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COMMENTARY: High-Tech Board Offers Hope for China's Innovative Companies

Rules for the new platform under the Shanghai Stock Exchange aim to ease the funding path for new firms and provide a hoped-for tonic to legal and regulatory problems plaguing China's A shares.

Mark Melnicoe
    Mar 09, 2019 4:35 AM  PT
COMMENTARY: High-Tech Board Offers Hope for China's Innovative Companies

A new trading platform for innovative Chinese companies seems like a natural evolution as the country gears up to compete globally in technology. But its success is far from guaranteed, given China's track record running stock exchanges.

Final rules governing the Nasdaq-style high-tech board were announced this week by China's securities regulator, the latest in a series of measures aimed at pushing the country's tech sector. The rules were rushed out just months after President Xi Jinping first proposed the idea in November.

The board will be part of the Shanghai Stock Exchange, and regulators on Thursday gave the green light to Chinese investors to register for trading. The exchange is expected to open by midyear.

It will ease the path for early-stage companies in emerging and high-tech industries to gain access to domestic capital. There's little doubt about pent-up demand in China, from both an investor and company point of view.

For years, many of China's most innovative companies have listed in Hong Kong or New York because the rules were less onerous than trying to list on the Shanghai or Shenzhen exchanges. IPOs were subject to approval from regulators, who often tied them up for months or longer, especially during times of market turmoil.

For Chinese investors, the chance for easy access to more promising domestic companies is tantalizing. China's main bourses have risen about 30 percent this year – the best performance of any major market in the world – after collapsing last year amid the trade war and other headwinds facing the Chinese economy.

Rules for the new board more closely resemble those in the U.S. and other capitalist markets. Company profitability won't be a prerequisite to listing, as long as the firms have demonstrated revenue and strong prospects. Biotech and pharmaceutical companies, for instance, must have obtained approval to conduct a phase II clinical trial of at least one new medicine or related product.

Steering the Market

Sectors eligible for the high-tech board reveal where the government wants Chinese tech to go: They include semiconductors and integrated circuits, artificial intelligence, solar and wind power, biopharmaceuticals and new-energy cars, among others. These are some of the same industries the government is incentivizing via R&D tax breaks and lavish subsidies in its Made in China 2025 initiative. The goal is to make China a global leader across an array of high-tech sectors, and the board will serve as a sort of financial incubator for these kinds of companies.

Made in China 2025 is a source of great friction with the United States, with the Trump administration's negotiators targeting it in trade talks. Even though Chinese officials are officially dropping the name, the initiative remains a pillar of China's economic planning, and the U.S. team is starting to realize that Beijing is not going to bargain it away.

The high-tech board likely will finish off the New Third Board, an OTC market in Beijing that has struggled of late. At least three companies already have delisted from the Third Board and plan to list on the new Shanghai board, the Caixin news portal reported. Last year, some 20 companies that had been listed on the OTC market pulled out and got listed instead in Shanghai, Shenzhen or Hong Kong.

The wisdom of creating the new high-tech board is not in question. The big question going forward concerns how well it will work. The legal environment for China's A shares – those traded on the Shanghai and Shenzhen exchanges – remains problematic, as laws from an array of different areas come into play.

A Caixin editorial noted that national laws, administrative laws, judicial interpretations, departmental rules, normative documents and others all touch on the exchanges, as do  "a set of unwritten rules."

"The language used is vague and the penalties are too light," it said, pointing out "fraudsters must be rubbing their hands with glee over a 600,000-yuan fine for crimes that could involve billions of yuan."  

Inherent Risks

Inadequate punishments are a common feature of corporate law in China – a big reason that companies do things like dump waste materials in rivers. The fines fall so far short of what's needed that many companies know it's a good gamble to try to get away with it.

In the financial markets, there's also the problem of regulators getting too zealous and stepping in to halt trading amid market volatility – which breeds lack of confidence. It's not yet clear how strongly regulators will act toward the high-tech board, though stocks will be allowed to swing up or down by as much as 20 percent in a trading session before sales are halted – double the allowable amount of the A shares.

Much rides on the success or failure of the high-tech board. It could provide needed funding for China's promising tech companies and instill international confidence in the stock market. Or it could become just another exchange with inadequate laws and too many low-quality companies.

"At present, China's A-share market remains a work in progress, without an overall, systematic plan," the Caixin editorial concluded. "What we don't want to see is the new tech board just being assimilated into the existing A-shares market and melting away."

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