China’s Star Market burns bright in coronavirus gloom
Shanghai’s new Nasdaq-style bourse has done more IPOs and raised more capital than any Chinese exchange – including Hong Kong – during the Covid-19 crisis. Questions remain, but so far the Star Market has been a resounding success.
While most of China’s bourses have stalled during the coronavirus crisis, its Star Market has roared.
The new bourse opened for business in June 2019. Modelled on New York’s Nasdaq, it has since completed more initial public offerings (97) than the far older main boards in Shanghai (36 IPOs over the period) and Shenzhen (24 IPOs), according to data from Dealogic.
Since China’s markets reopened on February 2 after Lunar New Year – before Covid-19 peaked in the mainland and the curve started to flatten out – most exchanges have struggled to reignite primary activity. Between the start of February and April 14, the Shanghai Stock Exchange (SSE) completed eight IPOs, raising a total of $1.06 billion. For Shenzhen, the count is six successful listings worth $504 million.
Then there’s the Star Market, with its tally of 15 listings and $3.4 billion in freshly generated capital. Even Hong Kong’s main board – 15 IPOs since the start of February, worth $658 million – can’t keep pace. Greater China’s two main growth markets, Shenzhen’s ChiNext and Hong Kong’s GEM, also trail in its wake.
For global investors keen to put their money to work in good mainland stocks and in a venue they can trust, the new bourse is welcome, ambitious – and anomalous.
The Star Market (or the Science and Technology Innovation Board, its rarely used formal title) was designed to be different from the start. Overseen by the SSE and the China Securities Regulatory Commission (CSRC), the main securities regulator, it differs from other onshore bourses in seven key ways. All are important and a huge departure from the norm in a country whose leaders have long feared and distrusted the inchoate nature of stock trading.
The Star Market matters because China is very ambitious about turning Shanghai into a financial hub able to go toe to toe with Hong Kong on a global footing - Eugene Qian, UBS Securities
First and foremost, the new market runs a standard registration-based system for all new IPOs, modelled on the main boards of New York and London. That means approvals based on facts and merit – no more waiting for officials in Beijing to give the nod of approval to a favoured state-owned enterprise (SOE).
Loss-making companies, still rebuffed with extreme prejudice by the Shanghai and Shenzhen stock exchanges, are actively embraced by the Star Market. So are firms with dual-class share structures and so-called ‘red chips’, Chinese firms incorporated and listed outside the country.
There are stiff penalties for rule-breakers – a major failure to disclose data leads to a compulsory delisting. That’s designed to eradicate the stop-start nature of China’s older bourses, where firms often flout listing rules then suspend and resume trading when the storm subsides. No delisted firm is allowed to reapply.
Two final measures stand out. A market-based underwriting mechanism, standard elsewhere but new to China, allows the size and speed of an issuance to be set by the market, with institutional investors paying a far greater role in pricing.
Listing reviews are carried out very publicly and transparently. The number of customers a company claims to have; its stated revenues and profits (or losses) and R&D spend; every inquiry from the regulator and each reply from the firm and its sponsors: it’s there for all to see.
It’s impressive and not before time. Politicians and regulators hummed and hawed about a more transparent and worldly stock exchange for years, before president Xi Jinping, eager to frame China as a champion of globalization, gave it the nod in November 2018. The new board is very much the president’s brainchild and is set up “to pick Chinese winners”, notes one investment banker.
So why now? A key reason is that it has no other choice. China “can no longer rely on inward FDI [foreign direct investment] to balance its books,” says Kenneth Koo, deputy general manager of Citi Orient, the US bank’s onshore broking business. “It doesn’t have unlimited money any more, not for the size of its economy and the issues it is grappling with. So opening up its capital markets fits nicely into its overall macroeconomic model.”
Beijing’s leaders know the economy is suffocated by unproductive SOEs that also dominate its bourses. This stymies China’s ability to avoid the middle-income trap and to become a rich and developed state. “If its capital and financial markets aren’t working well, nor will its economic model,” adds Koo.
It’s also a hugely capital-hungry country that burns through money far too fast and cannot generate enough of its own. It needs foreign help, both in the guise of professional underwriting advice from investment banks and from global investors as they snap up ever-larger blocks of mainland-listed shares.
