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Cover Stories Series 2014> Reform Initiatives Underway for 2015> Retrospect> Opinion
UPDATED: October 20, 2014
Suggestions to Improve China's Growth Enterprise Board

It has been five years since the very first crop of companies were listed on ChiNext, China's growth enterprise board, on October 30, 2009. The NASDAQ-style board has certainly played a vital role in boosting innovation in the country and now it's time for us to think about how to further improve the board so as to realize speedy and stable development. Adjustments can be made in the following areas.

First, the positioning of the ChiNext should be reconsidered. According to the theory of corporate life cycle, businesses will go through four stages—start-up, growth, maturity and decline. Previously, ChiNext was mainly targeted at companies in the growth and even the maturity phases. However, there have been mounting concerns over the loss of promising Chinese companies to pastures abroad with many prominent, but not yet profitable, Internet companies choosing to become listed on overseas stock exchange.

Amid the outcry that Internet companies currently operating at a loss would be allowed to list on China's A-share market, the China Securities Regulatory Commission (CSRC) recently released a regulation to encourage ChiNext to set up a special section for qualified Internet and hi-tech companies that are operating on a loss-making basis. This will enable such companies to list on the ChiNext after being traded on the New Third Board—a national share transfer system for small and medium-sized enterprises to transfer shares and raise funds—for a minimum of 12 months.

Therefore, the function of ChiNext should be redefined. ChiNext should extend its support to businesses that are at the start-up phase. Companies that are currently registering a loss should also be allowed to list, as long as investors think they are worth the gamble.

Second, there should be stronger supervision over the unloading of stocks by initiators, major stockholders, members of the board of directors, members of the board of supervisors and senior management. Spurred by the current market craze for hi-tech concepts and mergers and acquisitions (M&As), speculative activities have frequently occurred, even in some ChiNext-listed companies that register a flat profit, in which major stockholders have sold their stocks at high prices. In September alone, 478 million of shares in 145 companies, with a market value of 7.3 billion yuan ($1.19 billion), were sold by major shareholders.

A new regulation governing initial public offerings (IPOs) on ChiNext stipulates that a company can only become listed on ChiNext when it has been profitable for two consecutive years, with no less than 10 million yuan ($1.63 million) in accumulated profits during that time. A company may also be eligible if it has been profitable for the past year with annual business revenue of no less than 50 million yuan ($8.16 million).

In addition to the current regulations, the unloading of stocks by initiators, major stockholders, members of the board of directors, members of the board of supervisors or senior management can only be approved when the company fulfills the above-mentioned criteria. Especially after loss-making enterprises are allowed to list on ChiNext in the future, major stockholders will be able to sell their holdings only after turning the company into one that meets the requirements for IPOs on ChiNext.

Third, ChiNext should be prevented from becoming too frothy. As of October 13, the price-to-earnings ratio of ChiNext had reached 69. Among the 338 stocks traded that day, the prices of 25 companies exceeded 50 yuan ($8.16) while only 24 companies' prices were less than 10 yuan ($1.63), with the lowest being 4.44 yuan ($0.72). In sharp contrast, among the 216 listed companies on Hong Kong's growth enterprise board, only five companies had a stock price of over HK$10 ($1.3) on October 13, while stock prices of 63 companies were above HK$1 ($0.13) and those of 153 companies were less than HK$1.

Speculative activity is a major cause for the present overvaluation in ChiNext. This can be solved by a stock-trading program linking the Shenzhen and Hong Kong exchanges. After a sufficient amount of experience has been accumulated following the establishment of a connection between the Shanghai and Hong Kong exchanges, linking Shenzhen and Hong Kong exchanges should also be tried out. When the two exchanges are connected, the mindset of Hong Kong investors will affect the Shenzhen Stock Exchange, where the ChiNext is situated.

Finally, rules governing the M&As of ChiNext-listed companies should be improved. Currently, anticipation of M&As could set the prices of junk stocks rapidly soaring. The CSRC has prohibited backdoor listing on ChiNext since November 2013. However, even without backdoor listing, major M&A cases will also lead to market speculation and manipulation, as well as insider trading. In a bid to encourage innovation-driven and intrinsic growth among listed companies, ChiNext should have stricter rules regarding these major cases.

This is an edited excerpt of an article published in Securities Times 

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