China's bankers in uncharted waters as Shanghai launches U.S.-style tech board

SHANGHAI/HONG KONG (Reuters) - As Chinese investment banker Liu Guangfu prepares to file an application for his client to list on Shanghai’s Nasdaq-style technology board, he is heading into uncharted waters: how to price the new shares and sell them to the right investors.

FILE PHOTO: A man walks past an electronic board showing the benchmark Shanghai and Shenzhen stock indexes, on a pedestrian overpass at the Pudong financial district in Shanghai, China June 22, 2016. REUTERS/Aly Song

Until now, guidance set by Chinese regulators on the pricing of initial public offerings (IPO) has led to artificially depressed valuations, making it easy for bankers to find investors.

“Selling IPO shares was easy before,” said Liu, whose client, a maker of high-end equipment, is seeking an IPO on Shanghai’s new Science & Technology Innovation board, which is due to launch as early as June.

“Now, you need to find interested investors and talk about the future of the company, and the industry. It’s time-consuming and costly.”

Liu and other Chinese bankers are entering a new world as Shanghai launches its new board, complete with the country’s first registration-based IPO system that is seen by some as the boldest reform yet in China’s capital markets.

The pilot project, likely to be expanded if it proves successful, is making China’s bankers nervous though, as they are more used to the paternalistic guidance of regulators than the debates - often contentious - between executives, bankers and investors that form the basis for deals priced in leading IPO centres such as Hong Kong and New York.

“It’s a huge challenge to us,” said Chang Houshun, managing director at Sinolink Securities in Shanghai, who described previous IPO underwriting efforts as “mechanical”.

The reforms will do away with government control of IPO quality and timing, and allow still loss-making new company start-ups to list.

It will also end the unofficial, but always observed, pricing cap of 23 times a company’s trailing profits - a ceiling that tended to ensure new floats a hefty 44 percent jump on debut, the maximum allowed.

Without government guidance, Chinese bankers, like their western peers, have to set IPO prices that reflect a company’s growth potential and risks, as well as the market mood and issuers’ expectations.

The seismic rule change will likely accelerate market consolidation and weed out weak players, Chang said: “You will see China’s Goldman, Citi and JP Morgan emerge. Apart from several dominant players, not many will be left.”


That fear and a desire to win new business has triggered a scramble among Chinese brokerages to hone their skills.

Many are replenishing their capital since the new market - unlike Hong Kong or New York - requires underwriters to share the risk and subscribe for between 2 percent and 5 percent of each IPO they sponsor on the new board.

Underwriters must then hold the stake for at least two years.

At least one brokerage, Shenwan Hongyuan Group Co Ltd, has reorganised its investment bankers into industry teams to try to develop specialist knowledge in sectors including technology and healthcare - skills not needed before. The company is also raising funds via a $1.16 billion listing in Hong Kong.

“We’re moving toward the structure of a global investment bank,” said Tu Zhengfeng, managing director of Shenwan Hongyuan’s underwriting unit.

“It’s increasingly important to identify a company’s intrinsic value, and you need expertise to do that.”

The brokerage is also building its distribution capacity, which was redundant when IPO shares were almost always hotly sought after by investors as pricing favoured a strong market debut.

Roadshows - a staple of western deals, where executives meet would-be investors - have long been considered formalities in Chinese IPOs.

“Now, you need to tell investors a company’s story well - investment highlights, why it’s worth buying, and how prices are set,” said Tu.

Zhao Jun, investment banker at China Securities Co Ltd, said bankers also need a stronger network of contacts to source IPO candidates, especially in the tech sector.

“Now, we need to consult with industry experts, work closely with our analysts, and even communicate with some investors who can help us understand the technology,” Zhao said.


Peng Yigang, a senior executive at Shanghai Stock Exchange’s listing department, said there was a general feeling of anxiety among applicants and bankers.

“Many people come to us, asking for an answer (regarding their IPO applications). I said, sorry, we cannot give you an answer. Under the registration system, regulators no longer give you any answers. The market will decide,” he told a recent seminar.

Nearly 100 companies have submitted applications to list on the tech board.

To be sure, many bankers are sceptical that regulators will give up providing guidance completely, at least during the early stage, when demand will likely far exceed supply, potentially lifting valuations to extreme levels and raising the risk of a frothy market.

Previous attempts to help start-ups to list, such has Shenzhen-based Chinext, have largely foundered because early speculation sent prices soaring, only to later collapse spectacularly, souring investor sentiment to a point from which it never recovered.

Indeed, Hu Ruyin, former chief economist of the Shanghai Stock Exchange, said the broader opening up of financial markets in China posed a significant threat to the industry because it has had little experience pricing risks.

“Before you swim in the sea, you must learn how to swim in the pool. Otherwise, you would be drowned.”

Reporting by Samuel Shen and Julie Zhu; Editing by Jennifer Hughes and Neil Fullick