The Shenzhen Stock Exchange in south China's Guangdong Province formally inaugurated a special board for small and medium-sized enterprises on May 27, with the first initial public offering there expected to be completed within a month. After a three-year suspension of new listings, Shenzhen is once again on its way toward becoming a regional financial center. The move also marks a substantial step forward in China creating its long-planned second board for hi-tech start-ups, to usher in a new era of domestic stock market development, with the formation of a multi-level structure as the goal.

START-UPS' POWER SOURCE: Hi-tech small-caps are the priority of the newly created stock transaction platform in Shenzhen

China's stock market has had two main boards for over 10 years, since its reestablishment. But that situation may soon be a thing of the past, after the launch of a board tailored for small and medium-sized enterprises (SMEs) under the main board of the Shenzhen Stock Exchange this May. The sub-board is widely believed to be a pilot of the country's long-awaited NASDAQ-style second board.

Though it is not a real second board, commented industry experts, the establishment of the SME board is still a big step for the Chinese stock market's structural adjustment.

Fan Fuchun, Vice Chairman of the securities industry watchdog, the China Securities Regulatory Commission (CSRC), claimed, "The SME board's debut opens a new chapter in the institution innovation of the domestic securities market."

The launch of the SME board represents an important decision of the Central Government to boost sustained growth and promote economic restructuring, said a CSRC spokesman. Since China's stock market was resumed in 1990, it has constantly expanded in scale, amid remarkable progress in technical level and standardized management. However, the simple market structure is hard to meet the diverse demands of listed firms and investors. Given this, the SME board is expected to enhance the capital market's function in resource allocation, increasing SMEs' fund-raising channels and optimizing the overall structure of China's financial market. The SME board is a practical choice to phase in the second board under the current conditions, according to the spokesman.

China now has more than 8 million registered SMEs. In recent years, they have become the most dynamic and promising stimulus for economic growth of the country, contributing over 50 percent to the annual growth of national GDP. But cash inadequacies have created a bottleneck, handicapping their growth. A recent survey shows that in China's eastern areas where marketization level is comparatively high and SMEs flourish, nearly 60 percent of the SMEs' borrowing requests are turned down by banks, while capital crunch reportedly plagues 80 percent of SMEs nationwide. As a result, the SME board, a direct financing platform for eligible enterprises, is thought to be very helpful to solve their problems in this regard.

Wu Xiaoqiu, Director of the Finance and Securities Institute of the Beijing-based Renmin University of China, believes that the launch of the SME board would diversify China's capital market and improve its structure. He noted that the new counter would provide more opportunities for stock investors, especially minority traders.

In Wu's opinion, the functions of the country's two bourses, in Shanghai and Shenzhen respectively, will be further clarified in future. The SME board of the Shenzhen Stock Exchange, featuring small-caps, will mainly accommodate minority investors with awareness of risk, while transactions of blue chips among institutional investors will be carried out in the Shanghai Stock Exchange. Then investors with different appetites will have capital scale-divided markets to meet their respective demands, Wu continued.

On the other hand, the SME board is also a key step to implement the regulatory authorities' strategy to build China's technology-laden second board in a studied way.

China began to conceive a second board in early 2000, hoping to achieve this through reframing the main board of the Shenzhen Stock Exchange. But the government shelved the plan months later amid fears of excessive risks. At that time, a slump swept across almost all technology-heavy markets worldwide following the burst of the "new economy" bubble, which resulted in greatly reduced volumes of transactions and listings. A series of corporate scandals were also exposed. The development of global markets for technology start-ups suffered severe setbacks consequently. Domestically, the proposed trading rules for the second board, which stipulated that the founding controlling shareholders could sell their stakes after a three-year lockup, had led to the setup of a large number of shell companies on which the founders hoped to cash, as well as wild speculation of expected second board-listed stocks. Given this, great risks had faced the second board even before its formal inauguration.

According to the CSRC spokesman, his commission has closely followed overseas experiences when planning the country's second board. He said that the commission approved the SME board after giving comprehensive consideration to domestic market's initial capacity and risk-resistance ability, as well as the industrial distribution and performance of companies to be listed. "The move will comply with the step-by-step process of building the second board, observing all the necessary conditions, thus putting possible risks under effective control," the official explained.

