Why China’s New Tech Exchange Has Regulators Worried

1. What’s the STAR Market?

It’s “where the rising star companies cluster,” according to its website. Part of the Shanghai Stock Exchange, it has a simplified system under which tech companies and startups face less red tape in getting the nod to sell shares. The changes are aimed at lowering the wait time for approval to three months, compared to perhaps years on China’s other stock venues. The new board also removed limits on the pricing of initial public offerings and eliminates caps on first-day trading gains. To discourage fraud, regulators asked sponsoring brokerages to invest in the companies and lock in their capital for a fixed period of time. While unprofitable firms are allowed to list, they must meet minimum requirements for market value, revenue, research and development or cash flow.

2. What’s the rationale?

Market observers have been interpreting it as a gift to Shanghai from President Xi Jinping, who announced the plan in 2018, in line with his broader goal of boosting the city’s status as a global financial center. It’s also seen as an effort to stem the exodus of tech listings from the mainland especially as Hong Kong’s bourse opens its doors wider to such companies and the sort of dual-class listings many of them prefer. It provides another way for the government to get investors on board with Xi’s goal of championing Chinese leadership in the tech sector, and another option for Chinese firms as the U.S. moves ahead with new rules that could make it harder for some to list in New York.

3. What’s been the response?

Trading started with 25 companies on July 22, 2019, and was so frenzied that stock prices rose by an average of 140% that day. By late March 2021, more than 240 firms were listed with a combined market capitalization of 3.17 trillion yuan ($486 billion), mostly small- and mid-size companies. Some IPOs have done well; SMIC surged more than 200% during its debut in July 2020, a month later CanSino Biologics Inc. initially rose as much as 127%. That same year the relaxed rules were extended to the ChiNext exchange in Shenzhen, which has more than 760 members, most of them small technology firms with a track record of profitability at the time of listing.

The high valuations could be due to the herding behavior of Chinese retail (individual) investors, who tend to rush toward the next big theme, as well as to so-called unicorns for their relative scarcity. Most STAR board listings are in red-hot sectors including semiconductors and health care. It also shows what happens when IPOs have no caps on valuations and new stocks have no limits on price moves for the first five days. Meanwhile, a rising tide lifts all boats as central bank-fueled liquidity drove a broad market rally, with many retail investors diverting bank savings and fixed-income investments into equities. The nation has seen some of the world’s biggest equity bubbles in recent years, repeatedly testing the government’s ability to manage the market.

Not exactly. The tide turned for Chinese stocks this year as concern about tighter monetary policy replaced optimism about the post-pandemic economic recovery. Chinese regulators now are seeking to head off some of the more sub-par firms that have rushed to take advantage of the laxer oversight and high valuations to raise funds. The China Securities Regulatory Commission was said in March to be considering tighter rules that would require firms to prove their technology credentials to qualify. Plans by Geely Automobile Holdings Ltd. have already hit a snag because of it. Of the 84 firms that withdrew IPO applications in mainland China in the first quarter of 2021, the most since 2018, 28 of them were aiming for the STAR market, 48 for the ChiNext, according to data compiled by Bloomberg.

The changes would also raise the bar for fintech firms like Ant, which was forced to suspend its listing in November after the Chinese government suddenly slapped new rules on its consumer-loan business — part of a broader reining in of the country’s tech giants. Xi’s administration has been particularly concerned about eradicating systemic risks — such as unsupervised growth of consumer debt — in part to ensure financial stability and the Communist Party’s dominion.

7. So how’s the pipeline?

Some analysts think the huge number of tech startups in China will keep demand for the STAR board strong. The combined revenue of the 148,600 tech firms in the Haidian district of Beijing was expected to top 2 trillion yuan ($306 billion) last year, according to Minsheng Securities Co. Accounting firm Deloitte has projected around 150 to 180 stocks will be added to STAR Market in 2021, raising around 300 billion yuan.

8. How had tech stocks been traded?

Aside from the ChiNext, there’s the National Equities Exchange and Quotations, or NEEQ, in Beijing. The NEEQ sets its bar for listing much lower than the ChiNext does, with no requirement for profitability, for example. It is China’s biggest over-the-counter market with more than 9,000 companies, but trading turnover is tiny. Retail investors must have at least 5 million yuan of securities assets to participate.

9. What happened to the last big thing, CDRs?

A trial program in 2018 sought to lure Big Tech firms back with so-called Chinese depositary receipts, or CDRs, which would allow domestic investors to hold overseas-listed Chinese shares. But initial expressions of interest from the likes of Alibaba, JD.com and Xiaomi didn’t translate into action. In 2019, the government announced a waiver on some taxes for investors in CDRs to encourage participation. In January 2021, Lenovo Group Ltd. announced a plan to sell CDR shares on the STAR market, followed by Alibaba-backed artificial intelligence startup Megvii Technology Ltd.

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