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Taking Stock of Rule Changes

The revision of China’s Securities Law endorses a long expected and much debated reform for IPOs which is expected to be trialed on the new innovation board

By NewsChina Updated Jun.1

Big changes are taking place in China’s stock market, one of the world’s largest. At the end of April, the third draft revision to China’s Securities Law was opened for public comment until the end of May on the website of the National People’s Congress (NPC), China’s top legislature. It will be subject to a final decision by the NPC Standing Committee after that. The most important change is about how a company can be listed on China’s stock market, and by what standards. Calls for and controversy over the move have been swirling on China’s capital market for years.  
Actions have already moved ahead of words on paper. According to the draft, the new listing rule will be applied to the new science and technology innovation board, which is expected to become China’s Nasdaq. But while the draft is yet to be approved, the Shanghai Stock Exchange is reviewing more than 100 applications for listing on the new board on the basis of the principles of the new rules.  
As stated in the announcement of approving the trial by the NPC Standing Committee, the purpose is to pave the way for a more market-oriented floating system which can be potentially applied to the whole capital market. The current mechanism has long been criticized for excluding tech start-ups with current poor financial positions but growth potential, weak investor protection and for putting the assessment of a company’s prospects at the regulators’ discretion. The new system will focus on company information disclosure, crack down on irregularities in listing and trading and on letting investors decide whether a company, that either reports profits or losses during the listing process, is worth investing in. It is believed that the new board for tech start-ups is the right place to start the reform whose success can only be achieved under a legal basis.  

 Back and Forth
China’s Securities Law took effect in 1999, 13 years after the first corporate share was publicly traded in China and nine years after the Shanghai and Shenzhen stock exchanges were set up.  
As the size and demand of the market grew and the types of companies listed there became more diverse in terms of ownership, scale and sectors, there were calls for reform of the listing process and standards. Frustration among investors toward regulators surfaced in the aftermath of the 2008 global financial crisis, when China’s stock market fluctuated drastically, despite a strong rebound of the country’s economy which became the world’s second-largest in 2010. Analysts were divided on the causes of the significant market volatility and its deviation from the growth trajectory of the economy, but the listing system was widely agreed as the fundamental problem to address. Normally regulators are not responsible for market volatility or falls in share prices. But Chinese investors complained that regulators did too much on deciding what companies could be approved to be listed on what day and at what prices, but too little about cracking down on rampant irregularities, particularly insider trading, book cooking and corruption scandals involving some of the members of the committee that reviewed listing applications.  

“Companies that prove competitive in the future can’t usually turn a quick profit in the beginning. Distinguishing such companies from others demands market participants to have a deep understanding of the company, the related industry and the operators. Staff at regulatory authorities could not and should not make these judgments on behalf of investors,” Ren Zeping, chief economist with Evergrande, a Chinese property developer, wrote in an article on his WeChat account. 

In 2013, reform of the listing system was put on the agenda set by the Communist Party of China (CPC). Under the proposed new system, the quality of information disclosure, not the past financial performance of candidate companies, was the most important standard for listing. Stock exchanges will do the job of reviewing, while regulators will focus on law enforcement. Investors have more say on prices, and thus more responsibility for the results of their own decisions. The new system, called a registration-based system, is thought to be market-oriented, in contrast with the existing one led by regulators which is called approval-based.  

In April 2015, the draft amendment of the Securities Law, which aims to lay the legal foundation for the reform, was submitted to the NPC Standing Committee for its first reading. It was expected to be passed within the year. However, a stock crash two months later cast doubt on whether the market and regulators were ready for the reform.  

In December 2015, the State Council was given the right by the NPC to push forward the listing system reform toward a registration system before the Securities Law was revised. In April 2017, the reform leading toward the registration-based listing system was missing from the second revision draft of the Securities Law. When the State Council’s oversight of the reform expired in February 2018, the China Securities Regulatory Commission (CSRC) asked for an extension, reporting to top legislators that more time was needed to push the reform further as problems remained in building a multi-level capital market system, the maturity of traders and the capability of market players in pricing shares by themselves.  

Wu Xiaoqiu, vice president of the Renmin University of China, told NewsChina that no consensus was reached on a range of issues during the hearing on the draft, from what securities should be covered by the law to whether and how the step to the registration-based listing system should be taken.  The reform was finally launched in November 2018, when Chinese President Xi Jinping announced at the Shanghai International Import Expo the setting up of a science and technology innovation board which would try the registration-based listing rule.
Moving Fasttitle
Things have been moving fast since then. The new trading platform was approved in January 2019. The CSRC and Shanghai Stock Exchange published standards and the process of listing in the following two months. Reviews of applications for listing on the new board started in March. In an April meeting, the Political Bureau of the CPC Central Committee demanded the new board to implement the registration-based IPO system with information disclosure as the core standard. 

“In 2019, the biggest event in the capital market will be the launch of the science and technology innovation board and the registration system. The new articles in the third draft mean to ensure that the new board will be successfully launched, legally speaking,” Yin Zhongli, a research fellow at the Institute of Finance and Banking of Chinese Academy of Social Sciences, told NewsChina. 

According to the guidelines issued by regulators and the exchange and the latest draft amendment of the law, the new board will not make profitability and asset scale as the conditions for companies to go public. Instead, it is customized for technology companies that are often not qualified to be listed under the current system. “A science and technology innovation board will be meaningless without the registration system,” Wu said. 

“Under the highly market-oriented registration system, prices for the initial public offering of a company are set by the market, not issuers or regulators in advance. Some technology companies can be valued very low by conventional standards, but very high by investors on the new board even if they remain unprofitable at the time of listing,” Wu said.  

Some Chinese tech companies choose to grant more voting rights to certain proportions of shares held by founders and management. Some companies, especially internet ones, circumvented China’s policy limitation on foreign investment in their sectors through special arrangements by incorporating abroad but having their operations controlled by their Chinese founders. Prohibiting these companies with special shareholding structures from listing has been blamed for the absence of China’s internet giants like Alibaba and JD on China’s stock market, which had to seek listing overseas, notably on the Nasdaq.  

These bans have been lifted in the new board. Wu believes it is important to enshrine the changes in law to pave the way for the success of the new board. In this sense, he regards the adoption of the registration-based listing system as sending a clear message for the market-oriented development of China’s capital market. 

Meanwhile, more stringent penalties are imposed on irregularities under the amendment of the law. For example, anyone who is under investigation for irregularities can be suspended from trading securities for up to six months, compared with three months in the existing law.  The design of the science and technology innovation board embodies the essence of a registration-based IPO system in lowering the threshold and meanwhile reinforcing the supervision of information disclosure and punishment against financial fraud as well as strengthening supervision in the whole process, Ren said in his article.  

Ren suggested the reform toward a registration-based IPO system be pushed forward in China’s capital market on the basis of the experience and lessons from the pilot board.  However, Yin thinks the IPO system in China might follow a double track for some time, with some companies on the registration-based one and others not. In addition, Wu stressed that more laws, such as the Corporate Law, have to be revised to realize the reform. The test of the new board will certainly inform and bring new debates on the revision of the law.