IPO reforms draw skepticism in some quarters

Reforms are in the works for initial public offerings on the Chinese mainland stock exchanges, after a nine-month suspension of new issues, but industry experts do not expect a fundamental improvement in the listing process from the proposed changes.

On June 7, the China Securities Regulatory Commission released a draft set of IPO reforms for comment by financial institutions.

Market participants believe the reform proposal is a signal that the IPO moratorium, which began in November, will soon end. There are at least 677 companies waiting for their chance to be listed.

The draft reforms aim to address longstanding problems such as price manipulation and window-dressing of prospectuses.

The reforms require issuers to release a prospectus simultaneously with their IPO applications to increase transparency.

Underwriters should release evaluations of each issuer's performance, written in plain terms that smaller investors can easily understand. In each case, they must continue due diligence investigation of the issuer in case the company reports bad results not long after obtaining IPO approval.

Experts have welcomed the CSRC's efforts to enhance transparency. But many expect tougher measures to combat fraud.

The draft states that if major shareholders, members of the board or senior managers sell their shares within two years after the lock-up period, the sale price shall not be lower than the issue price.

Moreover, they must have a five-year contingency plan in case the stock price falls below net assets per share.

Pi Haizhou, an independent columnist, said that the CSRC's effort to squeeze "bloated" IPO prices, though well-intentioned, exceeds its responsibility, since no one can guarantee that a stock won't fall below its issue price. As a result, it's unreasonable to demand major stakeholders sell their shares at a price not lower than the issue price.

Ye Tan, also an independent columnist, said the reform attempt doesn't really address price differences between the primary and secondary markets.

Participants in the primary market often sell their shares to secondary-market investors at a profit. This is difficult for the buyers to determine. Primary dealers can collude to hide their original acquisition prices from buyers in the secondary market.

Ye suggested that the commission should clarify the penalties for "buying low and selling high" to deter rule breakers.

To guarantee fair pricing, the CSRC reform states that individual investors should be included in the price-setting process.

At least 20 individual or institutional investors are required for issues of less than 400 million shares. At least 50 such investors are required for larger issues.

Xiong Jinqiu, a financial expert, said the reform proposals place too much emphasis on prevention rather than punishment.

Overpriced new issues will only be temporarily suspended, at best. For instance, when new share prices rose last year, the CSRC concluded after a brief investigation that prices were being pushed up by many individual shareholders.

It did not occur to the commission, Xiong said, that the individuals might be acting collectively on behalf of a "price-rigging mastermind".

Since IPO reform no longer produces significant results, said Xiong, the CSRC should instead take tough steps to crack down on secondary market price manipulation to end fraudulent behavior.

The draft reforms also said that applicants waiting for IPO approval could issue bonds in the meantime to diversify their financing sources. Once approval is obtained, companies can choose the timing of the issue on their own.

Abolishing 'redline'

Further, the proposed reforms abolish the "25 percent" redline. According to IPO policies that prevailed last year, if the price-earnings ratio of the IPO is 25 percent higher than for comparable companies, the issuer must call a board meeting and submit an explanation to the CSRC. In that situation, the commission could order the issuer to reset the IPO price. Now, issuers would only have to release an explanation for the above-average prices and warn investors of potential risks.

Some analysts see the entire reform package as nothing more than tinkering with technical problems. Hua Sheng, a veteran economist and president of the Beijing Yanjing Overseas Chinese University, said that the proposal does not touch the most important issue - approval rights. The decision on conducting an IPO remains in the hands of the CSRC, rather than the market.

Lin Yixiang, chair of Beijing-based TX Investment Consulting, agreed with Hua's opinion that the reform sidesteps the question of "who decides who can go public". If the approval process remains the same, it is hard to make any breakthroughs.

Hua and Lin suggest the regulatory should loosen its control and leave it to the issuers and buyers themselves to decide when to go public, at whatever price, and whether or not the stocks are worth buying.

Xiong, however, is against the idea of loosening administrative power prematurely. The mainland stock market is still in its infancy, he said, and without CSRC oversight, issuers wouldn't wait to go public at any time, regardless of market conditions. This is because once listed, issuers have many prerogatives.

When companies see the stock market as an ideal place to rip off ignorant investors, lack of government involvement will do more harm than good.

Apart from increasing the accountability of issuers and underwriters, Ke Jingmin, a financial commentator, said the regulator itself should assume more responsibility.

Based on the principle of "with power comes responsibility", the CSRC must be accountable for giving the green light to IPO applicants who are later involved in fraudulent conduct.

The current system misleads investors into believing that companies that passed the CSRC's approval process are trustworthy, Ke said.

However, scandals such as those involving Green-land Biological Technology and Wanfu Biotechnology demonstrate that the CSRC's endorsement can't necessarily be relied on. The agency needs to be responsible for any approval it is going to grant, Ke added.