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Tuesday, June 30, 2015, 10:04

Nation's bourses enter new era of regulation

By Chen Jia

Listing rules and ownership structures set to change amid increasing turbulence.

The creation of a strategic emerging industries board on the Shanghai Stock Exchange, which is intended to bring back overseas-listed Chinese high-growth and innovative companies, will have to wait for the revision of the Securities Law, said an expert on stock financing.

After the revision, which is expected to be finished in November, the requirement that companies wanting to list must have a three-year record of profits will be dropped, said Liu Jipeng, a member of the Securities Law revision working group and director of the Capital Research Center at the China University of Political Science and Law.

Administrative approval for new offerings under the country's top securities regulator will also be changed into a registration system, and that will "fundamentally" eliminate barriers for high-growth and innovative companies wanting to list on the domestic stock exchanges, he said.

Strict listing requirements and red tape drove many Chinese high-tech companies, especially the Internet companies, to list on overseas capital markets.

As Chinese Internet startups often have difficulty meeting profitability requirements to list onshore, the Nasdaq in the United States has been a major forum for such companies to list.

Companies such as Alibaba Group Holding Ltd, Baidu Inc and Tencent Holdings Ltd used a so-called variable interest entity structure to raise funds in overseas capital markets while retaining absolute equity control of the company.

The VIE structure was developed to satisfy the ownership requirements of overseas security regulators without technically breaking Chinese law, because foreign ownership in China's Internet sector is restricted. But many overseas investors distrust such entities.

"The current situation is, most of the overseas-listed Chinese companies can hardly raise funds in a sluggish market. Instead, they are attracted by the domestic capital market," said Liu.

"More than 90 percent of the overseas-listed companies hope to return. They are only waiting for changes in listing policies. It also takes time to 'break' the VIE framework and change ownership structures."

On June 16, the State Council, issued a statement of support for the creation of a strategic emerging industries board on the Shanghai Stock Exchange.

To go from 2,200 points to more than 5,000 points, the benchmark Shanghai Composite Index needed only half a year, starting in October. A surge like that is a rare event in world capital market history.

The startup board, or the ChiNext, and the country's leading over-the-counter marketplace, the New Third Board, have attracted huge investor interest and high valuations.

"The average price-earnings ratio for stocks on the main board rose to 25 times from 13 times when the benchmark index increased to 4,000 points from 2,000 points, which is reasonable," said Liu.

"But after the Shanghai Composite Index blew through 5,000, bubbles have inflated. The ChiNext average PE ratio, which increased to about 145 times recently, is abnormal," he said. In the first five months of this year, the stock index rose 45.7 percent year-on-year, the largest gain in the world. But the market's path has not been entirely smooth.

On June 12, the Shanghai Composite Index reached a seven-year high of 5,178.19 points during the trading day. But the gauge has since plunged on concerns that valuations lacked fundamental support and a flood of new listings could drain liquidity from existing equities.

The volatility in China's stock market is also a rare development since the global financial crisis, experts said. "The 4,000 level may be a new bottom for the index, even though large fluctuations are possible in the near future," said Liu, who believes the government will act to stabilize the capital market.

"The Chinese stock market is more sensitive to government policies than are markets in other countries. The leadership sees it as an important strategy to strengthen the capital market and will make it an attractive investment target for global funds."

He added that the capital market will be a key engine to raise funds to achieve the "Chinese Dream" initiated by President Xi Jinping. However, the regulations need to be improved to facilitate sound development, or unexpected volatility may cause systemic risks, the expert said.

He pointed to conditions on the ChiNext, where he said that some share holders have stakes of as much as 80 percent in a company. When the stock price rises, the major shareholders tend to reduce stakes without full disclosure. Under such conditions, prices can plunge and hurt small individual investors. According to Wind Information CoLtd, as of June 8, senior executives at 227 ChiNext-listed companies had sold shares worth 33.94 billion yuan ($5.54 billion).

"We should watch this situation closely. Those who hold more than 30 percent of a company's stock should be restricted when it comes to selling shares, and they should have to make timely disclosures. Independent directors should not be appointed by major shareholders, or the two groups may collude to manipulate a company's share price."

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