IPO reform not going as planned

On November 30 2013, the day the 14-month IPO freeze was lifted, the China Securities Regulatory Commission (CSRC) issued the Opinions on Further Promoting the Reform of the System for Offering of New Shares (关于进一步推进新股发行体制改革的意见) (Opinion), in order to relieve burdens and give flexibility to the IPO of Chinese companies. But continued troubles with high issuance prices and an imbalanced stock market led the CSRC to issue the Measures for Strengthening the Regulation of Offerings of New Shares (关于加强新股发行监管的措施) (Measures) on January 12 2014 to promote transparency in the IPO process. By February 16 2014, 48 Chinese issuers completed their share offerings and 45 issuers got their shares listed on the stock exchange.



Historically, the high average price earnings ratio (P/E ratio) and high issuance price (relative to other stock exchanges) of the newly issued shares are normally followed by a drastic decline shortly after the IPO. This has been widely criticised by the public. The new laws aim to resolve this; the new issuance statistics indicate positive effects on controlling the issuance price of the newly offered shares. However, there are certain limitations due to the regulators' lack of practical experience in shifting from an approval-oriented to a registration-oriented share offering system.

The recent IPO suspension of Jiangsu Aosaikang Pharmaceutical (江苏奥赛康药业股份有限公司) (Aosaikang) confirmed the problem still exists. Aosaikang had a P/E ratio (67) higher than the average (55.31) of listed companies in the same industry, as well as excess cash-outs at the time of offering. The Measures were issued immediately following this event to increase scrutiny of the IPO process and promote fairness of the stock market.

Manipulating the issue price

The comparably high P/E ratio in the A-share market has attracted foreign investors to the PRC domestic stock market and investments in the pre-IPO companies. The CSRC has consistently controlled new share prices so as to protect public investors from a drastic decline of share price once publicly listed. This market-based IPO reform strengthens information disclosure requirements and reduces CSRC intervention as the issuance price will be set by the market, specifically by the issuer and lead underwriter based on the results of price inquiry. The Opinion also reinforces the responsibility trace mechanism (事后追究机制) for all related parties and imposes punitive sanctions on those who violate the fiduciary duty or collaborate with secondary market investors to fix an unreasonably high issuance price.

To promote stability in share prices, the Opinion also restricts the controlling shareholder, director or senior officer from transferring/cashing out their shares within two years following the expiration of their lock-up obligation, if the price of the shares then is lower than the issuance price.

But recent cases revealed that controlling shareholders have worked around this restriction and directed issuers to lower the issuance price by removing high price quotations and decreasing the number of investors with valid quotations. This adversely affected those who invested before the IPO, especially investors who participated in the IPO's offering of existing shares. Under the new Measures, issuers and major underwriters are now required to publish frequent reports during the price inquiry and roadshow processes informing investors of the risks and impacts of valuation.

We therefore advise foreign investors to actively oversee these processes, and prevent controlling shareholders and directors from depressing the issuance price.

Cashing out at IPO

Based on the PRC listing rules, shares issued to investors before the IPO must not be transferred within one year following the IPO, and shares held by the controlling shareholders are subject to a lock-up period of three years following the IPO. This lock-up requirement has been substantially relaxed by the new Opinion; existing shares held for no less than three years are allowed to be transferred on the secondary stock market during the IPO, provided there is no change of control after the transfer. This has been used far more than the CSRC expected.

According to the statistics provided by Wind Info, the existing shareholders of 39 out of 45 issuers transferred their existing shares at the IPO, collecting a total of Rmb10.717 billion (US$1.74 billion). The disclosed offline subscription of Aosaikang revealed that funds generated from the transfer of its existing shares amounted to Rmb3.2 billion – far above the amount raised by the IPO (Rmb784 million). This stark difference is also evident in Sunrise Technology (杭州炬华科技股份有限公司), GuangDong Qtone Education (广东全通教育股份有限公司), Beijing ECHO Technologies (北京安控科技股份有限公司) and seven other newly listed companies.

Foreign investors must pay attention to the number of existing shares offered by the controlling shareholders and the investors at the IPO. There is speculation that implementing rules are being written to this number so as to prevent too many from being cashed out.

Future prospects

In accordance with the Decision on Major Issues Concerning Comprehensively Deepening Reforms of the Central Committee of the Communist Party of China (中共中央关于全面深化改革若干重大问题的决定), the Opinion and Measures have symbolised the transform from an approval-oriented share offering system toward a market-oriented, registration-based system. This is good news to foreign investors looking for investment opportunities in China, as it entails an increase in portfolios listed on the A-share stock market as well as an exit channel more conducive to selling shares on the secondary market.

Foreign investors should also bear in mind that, though the Opinion and Measures have been influenced by western IPO systems, the CSRC has yet to relieve the burdens and standards of IPO approval; the process is still riddled with administrative interventions. The loopholes that give way to deliberate depression of the issuance price against market principles as well as transfer of too many existing shares during the IPO must also be carefully monitored.

Despite controversy over the policy reform, the new system shows a positive trend. Firstly, the CSRC will focus on information disclosure, legality and pro forma compliance during the application process instead of making judgments based on the issuer's profitability and investment merits. Secondly, the CSRC will improve the efficiency of its examination and approval procedures, raising the quality of issuers on the A-share market. Thirdly, the transfer of existing shares during the IPO will allow foreign investors to cash out without being restricted by the one-year lock-up, encouraging them to make early-stage investments to satisfy the three-year holding requirement. Lastly, the Opinion restricts the controlling shareholder, director or senior officer from transferring existing shares for two years after the lock-up expires, if the share price then is lower than that issued. This provides investors with a share price stability guarantee.


Jason Liu, Zhong Lun Law Firm, Beijing


More from CLP:
Regulatory Guidelines for Listed Companies No.4: Undertakings of De facto Controllers, Shareholders, Affiliated Parties and Acquirers of Listed Companies and of Listed Companies, and the Performance Thereof
Measures for Strengthening the Regulation of Offerings of New Shares
Rules for the Preparation and Submission of Information Disclosures by Companies That Offer Securities to the Public No. 26: Special Provisions for Information Disclosures by Commercial Banks (2014 Revision)
Why the IPO reforms don't go far enough
Opinions on Further Promoting the Reform of the System for Offering of New Shares
Guidelines on the Disclosure of Major Financial Information and Information on the Business Position Since the Financial Report Audit Date in Prospectuses for the Initial Public Offering of Shares and the Listing thereof of Companies
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