China’s IPO Freeze to Melt in Midwinter
IPOs are returning to China. The China Securities Regulatory Commission this weekend announced its long-awaited guidelines on a new, somewhat liberalized process for approving IPOs. The rush is now on to get new IPOs approved and the money raised before Chinese New Year, which falls on January 31st, less than two months from now. Ultimately, the CSRC hopes to clear within one year the backlog of over 800 Chinese companies now with IPO applications on file. Thousands of other Chinese companies are waiting for the opportunity to submit their IPO plans. The CSRC stopped accepting new applicants almost 18 months ago.
From what I can tell, the CSRC has concluded, rightly, its old IPO approval process was broken beyond repair. The regulator used to take primary responsibility for determining if a Chinese company was stable enough, strong enough, honest enough to be trusted with the publicâ€™s money. No other securities regulator took such a hands-on, the â€œbuck stops with meâ€ approach to IPO approvals. The CSRC now seems prepared to pass the buck, in other words, to put the onus where it belongs, on IPO applicants, as well as the underwriters, lawyers and accountants.
This should eliminate the moral hazard created by the old system. Companies, as well as their brokers and advisors, had a huge amount to gain, and much less to lose, by submitting an application and hoping for a CSRC approval. They could cut corners knowing the CSRC wouldn’t. For the successful IPO applicants who got the CSRC green light, valuations were sky-high, and so were underwriting and advisory fees.
Going forward, the CSRC seems determined to switch from security guard to prosecutor. Rather than trying to detect and prevent all wrongdoing, it is now saying it will punish severely companies, and their outside advisors, where thereâ€™s a breach in Chinaâ€™s tough securities laws. The CSRCâ€™s powers to punish any wrongdoing are significant. Heaven help those who end up being convicted of criminal negligence or fraud. As I noted before, Â there are no country club prisons in China for white collar offenders.
While baring its sharp teeth, the CSRC is also now using its more soothing voice to tell retail stock market investors they will need to do more of their own homework. It wants more and better disclosure from companies. It hopes investors will read before buying. And, the CSRC also hopes the stock market will itself begin to provide investors will clearer signals, through share price movements, on which companies may not be suitable for the more risk-averse.
Up to now, companies going public in China did so with a kind of â€œCSRC Warrantyâ€. Thatâ€™s because the CSRC itself said it had already done far more detailed, forensic scrutiny of the company than just reading through its public disclosure documents. The approval process could take two years or more, with company execs, lawyers and accountants being called frequently to meetings at the CSRC headquarters to be grilled. All this to give comfort to investors that nothing was awry.
The warranty has effectively been revoked. This may make some investors more nervous, but it represents a significant and positive breakthrough for the CSRC.
It needs to lighten its grip. Markets need regulation, need rules and effective mechanisms for punishing bad actors. But, the CSRC took on too much responsibility for assuring the orderly functioning of Chinaâ€™s stock market. This was always going to be difficult. Chinaâ€™s stock markets are far more prone to speculative frenzy than stock markets in the US, Europe. Shares on the Shanghai and Shenzhen stock markets are bought and sold mainly by retail investors, or as the Chinese say, â€œold granddads and granniesâ€ (è€çˆ·çˆ·è€å¥¶å¥¶ï¼‰. Institutional investors are a minority. As for investment fundamentals, on China’s stock market there are mainly just two:Â “Buy on rumor. Sell on rumor”.
Over the last year, Iâ€™ve written about problems at the CSRC that helped cause and prolong this long freeze in IPOs. The CSRCâ€™s first instinct back in 2012 was to try to toughen its regulation, toughen its own internal systems and procedures for rooting out fraud. It then switched tracks, and decided to let the market play more of a role. Â This is a major concession, as well as important proof that Chinaâ€™s larger process of economic transformation, of freeing rather than freezing markets, is headed in the correct direction.
As if on cue, this past weekâ€™s Wall Street Journal last week digested a section from the Nobel Prize acceptance speech by economist Friedrich Hayek.
â€œTo act on the belief that we possess the knowledge and the power which enable us to shape the processes of society entirely to our liking, knowledge which in fact we do not possess, is likely to make us do much harmâ€¦Even if such power is not in itself bad, its exercise is likely to impede the functioning of those spontaneous ordering forces by which, without understanding them, man is in fact so largely assisted in the pursuit of his aims.Â â€
Iâ€™m delighted Chinaâ€™s IPO market is going to re-open. My own prediction here a couple of months ago was that it IPOs would resume around now, rather than next month. This just goes to show all forms of market timing â€” whether itâ€™s trying to guess when a stock price has hit its peak or when a stock market itself will change course, and its once omnipotent regulator change its entire approach â€” is a fool’s errand.