Reform in need of time to fix overpriced IPOs(2)

"The suspension of the Aosaikang IPO looks like the commission is eating its words about liberalizing the IPO market. But we are at a very early stage of the change and there are bound to be relapses. The key is to improve the regulation system," she added. "The reform needs three to five years to be carried out. So investors deserve more time to mature."

On Dec 30, the equity market watchdog issued a package of new IPO rules to kick off the A-share market reform. The pack features stricter rules on information disclosure and emphasizes the liberalization of the market. In addition, it vows to bring down the issuing prices and protect the interests of individual investors.

Following the new rules, the authority resumed the IPO pipeline, which had been stopped since September 2012. In less than two weeks, up to Jan 9, the commission approved 51 listing applications. This week, 33 companies have been scheduled to debut. More than 700 other companies are still in line for the green light.

"The IPO rule reform is long-term positive to the A-share market, because the trend is now clear that the mainland capital market will apply a registered system for listing," said Benson Wong, partner of PricewaterhouseCoopers Ltd.

"As the A-share market liberalizes, the average price-to-earnings ratios of IPOs will decline. We see the valuation gap between the mainland and Hong Kong stock markets narrowing now. Because the A-share market tends to provide similar protection to investors, and the supply of new stocks is huge, the share prices of the two sides will get closer."

Analysts from Deloitte China also said they believe the new rules will settle the overpricing problem of IPOs on the mainland stock market.

"One of the factors behind the high listing price is the shortage of supply. Because China is a relatively closed capital market, idle money has to be used at every opportunity. New stocks are very attractive to people," said Anthony Wu, China A-share capital market leader of the national public offering group at Deloitte China.

"The registered system will lead to a large amount of new stocks, which in turn can ease the pressure."

It promised in the commission's Dec 30 rules that the authority will make its decision within three months after an IPO application is filed. "That should significantly speed up the application process," said Wu, adding there used to be no limit on how long the authority took to deliver results.

"Small cases took roughly six months, and there was no surprise if bigger caps had to wait for 18 months or more."

Meanwhile, the new regulation encourages major shareholders of companies on offer to release old shares in order to make sure demands for new stocks are met.

"If there is over-subscription, the company must offer more old shares. That can ease the pressure in the supply of new stock," said David Xian, an audit partner at Deloitte China.

Apart from that, under the new rules, the amount of new stocks retail investors can subscribe to is linked with the valuation of shares they own in the secondary market. "Individual investors will be less active in subscribing to new stocks," said Xian. "For those who used arbitrage in IPOs with all their capital, the good days are over. Now a large proportion of their cash is trapped."

Dick Kay, co-leader of the national public offering group of Deloitte China, said that less participation by retail investors in subscriptions will help to solve the overpricing problem because institutional investors are more reasonable.

"Retail investors take a more speculative approach. They are not capable of pricing a company. Investing in the equity market requires a lot of research, which should be left to the professionals," he said.

However, AMTD's Tang said that Chinese institutional investors are not reliable partners in the reform, either.

"The Aosaikang event shows that the mainland market is full of short-sighted investors. Even institutions are eyeing fast cash. That's no good for stabilizing the valuation of A shares. People hoard small caps. Big names are left aside," said Tang, adding the maturity of a market depends not only on its regulation system but, more importantly, on the quality of participants.

"What the A-share market needs is long-term investors," he said. "It's helpful that the recent financial reform raises insurance companies' exposure to the stock market. The IPO reform also gives priority to the Social Security Fund and public offering funds in new stock subscriptions. In the future, the regulator should bring in more long-term capital such as pension funds to stabilize the market and build up confidence."

However, Haitong International's Chen said that those who get burned learn fast. "The authority should have allowed Aosaikang's IPO proceed as planned," she said.

"Some investors just have to learn their lesson the hard way. There should be several occasions when the market sees new stocks fall to the limit on their debut. Only when people realize buying new stocks is not risk-free will they start to be rational about IPOs."