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January 13, 2014

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Home » Business » Finance Special

Investors braced for repeat of rollercoaster

China’s beleaguered stock markets enter a new year amid hopes that a series of reforms will improve transparency, root out corruption and restore investor confidence.

The first real test of the new regulatory framework will come as the nation resumes initial public offerings after more than a yearlong ban that was imposed, in part, because of weak market performance and scandals surrounding new shares.

Among other changes are new measures to allow qualified companies to issue preferred shares and to expand over-the-counter stock trading.

Markets watchers have generally welcomed the reforms.

“We believe they will result in a better supervised and healthier capital market,” said Frank Lyn, Beijing-based China and Hong Kong markets leader at PricewaterhouseCoopers. “This will instill confidence, while creating systemic guarantees for the market.”

IPO Resumption

The highlight of China’s stock market in 2014 will be the reopening of IPOs, testing new rules that aim to scale back high offer prices and rein in speculative chasing of new shares.

Approvals for new listings came much faster than expected, with 50 companies having received the regulatory nod to go public as of Friday. Eight of them have started to take subscriptions for their IPOs last week.

To better align offer prices to companies’ fundamentals, the new rules require issuers to weed out at least 10 percent of the highest offers made during the offline subscription bidding process, which is mainly open to institutional investors. That means bidders with higher prices are not necessary guaranteed the number of shares they seek. 

However, offer prices disclosed by IPO candidates still remain high, compared with industry peers. Most companies are pricing their shares at more than 30 times earnings.

Still, there are signs of strong appetite for new shares among retail investors, who expect the first batch of IPOs to be of high quality after undergoing strict regulatory review. 

Some analysts said offer prices will come down eventually as the frequency of IPOs brings more rationality to the market.

UBS Securities estimates that a record 350 to 400 IPOs will be launched on domestic exchanges in 2014.

Preferred shares

Regulators are moving toward the launch of preferred stock issues as a new funding channel for companies and a diversified instrument for investors.  

China’s securities regulator is soliciting public opinion on draft rules governing preferred stock, following the State Council’s decision to launch a pilot program on such share issues.

Market watchers said they expect the rules to be finalized as early as this month, enabling qualified companies to sell preferred shares shortly afterward.

Preferred stock is a hybrid financial instrument that has properties of both equity and debt. It has priority over common shares in dividend payments and in liquidation proceedings, while holders of preferred shares have no voting rights in most cases.

“For fundraisers, one of advantages of selling preferred shares is that it offers an equity financing tool that does not water down the value of existing common shares,” said Pan Xiaoguo, analyst with Guosen Securities.

Moreover, preferred stock can help issuers raise money even in a bearish market, when common shares are hardly appealing. Holders of preferred shares receive fixed dividends that are not affected by fluctuations in a company’s share price.

The stable dividends offered by preferred shares make them attractive to value-oriented long-term investors.

The China Securities Regulator Commission said earlier that it would allow financial institutions, Qualified Foreign Institutional Investors and RMB Qualified Foreign Institutional Investors to invest in preferred shares. Individuals with assets of more than 5 million yuan (US$820,000) can also invest in the shares, said the regulator.

According to the draft rules, the pilot program will first be open to 50 companies tracked by the SSE 50 Index, which are 50 largest stocks of good liquidity on the Shanghai Stock Exchange.

Analysts expect banks to be the biggest beneficiaries from the launch of preferred stock.

“The new tool enables China’s commercial banks to raise funds to meet the tougher Basel III capital requirements without adding pressure on common share investors,” CITIC Securities said in a report earlier.

The draft rules also said that issuers can use funds raised from sales of preferred shares to buy back common stock. A buyback allows listed companies to reduce the number of shares and boost their valuation.

China’s securities regulator has been encouraging underperforming companies to buy back shares. However, buybacks in China are still relatively uncommon because companies prefer to invest their cash in business operations.

With preferred shares, issuers can buy back common shares without burning their cash resources.

And, compared with bond financing, preferred share issuance will not increase debt ratios.

“The launch of preferred stock is expected to encourage a round of buy-back activities in the stock market, especially among blue-chip companies with low valuations and high debt ratios, and help to boost market liquidity,” CITIC Securities said in a separate report.

OTC market

China’s over-the-counter market gained new momentum after the central government expanded it nationwide last month, providing a new fundraising platform alongside the Shanghai and Shenzhen stock exchanges.

The expansion allows qualified companies across the country to transact equity on the OTC market, also known as the New Third Board. The board was open only companies in four industrial parks in the cities of Beijing, Shanghai, Tianjin and Wuhan.

China set up its first OTC market in Beijing’s Zhongguancun Science Park in 2006 as a pilot project to provide a financing channel for non-listed start-up firms that have difficulties borrowing money from banks.

According to the China Securities Depository and Clearing Co., 260 companies will list shares on the OTC board on January 24, bringing the total number of listed firms to 615 from the current 355.

PricewaterhouseCoopers estimates that more than 5,000 companies will be trading on the board in the next five years.

Along with the expansion, the regulator will allow OTC-listed firms to move their shares to stock exchanges when they meet listing requirements, further boosting the OTC market’s attractiveness to small and medium-sized enterprises thirsty for cash. 

There has been concern that the expansion of OTC market may divert funds from exchanges, but Zhou Jintao, an analyst with China Securities, said the expansion is unlikely to have significant impact on the stock market due to the limited size of the OTC board and its high thresholds that would keep many retail investors out.

Under the current rules, individual investors with securities assets of less than 5 million yuan are not allowed to invest in the OTC market.

Meanwhile, a market-maker rule has been introduced in the OTC equity market, under which brokerage companies will quote both bid and offer prices and facilitate the trading.

“The introduction of market-maker rules will largely boost the trading activity on the OTC market as well as its investment value,” said Huang Binhui, analyst with China Galaxy Securities.

 




 

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