China’s top securities regulator recently unveiled a much-anticipated guideline to bring the country’s initial public offerings system closer to a registration-based mechanism, paving the way for ending a year-long hiatus of new stock issuance.

The guideline, which came as a surprise on the last Saturday of November, has an array of market-oriented changes on information disclosure, pricing and distribution of new share sales. It aims at improving transparency at every step of the listing process while reducing regulatory interference.

“The regulator will focus on the compliance review of IPO paperwork, rather than making judgment on the profitability and investment value of issuers,” the China Securities Regulatory Commission said in a statement together with the release of the guideline.

Prospective issuers and IPO managers should ensure the authenticity and integrity of the information they disclose  while investors should evaluate the risks and make investment decisions based on their own judgment, said the CSRC.

The securities regulator said the implementation of the guideline is an interim for China to finally replace its IPO approval system with a registration system that is widely used in mature capital markets.

China’s IPO approval system has long been criticized for its opaque vetting process, under which the CSRC has the absolute power to decide whether a company is qualified to go public. While with a registration system, regulators would check only the validity of a company’s information disclosure. 

“The guideline sets a course toward a registration-based listing mechanism, reflecting the regulator’s resolution to build a market-oriented and law-based capital market,” said Daniel Li, chief accountant with PricewaterhouseCoopers Zhong Tian LLP.

Li said the transition to a registration system would not happen overnight, but it would be a step-by-step process that requires a compatible legal system.

Lin Jin, an analyst with Shenyin & Wanguo Securities, said the major obstacle to install a registration system for IPOs is that the Chinese securities law has set the legal basis for examination and approval of public listings. The law is likely to be amended in 2015.

In the wake of a sweeping reform package released after the Third Plenum of the Central Committee of the Communist Party of China, the new IPO rules underscore the central government’s pledge to allow the market to play a “decisive” role in allocating resources.

Without interference

The new rules allow prospective issuers and IPO underwriters to schedule their IPOs within 12 months of receiving regulatory approval. They will also be able to determine the price and allocations of their share offerings without regulatory interference.

The CSRC said the liberalization will allow issuers to time their listings debuts according to market conditions and enable stock pricing to better reflect market supply and demand.

“One of the highlights in the guideline is that it boosts brokerages’ independence in new share sales, helping them to improve bargaining ability and cultivate long-term relationship with institutional clients,” said Wei Tao, an analyst with China Securities. 

Meanwhile, the CSRC noted that more liberalization doesn’t mean deregulation. Thus, the guideline also includes measures to curb overpriced IPOs, tightened regulation on post-flotation and strict penalties on irregularities.

According to the guideline, issuers should disclose detailed information of their IPO pricing process. It also requires controlling shareholders, directors and senior managers of the prospective listing firm to promise not to sell their holdings at below the IPO price within two years after their lock-up periods end.

Under the new rules, the CSRC will no longer accept applications submitted by sponsors of listing firms that post a more than 50 percent drop in profits or report losses in the first year after going public, unless the issuers have reminded investors that risk in prospectus.  

A listed firm will be ordered to buy back all the shares in its first sales if it was found to have made false disclosure that would invalidate its qualification for a listing, according to the guideline.

Chinese investors have long been burnt by “window-dressed” IPO documents and inflated issue prices.

In many cases, new shares hit the market with stunning first-day gains, only to turn into a downward spiral once IPO insiders have grabbed their profits and run. Individual investors are left holding the bag.

“The emphasis of the new IPO guidance on adopting more stringent information disclosures and transparent pricing mechanism is positive because it will reinforce public confidence in the capital markets,” said Moody’s Investors Service in a note.

With a liberalized listing rule, China’s stock market is set to reopen for new issues after a 13-month moratorium. The securities regulator said around 50 companies will be ready for IPOs by the end of January after preparatory work is done.

China’s IPO market has been frozen since last November in a regulatory bid to crack down on fraud and misconduct, leaving more than 760 companies in the backlog of IPOs. Some even have been waiting for more than five years. The CSRC said it will take about a year to review all of these companies.

The resumption of new listings is expected to give a boost to China’s brokerage industry that has suffered from the persistent downturn in the stock market and an IPO moratorium.

Benefiting brokers

The IPO hiatus led to a drop in investment banking revenue at Chinese securities firms to 10.6 percent of their total operating revenue in the first half of the year, compared with 13.9 percent a year earlier, according to the Moody’s.

“Securities firms will be direct beneficiaries of the reopened IPO pipeline and broader reforms because these developments could mark the beginning of a sustained increase in their investment banking income,” said the rating agency.

“Aside from boosting overall profitability, the reforms will help reduce their heavy reliance on a traditional brokerage business and proprietary trading, which accounted for more than 70 percent of their operating revenue in the first half of the year.”

However, the upcoming reboot of IPOs spooked investors who worry that a glut of IPOs could divert funds from the secondary market. 

ChiNext Index, a gauge of China’s Nasdaq-style board of growth firms, plunged 8.3 percent on the first trading day after the guideline was unveiled, the biggest single-day slump since the board was launched in October 2009.

“The ChiNext, which is obviously overvalued compared with its international peers, will be hard hit as 43 of the 83 companies that passed regulatory scrutiny are going to list on the board,” the UBS Securities said in a note.

However, Everbright Securities said although the restarting of IPOs will depress the market in the short term, it won’t change market fundamentals.

“The reform of the listing mechanism untangles the relationship between the market and the government, helps to improve the quality of listed firms and strengthens protection on investors,” said the broker, “All those would benefit the healthy development of the stock market in the long run.”