After his appointment as the first chairman of the China Securities Regulatory Commission in 1992, Liu Hongru lamented that his new job meant he was being deployed into a “volcano crater”.
The CSRC was created just two months after the infamous ‘August 10 Incident’ when hundreds of thousands of retail investors stampeded into Shenzhen to buy IPO shares, and then rioted when the authorities ran out of application forms.
After the chaos receded, Beijing called a moratorium on fresh flotations.
“Investors out there are unhappy when prices fall too much. Leaders up there are unhappy when prices climb too quickly. If the market stagnates, everyone will be unhappy,” Liu reminded his 90 or so hastily recruited colleagues at their first meeting, and characterising their task ahead as a thankless one.
One of Liu’s earliest duties was to maintain stability when the IPO market reopened with Tsingtao Brewery’s debut in Shanghai in May 1993. To avoid a repeat of the previous August, Liu ordered that an unlimited supply of application forms be made available. To a Western mindset that may sound like a fairly straightforward administrative decree, but it was actually one of the first acts of deregulation for the stock market. Previously, authorities had used the number of application forms as a way to control a process that some hardliners still found deeply distasteful.
Investors flocked to Tsingtao’s offering. And this time things went smoothly with the brewer successfully raising Rmb636 million ($105 million).
Since then the CSRC has grown into a powerful regulator overseeing the world’s second biggest stock market by capitalisation. But that hasn’t made Liu’s metaphor of policing a volcano any less relevant nor the stock market police any less cautious about the risks of new eruptions. Over the 1990s there were at least eight moratoriums on new IPOs and the primary market has been shut for 33 individual months since 2005 (see WiC219).
The lengthiest ban, which began in October 2012, finally ended last month. Before reopening the market the CSRC faced a logjam of nearly 800 companies wanting listing approval and the first candidates are now coming to market. More precisely, 51 candidates have been given the green light to go ahead with their roadshows.
One would have thought that the CSRC has had ample time to figure out how best to oversee this process. Moreover it had earlier unveiled reforms that promised less intervention in the market on its part, not more interference. But as the first IPOs started to price their offerings this month, investment bankers were already wondering if the regulator was backtracking on some of its bolder initiatives, especially the plan to be more hands-off about how listings are priced.
That didn’t look to be the case when Jiangsu Aosaikang Pharmaceutical pulled its Rmb4 billion ($661 million) offering after speculation that the CSRC was unhappy its shares were overpriced (admittedly they were feisty at 67 times 2012 earnings or 20% higher than the sector’s average).
The regulator then denied that it had ordered a halt but the news still came as a shock. Aosaikang was set to be the biggest debut among the first batch of new listings. Five companies then postponed their own IPO plans last week.
The South China Morning Post wasn’t impressed, decrying “an obvious sign of breaching the market-driven model, leading to a dent in confidence about the authorities’ self-proclaimed market reforms”.
But the China Daily pleaded for patience as “2014 will be a transition and learning period” for both regulator and investors as they adapt to the new norms.
A better indication of progress, according to Century Weekly, is to keep an eye on the CSRC’s internal reforms. The magazine said the watchdog will undergo a major reorganisation itself by the end of this month, including a plan to eliminate the powerful committee that vets new listings. That will align the Chinese system more closely with those in developed markets (where market watchdogs concentrate less on deciding if firms are fit to list, and more on upholding the integrity of the disclosure process).
The most entrenched problem for the CSRC is the obsession retail investor have with speculating on new stocks. For these investors, it doesn’t really matter if new listings are overpriced or not. Most still view the primary market as the best way to make money, expecting post-IPO prices to get a bounce as a matter of course.
Perhaps it’s self-perpetuating but there is merit in that view. Neway Valve, the first IPO in Shanghai since 2012, climbed more than 40% on its trading debut last week. The shares of eight other debutants in Shenzhen all jumped more than 30% this week.
So what should the CSRC do? Liu Hongru’s old formula as regards application forms – i.e. don’t restrict supply – might still work. The China Daily reckons the CSRC should dull its interventionist instincts, allowing more new IPOs to flood the market and thereby tame some of the speculation shaping investor sentiment.
Of course, that won’t be to the liking of companies already trading on the Shanghai or Shenzhen bourses, which fear losing investor interest to the new entrants. But at least more competition for capital might prevent sponsors from overpricing some of these new stocks. And investors expecting easy money on IPOs would learn a lesson too. “Those who get burned learn fast,” the China Daily suggests. “Some investors just have to learn their lesson the hard way… Only when people realise buying new stocks is not risk-free will they start to be rational about IPOs.”
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