Looking through Essence of the SSE Star Market Regulations
Our take on the rules of China's headline-hitting tech board.
The Shanghai Stock Exchange Science and Technology Innovation Board, known as the Star Market, was announced by China’s leader at the first China International Import Expo held in Shanghai last year.
Intending to fit into the modern global economic landscape, China has been undertaking systematic reforms in the most fundamental fields. For one, the Belt and Road Initiative, which was first mentioned in 2013 and then launched in 2015, aims at increasing transregional integration, bolstering the presence of Chinese capital in numerous (more than 70) countries. At the same time, infrastructure development and cross-cultural communication are emphasized as the key pillars of the initiative.
The financial sphere – the ‘blood-vascular system of the economy’ – is the next area to see improvement in this regard. The Chinese government has started from its essence – equity markets. The latter has a bad reputation and is widely derided as erratic and volatile.
While volatility is, indeed, among the most vital characteristics of a certain exchange, it is not the only one. The degree of transparency is another important issue that market regulators should zoom in on. An extensive list of other dimensions across which to compare different bourses exists; however, market size and stock variety are arguably the first and the second factors both investors and companies ponder over when considering whether to enter public equity markets.
The four things mentioned (volatility, transparency, size, stock variety) need to be targeted by a certain marketplace in order to improve internal conditions, thereby attracting more high-quality listings and experienced traders. It is paradoxical that these ‘explanatory variables’ are affected by the quantity and quality of the market players as well.
We may confidently call this a vicious circle. Highly volatile, non-transparent, small, and non-diversified markets become even worse as the companies and investors – which can potentially improve the ‘big environment’ – opt for other exchanges, get acquired or just stay private, waiting for better conditions.
For these two groups, whether to join an exchange (either by listing or capital allocation) is a binary choice. Thus, ceteris paribus, the comprehensive ‘marketplace value’ – a combination of the abovementioned parameters – is a function of two components: firms and public equity investors. Companies and traders mostly consider four groups of factors when making their decisions: ecosystem and big environment, regulations, existing alternatives and the marketplace’s ex post records.
The first variable indicates current macro circumstances, including the political, social and cultural environment. It is rather objective and can’t be directly changed by the rule-makers (at least, in the short run).
Noteworthy is that there are two groups of alternatives: firstly, other domestic and foreign marketplaces; secondly, other kinds of investment, including debt financing, mezzanine capital and non-IPO types of equity financing.
Rules and regulations are seemingly the only component of this equation that can be altered in the short term. And this is what the new board is basically about – the new rules. There are two types of requirements in regard to public equity marketplaces: for listings and for traders. As China’s regulators need to address the problems of transparency, volatility and variety, a fresh venue must be different from the existing ones in terms of both sets of rules.
The registration-based IPO system is an absolute novelty of the Star Board, which is expected to replace the obsolete approval-based mechanism putting Chinese cash-strapped businesses through the mill of the regulator’s scrutiny.
Under the old system, the China Securities Regulatory Commission (CSRC), a top market watchdog, normally inquired about various aspects of applicants’ businesses, making them wait for a quite long time (usually, more than 18 months). With the new listing method was applied, the venue became in a class of its own in China, being conceptually closer to the leading bourses in western countries.
'Time is money'
In a nutshell, an IPO is just another way to raise money for the expansion of a certain company’s business, cementing the market position and other development-related purposes. The time spent during the application process (including time in the ‘queue for an IPO’) is a vital factor for startups in fast-growing China. Before the Star board was founded, it usually took local companies 2-3 years, a huge stock of patience and a tiny bit of luck to successfully go public on one of the country’s marketplaces.
(Read more about the recent exit overhang in China)
This bureaucracy often turns promising businesses away from the local trading platforms. One of the most famous stories so far refers to Xiaomi (1810:HK), which once applied for a listing in Shanghai, and then got asked 84 questions, including “Why does Xiaomi position itself as an Internet company?”
This ended up with Xiaomi making a Hong Kong Stock Exchange listing. Later on, the firm announced its intention to issue CDR (Chinese Depositary Receipts) – the Chinese answer to ADR that still remains on the drawing board. It might shape the next possible step in the way of the comprehensive financial market reform.
The new vetting system has shrunk the review process duration to just a few months. For example, the first batch of the Star market stocks was finally confirmed in less than 100 days after the application. Sixty-nine days sufficed for Hangke Technology (688006:SH), a Hangzhou-based battery test equipment producer, to go through the five stages from ‘application received’ to ‘registered for an IPO’.
A drop in the number of links in the application process chain has significantly reduced the duration of the vetting procedures and ‘queuing up’. By running down the presence of the market watchdog (CSRC), China has greatly simplified the IPO registration process.
Nevertheless, as the recent practice has shown, the system is still tightly regulated: on August 26, Eversec, a Beijing-based cloud security services provider, became the first company to be rejected by the CSRC despite having passed the vetting process and despite being approved by the bourse.
Being way higher than any exchange in the current state structure, the regulator, evidently, stills calls the shots. This case is an illustration of the ‘Chinese characteristics’ broadly discussed these days. Moreover, the central government is likely to hold the power of veto in the long run as well, in order to insure against any perils and systematic risks.
Not for everyone?
The new requirements for investors is the first major change in the trading rules made when the venue was launched. As it is quite obvious that volatility has a lot to do with the professional attitude of the mass-market players – individual investors of different kinds – the new attempt to limit irrational behavior was made by the market shapers.
Traders that opt to register an account on the new platform must have at least two years of related experience and more than CNY 500,000 (USD 70,200) at their command. While it doesn’t sound like an insurmountable obstacle for under-qualified trading (they may easily make transactions through ‘experienced’ acquaintances for a small fee, for instance), the new standard has symbolic meaning: the regulators made it known that the trading venues might be even harsher to the market users in the near future.
At the same time, Chinese tech startups got a huge relief in terms of listing standards. The Star Market is the first board in the country’s financial sphere that doesn’t require its applicants to be profitable. There are five different options for the potential candidates for an IPO at the venue, and only one of them contains profitability as a key requirement.
This set of options much resembles the SSE’s American peer – the Nasdaq Global Market with its four standards. There are two things worth emphasizing in this regard. Firstly, the Chinese board still doesn’t look ‘transparent’, as the fifth standard creates a room for ‘non-market’, state-backed IPOs.
Besides, the delisting criteria are also based on this list, and companies that fit more than one of the options are thereby likely to choose the safest way to keep the lights on continuously after the public debut. And this is exactly what is happening right now.
As of August 2019, 131 of the 153 applicants to date intend to go (or have already gone) public under the first standard (‘profitability’), while 10 firms, half of which have gotten listed on the board, opted for the ‘revenue’. As mentioned above, a handful of tech firms that fit several criteria at once chose the ‘profitability’ standard.
Several other novelties regarding the pre-IPO requirements on the Star board exist. Red-chip companies – businesses registered in China but incorporated and listed abroad – are allowed to list their stocks on the new marketplace. There are two listing standards designed for such firms. Besides, shares with weighted voting rights (WVR) are also welcomed (with another two distinct standards for such cases).
As of September 11, 2019, only three companies of these types have applications on the sci-tech board. One of them is personal transportation juggernaut Segway-Ninebot (A19108:SH), the firm providing self-balancing scooters and other micromobility devices for Lime, Bird, Uber, Lyft and the like. One of the few yet-to-be-profitable firms on the Star Market, it has responded to the bourse’s inquiries two times, making it clear that this listing is a serious deal for the company.
While the new board has definitely become a big deal in China, it is still somewhat structurally unbalanced. There is a spacious room for further improvement of the stock market-related institutions.