Overhaul of China's IPO market

The CSRC released on Friday night the draft new A-share IPO guidelines for a two-week consultation period in 22 May - 5 June, which is titled “Instructive Opinions regarding Further Reforming and Improving of IPO Mechanisms (关于进一步改革和完善新股发行体制的指导意见).” This would end a de facto suspension of IPOs on the Shanghai and Shenzhen stock exchanges since September 2008, and new IPOs could resume after the effectuation of new guidelines post-consultation. SHCOMP closed at 2,598 on Friday, or less than 4% short of our year-end target of 2,700. Clearly it's negative for market sentiment and could put pressure on market performance in the next-term (except for the listed brokers). According to the Wind, there are 33 companies in the listing pipeline that were already approved the CSRC, such as China Everbright Securities, China Merchant Securities and China Construction Group (the parent co. of China Overseas 688 HK and China Construction 3311 HK). Nonetheless, regulators are well aware of market dynamics and actual impact depends on frequency and magnitude of new offerings to come, which is controllable by the CSRC. We think the new guideline actually paves way for the debut of long-waited Growth Enterprises Market (GEM) board on Shenzhen Stock Exchange in August/September and large-scale A-share listing on the main board in Shanghai Stock Exchange probably won't happen until after successful launch of GEM board, or likely in 4Q09. For instance, China Construction Group planned to issue 12bn shares to raise over Rmb40bn. The new guidelines aim to improve the price discovery function of the stock market, and help retail investors subscribe to newly issued stocks. Three key highlights are: 1. The quotation and bidding process (询价和申购) should be revised so that issue prices faithfully reflect market demand, and underwriters should take steps to avoid unreasonably high prices; 2. Under the new rules, stock subscribers need to use either the online or off-line subscription system (网下网上申购), but not both, to purchase new stocks. Institutional investors used to enjoy the privilege of subscribing through both systems, while retail investors could use only the on-line (网上) system. Moreover, underwriters need to set the maximum bidding volume for a single on-line subscription account, or 0.1% in principle. This should increase allocation of new IPOs in favor of retail investors and also alleviate concern of liquidity withdraw by institutional investors from second market to IPO market. We think this is a very positive development in the long-run to lower the risk of flip-flopping IPO shares by institutional investors - anyone can still recall PetroChina's A-share offering fiasco? 3. Offering by existing shareholders pre-IPOs (存量发行) during IPO is still not allowed. According to article 142 of “Company Law” in China, shares held by existing shareholders pre-IPOs are subject to one-year lock-up period. Links to original Chinese documents: http://www.csrc.gov.cn/n575458/n575667/n818795/11213650.html