As a new part of China's stock market, it is stipulated that existing regulatory rules and listing requirements will apply to the new SME board. For example, companies to be listed are required to report net income in recent three consecutive years. But the counter is expected to run independently with its own index, trade code and supervisory system. This measure is reportedly designed to advance institution innovation and prepare managerial expertise for the NASDAQ-style second board.

Reiterating that the functions of the two bourses in Shanghai and Shenzhen would be further divided after the SME board was in place, the CSRC spokesman predicted better interactions between them and stronger momentum for institution and product innovations in the stock market as a whole. This is of positive significance to enhance investor confidence and boost the market, he said.

The official admitted that the establishment of the SME board would inevitably increase stock floatation and divert capital from the main board. But he tried to play down the fears among investors concerning the future capacity expansion of the SME board. 'To ensure market stability, the CSRC will closely watch relevant changes after the SME board begins operation and do its utmost to keep harmony between the volume and speed of flotation and market capacity."

Professor Xiao Zhuoji, a prominent securities expert, also made light of the fears. Despite the limited role of the SME board in diverting capital, he said, the new counter would contribute more to the growth of the tech sector on the main board and create a positive interaction between the two boards. Xiao continued his elaboration with a calculation: Assuming 100 firms would be listed on the SME board, each with a flotation of 20 million shares and their transaction prices averaging 20 yuan per share, the total market value would be 40 billion yuan ($4.83 billion), equivalent to only 3-4 percent of the current negotiable market capitalization of the Shanghai Stock Exchange. This amount of capital loss, according to the professor, is undoubtedly tolerable to the main board.

The mainland's SME board has been a hot topic in Hong Kong's securities sector as well, but there is still no consensus on its effects on the local stock market. Some argue that most mainland enterprises would finally sub-stitute Shenzhen for Hong Kong for their listings, while others insist the new board in the mainland would prop up the region's Growth Enterprise Market.

Chow Man-yiu, Chief Executive of Hong Kong Exchange and Clearing Ltd., believes there would be no competition between mainland and Hong Kong markets. "Though the Growth Enterprise Market also mainly serves mainland enterprises, the two markets in the mainland and Hong Kong have different capital sources and cater to different investors. So they can meet divided fund-raising and development strategies of listed companies," he noted.

Though the Growth Enterprise Market also mainly serves mainland enterprises, the two markets in the mainland and Hong Kong have different capital sources and cater to different investors 

Lew Mon-hung, Chief Consultant with the Core Pacific-Yamaichi International (Hong Kong) Ltd., is also optimistic toward Hong Kong's stock market, saying policies on the mainland forbidding state shares to become tradable and RMB capital accounts inconvertibility are two biggest disadvantages of the SME board. He explained, "Shares of Hong Kong-listed companies are all tradable, which ensures an opener, fairer and more transparent investment. In addition, companies that badly need foreign exchange to explore overseas markets or for their foreign shareholders to cash in have to seek Hong Kong listings.

"There are 10 limitations on issuance of additional shares in the mainland, but Hong Kong executes only one of them that provides issuance of additional shares in excess of 20 percent of the original total shall be approved by the shareholders' meeting. This adds to Hong Kong market's appeal to mainland enterprises," Lew added.

Compared with the mixed reactions in academic and banking circles, people in the business circle have unanimously welcomed the inauguration of the SME board.

Considering the high cost of overseas listings, the SME board in Shenzhen is attractive to enterprises in Zhejiang, said an official with the province's SME Development Bureau, who added that the new board would become eligible local companies' first choice for listing.

Zhejiang has China's most flourishing private economy. It is also a province with the most SMEs, totaling 680,000, and 99 percent of them are in the industrial sector. The province accounts for 900 of China's 2,900 most successful SMEs rated by the National Development and Reform Commission and other departments, as well as 108 of the 500 most promising SMEs in the country.

But lack of stable fund-raising channels has long been a bottleneck in local SMEs' development, which, in turn, makes relevant parties more sensitive to changes in the capital market. This April, soon after it learned of the upcoming launch of the SME board, the provincial government devised a plan to capitalize local SMEs with benefit of the new market.

