Beijing regulators may have effectively hosed down the rash of redc-hip shares creating fever symptoms among investors and over-competitive stock exchanges.
Frustrated by a moribund domestic market, Chinese companies have been flocking overseas to raise money. Many have been using the fast-track method of converting themselves into foreign investment holding companies. Now new rules promulgated by the State Administration of Foreign Exchange (SAFE) are lengthening the approval process for IPO-hopefuls going that route.
If the change in regulations inhibits the stampede of newly minted red chips onto foreign bourses, it may be no bad thing. Experience shows that the further away companies travel from a natural demand for their shares, the less liquidity they command in the marketplace, after the initial speculative splurges.
Hong Kong is the obvious platform for listings of mainland Chinese companies by reason of size, proximity, language, culture and market depth. The Hong Kong Exchange hosts 83 red chips headed by heavyweights China Mobile, the CNOOC oil group and Bank of China (Hong Kong). In addition, there are 72 H shares of companies whose parents are incorporated in China. The biggest of these are PetroChina Co and China Petroleum and Chemical. As of March 31, the value of the red chip sector topped US$180bn or 21.5% the total market capitalization. It has taken the Hong Kong Stock Exchange one full cycle of the Chinese calendar to reach that position.
Since the emergence of China as the world's fastest growing economy, there has been an unseemly stampede by international stock exchanges hungry to grab a slice of the action. Singapore has been especially fast out of the blocks in listing 60 red-chip counters, which now account for one in 10 of the shares quoted in the City Republic. The Stock Exchange of Singapore became a little nervous in the middle of last year – and introduced tougher disclosure rules on the newcomers and urged investment bankers and lawyers to be more diligent.
When trouble came, the culprit boasted such blue blooded credentials that it could well have been rated, not just a red, but a purple chip. Chinese Aviation Oil (CAO) arrived in town with a monopoly on importing aviation fuel. As a state-owned company, it had the implicit backing of the Chinese government. The Securities Investors Association, a de facto watchdog for small investors, awarded CAO its "Most Transparent Company Award". The CEO, 43-year old Chen Juilin was named one of 40 "New Asian Leaders" by the Swissbased World Economic Forum.
You could also see what was coming. But nobody did. Dealings in CAO shares were suspended following news that the company had blown US$555m speculating in oil futures. It seems trading limits were ignored as Chen bet the company on world oil markets being wrong about the price of oil.
It is highly unlikely that any outside agency could have spotted the dodgy dealing before CAO's tardy disclosure. But it was a black eye for red chips. And Singapore suffered some collateral damage. No stock market is free of scandal. Hong Kong has had its share, and evidence crops up almost daily of corporate chefs cooking the books on Wall Street.
China continues to hit the economic ball right out of the park. International investors find it hard to understand why that is not being reflected in the domestic share markets, which are struggling along at six year lows. Part of the answer is that, although the rules for listed companies are in place, there is little or no effective enforcement. Controlling shareholders, be they communist party officials, families or entrepreneurs, often have little grasp of the fiduciary duty they owe minority shareholders.
The concern must be that these deficiencies are in some cases carried over when companies are granted a quotation overseas.
Bob Broadfoot, who runs Political and Economic Risk Consultancy in Hong Kong, has been watching the birth pangs of Asian equity markets for 30 years. "As Chinese companies increasingly look to world markets to fund their transition, outsiders will be affected. The record is not good," he said. Broadfoot said the CAO affair reflected low accountability and lack of transparency of many Chinese companies.
Stock exchange peddlers
Why then are emissaries from stock exchanges around the world wearing the carpets thin in China peddling their wares as the best places to list? A dozen bourses, including NASDAQ, the American Stock Exchange, London, Toronto and Tokyo, turned up at a seminar in Shenzhen last October. The New York Stock Exchange was not in evidence. A score of Chinese entities have NYSE listings. The premier stock market is tightening up its rules for companies following the Sarbanes-Oxley Act imposed in the wake of the Enron scandal.
The London Stock Exchange has gone so far as to open an Asia-Pacific office in Hong Kong in hopes of snaring small to medium size red-chip IPOs for its 10-year-old Alternative Investment Market (AIM). Customers are wooed by promises that no trading records will be required, no prior approval from market officials for transactions, and no minimum numbers of shares in public hands.
That does not send a very good message. The LSE hints that the US market has become very prescriptive and that London is still swinging.
It all sounds like a Fee-for-All: Listing fees for the exchanges, fees for the investment banks arranging the floats, and fees for the lawyers arranging the paper work.