But foreign investors won’t buy any old assets. “The country’s primary problem is an imbalance of too much liquidity and too few good investable assets,” notes a senior official at a big four professional services firm. “Its markets are big but dominated by state firms that most funds don’t want to buy.”
At a macro level the Star Market is designed to make China’s capital markets “more relevant and more in tune with the country’s size and ambition” says Eugene Qian, chairman of UBS Securities, the Swiss bank’s majority-owned onshore brokerage and advisory joint venture. While at a micro level its purpose is to convince good private firms that their future is best served by pursuing a listing in Shanghai and not, as is often the case, in Hong Kong or New York.
Will it work? So far the jury is out. Xiaomi’s plans for a $10 billion dual Hong Kong-Shanghai IPO two years ago was viewed by mainland regulators as a potential landmark moment. They saw the smartphone maker as a pioneer of Chinese depositary receipts (CDRs), then a newly-devised secondary listing mechanism. When the instruments began trading, they reasoned, other technology giants including Nasdaq-listed Baidu and Alibaba, whose shares trade in Hong Kong and New York, would follow suit and issue their own CDRs.
It didn’t work out that way. Xiaomi struggled to answer a list of 84 questions posted online by the CSRC, with the regulator also expressing concerns the IPO was overpriced and could wipe out retail investors if its shares underperformed. In the end Xiaomi opted for a sole listing in Hong Kong, where it raised $4.72 billion.
The regulator learned from that loss of face and the Star Market was designed with simplicity in mind. Bankers note that some of the firms actively engaged in talks with the bourse are already listed abroad. The list includes Junshi Biosciences and CanSino Biologics, both of whose shares trade in Hong Kong.
But turning the Star Market into a playground for next-generation firms won’t be easy. A New York listing is “the dream of most entrepreneurs in China,” says Michael He, a co-founder and head of technology at Beijing-based augmented reality firm WiMi Hologram, whose IPO raised $26.1 million and began trading on the Nasdaq on April 1.
A New York ticker “gives you a good global image, and credibility,” he adds. “If you want to do business internationally, it is a big help. Plus, the US market has the best liquidity in the world. China is trying to build a stock market that follows the pattern of the Nasdaq. But I don’t think they can compete, even in the long run.”
Still, the new bourse is a clear sign that Party leaders are finally taking the image of their stock markets seriously. That it is happening just as global index providers expand their reach into China can be no coincidence – the MSCI in March 2019 said it would increase the weighting of onshore-listed A shares in its global benchmarks from 5% to 20%.
It is also proof that the authorities are serious about giving Shanghai a much needed upgrade. “The Star Market matters because China is very ambitious about turning Shanghai into a financial hub able to go toe to toe with Hong Kong on a global footing,” says UBS Securities’ Qian.
Eugene Qian, chairman of UBS Securities
Another banker notes that with the advent of the new bourse, Hong Kong’s advantage over its mainland peers – its execution speed, higher liquidity, lack of capital controls and better legal system – “starts to narrow”.
It’s a trailblazer in other ways. Since the creation of Shanghai’s SSE in 1990 and its Shenzhen cousin a year later, China’s bourses have largely been a retail playground. Retail investors control around 80% of the market, leading to higher volatility, mispricing and decisions based on speculation rather than solid research.
“This has been its biggest problem, one that really bothers regulators,” says a Hong Kong based banker. “It’s a weakness. Retail isn’t smart, isn’t professional, is short-term. And every time there was a fraud with a listed firm or a stock crash [like the one in 2015] retail investors will show up at the door of the CSRC to protest.”
For small investors, lacking the ability to launch class-action lawsuits or to rely on regulatory arbitration, such as that meted out by the US Securities and Exchange Commission, public action and anger is often the only way to get heard.
There is always a sword of Damocles hanging over us, in that it’s up to us to compensate investors when egregious failures come to light after an IPO - Investment banker
So whenever internal fraud leads to a company collapsing and being delisted, the regulator’s instinct is to point the finger of blame at underwriters. “There is always a sword of Damocles hanging over us, in that it’s up to us to compensate investors when egregious failures come to light after an IPO – even before authorities determine who is at fault,” says an investment banker.
