The One Country, Two Systems regime has helped to maintain the impression since the late 1990s that while the Chinese mainland is ruled along one-party-led socialist lines, Hong Kong and Macau remain out-and-out capitalist free markets.
Now a new form of One Country, Two Systems is brewing at a stock market level.
The Shanghai Stock Exchange said last week that it has received the first listing applications for its technology innovation board – a new Nasdaq-style startup board for fast-growing companies to raise capital without having to adhere to the complex rules and financial requirements of the main board.
Behind the simpler, expedited approval process is a fundamental change in the way China's securities regulator handles initial public offering applications – from what was known as an approval-based system to a disclosure-based regime.
Under the new regime, the China Securities Regulatory Commission (CSRC) will work to ensure all listing candidates comply with disclosure requirements and check the veracity of the information in their prospectuses. But it will not question or comment on them.
That marks a sharp contrast to CSRC's existing role to approve or reject listing applications based on its assessment of the underlying business and its financial health, as well as more subjective interpretations on their quality and prospects.
In short, the regulator’s role has been changed from gatekeeper to fact checker.
The move to a disclosure-based system is the centrepiece of China’s IPO reforms, which aim to create a more market-driven listing process with minimal regulatory intervention.
The securities regulator said the new tech board will be a test case for the future implementation of a disclosure-based regime nationwide, including on the main boards of Shanghai and Shenzhen.
Currently, most exchanges in Asia including Hong Kong implement an approval-based system. The disclosure-based system, in contrast, is used in the US, including the New York Stock Exchange and Nasdaq.
China's IPO reform is being hailed by the market for bringing a more transparent and fair listing process for companies seeking public funding.
If implemented nationally it could also provide a solution to China’s long-standing problem of having an extremely long queue of IPO applications – in part due to the complicated vetting process of the existing approvals-based regime.
At its peak in 2016, more than 900 Chinese firms were waiting for listing approval. The average wait time was two years.
Many Chinese firms have since explored alternative listing destinations in Hong Kong and the US, effectively costing the country billions in capital outflows.
The Shanghai Stock Exchange said it expects the IPO process to shorten to less than three months for companies seeking to list on the tech board.
Supporters believe the new, streamlined process will help create a bigger domestic IPO market, create more investment opportunities for public investors and provide better funding for early-stage companies.
However, sceptics are doubtful whether China’s stock market is really ready for such deregulation and whether investor interest can be effectively protected under the new regime.
It is likely that the total number of IPOs will increase significantly because the listing threshold will be lower. All companies meeting disclosure requirements will be eligible to list without the need for prior regulatory approvals.
However, the overall quality of listed companies is bound to fall in the absence of regulatory IPO screenings.
Naturally, the role of IPO underwriters will become more important in determining the quality of companies. But public investors will have to increasingly rely on their own judgement under the new mechanism.
That is not good news for a stock market that is already highly speculative and remains largely driven by retail investment.
Likely to make things worse is the fact that the new tech board is poised to host a wide range of technology companies, including unprofitable startups and pre-revenue biotech firms. Typically, the value of these companies is harder to assess even for sophisticated institutional investors.
As one corporate lawyer told FinanceAsia, public investors are bound to fall into hidden traps.
“Let’s assume a company is being investigated for breaching environmental protection laws and is subject to millions of dollars [in] fines,” the lawyer said. “Under the old system, its listing application will likely be put on hold, but [under the new mechanism] it will be able to list as long as it discloses it is being investigated.”
Theoretically, investors can avoid these risks by reading the company’s disclosures. “But frankly, who will go through a 400-page prospectus in detail before making their investment in IPOs?” the lawyer said.
An increasing number of listed companies also implies weaker overall research coverage because brokers will spend less resources on each firm. That will undermine the ability of investors to understand their target companies, extract investment value and identify risks.
All these factors are pointing towards one possible outcome – that the stock market will become more speculative and more volatile.
After all, it is hard to tread a fine line between creating a free market and ensuring market discipline through rules and regulations.
But in view of the nature of China’s stock market and its unique characteristics, it is fair to say the IPO reform remains a double-edged sword that is set to bring some uncertainties at least in the short term.