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Opinion

Shanghai tech board opens door to broad China IPO reform

STAR Market can bring change if it steers past fraud, red tape and speculation

Just eight months after Chinese President Xi Jinping unexpectedly announced plans for a new share board for the freer trading of technology stocks, the Shanghai Stock Exchange's STAR Market is set to begin trading on Monday.

The STAR Market's rules mark a bold change from current practice in China but whether it will truly bring about a new era for the country's stock markets remains to be seen as the specters of fraud and speculation dog domestic companies as much as ever.

The new board has a narrower target than previous initiatives, which were spearheaded by the Shenzhen Stock Exchange and aimed more broadly at private companies and startups.

The notion this time is to draw in and channel funds to homegrown companies with cutting-edge technologies in areas like artificial intelligence, big data, cloud computing and advanced materials. Beijing hopes this will persuade promising local companies to list at home rather than in the U.S. while also providing a test bed for broader stock market reforms.

Over the past 20 years, Chinese tech companies like Baidu, Sina, JD.com and Alibaba Group Holding have flocked to New York for their initial public offerings. Sixteen Chinese companies have listed in the U.S. so far this year, with more in the pipeline, attracted in part by the prospect of escaping the clutches of Beijing's capital controls.

Over the past 20 years, Chinese tech companies like Alibaba Group Holding have flocked to New York for their initial public offerings.   © Reuters

The STAR Market could change the calculus of such companies if it can sustain its promise of quick and easy listings. Rather than the traditional yearslong process of applying for IPO approval from the China Securities and Regulatory Commission, the new board has a simpler registration-based system like major foreign exchanges.

Limits on IPO pricing, common to other Chinese exchanges, have been waived, with price instead to be determined based on indicative orders from institutional investors. STAR market candidates also do not need to show they have been profitable for at least three years, opening a listing path for high-growth startups that have yet to post positive net income.

Such measures are welcome and long overdue. IPO reforms like this have been on Beijing's radar for over a decade.

The first 25 STAR listings are set to raise 37 billion yuan ($5.38 billion) at an average valuation of 53 times annual earning, significantly higher than the price-to-earnings ratio cap of 23 maintained by the CSRC.

STAR stocks will trade freely for five days after their market debut though with special rules for market opening and closing auctions to combat price manipulation and abnormal trading. From that point on, share movement will be limited to daily price swings of 20% versus 10% on existing Chinese boards.

In relatively new sectors with high growth but low earnings, companies might be selling only dreams. In acknowledgment of this, institutional investors in the STAR Market are being asked to sign risk disclosure statements. Participation in trading is limited to investors with at least 500,000 yuan of assets and two years' trading experience.

Foreign investors will be able to buy into STAR stocks through China's various Qualified Foreign Institutional Investor programs but not the Shanghai-Hong Kong Stock Connect market link. For now, the new board is to be primarily a domestic matter.

In China as much as anywhere, tech startups are far better at promising to deliver great things in the future than at generating real earnings. The new board aims to be more aggressive in delisting companies that fail to live up to their business plans. Dud and zombie companies are all too familiar on existing Chinese exchanges, so active culling of failing companies would be a welcome development.

But will the STAR board be able to avoid dubious Chinese business practices?

News headlines in recent months have highlighted allegations of questionable or outright fraudulent management at previously highflying Chinese private companies. Faked revenues and cash positions overstated by billions of dollars are not unusual news in China.

Retail orders for shares in the STAR board's initial crop of IPOs have exceeded supply by as much as 2,000 times. While this is partly a function of small deal sizes and limited retail allotments, STAR investors are in danger of again following hype over fundamentals.

China knows how to build capital market infrastructure, but whether the new board can drive the financial reform that the country needs will be the real test. Looser rules are being applied to fresh listings in a controlled environment and do not yet represent a wholesale revision of existing practices.

As seen previously with the opening of China's onshore futures markets, the authorities prefer to test innovations in new markets rather than dramatically change the dynamics of existing ones. Whether or not the STAR board lifts up high-tech winners, it can be a success simply by managing to bring market forces to the fore for all Chinese IPOs.

Fraser Howie is co-author of "Red Capitalism: The Fragile Financial Foundation of China's Extraordinary Rise." He has worked in China's capital markets since 1992.

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