Home' Trinidad and Tobago Guardian : November 28th 2013 Contents NOVEMBER 2013 • WEEK FOUR www.guardian.co.tt BUSINESS GUARDIAN
INTERNATIONAL | BG29
China s plan to allow the market a greater
role in initial public offerings hinges on stamp-
ing out a raft of practices that deceive investors,
from lax underwriting standards to executives
who falsify earnings to obtain higher valua-
The proposed switch to a US-style IPO
model comes after a 14-month moratorium
on Chinese offerings and is part of a wider
push by the Communist Party to lessen gov-
ernment control of the economy. The so-
called registration system would leave questions
of IPO supply and timing of deals to compa-
nies, not Chinese regulators who now must
approve most facets of an offering. Hurdles
abound, including creating a legal system
robust enough to guard against stock-sale
"The registration system is the right direc-
tion, but it requires many other conditions to
make it work," said Zhang Yuanzhong, a Bei-
jing-based lawyer at Wentian Law Firm spe-
cialising in securities litigation. "You need a
compensation mechanism that allows investors
to recover losses, and a legal definition of secu-
rities fraud needs to be established to allow
investors to bring cases to court."
Beijing s plan to overhaul its IPO process
came in a 60-point statement released Novem-
ber 15 after leaders gathered in the third full
meeting, or plenum, of the party s 18th Central
Committee. China was home to the world s
largest IPO market in 2010 with US$71 billion
worth of offerings. The market is frozen now
as regulators draft rules to curb misconduct
in first-time share sales.
Acknowledging the obstacles to the proposal,
China Securities Regulatory Commission chair-
man Xiao Gang said Nov. 19 the shift to a
looser IPO system must be gradual to avoid
shocks to the market.
'Touch one hair'
The CSRC may need until at least 2015 to
introduce the new system, as it would first
have to overhaul the country s securities law,
said Leon Qi, a Hong Kong-based analyst at
Daiwa Securities Group Inc. It must also clear
a backlog of more than 700 companies waiting
to go public under existing rules, Qi said.
Xiao warned of the enormity of the task at
hand, saying that creating a registration-based
system is the kind of reform where "if you
touch one hair, the whole body feels the
China now relies on the CSRC to act as a
gatekeeper for offerings. A seven-person listing
review committee examines each application
in a lengthy process, judging factors such as
investment potential and profit sustainability.
It even uses its power to sit on IPO applications
when stock markets are weak to restrict the
supply of new equity.
"Government control of the IPO tap provides
a floor to the markets," said Keith Pogson, a
partner at Ernst and Young who oversees
financial services in Asia.
Under the new model, the watchdog s role
would switch to ensuring only that companies
disclosures meet certain legal and financial
requirements, a model used by developed
countries including the US.
That places the burden of ensuring the
accuracy of disclosures on the listing companies
and its bankers, some of whom currently lack
the capability to conduct proper due diligence,
according to Xiao.
"It s going to be tough," said Beijing lawyer
Zhang. "Many companies have deep-rooted
connections with local authorities, and local
courts may lack independence."
Chinese investors now lack legal channels
to seek compensation for fraud losses, accord-
ing to Zhang. That s especially a problem as
individual investors dominate trading on
China s stock exchange. Institutions account
for just 17 per cent of the free float, said former
CSRC chairman Guo Shuqing.
One outcome of a registration-based system
should be more realistic valuations as the
number of IPOs increases, said Gary Liu, a
researcher at the China Europe International
Business School in Shanghai.
Rich valuations for IPOs helped drive a
boom in new offerings three years ago. Price-
to-earnings ratios of Chinese IPOs averaged
58 times in 2010 and 48 times in 2011, accord-
ing to former CSRC chairman Guo.
"The fact that so many companies have
lined up to sell shares indicates that valuations
are still too high," Liu said in an interview in
Chinese regulators are already in the midst
of a crackdown on securities fraud. The CSRC,
under pressure to avoid exacerbating a 24 per
cent slump in the Shanghai Composite Index
in the past three years, has been drafting
tougher rules to curb misconduct. Last Decem-
ber the CSRC ordered companies to reexamine
their offering documents for spot checks, forc-
ing more than 200 firms to withdraw their
Since May, at least 21 bankers, auditors,
lawyers and executives have been barred from
China s securities industry.
The CSRC fined Ping An Securities Com-
pany 76.7 million yuan (US$12.6 million) and
Minsheng Securities Company three million
yuan in May for failed due diligence in IPOs,
while Nanjing Securities Company was cen-
sured for similar violations. Bankers at all three
firms were barred from the industry for life.
Ping An was arranging the IPO of Wanfu
Biotechnology Hunan Agricultural Develop-
ment Company, which had forged financial
data, the CSRC said.
"China still has this get-rich-quick mentality
and it s deeply embedded in the current cul-
ture," said Ernst and Young s Pogson. "People
are more willing to take short-term risk and
care less about their long-term reputation."
Proposed regulations, published in draft
form in June on the CSRC s Web site, call for
penalties against brokerages and their employ-
ees for transgressions such as including inac-
curate information in a prospectus and poor
risk disclosure, or when companies post a
drop of more than 50 percent in profit in the
year following an IPO.
Under the rules, the regulator could tem-
porarily ban a securities firm from equity
underwriting if key data is omitted, or if mis-
leading or falsified information is published
in the prospectus.
"You can t jump from complete state control
to market-driven overnight," Pogson said. "The
transition needs to be carefully managed."
China's path to
US-style IPOs confronts
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