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Chinese portfolio investors may never forget PetroChina Co. Ltd.’s initial public offerings （IPO）. On November 5， 2007， PetroChina was listed on the Shanghai Stock Exchange as the most profitable company in Asia. Its IPO price was 16.7 yuan （$2.71）， but shares opened at 48.6 yuan （$7.88） on the first day of trading. The resplendent financial figures attracted flocks of investors. But two days later， its stock price began its long downturn. The stock price fell below the offering price of 16.7 yuan a year later， and on June 27， its stock price only stood at 7.36 yuan （$1.2）.
Chinese securities experts， media and investors at the time blamed China’s immature IPO market for causing the stock’s nose-dive.
To strengthen the country’s stock market， the China Securities Regulatory Commission （CSRC） issued new IPO draft rules on June 7 to collect public opinion until June 21， after which the rules would come into effect and allow for new listings to resume after they were suspended seven months ago.
Problems
China’s stock market has a history of only 20 years. The present IPO mechanism began on January 1， 2005， when a quasi-market-oriented approach was adopted. The IPO needed examination and approval while the market decided stock prices. That is to say， whether a company can be listed on the stock market is approved by the CSRC， but the IPO prices are decided by issuance institutions through competitive means.
Wang Yong， a researcher with CITIC Securities Co. Ltd.， says such a quasi-marketoriented mechanism causes high IPO prices， high price-to-earnings ratio and high IPO capital. Almost all the new stocks in China face the three “highs，” which usually result in unreal stock prices and damage investor interests.
The most serious problem is fraud， says Wang. To get listed， some companies fake financial figures in order to pass CSRC scrutiny. Moreover， during the IPO process， the issuers and underwriters both hope for an over-subscription of shares， because underwriters can get higher underwriting fees while the issuers and private equity institutions can cashout at higher prices after the IPO. Therefore the issuers， securities companies and private equity institutional investors are likely to be in cahoots with each other. However， Chinese law has no provisions on the legal liabilities of IPO underwriters and issuers.
“The problems in the IPO and pricing process are due to an immature system which cannot meet the demands of market development. But the root cause is that the present IPO mechanism is not yet thoroughly market-oriented，” said Wang. Market-oriented
According to a CSRC statement， the reforms are aimed at enhancing the obligations of issuers and holding shareholders， making the pricing process of new shares more market-oriented and strengthening supervision and law enforcement.
In its draft document， the CSRC proposed that the timing of the IPO should be decided by the issuer and its underwriters in accordance with market conditions， and the IPO process should be controlled by the market itself instead of being decided by the CSRC and stock exchanges.
Furthermore， the draft prospectus of a company will be disclosed on the CSRC’s website after being accepted by the commission. A company whose IPO application is being examined can issue corporate bonds first. The CSRC will explore and encourage companies to issue other forms of stock rights other than common stocks or finance in the form of combining stocks and bonds. After an issuer passes the procedures of the CSRC’s Public Offering Review Committee， the CSRC will approve its IPO and the issuer can decide the timing of the IPO within 12 months of approval.
Compared with the existing IPO apparatus， the draft document also makes breakthroughs in the pricing of new stocks. The draft document allows market-oriented adjustments in IPO pricing， individual investors’ participation in pricing and strengthens information disclosure during the pricing process. According to the document， the offering price should be fixed by the issuer and its underwriters and the way in which the price was determined should be disclosed in an IPO announcement. Qualified individual investors can participate in pricing and placement.
The draft document allows underwriters to reserve shares for certain investors. Lead underwriters can independently choose to sell stocks to investors who have offered effective quotes.
When advancing the market-oriented reform of the IPOs， the draft document stresses strengthening supervision and law enforcement to prevent illegal activities. For example， if the issuer makes false or misleading statements in its application or legal documents， it will be subject to an investigation by the CSRC； if the allegations hold， the issuer will not be accepted for IPO application within 36 months.
Breakthroughs
He Liping， Director of the Financial Department of Beijing Normal University， said compared with the previous reforms of the IPO structure， this is a real market-oriented reform. “I still feel disappointed because it doesn’t resolve some essential matters. If the CSRC does not make significant revisions， the new round of reforms will be spoiled again，” said He.
The draft document stresses to “make the IPO pricing more market-oriented，”he said， but seeing from the present stock structure of listed companies， such reform doesn’t go far enough. In the stock structure of listed companies， the proportion of tradable shares in the IPO is very small， while the proportion of restricted shares is quite large， including the large amount of shares held by controlling shareholders. “When the proportion of tradable shares in the IPO is small， how can the pricing be market-oriented？”said He.
He said this issue is the foundation to reform the IPO mechanism. If this cannot be solved， all the other reforms will come to nothing.
To solve this problem， he suggested that the CSRC can require that tradable shares of an IPO should not be lower than 50 percent of the total shares （excluding state-controlled companies）； all the shares above 30 percent held by the actual controller must be transferred to preferred shares.
The professor added that IPO reforms should also make clear that companies who commit fraud should be immediately delisted from the stock market. In the meantime， the CSRC should also effectively protect the rights and interests of investors.
“The IPO system needs thorough reform， so I hope the CSRC can make major revisions on the draft document，” He said.
CSRC’s New IPO Rules
The company prospectus will be disclosed upon acceptance， and the issuer and intermediary institutions must be responsible for the “authenticity， accuracy and completeness” of the prospectus hereafter.
The IPO will be approved after a review of the CSRC’s Public Offering Review Committee. The issuer is free to choose the timing of IPO within 12 months of the approval.
The controlling shareholder and shareholding senior management of the issuer must agree that if they sell their shares within two years after the lock-up period expires， the selling price shall not be lower than the offering price.
