China’s move to end a 14-month ban on initial public offerings and allow the sale of preferred shares led to a rally in financial stocks as investors bet the measures will boost fees for brokerages and ease banks’ funding.
Citic Securities Co., China’s largest brokerage by market value, surged to a record high in Hong Kong trading. Smaller companies fell after the securities regulator said on Nov. 30 that 50 companies will be ready for IPOs by end of January and the watchdog may also begin a trial program for letting companies sell preferred stock.
The IPO freeze will be lifted following new rules that pave the way for a switch to a U.S.-style registration system and letting investor demand determine pricing, underscoring Communist Party leaders’ pledge to allow markets to play a “decisive” role in allocating resources. China, the world’s largest IPO market in 2010, hasn’t had a new listing since October 2012 amid a crackdown on fraud and misconduct.
“Resuming IPOs will be a big boost to brokerages’ investment banking business,” Zhang Yanbing, a Shanghai-based analyst at Zheshang Securities Co., said by telephone. “Some investors believe that China’s stock market will enter a bull market soon.”
Smaller companies led declines today on concern new stock sales will divert funds from existing equities. The ChiNext Index of companies with a median market value of $1 billion tumbled 8.3 percent today, its biggest retreat since it was created in June 2010. The gauge has surged 76 percent this year.
“This is positive for the long-term development of the market as both companies and stock investors will gradually have more choice,” said He Zongyan, an analyst at Shenyin & Wanguo Securities Co. in Shanghai. “It may add downward pressure on the stock market in the short term as 50 new IPOs in the next few months may drain capital and force a correction in some inflated stocks.”
The benchmark Shanghai Composite Index has dropped 2.7 percent this year and the CSI 300 Index has fallen 4.1 percent.
It will take about a year to review more than 760 companies that are seeking first-time share sales, the China Securities Regulatory Commission said in a statement on its website on Nov. 30. A total of 83 companies’ IPO applications have been cleared and are pending final approval, including those of Shaanxi Coal & Chemical Industry Group Co. and China Postal Express & Logistics Co., the regulator’s website shows.
Shares of Citic Securities jumped 10 percent in Hong Kong to HK$21.60, the biggest increase since Nov. 18, while the benchmark Hang Seng Index gained 0.7 percent. China Merchants Securities Co. climbed by the 10 percent daily trading limit in Shanghai to 12.03 yuan.
State-backed Citic Securities and China Merchants will probably be the main beneficiaries when new equity offerings resume, as IPOs they are managing account for the biggest share of the sales that are likely to come to market first, Jiao Wenchao, a Beijing-based analyst at Ping An Securities Co., wrote in a note today.
Foreign investment banks including Goldman Sachs Group Inc. are allowed to manage IPOs in China only through their joint ventures with local firms.
Commissions from underwriting IPOs in China may exceed 10 billion yuan ($1.64 billion) next year, Ping An’s Jiao estimated. Fees that securities firms collected from underwriting IPOs in China dropped to $803 million in 2012 from $1.95 billion in 2011, according to New York-based research firm Freeman & Co.
Net income in China’s securities industry will probably grow 31 percent to 60.1 billion yuan in 2014 as the resumption of IPOs boosts the value of initial and secondary stock sales to 600 billion yuan, Shao Ziqin, a Citic Securities analyst, wrote in a Dec. 1 report. Chinese share sales raised 172.4 billion yuan this year, data compiled by Bloomberg show.
The CSRC also proposed drafting rules for a trial program to allow companies to sell preferred stock, based on guidance issued Nov. 30 by the State Council. That class of equity, which doesn’t carry any voting rights, grants holders a greater claim on a company’s assets or earnings than common stock.
Banks will be able to include preference shares in calculations of Tier-1 capital, giving them a new financing avenue to meet requirements for risk buffers, while helping reduce corporate debt levels, CSRC spokesman Deng Ge said in a separate statement.
Banks stand to benefit from a “safer and more stable” capital base and insurers will gain new investment opportunities from the sale of preference shares, according to Zheshang’s Zhang. China Life Insurance Co., the nation’s biggest insurer, gained 2.8 percent in Hong Kong, while Ping An Insurance Group Co., the second-biggest, advanced 4.2 percent.
“Investors are looking for a way to express their optimism on China’s economic outlook,” Zhang Jian, a Beijing-based strategist at BOC International Holdings Ltd., said today. “They believe that banks won’t have to sell common equity shares if they are allowed to issue preferred stock.”
The CSRC stopped reviewing applications for listings on the country’s stock exchanges in Shanghai and Shenzhen amid concern a flood of new shares could hurt investor confidence. Xiao Gang, a former central banker and Bank of China Ltd. chairman who was named head of the CSRC in March, said last month the shift to a looser IPO system must be gradual to avoid shocks to the market.
The new IPO rules build on reform pledges made in a 60-point document released by the Communist Party on Nov. 15 after leaders met to map out policy changes for the coming decade. Item 12 focused on improving financial markets, including moving to a registration-based system for issuing stocks.
Under existing guidelines, companies go through a review and approval system, where a CSRC committee decides whether a company is fit for listing. With the new procedures, regulators will review applications to ensure that disclosures meet requirements, leaving investors to judge a company’s value and the risks of buying its shares.
The new rules impose requirements on IPO advisers -- and threaten penalties -- in an effort to curb misconduct in first-time share sales. Since May, the CSRC has punished at least three brokerages for inadequate due diligence on IPOs and barred at least 21 bankers, auditors, lawyers and executives from the securities industry.
“The re-opening of the IPO market is needed to reduce companies’ dependence on bank financing, diversify their financing channels and resolve the capital bottleneck,” Ronald Wan, chief China adviser at Asian Capital Holdings Ltd., said by phone today.
The securities regulator also began urging state-owned companies to increase dividend payouts and encouraged institutional investors such as the nation’s social security fund to exert more influence on companies’ policies and corporate governance. The CSRC will work with tax authorities to frame policies that encourage companies to return funds to shareholders, according to a separate statement on Nov. 30.
While CSRC data show the ratio of Chinese companies’ earnings paid out in dividends rose to 24 percent in 2012 from 18 percent in 2010, dividend yields are still lower than bank deposit rates, according to Citic’s Shao. The Shanghai Composite has a 12-month gross yield of 2.9 percent, compared with the central bank’s current one-year deposit rate of 3 percent, data compiled by Bloomberg show.
“As China’s economic growth slows, what used to be growth stocks have become value stocks,” Shao wrote. “Without a steady cash payout, these stocks will become less and less attractive.”
The CSRC also issued new rules for backdoor listings, where a firm joins the stock market by buying a publicly traded company, thus skirting the stricter requirements of an IPO. The regulator banned such listings for the Nasdaq-style ChiNext board and raised the qualification criteria for a backdoor listing on the main markets to curb excessive speculation in poorly performing companies.
— With assistance by Aipeng Soo