On June 10, 2009, the China Securities Regulatory Commission (CSRC) issued the Guiding Opinions on Further Reforming and Improving the New Stock Issuance System, which took effect on June 11, 2009. The release of the Guiding Opinions indicated that CSRC was gearing up for the resumption of initial public offerings (IPOs) on China’s A-share stock market. On June 18, 2009, drugmaker Guilin Sanjin Pharmaceutical Co. (Sanjin) became the first company to win approval for an IPO in China since regulators halted IPOs in September 2008 after a steep slide in the Chinese stock market from its high in 2007. On June 29, 2009, Sanjin was listed on the Shenzhen Stock Exchange.
The nine-month suspension of IPOs took a toll on China’s capital markets. Through the Guiding Opinions, CSRC aims to transform the IPO system by facilitating the price marketization of new stocks, enhancing the effectiveness of new share allocation among investors, providing favorable policies for small and medium individual investors on share acquisition, and raising risk awareness in the primary market.
The Guiding Opinions call for a market-based pricing mechanism that requires parties making a price inquiry, such as fund management or securities companies in compliance with CSRC’s requirements, to report true issuance prices. Based on the assumption that the price reported from an inquiry should be logically consistent with the price requested for a purchase, the Guiding Opinions require lead underwriters to eliminate cases where a high price is reported but no purchase is made, and where a low price is reported but a purchase is made at a high price. In addition, the issuer and lead underwriter are expected to set a minimum number of shares that may be requested for purchase based on the total number of shares to be issued and the prevailing market conditions. If the final issuing price is higher than the issuer anticipated and leads to additional revenue, the issuer must indicate the use of this revenue in its Prospectus.
CSRC also aims to optimize the online issuing mechanism by separating purchase requests made through the online and offline subscription systems. Specifically, for a given stock issuance, the Guiding Opinions provide that an individual or institutional investor may submit a purchase request either online or offline, but not both. This should help prevent institutional investors from competing with smaller investors for the acquisition of new shares online, giving individual investors a greater chance of acquiring new shares than they had in the past.
In addition, the Guiding Opinions impose an upper limit on online share purchases. Although an issuer and its lead underwriter have some discretion in setting a cap on the number of shares that a single online share subscription account can acquire, the cap, in general, should not exceed 0.1 percent of the total number of shares accessible through the online system.
Another focal point of the Guiding Opinions is the need for increased awareness of the inherent risks in the primary market. Issuers, lead underwriters and securities companies, for example, are required to disclose the risks associated with IPOs, so that potential investors can judge an issuer’s performance rationally. This requirement should help to refute the common misconception in China that a stock price will not drop below its initial issuance price in a bull market, to reduce the difference between share prices in the primary and secondary markets.
CSRC further stresses the obligations of all participants in the capital market. Issuers are expected to publicly disclose any information that may impact the value of their stock and to safeguard the rights and interests of their shareholders. Underwriters and securities companies are encouraged to safeguard the long-term interests of both sellers and buyers by fulfilling their fiduciary duties. Parties making price inquiries should carefully analyze the relevant information and settle on a price that helps guide prospective investors to act rationally. As for investors, particularly individual investors, the Guiding Opinions advise them to focus on the inherent value of an issuer and not speculate or scalp stocks.
Currently, China’s primary market has three significant problems that the Guiding Opinions address:
- An ineffective price inquiry system that results in large discrepancies between the price reported from an inquiry and the final issuance price;
- An abnormally high rate of return for Chinese IPO investors compared with their American counterparts; and
- Low chances of acquiring new shares for small and medium individual investors.
However, the Guiding Opinions are merely a first step toward fixing these problems. Supplementary regulations are needed in order to truly reform the primary market, particularly since the obligations that the Guiding Opinions assign to all market participants may not be enforceable without concrete provisions to back them up.