The lesson from the ChiNext launch is as old as China’s stock market: Too much regulatory protection leads to speculation.
(Caijing Magazine) China’s growth enterprise board ChiNext recently opened after 10 years in the making. Hopes ran high, and trading sizzled. But the debut quickly led to disappointment, recalling the now-sputtering Shenzhen SME board, which began with a dramatic flash but eventually cast a pall over growth stock trading.
Shares for all 28 companies on the ChiNext board skyrocketed to the 10 percent limit on opening day. Shares in Jinya Technology, for example, surged 80 percent in a buying frenzy. Overall, first-day gains averaged 106 percent.
But it was a flash in the pan, unchecked by regulator warnings and a fat book of regulatory measures designed to prevent speculation. Within a few days, prices tumbled. Suddenly, ChiNext was nothing more than a new game in town that pulled players into the same kind of mania seen a couple of years ago when PetroChina A-shares reached the stratosphere in an IPO and when stock warrants had manipulated, rollercoaster price changes. Moreover, some of the 28 newly tradable companies became subjects of critical media stories about instant wealth, overselling of pre-IPO shares by management, and cases of cooking the books.
How did this newborn trading platform, so carefully planned and nurtured through a long gestation, fall captive to the old, genetic flaws of China’s stock markets? A crucial factor was excessive protection.
A successful growth enterprise board is not just a capital-raising platform; start-ups are far more valuable than blue chips in many ways. ChiNext was designed to encourage start-ups and new technology companies. It should be in a position to help traders pan for gold and turn ugly ducklings into swans.
But ChiNext was never given enough room to let the market play its resource allocation role. In the first place, IPOs for ChiNext still had to go through a government authorization process. Each of the 28 companies was chosen by regulators from among hundreds of applicants. This review process, which is based on company documents provided to the government rather than through public information disclosure, may look like accountability in the eyes of investors. But it actually restricts market selectivity.
The selection process was designed to signal that each of the 28 companies had a good chance for survival. So after giving permission to this first batch of companies for board trading, regulators suspended review of new applications for a month and concentrated on the ChiNext launch. Media euphoria and promotion activity by energetic brokers further diluted any sense of risk awareness among the trading public.
Yet such artificial control of supply and demand distorts the market. And this is nothing new. Past experience has shown that it’s futile in such circumstances to prevent volatility through regulation and investor warnings following an application process.
Moreover, speculation fire was fanned by murky delisting requirements. Regulations covering growth enterprise stocks on the Shenzhen Stock Exchange, which sponsors ChiNext, say companies should be warned before being delisted. The exchange, however, can rescind a warning if a company implements a “restructuring plan.” This means that, despite the rule for delisting start-ups, the exchange still leaves a back door open to creating shell companies – and attracting punters – by allowing restructuring. Such loose market conditions help whip up speculative frenzy.
Of course, conditions are similar on the A-share main board. Excessive protection stems from a regulatory intent to list quality companies and inject vitality into the market. And in the area of delisting, strict enforcement is out of the question because regulators feel compelled to bow to public sentiment and give any shaky company another chance in the name of investor protection.
However, this protection oversteps the bounds and chokes market vitality. It will surely backfire. Regulators have created conditions for rent-seeking by listed companies, which then turns investors into speculators.
Success for ChiNext should depend on several big-picture factors including growth potential, investment environment and rule of law in society. Regulators can not and should not guarantee financial results and return on investment; they should not set goals for market size and trading volume. Otherwise, even perfect schemes would be hijacked by powerful interests under the banner of protecting investor interests.
Ensuring healthy development of the market is the duty of the China Securities Regulatory Commission as well as stock exchange operators. But their jobs should focus on making and implementing rules, not making market choices. They should concern themselves with improving the trading system, watching interest groups, ensuring adequate information disclosure, penalizing offenders, and educating investors. These tasks, ranging from the minute to critical issues for certain interest groups, can be easily overlooked. They should not.
In the international arena, successful growth enterprise boards are rare and their development paths are strewn with obstacles. China, as the world’s largest emerging economy, has no shortage of innovative ideas. And the market is active indeed. What China lacks, however, is a system that ensures healthy market function. The less-than-perfect inauguration of ChiNext should sound an alarm for regulators. It is not too late to take corrective action.