China’s Public Equity Markets: Unwieldy and Outdated
A look at the rules, regulations, and structure of the country’s stock exchange system.
Over the last decade, many technology companies in China have been complaining about the strict listing criteria used by the local exchanges. The de facto profitability requirement was the key hindrance in the way of new economy firms striving to go public. In this article we dissect the country’s stock market and scrutinize its structure in order to figure out the inherent contradictions and challenges facing China’s financial system.
While numerous enterprises are willing to achieve a higher degree of transparency, boosting and diversifying their capital pool by filing for an IPO, the regulatory institution looks for a balance between “big” and “sporadic”, “quantity” and “quality”. A tradeoff exists between increasing the stock market participation rate (less than 10% of China’s population own stocks as of August 2019) and decreasing the inner volatility of the country’s public equity markets, as the two goals can’t be achieved at once.
The government is seemingly more into “quantity” so far: no thresholds for traders exist on the main boards of the Shanghai and Shenzhen bourses. This led to a preponderance of inexperienced investors on the local trading scene, with the volatility issue becoming more exacerbated.
Casino-like trading is not the only thing that turns businesses away from domestic exchanges. Daily price limits, which are designed to combat this irresponsibility, also scare private equity investors and other shareholders that often plan to gain large returns shortly after lustrous IPOs.
Since 1990, when both exchanges were founded, not too much has changed in terms of price limits. It is hard to say whether these are the proper brackets that China’s capital markets need. The fact is that they didn’t help to stabilize matters during the most recent period of turbulence (2015-2016). Many studies have proved that stock prices on both bourses are strongly linked to firm fundamentals. Thus, the value of limitations of this kind is open to debate.
Two bourses, four boards
Shenzhen, the city in Guangdong province, which is often called “China’s Silicon Valley”, was the major platform for stock market experiments. The country has established two boards within the Shenzhen Stock Exchange:
The SME board, which was designed to facilitate listings of small and medium-sized enterprises, kicked off in 2004. Although it allows small companies to go public, ameliorating the traditional model by adding extra channels to raise capital, the listing and maintenance rules don’t differ from those of the main venues. Almost 900 companies with over CNY 9 trillion in combined market capitalization are listed on the SME board as of September 4, 2019.
Hikvision (002415:SZ), Hangzhou-based video surveillance giant, is the largest among them with CNY 309 billion (USD 43 billion) in market cap. The state-backed firm serves the country as a core element of the public security system. The runner-up is a CNY 240 billion (USD 34 billion) energy corporation, China General Nuclear Power Group (003816:SZ), another state-owned business. Shenzhen-based delivery company SF express has the third biggest market cap in the venue at CNY 175 billion (USD 24.5 billion). It got listed on the SZSE through a reverse takeover deal completed in 2017.
The SME board was meant to be the first step in the implementation of comprehensive financial market reform. Since 2010, the SME Index has been continuously outperforming the A-share market index. Despite that, stocks on the platform are way more volatile than those listed on other marketplaces, except for one – ChiNext.
ChiNext, the first venue zeroing in on innovative businesses, was inaugurated in 2009. An attempt to provide the new generation of tech enterprises with another way to raise capital, it was called a “Chinese Nasdaq”. In fact, the submarket’s architects have adopted some of the practices from the American role model, creating more variety in terms of listing standards.
Nowadays, the platform is a home for 770 stocks of China’s major innovative firms, with a combined market cap of CNY 5.5 trillion (USD 769.65 billion). Global medical instrumentation manufacturer Mindray (300760:SZ) is the largest firm therein to date, its market cap is over CNY 220 billion (USD 30.82 billion). ChiNext index (SZ399006:IND), just like the SME board, has been outperforming both main boards for many years. However, it is so far the most turbulent marketplace in China, with the highest degree of volatility among all the platforms.
ChiNext was first mentioned twenty years ago, right before the “dotcom bubble”. The two crises had thwarted the plan of accelerated implementation, so it took Chinese regulators and lawmakers ten years to finally launch the Nasdaq-style platform.
Shanghai, the largest financial center of Mainland China, hadn’t been directly touched by the reforms, remaining a final destination for the solid state-backed infrastructure behemoths and financial corporations. ICBC (Industrial and Commercial Bank of China, 601397:SH), China Construction Bank (601939.SH) and Ping An Insurance (601318:SH) top the list, having CNY 1.95 trillion (USD 273 billion), CNY 1.75 trillion (USD 245 billion) and CNY 1.61 trillion (USD 226 billion) in market capitalization respectively.
Chinese government bets big on Shanghai, considering the city as a key pillar of both trade and finance systems. According to the World Shipping Council data, the Port of Shanghai is the busiest trade artery worldwide, with more than 41 million TEU shipped in 2018. At the same time, the “financial” component still lags behind, due to several fundamental reasons.
Currency is one of them: though the Chinese yuan was included in the latest version of the SDR basket in 2016, the “people’s currency” still represents less than 2% of the global allocated reserves. Another hindrance comes from the double standards for citizens and non-citizens: channels through which foreign investors can trade stocks in China are limited.
Although it is huge, the stock market in the country is not nimble enough. With rusty approval-based listing mechanisms and moss-grown stock maintenance regulations, the Shenzhen and Shanghai bourses are seemingly not capable of luring the new economy companies, especially those with enough scale to go public in the more advanced venues abroad.
Bulky markets, sky-high ambitions
The fundamental problems described above can’t be the only scapegoat in the present state of affairs. There is another red flag betraying fragility: the industry-level structure of the current listings.
China's stock market is filled with 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 proclaimed by the high-ranking Chinese officials isn’t reflected here: the sector grabs a tiny 7% share in the index. By comparison, IT companies represent more than a quarter of the total value of the CSI's American prototype – the S&P 500.
Another distinctive feature of China's emerging economy is 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, it is way more challenging for private companies that have no mighty state behind them.
Lately, Mainland China’s public equity markets are meeting a healthy demand from countless local startups that are queuing up to be listed on the local bourses. Nevertheless, the obsolete, bureaucratic system is scaring away the promising rookies that end up listed in Hong Kong or on one of the two New York exchanges. As of August 2019, 56 China-based companies with market capitalization exceeding USD 1 billion are listed in the States. Among them, the almost-half-a-trillion-dollars Alibaba and the oil and gas colossus PetroChina (PTR:NYSE).
To prevent a further stampede of successful businesses, resolve the exit overhang problem, and (maybe) lure back those who have already listed the stocks abroad, China’s regulators have initiated the new stock market reform, preparing the ground for the germinating local startup scene; in this effort, the Science and Technology Innovation Board, known as the Star Market, was recently launched as a new trading venue on the Shanghai Stock Exchange.
While miles of road lay ahead, China's public markets have already started shifting towards a more balanced trading system designed to help technologically advanced companies to attract more equity capital.
Read more about the country's latest attempts to reform its clumsy capital markets.