IPO momentum builds as regulator relaxes oversight

Linklaters partner Paul Chow agreed, telling CLP he thought the government was “really trying to make the whole IPO and pricing process much more market-driven”. Another capital markets specialist said attempts were being made to bring the PRC's system more into line with international systems.

The Opinion talks of reducing administrative guidance and preventing phenomena such as “high quotes without buying” and “low quotes with buying high”.

In many jurisdictions, including Hong Kong, the practice is for underwriters to carry out a book-build exercise involving making a circuit of investors and asking them to make bids. Although there is no legal requirement for bidders to make a purchase, market practice says the bid is binding. Before the Opinion was issued, the practice in mainland China was also for underwriters to make a circuit of institutions; but instead of asking for a bid, they would ask the investors what they thought the shares were worth and there was no related obligation to buy at that price. This could result in institutions putting in high quotes (bids) without an eventual purchase being made, or giving low quotes when they would in fact be willing to pay a higher price to purchase the shares.

“[The Opinion] is in effect saying there has to be some sort of legally binding or market-based mechanism to ensure investors will put in realistic bids which they have to back up with their money,” said Antony Dapiran, a partner of Freshfields Bruckhaus Deringer.

“If you bid low, you shouldn't be going in and buying high,” added Chow. “The whole point is to make sure the pricing process fairly reflects the market price.”

Shifting the balance
Another trend reflected in the Opinion is the effort to shift the balance in favour of retail investors.

Mainland China has not traditionally had a restriction on making multiple applications for IPOs. (By contrast, in Hong Kong there are two distinct tranches during an offering – the institutional and retail tranches – and investors may only apply under one of these.) There were two methods of applying for shares, known as online and offline, and there was nothing to stop investors applying on both sides. Section 2(2) says they must now choose only one method: “… any one private placement target may opt to subscribe the new shares either offline or online, but not both.”

“[The Opinion] is also to do with making it a more fair process,” said Chow, adding that a proposed cap of 0.1% on online subscriptions would make the advantage for institutional investors
“much smaller”.

There was previously limited provision for clawing back shares from the institutional side if demand from retail investors was higher than expected. But at a recent press conference, a CSRC official said the regulator had received feedback that people wanted to improve the clawback mechanism. The new Opinion, in section 1(2), obliges underwriters to do this, pushing mainland China toward an international market standard.

Dapiran acknowledged this move as a “step in the right direction” but said there is room for implementing regulations.

“It is still very vague and principle-based; there are no concrete rules,” he said. “It is also interesting that the Opinion pushes the obligation to the underwriters rather than the regulator to devise these measures.”

Hong Kong's system also gives the underwriters responsibility for implementing a clawback mechanism, but includes far clearer rules on how they must do this.

So, is the new Opinion bad news for institutional investors?

“Institutional investors would probably prefer the old system, but I think it's fair and is moving to align with international practice,” said Chow. “A healthy capital market has to balance the needs of retail and institutional investors – it's working towards the right direction.”

Next in line
China State Construction Engineering Corporation (China Construction) will be the next big company to list in Shanghai. The China Daily said recently that the home building company, which is state owned, has completed the transfer of 1.2 billion shares to the national pension fund. This is a sign of an imminent listing, and was done to fulfil a requirement found in new measures designed to help alleviate China's social security problems.

The Implementing Measures on Enrichment of National Social Security Fund by Transferring Part of State-owned Shares in the Domestic Securities Market (境内证券市场转持部分国有股充实全国社会保障基金实施办法) were jointly issued by the Ministry of Finance, State-owned Assets Supervisory and Administration Commission, China Securities Regulatory Commission (CSRC) and National Council for Social Security Fund in mid-June 2009.

Under the measures, companies which sell shares must transfer state-owned shares equivalent to 10% of their IPO to the National Social Security Fund, instead of selling them. The lock-up period on these shares will be extended by another three years.

“This is expected to have a positive effect on the stock market overall – boosting market stability and investor confidence,” said Hubert Tse, managing director and head of Yuan Tai PRC Attorneys.

The requirement will also enlarge the pool of funds in the Fund, a result which is expected to stimulate consumers' consumption power.

“However, there are no details regarding next steps for such state-owned shares after the new extended lock-up period,” added Tse.

Early in July, China Construction filed a prospectus with the Shanghai Stock Exchange which revealed plans
to raise around US$6 billion through the issuance of up to 12 billion A-shares. It set the offer price at the top of its price range, and “slightly below market price” according to the company's chairman. The IPO is the world's biggest in over a year.

Additional reporting by Tom Young (Asialaw) and Rachel Evans (IFLR)