China stocks ride reform roller coaster

China's ChiNext Index, which is composed mainly of hi-tech start-ups, on Monday responded dramatically to moves for a more standardized market.

Down a record 8.26 percent -- the worst daily loss since trading started in 2009 -- 325 of 328 shares listed on the board fell, with 225 collapsing by the daily limit of 10 percent. Profit taking was triggered by suggested reform to the initial public offering (IPO) system.

The China Securities Regulatory Commission (CSRC) on Saturday unveiled the reform plan, which was seen as a major step toward replacing the current administrative approval mechanism.

Director of the CSRC research center Qi Bin said the plan will vitalize the capital market by enlarging the development space and enabling more investors to benefit from the process of economic transition. In China, direct financing makes up 42 percent of total financing, lagging behind the rate of developed and other developing countries which stands at around 70 percent.

He warned that the rate has been dropping for several years as bubbles in the stock market inevitably burst, threatening overall economic development as resources are allocated with moderated market influence.

Steven Sun, head of HSBC's China Equity Strategy, said in a research note that medium-term impact on the main board was limited, but the news could trigger profit taking on ChiNext and brokerage stocks.

"In short, we expect A-share IPO resumption to have only limited impact on the main board index, but ChiNext, given its hefty valuation and the bull run this year, might see a much bigger correction due to the anticipated supply shock," he said.

Since A-share IPO suspension in November 2012, the ChiNext index has risen more 130 percent, purely on valuation multiple expansion as the price earning ratio (PE) has re-rated over 120 percent to 58 times. Of the 88 companies that have received IPO approval, half of them will list in the ChiNext board.

Furthermore, the new rules prohibit companies from using ChiNext listings as shell companies for asset injections and backdoor listings.

The news could be an excuse for investors to take profits on listed brokerage companies, since their share prices have run up more than 30 percent following the release of a key policy document of the ruling Communist Party of China and in anticipation of A-share IPO resumption, according to Sun.

The CSRC said in a statement that the plan would focus on the market and legislation, and emphasize a regulation philosophy with information disclosure at its core. Reviews of new listing candidates will be more transparent, and the process will be made public at the same time. Increasing transparency, the CSRC said, will allow the public to monitor the whole review process.

China has an approval-based IPO system, whereby new listing candidates go through a complicated application process that can take multiple rounds of reviews and several years to receive approval from the CSRC.

Under the new registration-based system, the CSRC would focus on compliance reviews of candidates. The timing of new share issues and how to issue shares will be determined by the market. The valuations of new share offerings will better reflect demand-supply dynamics.

The CSRC believes the plan will protect small and medium investors by safeguarding their right to know, right to participate, right to supervise and right to claim compensation.

The plan would also further clarify the liabilities of new share issuers, IPO sponsors, accounting and law firms, among others in IPO issuance. Issuers and brokers should compensate losses to investors if serious lapses in information disclosure cause those losses.

A commission spokesman said the plan did not mean relaxation of regulation. On the contrary, there will be more regulation during the listing and stricter enforcement after listing.

The spokesman said that it could take about one month to complete preparations before the first to-be-listed company can begin its registration process.

He predicted around 50 companies would be able to complete their registration procedures for IPO by the end of January.

IPO issuance in China has been on hold since November last year, with around 700 firms in the IPO pipeline.

Supported by blue chips, particularly banks and oil companies, shares edged down on Monday's closing, with the benchmark Shanghai Composite Index down 0.59 percent and the Shenzhen Component Index down 1.94 percent.

The large caps were buoyed by new rules mandating cash dividends and an announcement by the State Council on a preferred share pilot. Two surveys also pointed to stabilizing factory growth in November.

The ups and downs are a reflection of a change of market style in the current macro situation, and support the switch to true supply and demand, said a report of Shanghai-based BOCOM Schroders Fund Management Co., Ltd.