China is preparing to establish regional over-the-counter (OTC) equity markets as part of its latest effort to provide access to credit for the country’s cash-strapped SMEs and to encourage private participation in the financial system.
The new fund-raising channel, together with other measures such as broadening the scope for cross-border renminbi investment, signals that a new round of financial reform in China is taking shape, according to Jing Ulrich, managing director of global markets, China, at J.P. Morgan.
The OTC market, known in China as the “new third board”, will focus on high-tech companies and will trade through a network of regional dealers that negotiate directly with one another. The aim is to provide a financing channel for smaller companies that are unable to meet the requirements for listing on a formal stock exchange.
The plan is still subject to official cabinet approval, but Guo Shuqing, chairman of China Securities Regulatory Commission (CSRC) said at a financial conference in Hubei this week that the regulator has been actively preparing the system.
Guo said there are two key guidelines for the new OTC market: first, there should be no collective trades and, second, the participating companies should not have more than 200 shareholders.
Moreover, the regional OTC member companies may later graduate to the national OTC board, the Growth Enterprise Board or even the A-share market.
Actually, the new third board is not really new. Beijing had rolled out a trial version of an OTC board in Beijing's Zhongguancun district, home to many high-tech companies, in 2006.
Although the large state-owned companies tend to dominate news coverage, China’s future is more closely aligned to the performance of smaller private firms. There are roughly 100 million of them, and they account for 99% of the total number of Chinese companies, employing 80% of China’s working population and contributing 50% of the government’s tax revenue, as well as 60% of the country’s GDP, according to Citi.
“Compared to the state-owned companies, many of which remain in a monopolistic position in strategic fields, the SMEs’ profit margins are low, funding costs are high, room for development is limited,” said Hu Yifan, chief economist at Haitong International Securities.
The OTC board is the security regulator's second attempt to address an entrenched problem: big SOEs have more capital than they need, while money is not filtering down to the SMEs. In 2009, China launched a Nasdaq-style board, ChiNext, aimed at providing a financing platform for upstart companies.
China is in the midst of reforming its capital account, with Chinese policymakers introducing pilot reforms in some cities. In late March, Beijing approved eligible informal lending institutions in Wenzhou to be converted into rural banks, and also allowed private individuals to make direct investments in overseas non-financial companies — up to a cap of $200 million in total per year.
Beijing has also allowed Shanghai to launch a pilot programme that would allow qualified foreign limited partners to raise renminbi funds on the mainland for investment in overseas markets.
