China's CSRC issues new regulations on IPOs

Will Hong Kong gain from CSRC moves to make Mainland IPO''s more difficult?

In a statement released on Monday, the CSRC announced that Mainland companies wishing to IPO will have to conform to raft of new measures concerning their profitability, the independence of the listed company with regard to its largest shareholder and limitations on the amount of funds they can raise.

Ironically, some of China's most high profile and profitable firms, such as Sohu, Sina and Netease would have had no chance of listing under the new regulations.

"The regulations will continue to put pressure on companies to improve their corporate governance, though personal liability does already exist for companies' legal representatives," comments Walker Wallace, a listings specialist at O'Melveny and Myers' Shanghai office. "It will also help listings in Hong Kong."

Chinese companies, which find it too long and arduous a process to list on the Mainland have long dominated Hong Kong's growth enterprise market, and the new regulations could deepen that trend.

A number of categories are excluded from the new provisions: namely state-owned companies undergoing restructuring; limited responsibility companies in the same category and companies specially exempt by China's parliament, the state council.

From next year, companies will have to have been established as shareholding companies for at least three years before applying for an IPO. And in order to maintain accountability over the company's financials, high-level executives with real control over the company will not be allowed to swap between positions, or leave the company.

New governance provisions come into effect this October and aim to prevent the misappropriation of funds that goes on routinely in China's stock market. The CSRC has also stipulated that the listed company should be managed in an "independent" manner.

In addition, the amount of produce sale, or acquisition of raw materials, from related company transactions, should each not exceed 30% of the listed company's sales; the same being applicable for sales and acquisitions made when the largest shareholder carries out transactions on behalf of the listed company. Finally, assets used for expanding manufacturing operations of the listed company may only originate from the parent company's assets to the extent of 30% of the listed company's operating income.

Also, in order to limit companies raising more capital than they need, the notice stipulates that the amount the company raises during its IPO must not total more than twice it's audited net asset value at the end of the previous accounting year.

Companies, which have applied for a listing before October 1 of this year, will be exempt from these latter provisions.

The new regulations come on the back of a string of attempts to regularize companies coming to the market. In 1999, the CSRC stipulated that companies had to have been reformed into a share owning company for one year before applying for a listing. Previously companies had listed with their incomplete shareholding structures, leading to meaningless balance sheets, or fraudulent ones that claimed a profit.

The regulations also complement provisions in the company law that requires companies (not necessarily in shareholding form) to be profitable for three consecutive years before applying for a listing.

Stephen Green, author of a recent book on the Chinese stock market, points out that some of the clauses are already familiar.

"The three year rule has been talked about for some time, as has the the limit on the amount raised," he comments. "But it's more transparent and effective to have all the regulations packaged in one measure."

The difficulties the CSRC is facing in tackling the main problem of the stock market, namely the dominance by poorly-performing state companies, were highlighted during a conference last week when an economics expert from a government think tank emphasized that the state asset reorganization under the leadership of the SAMC (state asset management commission) should not be viewed as privatization.

Says economics expert Li Yining, "The reorganization is a crucial link in the move from a planned economy to a market economy, and will represent the substitution of the traditional system with a new system - but the process does not amount to a privatization as it is commonly understood."

The process underway could be described as a new form of state ownership, he argued, but one that is compatible with the market. He also indicated that reform of the state-owned sector should take precedence over clarifying and developing the still 'indistinct' concept of the private economy.

Such thinking from a government official indicates it may take a while yet before more profit oriented private companies begin to get a greater share of capital resources.

Over 1200 companies are waiting to list on China's stock market. The CSRC is torn by the need to streamline the listing system, while ensuring that poor companies do not receive precious capital.

But it is limited by the predominance of state owned company looking to list. Too often these benefit from powerful official backing and the hobbled state of private companies, only a handful of which have succeeded in reaching any significant size.

Observers say it is vital to re-establish investor confidence by improve the state of the mainland capital markets and especially the issue of newly listed companies announcing distorted profits. Last week, the Shanghai composite index dropped through the psychologically important 1400 points level, down almost 40% from its high of 2100 in 2001.