Dissecting New 'China’s Nasdaq': What is the SSE Star Market?
COVID-19 and China
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Making considerable progress in VC and tech industry development, China still lacks a transparent, well-organized primary market institution that may support local tech upstarts all over the 'public' way.

Even a hasty glance at the industry-level structure and the major companies that are listed on the two local marketplaces (the Shanghai Stock Exchange and the Shenzhen Stock Exchange) might provide a deep insight into the problems hanging in the air.

China's stock market is filled by hulking state-owned financial corporations such as the 'big four' commercial banks (Bank of China, the China Construction Bank, the Industrial and Commercial Bank of China, and the Agricultural Bank of China) that severely outweigh other categories: the sector accounts for 44% of the CSI 300 total value.

The pivotal role of the IT industry that is often emphasized by high-ranking Chinese officials hasn't found any reflection here: the sector grabs a tiny 7% share in the index. By comparison, IT companies represent more than a quarter in the total value of the CSI's American prototype, S&P 500.

Another distinctive feature of China's emerging economy – insignificant healthcare companies' presence in the index: the ultimate goal of providing 1.4 billion people with decent medical services is still far from being reached. Furthermore, this race is way more challenging for private companies that have no mighty state behind.

Throughout the last decade, we’ve seen a bunch of tech behemoths (including record-breaking Alibaba) that went overseas to undertake a successful world-class listing. This strategy of prominent Chinese enterprises used to be a win-win one before the recent trade tensions appeared – 'big picture' doesn't seem to be the same anymore.

Changing international landscape and chaotic macroeconomic shocks make China encounter risks that can't be controlled domestically. Interim results of the trade war and the market experts' negative expectations resulted in the recent poor performance of stocks traded in Mainland China: the Shanghai Composite Index dropped 13% in early May this year as a result of the new restrictions imposed by the U.S. government. Before that, the SCI sank almost 30% (from the peak of 3558.13 on January 21, 2018, to 2493.90 on December 23, 2018) during last year, affected by the same forces.

The tech industry is also struggling: Huawei's story is viral nowadays. And there are some more firms are being under the gun. However, those forecasting even fiercer trade combats now could settle down for a while, observing China's fundamental attempts to protect its lately incubated companies and, maybe, to lure those tech heavyweights listed overseas back home (by that, ensuring the sustainability of the economy's supply-side and global competitiveness).

New problems, new solutions

Leakages matter when it comes to economic growth. How to stop crucial processes such as brain drain and capital outflow? There are only two known ways so far: restrictions or improvement. Measures of the first type don't fit the modern era (most of the autarky-like countries aren't doing well lately). Seemingly, the only reliable method here is to create proper conditions inside. And China tries to.

The Shanghai Stock Exchange STAR Market started its history as a narrative in November 2018. Xi Jinping, President of the PRC, announced the project during the 1st China International Import Expo in Shanghai.

"We will launch a science and technology innovation board at the Shanghai Stock Exchange and experiment with a registration system for listed companies." – Xi Jinping.

Science and Technology Innovation Board (STIB) was an original name broadly used to describe the upcoming trading platform until the official opening on June 13 when the new venue got the name of SSE STAR (Shanghai Stock Exchange Sci-Tech innovAtion boaRd) Market (a bit far-fetched, indeed).

The establishment of the STAR Market is among the key steps taken to increase the degree of control over local innovation as the number of nascent concerns about external technology barriers is accruing. Risk mitigation is what this is all about.

What makes the STAR shine?

Talking about trading venues, the first thing to consider is, admittedly, barriers to entry, including financial requirements and liquidity requirements that must be met by the applicants. A particular firm's executives ponder the options existing before they choose a marketplace to file for an IPO.

The macro-level factors, such as currency of listing and legal environment, matter; however, more practical issues come first. Marketplace thresholds and requirements for both the supply (companies to be listed) and demand (investors) sides shape the way of operational routine at the venue and, more importantly, define the scale and the number of economic actors that can join the league.

Obviously, in the eyes of the want-to-be-listed tech firms, the new board will have an absolute advantage over the existing Chinese sub-platforms. That won't be a hard task to lure those that had been preparing to submit listing applications in Shanghai or Shenzhen (for these companies, the better offer appeared as the manna from heaven).

As a result of this, a comparison between the supply-side requirements of the "local old" and of the "local new" is arguably pointless. What's of the greater importance is how the new board can look like by the side of Nasdaq in terms of financial listing requirements.

With the publicly traded share capital proportion at the level of 25% for the small-sized (or just barely traded) companies, the SSE STAR IPO thresholds are more stringent. However, in practice, this barrier is low: the minimum value of shares to be issued by a specific company at the STAR venue amounts to CNY 7.5 million (less than USD 1.1 million).

At the same time, Nasdaq requires its clients to have a publicly-traded shares market value of at least USD 8 million. While this might find favor with average companies, global juggernauts will think twice before list one-tenth of their total share capital.

As can be seen, the new tech board governors are intended to accept non-profitable firms (we haven't seen such companies so far though): positive net income is considered in only one of the five criteria. It is a novelty in Mainland China, but globally it has become a new normal. A bunch of companies that were unprofitable in the year leading up to their IPO went public through the U.S.-based platforms lately. And investors love them.