Sichuan Province in southwest China also has a multitude of SMEs. According to Luo Guanghui, Director of the SME Development Center of the province, Sichuan had actively prepared for the second board years ago. After the establishment of the SME board was announced, more than 100 local companies had consulted Luo's center on listing procedures. To meet their demands, the director said, the center would set up a special department to promote their early listings.

Chronology of China's Stock Market

December 1, 1990: Shenzhen Stock Exchange starts trial run.

December 19, 1990: Shanghai Stock Exchange is inaugurated.

1992: Shanghai and Shenzhen bourses are transformed from regional to national markets.

1992: State Council Securities Commission and China Securities Regulatory Commission (CSRC) are established successively.

March 1995: Transaction volume of the Shanghai Stock Exchange exceeds that of its Shenzhen counterpart.

1996: Stimulated by Hong Kong's upcoming return to Chinese sovereignty in the following year, the Shenzhen Stock Exchange increases input in its facilities and services. Since August, transaction volume of the counter exceeds that of Shanghai. The annual growth of Shenzhen composite sub-index in 1996 ranks first worldwide, reaching 174.92 percent.

1998: CSRC bans enterprises to voluntarily choose their listing locations.

August 2000: Proposed listing rules for the second board is issued and the Shenzhen Stock Exchange is authorized to conduct relevant qualification examinations.

September 2000: The Shenzhen Stock Exchange stops new listings and surrenders the right to the Shanghai bourse.

May 17, 2004: CSRC approves the Shenzhen Stock Exchange to establish a small and medium-sized enterprise board (SME board) under the main board and endorses the implementation plan.

May 27, 2004: SME board debuts on Shenzhen Stock Exchange.

Venture Capital's Blessing

The establishment of the small and medium-sized enterprise board in Shenzhen has absolutely brought glad tidings to all venture capital investment companies in the country, said Wang Shouren, Secretary General of Shenzhen Venture Capital Association.

As China's first region to develop venture capital investment, Shenzhen leads the country in the number of investment institutions and the amount of capital for this purpose. By November 30, 2003, the city had registered 197 venture capital investment companies, or one-third of the national total, which combined to realize one-third of the investment nationwide.

Though the SME board is still not a real second board where all shares have to be tradable, a lot of industry insiders hold its birth deserves warm applause since it gives the venture capital investment companies the first sign of hope.

The establishment of a NASDAQ-style second board in China has been a dream of investment bankers for years. But the venture capital investment industry had to undergo a hard period in the past three years after the government decided to suspend the second board's creation in 2000.

After nearly three years of operation, explained Zhu Fang, Vice President of the Shenzhen Venture Capital Association, a lot of hi-tech projects have finished the incubation period to become profitable in the last two years. He added that since the second board was not in place, the investors had lost a major channel to exit after cashing in on their investment projects and their development had therefore stagnated.

The development of the venture capital investment industry is preconditioned upon the flourishing of small and medium-sized hi-tech start-ups. Official statistics show the country now has more than 1,200 SMEs eligible for flotation on the SME board, bigger than any overseas market in terms of listing resources.

Moreover, the projected revitalization of the venture capital investment industry amid the development of the SME board has again aroused Shenzhen's ambition to become a regional financial center.

Zero2IPO Co. Ltd., one of China's leading venture capital investment companies, has announced to place its emphasis in Shenzhen this year and signed agreements on strategic cooperation with the Shenzhen Venture Capital Association and the Guangdong Provincial Council for the Promotion of Venture Capital Investment. A company executive expressed that Shenzhen has a lot of economically potential projects waiting for investors' discovery and Zero2IPO would build a bridge between project developers and investors.

After the Shenzhen Stock Exchange suspended initial public offerings three years ago, a large amount of securities investment capital has left local market for the country's other stock exchange in Shanghai. As a result, some investment analysts once warned that Shenzhen's status as a financial center is in danger of being marginalized. But, after the SME board's inauguration, a growing number of signs show that Shenzhen, a city known to the world for its enterprising spirit, is regaining investors' confidence.