China unveils a series of market-oriented reforms for the stock markets

Two weeks after the Third Plenary Session of the 18th Central Committee of the Communist Party of China (CPC) which promised the boldest reforms in the world's second largest economy, China's securities regulator became the first to dash toward that goal by announcing a market-oriented reform for the stock markets.

The China Securities Regulatory Commission (CSRC) on November 30 released four documents on regulating stock markets, including measures for market-based change in the initial public offering (IPO) issuance mechanism, preferred shares, better protection of investor interests in cash dividends and stricter scrutiny of backdoor listing. The securities watchdog promised to streamline the IPO approval process while strengthening supervision over listed companies.

This is the first time that the CSRC has released such a comprehensive set of policies. The move was felt in the stock markets, as the ChiNext Index, which tracks China's Nasdaq-style board of growth enterprises, nosedived 8.26 percent¡ªthe biggest single-day slump since the establishment of the board¡ªon December 2, the first trading day after the new policies were made public. Experts, however, say market-based reform measures will help build more mature stock markets, leading to healthier development of the markets in the long run.

Focal points

The reform of the IPO issuance mechanism has attracted the most attention among all the measures announced by the CSRC, and is seen as a key step in overhauling a lengthy approval process and changing it into a system based on registration.

The CSRC said it will turn China's IPO issuance mechanism from an approval-based system to a registration-based one, in which the market will play a bigger role in judging the risks and value of listed companies. This is in line with decisions made at the Third Plenary Session of the 18th CPC Central Committee, which promised the market a "decisive" role in resource allocation.

"After our audit of the sector, when and how new shares are issued will be under market constraints and will be independently decided, pricing of shares will more closely reflect true levels of supply and demand," the CSRC said in a statement.

China used to adopt the approval-based IPO system, whereby new listing candidates need to go through a complicated application process that can take multiple rounds of reviews and several years to receive approval from the regulator.

Under the new registration-based IPO system, the CSRC will only have the responsibility to decide whether companies follow the rules. The value and risks would be for investors and the market to judge.

"We will expand the scale of information disclosure and make our review standard and process more transparent. We will open the IPO process up to the public so that they can have closer supervision over the issuance process," said Deng Ge, spokesman of the CSRC, during a press conference held on November 30.

He said the plan will serve the purpose of protecting small and medium-sized investors by safeguarding their right to know, right to participate, right to supervise and right to claim compensation.

Listings on the mainland stock markets have been put on hold since October 2012, with around 700 firms waiting for IPO clearance.

Deng predicts that around 50 companies would be able to complete their registration procedures for IPOs by the end of January 2014.

The IPO reform does not amount to deregulation, the CSRC stressed, saying it would toughen up monitoring and increase punishments for non-compliance. It dealt with 46 cases of incomplete or deceitful information disclosure from January to October this year.

The CSRC also announced details of a trial run of preferred share issuance by Chinese firms listed on mainland markets.

China has decided to launch a trial for preferred stocks to meet actual demand. The preferred stock trial will lead to many positive results, such as boosting companies' direct financing activities, helping commercial banks innovate their capital products, meeting the diversified needs of investors and facilitating the mergers and acquisitions among enterprises, Deng said.

A separate document released by the CSRC put a greater emphasis on the protection of investor interests in cash dividends.

Cash dividends by listed companies are a fundamental policy in the capital market that can effectively strengthen appeal for investment. The new rule aims to protect the interests of small and medium-sized investors, according to Deng.

The proportion of listed companies that offered cash dividends has increased to 68 percent in 2012 from the 50 percent in 2010, according to data from the CSRC. The ratio of cash dividends by listed companies rose to 24 percent from 18 percent during the period.

The CSRC said it will continue to urge listed firms to standardize and improve their profit allocation, increase dividend transparency and diversify their ways of paying back to investors.

Requirements for a backdoor listing are currently lower than those for an IPO. Candidate companies and brokers have been seeking backdoor stock market listing as an easier alternative to an IPO.

To that end, the CSRC said candidates aspiring for a backdoor listing will have to meet the same requirements as for an IPO. It has also prohibited any candidates for backdoor listing from acquiring a listed shell company on ChiNext and getting listed on the board.

Deng said the new requirements will also help curb investors' speculation activities on listed companies with poor performance. It would essentially reduce incentives for insider trading and eventually help establish an effective mechanism for delisting.

Long-term benefits

Despite the fact that new policies have sent ripples through stock markets, the reform measures are believed to benefit the stock markets in the long term.

Zhao Xuejun, CEO of Harvest Fund Management, said he was impressed with the scale of the reform this time.

He believes the reform plan will strengthen the information disclosure responsibility of all market players, tighten punishment for non-compliance, and, most importantly, it will rationalize China's IPO pricing mechanism by expanding current pricing scales, Zhao told Xinhua News Agency.

Ye Tan, a financial commentator, said a reshuffle in the stock markets is necessary, referring to the massive sell-off on ChiNext after the new policies were revealed. "The growth enterprise board is now often used for market speculation, which has raised the prices of listed shell companies. The new ban on backdoor listings in the growth enterprise board will put the board back on the right track."

Liu Rui, deputy dean of the School of Economics at Renmin University of China, said more emphasis on cash dividends and an increase of dividend proportion will help keep long-term investors in stock markets. "The stock markets have long suffered from the problem of no dividend payment or too low proportion for dividends, which has driven long-term investors away."

Pan Dengxin, Director at the Finance and Securities Institute at Wuhan University of Science and Technology, said more needs to be done to clear out junk stocks.

"Since 2012, a lot of progress has been made in delisting. But the new delisting scheme hasn't been perfectly integrated with old policies, leaving room for market speculation. No mercy should be shown to trash stocks and delisting should have a more deterrent impact."