “But if you continue to keep the door closed, it will marginalize the equity market’s basic function of allocating resources efficiently.”

The bottom line More than 700 companies are waiting to go public while China’s stock market regulator writes rules to combat corruption.


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