The solution for China’s ‘Cursed’ IPOs

Written by Victor Fan || 12 Aug 2013

Throughout the history of capital markets in China, public listings, or IPOs in the Chinese A-share market have been suspended 8 times; we are currently in the 8th suspension period. The modern Chinese stock market is only about 23 years old and of that, IPOs have been suspended for nearly four and a half years, which makes up almost 20% of the market's history. There is still no actual timetable to reopen the IPO market, but according to some market information, it could be possible at some time in August or September, 2013.

In theory, the main purpose of IPOs is to raise capital to meet the funding needs of Chinese corporations. However, in China, it seems that the nature of IPOs has changed long time ago. The offering prices of new shares listed are always very high when the A-share markets are performing well. Individual and institutional investors are still crowding into the market to apply for purchasing new shares before the first trading day of that stock despite the high PE ratio. Then, on the first trading day of the new stock, the transaction volume is normally extremely large due to irrational speculative behaviour. The stock price usually fluctuates dramatically during the first trading week after the IPO. Some investors make a lot of money from IPOs, but someone else needs to pay for that because that is a zero sum game. Often the biggest beneficiaries of IPOs are the senior managers of the listing firm due to their ownership stake in the private company.

When the market is not performing as well, such as after the 2008 financial crisis, the IPOs can sap what little liquidity is available in the market, so in some extreme situations, the CSRC will halt IPOs to prevent falls in the stock prices. However, the suspensions don't really seem to make a difference: in the former 7 suspensions, only 4 times has the stock index risen during the suspension periods which is an indication that suspension of IPOs is not really the solution.

In western markets, if accounting fraud or insider trading is discovered in a public company, it is possible that the company could be delisted from the markets. However, in China, as the supervision is not so strict and serious bribery and corruption exists, the probability of finding these problems is quite small. Once listed, there is almost riskless from the delisting perspective as the delisting mechanism is so immature. So the CSRC and other related Chinese government institutions tried other ways to deal with the ‘lake dam’ of IPOs in the A-share market, such as developing OTC markets, the growth enterprises market board and the SME board. Stronger supervision and auditing behaviors from the CSRC in the previous few months has forced some pre-IPO firms to stop queuing for IPOs in the A-share markets. They may try to get themselves listed in Chinese OTC market, growth enterprises market board, SME board or even a foreign exchange.

Financial market analysts are quite worried about what will happen when IPO listings start again. The stock index is currently at a very low level and investors are still suffering from great losses or even are just avoiding trading in the A-share market altogether. New IPOs will likely fail in a market without confidence and that is what CSRC officials need to consider. Regulators have been very generous recently for foreign investors by increasing the QFII quota, because they know fewer and fewer Chinese investors are willing to pay for the bills and they must get money in regardless where the money is from.

From our point of view, a more mature delisting mechanism would help support the stock market. However, in the longer-term, the transformation of Chinese economy and political system are thought to be the best solution for solving IPO problems. After all, helping to improve business and economic performance is one of the goals of a mature stock market.

Kapronasia Newsletter

Sign up for our email list and stay up to date with our latest insights.