The attempt to emphasize importance (it is a "Sci-Tech board" after all) of the R&D expenses by proposing the second option is logical. This segment, in our view, is going to be a bellwether of the entire "STAR project". Its size and share in the stock exchange records will provide insights regarding the real state of matters. As of early June 2019, 107 out of 123 companies that submitted documents have chosen the first standard. Evidently, the system is unbalanced and needs to be further improved.

At first glance, we may think that the new venue provides more variety. But this is just another fallacy. Nasdaq's set of options exhaustively covers critical performance indicators that speak for themselves. Selectivity is among the features of the American board, the gauges are clearly stated, and the four standards are more authentic, there is no room for the "Quality factor".

Unlike Nasdaq, SSE STAR cares about how much a total company costs and what part of this value is freely circulating within the marketplace. The inclination for risk mitigation caused the need to be aware of the more detailed picture; merely knowing what's up for sale isn't about the regulators like the CSRC.

As for the "Quality factor", it doesn't seem to be a real "market" criterion due to the fuzzy formulation. The fifth standard looks like a channel for financing massive (half-unicorn-sized) government projects. In short, the "experimental" nature of the new board hasn't caused an eagerly anticipated shift from the state-backed listing prevalence to a more market-like model.

The first steps in swaddling clothes

As mentioned above, the new venue took its rise in early November 2018 when Chairman Xi first proposed it. Seven months later, it formally started operating. We dissected the process of the SSE STAR Market's development to several steps. 

1. Another top-down initiative? Sure. 'Being brought in by the national leader' is a tried method for getting viral in China. For one, Belt&Road Initiative gradually makes China play the first fiddle in the region over the last five years.

2. China Securities Regulatory Commission previously presented itself as a pretty tight player that isn't willing to take unnatural risks. This time, the state body combats its clumsiness by initiating the internal restructuring. It is worth mentioning that CSRC has obtained an enormous amount of relevant experience while operating the SME board (2004) and ChiNext (2009) -- two submarkets within the Shenzhen Stock Exchange.

3. Central Economic Work Conference is an annual gathering of Chinese policymakers, one of the core events in the course of national economic policy coordination. Held in late 2018, the meeting called for accelerating the launch of a science and technology innovation board on the SSE and experimentation of the registration system.

4. One of the leading country's reformatory units, Central Comprehensively Deepening Reforms Commission, proposed a plan and a guideline both on launching the new tech board and experimenting with the registration-based IPO system. From here, the new marketplace started taking shape.

5. The CSRC issued the "Implementing Opinions for the Establishment of the Science and Technology Innovation Board on the Shanghai Stock Exchange and the Piloting of a Registration System". The public draft announcement was used to check the water before crossing the river. Although the timing of such undertaking is questionable (it mainly fell on the winter holidays accompanying Spring festival), the regulator collected needful data from the potential tech board stakeholders.

6. Resulting from the public discussion initiated at the previous step, SSE issued complementary rules such as the "Rules of the Shanghai Stock Exchange for Reviewing the Offerings and Listings of Stocks on the Science and Technology Innovation Board", officially opening the front door to the STIB and the registration system.

7. "Circular on Issuing the Guide to Business Processing of Sponsors in the Issuance and Listing Examination System for Stocks on the Science and Technology Innovation Board of the Shanghai Stock Exchange" was the full name of the document issued by the Shanghai marketplace. It portended the start of the STAR Market operation.

8. The official application process for the companies that had been keeping their eyes on the new venue development began. Twenty-eight firms submitted the documents within the first two weeks after this date. The other 47 business units joined them in the following two weeks. As of June 19, 123 companies are waiting for either the SSE's response or the final listing on the marketplace.

9. The SSE STAR Market was launched. Simultaneously, Yi Huiman, Chairman of the CSRC, made it abundantly clear that the local stock exchange ecosystem will be improved shortly. Inchoate marketplace's early-stage experience will help to unwrap the pack of more comprehensive financial reforms.

The new industry mechanisms need a careful and bold implementation in order to get fully fueled as spacious room for the stock market development exists in China. Let's depict this room: Global integration ante Omnia? China represents over 10% of the global stock market, but international participation has been meager, with foreign investor quotas unfilled.

Another dimension – presence of the internal actors. The stock market capitalization-to-GDP ratio is indicative of the supply side. And the figure has been fluctuating in the corridor between 40% and 70% throughout the last ten years, while it surpassed a 100% mark in the developed countries a long ago (for example, in the case of Japan it peaked at 127% in 1989). The demand side is also far from perfect: with a household saving rate of 37% in 2018, China is among the thriftiest nations worldwide.

Long story short, three components allow us to conclude that the potential of capital markets in China is vast: underperforming foreign sector, low supply, and washy demand. Believing that tech will dictate the future, the country leaders exert their efforts in the way of creating healthy conditions for the upcoming possible game-changers. Besides, luring the abroad-listed industry giants back home might also be fruitful. Both things don't seem to be simple, though.

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