Chinese regulators have introduced a series of tough measures to vet the financial fundamentals of companies considering a public listing. The rule changes might force many companies to reconsider their plans to float. The aim is to ease the IPO backlog by weeding out under-qualified applicants and building investor confidence.
According to research from Deloitte, between 20% and 25% of IPO applicants might reconsider their listing strategies or withdraw their listings altogether in the first quarter of this year in the light of the new regulations.
China’s capital markets have a bad reputation beyond its borders, with corporate governance and transparency often seen as areas of concern.
"The China Securities Regulatory Commission is trying hard in general to clean up and to tighten China’s capital markets. The aim is to bring in ideals of best practice," says a capital markets banker based in Hong Kong. "Any regulatory changes should be seen in this light. The changes will make the market more profitable, will build confidence among investors and will ensure that the quality of IPOs listed is of the highest standard."
Underwriters and auditors of potential IPO applicants will be advised to thoroughly review the financial statements of companies looking to go public this year. Companies will have until the end of March to complete these inspections.
The Chinese Securities Regulatory Commission (CSRC) will also conduct its own examinations over the next couple of months. This will include the deployment of 15 teams to carry out comprehensive checks of the financial statements of between 20 and 50 companies currently on the IPO waiting list. Applications that are found to be incomplete or incorrect might face administrative and/or criminal punishment.
China’s IPO market has been put on hold for almost three months as regulators worry that any further supply will weaken the already saturated market. The number of IPOs awaiting approval from the Chinese securities regulator stands at 882.
Burdensome but beneficial
"The updated process for companies hoping to issue an IPO in China could be slightly more burdensome for them. But if it is the case that it puts them off from listing, this is probably a good thing. They obviously weren’t planning to follow the rules," says the banker.
In an additional attempt to ease the backlog, the CSRC has simplified rules for mainland companies seeking to list their companies offshore. Under the streamlined approval process, candidates will be able to send their offshore applications directly to the securities regulator in China.
Previously, companies wishing to list offshore needed preliminary approval from their provincial governments. The new guidelines also lowered net income and net asset requirements of the company in question.
According to Deloitte, the recent relaxation of the H-share listing requirements for mainland companies would spur some of the A-share IPO applicants to switch to H-share IPOs and list in Hong Kong.
After last year’s weak IPO market, "this year, Hong Kong has a strong potential to become one of the top three global IPO venues again," says Edward Au, co-leader of the national public offering group of Deloitte China in a statement.
There were numerous blows to Hong Kong’s IPO market in 2012. Graff, a London-based luxury jewellery company pulled its $1 billion IPO from Hong Kong because of weak demand; football club Manchester United decided to issue in New York because of poor sentiment in Hong Kong.
Advantage Hong Kong
Despite the need to improve on last year’s uninspiring IPO market, very few Chinese companies will be allowed to list. In line with current regulations and the high expectations of retail investors in Hong Kong, only high-quality Chinese issuers with strong fundamentals will be permitted to issue there. However, the net impact of the mainland reforms should eventually be to strengthen Hong Kong’s position as a home market for Chinese companies and as a global financial centre.
Transparency and due diligence in China came under the spotlight last month when Caterpillar, a US equipment producer, said it would be forced to write down the value of ERA, a small mining equipment company in China, by $580 million.
Caterpillar acquired ERA in June last year for $700 million in an effort to drive growth in its mining business in China. But it was soon discovered that the mining company had vastly overstated its profitability over several years by claiming fictional sales on inventory that couldn’t be found.
"Regulators are reacting in part to what has happened in the Caterpillar-ERA case. This was mainly an offshore issue, but it was still of huge concern to the regulators in China," says the capital markets banker.
It is understood that the scandal contributed to the departure of Luis de Leon, a vice-president at Caterpillar responsible for the mining-products division of the group.