This is also a key reason why the approval-based IPO system clung on for so long. For officials at the CSRC it was easier to accuse an underwriter of negligence in the wake of a corporate collapse than to blame the whole system.
By contrast, the Star Market is designed “to cater to institutional investors from day one,” notes an investment banker. That’s a key factor for the many foreign banks now allowed to control and own a majority stake in their onshore joint ventures.
The new bourse began with a bang, with 27 listings in July 2019, raising a total of $5.9 billion. Activity then tailed off and picked up later in the year. The first firm to list, in June, was integrated circuit maker Suzhou HYC. UBS Securities was the first foreign bank to sponsor an IPO on the new bourse, helping Haohai Biotech to raise Rmb1.5 billion ($212 million) in October.
Rules state an issuer must be a legal joint-stock company with at least three years’ business history, be audited and have a sound internal control system. There can be no ownership disputes over assets, core technologies or trademarks, or changes in ownership over the past two years. And each successful candidate must meet one of five listing criteria, based on its annual revenues, income and R&D spend.
The market has been inundated with listing requests – sources say even before it opened for business it got more than 150 IPO submissions. There have been complications. While the entire process, from initial discussions to listing day, is around eight months, against several years on China’s traditional bourses, there are tales of delays as the system gets up to speed.
Valuations have cooled somewhat after a frantic first few months of trading marked by high volatility – exactly what regulators feared. Still, the market’s price-to-earnings ratio stood at over 62 times forward earnings on April 15, against 43 times for the ChiNext and 13.38 for the Shanghai composite index.
This is both a curse and a blessing. Valuations tend to be higher in China than almost anywhere else, a consequence of the size of the market and an associated lack of desirable and investable assets. That attracts new candidates but also acts as a deterrent to mainland firms already listed on a foreign bourse and fearful of pricing a new batch of shares at the top of the market.
So far, any concern the regulator would err on the side of inaction with rule-breakers proved wide of the mark. On April 13, the CSRC barred Ningbo Ronbay New Energy and Zhejiang HangKe Technology from tapping public markets for fresh funding for a period of one year. The two firms, both in a large batch of companies that listed in July 2019, were punished for failing to disclose links to a customer that failed to pay its bills.
Still, the censure did little to dampen the ardour of investors. Both stocks dipped a little before rebounding. At the close of trading on April 15, Zhejiang HangKe’s shares were trading at a forward multiple of more than 40 times earnings, with Ronbay trading at a multiple of more than 50.
It is too early to call the new market a success. That will only be clear if more good local firms choose to list there. Regulators will surely be pained by the decision of WiMi to list in New York and of biopharmaceutical firm Akesobio to sell shares in Hong Kong. Akesobio’s stock began trading on April 17, after it raised $333 million.
So far, however, the signs are good. That the new market is so transparent means there is nowhere for IPO applicants to hide. If problems such as hidden fraud or related party transactions come to light after the listing, it is the issuer not the underwriter or the regulator who will hang for it.
Such clarity is doubly helpful in that it opens the door to others to do the regulator’s work for it. When a company files for an IPO, its whole financial setup is laid bare. That, notes Citi’s Koo: “Opens the door to a competitor to perhaps blow a whistle and tell regulators if they believe a listing candidate doesn’t have X number of customers or patents, or level of income. And the CSRC does get anonymous letters that can hold up a listing application.”
It’s all part of a wider push to get more of the financial system online. In January, long before new cases of coronavirus peaked in China, regulators issued rules that force underwriters, issuers and auditors to adhere to a wholly digitized listing process. Plans are being readied to transpose the Star Market’s structure, including stiffer delisting rules and an IPO registration process, onto the ChiNext board in the second half of 2020. The main boards in Shanghai and Shenzhen should follow.
Questions persist. Will local private equity firms see it as a possible listing venue for parts of their portfolio? What of the possibility of foreign firms being added to the fold? Bankers tell of foreign chief executives feeling them out about a Star Market listing. For both groups, the main reason not to pursue a listing on Shanghai’s new bourse is the simple but intractable issue of capital controls.
That is not a permanent deal breaker. It remains to be seen what kind of world will emerge from the Covid-19 pandemic. China may surprise everyone by loosening not tightening capital controls in an effort to make its stock markets roar and to create a new generation of world-beating companies.