The issuer and underwriters can independently fix the offering price， and if the price-toearnings ratio is higher than the average level on the secondary market， they must issue a special announcement on investment risks.
False records， misleading statement or omission of major items will not be accepted for IPO applications within three years.
The CSRC plans to establish a system to suspend trade on the first day of trading to curb speculation on new stocks.
Chinese securities experts， media and investors at the time blamed China’s immature IPO market for causing the stock’s nose-dive.
To strengthen the country’s stock market， the China Securities Regulatory Commission （CSRC） issued new IPO draft rules on June 7 to collect public opinion until June 21， after which the rules would come into effect and allow for new listings to resume after they were suspended seven months ago.
Problems
China’s stock market has a history of only 20 years. The present IPO mechanism began on January 1， 2005， when a quasi-market-oriented approach was adopted. The IPO needed examination and approval while the market decided stock prices. That is to say， whether a company can be listed on the stock market is approved by the CSRC， but the IPO prices are decided by issuance institutions through competitive means.
Wang Yong， a researcher with CITIC Securities Co. Ltd.， says such a quasi-marketoriented mechanism causes high IPO prices， high price-to-earnings ratio and high IPO capital. Almost all the new stocks in China face the three “highs，” which usually result in unreal stock prices and damage investor interests.
The most serious problem is fraud， says Wang. To get listed， some companies fake financial figures in order to pass CSRC scrutiny. Moreover， during the IPO process， the issuers and underwriters both hope for an over-subscription of shares， because underwriters can get higher underwriting fees while the issuers and private equity institutions can cashout at higher prices after the IPO. Therefore the issuers， securities companies and private equity institutional investors are likely to be in cahoots with each other. However， Chinese law has no provisions on the legal liabilities of IPO underwriters and issuers.
“The problems in the IPO and pricing process are due to an immature system which cannot meet the demands of market development. But the root cause is that the present IPO mechanism is not yet thoroughly market-oriented，” said Wang. Market-oriented
According to a CSRC statement， the reforms are aimed at enhancing the obligations of issuers and holding shareholders， making the pricing process of new shares more market-oriented and strengthening supervision and law enforcement.
In its draft document， the CSRC proposed that the timing of the IPO should be decided by the issuer and its underwriters in accordance with market conditions， and the IPO process should be controlled by the market itself instead of being decided by the CSRC and stock exchanges.
Furthermore， the draft prospectus of a company will be disclosed on the CSRC’s website after being accepted by the commission. A company whose IPO application is being examined can issue corporate bonds first. The CSRC will explore and encourage companies to issue other forms of stock rights other than common stocks or finance in the form of combining stocks and bonds. After an issuer passes the procedures of the CSRC’s Public Offering Review Committee， the CSRC will approve its IPO and the issuer can decide the timing of the IPO within 12 months of approval.
Compared with the existing IPO apparatus， the draft document also makes breakthroughs in the pricing of new stocks. The draft document allows market-oriented adjustments in IPO pricing， individual investors’ participation in pricing and strengthens information disclosure during the pricing process. According to the document， the offering price should be fixed by the issuer and its underwriters and the way in which the price was determined should be disclosed in an IPO announcement. Qualified individual investors can participate in pricing and placement.
The draft document allows underwriters to reserve shares for certain investors. Lead underwriters can independently choose to sell stocks to investors who have offered effective quotes.
When advancing the market-oriented reform of the IPOs， the draft document stresses strengthening supervision and law enforcement to prevent illegal activities. For example， if the issuer makes false or misleading statements in its application or legal documents， it will be subject to an investigation by the CSRC； if the allegations hold， the issuer will not be accepted for IPO application within 36 months.
Breakthroughs
He Liping， Director of the Financial Department of Beijing Normal University， said compared with the previous reforms of the IPO structure， this is a real market-oriented reform. “I still feel disappointed because it doesn’t resolve some essential matters. If the CSRC does not make significant revisions， the new round of reforms will be spoiled again，” said He.
The draft document stresses to “make the IPO pricing more market-oriented，”he said， but seeing from the present stock structure of listed companies， such reform doesn’t go far enough. In the stock structure of listed companies， the proportion of tradable shares in the IPO is very small， while the proportion of restricted shares is quite large， including the large amount of shares held by controlling shareholders. “When the proportion of tradable shares in the IPO is small， how can the pricing be market-oriented？”said He.
He said this issue is the foundation to reform the IPO mechanism. If this cannot be solved， all the other reforms will come to nothing.
To solve this problem， he suggested that the CSRC can require that tradable shares of an IPO should not be lower than 50 percent of the total shares （excluding state-controlled companies）； all the shares above 30 percent held by the actual controller must be transferred to preferred shares.
The professor added that IPO reforms should also make clear that companies who commit fraud should be immediately delisted from the stock market. In the meantime， the CSRC should also effectively protect the rights and interests of investors.
“The IPO system needs thorough reform， so I hope the CSRC can make major revisions on the draft document，” He said.
CSRC’s New IPO Rules
The company prospectus will be disclosed upon acceptance， and the issuer and intermediary institutions must be responsible for the “authenticity， accuracy and completeness” of the prospectus hereafter.
The IPO will be approved after a review of the CSRC’s Public Offering Review Committee. The issuer is free to choose the timing of IPO within 12 months of the approval.
The controlling shareholder and shareholding senior management of the issuer must agree that if they sell their shares within two years after the lock-up period expires， the selling price shall not be lower than the offering price.
The issuer and underwriters can independently fix the offering price， and if the price-toearnings ratio is higher than the average level on the secondary market， they must issue a special announcement on investment risks.
False records， misleading statement or omission of major items will not be accepted for IPO applications within three years.
The CSRC plans to establish a system to suspend trade on the first day of trading to curb speculation on new stocks.