* Issuers, underwriters failing to price IPOs properly
* Retail investors prefer short-term, small-cap gambles
* Reforms to preferred shares, market-driven system may be
* Net issuance may miss expectations in 2014
By Lu Jianxin and Pete Sweeney
SHANGHAI, Feb 19 The worrying spectre of insider
trading in China's IPO market has prompted regulators to tighten
control and Beijing may now be forced to scale back the pace of
The China Securities Regulatory Commission (CSRC) let
initial public offerings resume in January after a 14-month
haitus, but traders say the authorities are concerned the market
is being exploited by connected stakeholders ensuring generous
cashouts for insiders.
The CSRC has tightened up rules on IPO pricing, and also
stands accused of intimidating some firms into "voluntarily"
suspending their listings, despite verbal commitments to stop
meddling in the market -- an accusation it denies.
"I think this is a total retreat in comparison to other
areas of reform in China," said Ding Yuan, professor at the
China Europe International Business School in Shanghai who also
runs a mutual fund investing in domestic equities.
Ding said that instead of giving markets a "decisive role"
as promised, January saw the "most heavily intervened IPO in the
history of China". Drug maker Jiangsu Aosaikang apparently
delayed its IPO over concerns the listing was overpriced.
"People may have felt like the IPO wasn't politically
correct, but it was totally legal. (Aosaikang) followed the
regulations to the letter. For me that proves the soap opera we
are seeing will continue."
REGULATING OR MEDDLING?
The problem of price manipulation during IPOs is one Beijing
has struggled with for years. Ironically, some market-driven
reforms may have exacerbated the problem.
"Look closely at companies that have gone public this year
in China. They include ones from industries, or with P&Ls
(profit-loss ratios), that previously CSRC would not allow to
IPO in China," said Peter Furhman, chairman of China-focused
international investment bank China First Capital in Shenzhen,
who is optimistic regarding the CSRC's commitment to reform.
"To have a private sector company with downward-drifting net
income successfully IPO in China was heretofore unthinkable.
Hence, it is already far more of a market-driven system."
By allowing financially weaker companies to list, and at the
same time making it easier for their owners and cornerstone
investors to cash out on the primary market for the first time,
the CSRC may have inadvertently encouraged overpricing.
That strategy was nipped in the bud by the new guidelines
locking PE ratios within range of industry peers; some even
priced themselves at discounts.
The price controls reduce the incentive for collusion to
manufacture artificially high prices, and theoretically that
benefits retail investors too, as it means more potential upside
to the shares once they begin trading publicly.
But Ding of CEIBS said the strong hand of regulation
disincentivises risk taking. "If you always treat a child like a
child, it will never become an adult."
And by signalling to retail investors that the CSRC will
protect them from price downsides, it is adding the same moral
hazard to the stock market that distorts bonds and real estate.
The question remains how to encourage investors to invest in
long-term growth instead of gambling on volatility.
Unfortunately, Chinese exchanges remain some of the world's
worse-performing, still down more than 60 percent from a peak in
2007, making such strategies a tough sell.
The problem is illustrated by the wide gap in PE ratios. The
average PE ratio for the Shanghai exchange, heavy with large-cap
firms, stands at 11 times of 2012 historical earnings. Smaller
firms listed in Shenzhen are in comparison nearly three times
more expensive by the same measure.
But even though they may be more expensive, speculating on
small-cap listings continues to pay off.
Nearly all the 39 firms which debuted on China's smaller
Shenzhen exchange in January maxed out their 44-percent limit-up
on debut, and continued hitting the 10-percent upward daily
limit over several days. Most of them have more than doubled in
value since listing despite relatively high average
In contrast, Shaanxi Coal Industry Co in
Shanghai, China's largest listing since March 2012, fell back to
near its IPO price within four days after listing, forcing the
parent to buy back shares to support prices.
Traders say the setbacks will most likely restrain China's
IPO market in 2014 from reaching earlier projections. PwC in
January estimated Chinese firms could raise 250 billion yuan
($41 billion) from listings in Shenzhen and Shanghai this year.
($1=6.07 Chinese yuan)
(Editing by Jacqueline Wong)