Back in business?

With mainland equity markets recently recovering from their dizzying falls of 2008, Qian Guohua, a 60-year-old retail investor, took the opportunity to sell most of his holdings. He managed to recoup his losses, but market volatility has convinced him to sit on his cash for now.

"I am luckier than many of my friends, but I don’t want to be involved in speculation anymore," said Qian, a retired worker in Shanghai. "No one knows where the market will go the next day. I’m actually waiting for the resumption of [initial public offerings], as newly listed stocks often bring good returns."

China has not had an IPO on its own bourses since September 2008, as the global financial crisis has taken its toll on the economy and corporate profit margins. Now, investors like Qian are hoping that the hiatus may soon end. The government has vowed to help capital-stripped firms combat the worsening business climate, and new listings are one weapon in its arsenal. In March, Shang Fulin, chairman of the China Securities Regulatory Commission (CSRC), said his staff were deciding on the best time to restore new equity sales as well as introduce a new IPO pricing system.

Sources close to the CSRC said IPOs are likely to return in May, starting with small firms. A growth enterprise market (GEM) is to be set up at the same time, to be patterned after New York’s NASDAQ exchange, with an emphasis on smaller, cash-strapped technology companies that exhibit solid growth potential.

"The premise of the GEM’s launch is to change the IPO pricing and issuance system," said Tang Yonggang, chief strategist at Hong Yuan Securities. "Without doing that, things won’t improve."

Beginning with the establishment of China’s stock market in 1990, and through to the early part of this decade, negotiations between investors and issuers played only a minor role in pricing domestic IPOs. Although the CSRC adopted a book-building system in 2005, which let institutional investors consult with issuers to fix IPO prices, retail investors have complained about the large allocations given to institutions.

Currently, the stock-sale process is divided into offline and online subscription periods. The offline period comes first, during which sponsors invite institutions for initial price consultations, and set a price range. Based on the range, institutional and corporate investors then bid for a tranche of the new stock sale, usually 30% of the total, and fix the IPO price. Big, cash-rich institutional investors can also participate in the subsequent online subscription for the remaining 70% of shares, also open to individual investors.

"That’s clearly not fair," said investor Qian. "Institutions set the price and get the lion’s share of the stocks. For us, if you deposit RMB1 million (US$146,000) in a subscription, you’re lucky if you can get one lot."

Dodgy dealings

The CSRC has also found that some institutions quote unreasonably high prices during initial consultations with underwriters and later choose not to bid. A higher price range would translate into a higher IPO price, which in turn would boost the size of the stock sale and increase underwriters’ commissions.

Such activities led the Securities Association of China in February to ban a broker and a fund manager from taking part in the IPO price-setting process for three months, while issuing warnings to 34 other brokers and fund managers. The CSRC hasn’t revealed any cases of direct profit transfers between stock issuers and institutional investors.

Whether or not there have been direct profit transfers, observers say the system is in need of reform.

"The price-consultation system must be improved in order to protect the interests of minority investors," said Hua Sheng, an economist and principal of Yanjing Overseas Chinese University. Hua suggested that the initial price consultation process should be scrapped, letting all institutions directly bid for the institutional tranche to fix an IPO price.

Not all agree that the system should be scrapped. Li Daxiao, director of the research unit of Yingda Securities, said that the CSRC should simply order institutions to place deposits during the initial price-consultation period. An institution quoting a price but not buying a certain number of shares at that price would lose its deposit. Li also suggested that the regulator could separate the individual and institutional stock-sale processes by banning institutional investors from participating in the online subscription period.

To some investors, though, reforming the IPO pricing mechanism is merely cosmetic. They argue that China’s equity market can only become fair and balanced if more fundamental issues are addressed.

"Just reforming the system is not enough," said Xu Xiaojin, a 28-year-old designer. "We want stable market performance of quality shares … A mechanism must be set up to prevent big institutions from flipping a large chunk of shares soon after their purchase."

Chance for renewal

There are also concerns that the resumption of IPOs, such as through the introduction of the GEM, could drain capital out of existing shares. A glut of new shares flooding the market – some newly listed, others newly unlocked – helped drive down stock valuations down in 2008.

However, earlier fears that the GEM might siphon capital from existing main markets have eased as it has become clear that new bourse will be focused on smaller capital raisings, and then only on a trial basis. Observers say it will be more likely to help than hurt market confidence.

"To resume IPOs when the market valuation is still low will likely lay a good foundation for the index to rally," said Qiu Yanying, an analyst with TX Investment Consulting. "The resumption may give the market a new birth."