(Bloomberg Opinion) — In the past, Beijing has responded to wild swings in its stock markets with regulatory crackdowns. This time is likely to be different. That’s why investors should see gyrations as wide as 3,000% in shares on Shenzhen’s ChiNext market as a sign of emerging maturity.
The 18 companies that made their trading debuts on the Nasdaq-like board last week rose an average of 200%, under revamped rules that remove limits on price moves for newly listed stocks. Previously, shares were restricted to a maximum increase of 44% or a decline of 36% on their first day of trading. For existing stocks, the daily limit on price movements has been doubled to 20% from 10%.
China’s market reforms have been a stop-start process. Regulators have repeatedly sought to liberalize, only to step in when gut-wrenching volatility and wild speculation test their resolve. That pattern has played out repeatedly over decades, from the suspension of green-bean futures in 1995 to the government’s unsuccessful attempt to stem the collapse of a stock bubble in 2015.
Officials’ distrust of unfettered market forces and determination to impose guardrails has produced distortions. One reason why new listings tend to soar is that pricing of initial public offerings is artificially depressed. Unofficial rules cap price-earnings ratios at 23. The result can be parabolic increases in stocks perceived to have the hottest growth prospects. In 2016, China Film Co. rose the permitted 44% on its debut and then by the 10% maximum for the next 11 trading days.
The latest loosening of constraints might appear to confirm regulators’ worst fears of chaotic markets that expose small investors to the risk of socially divisive losses and ultimately undermine market integrity. With the ChiNext training wheels removed, Contec Medical Systems Co. spiked as much as 2,932% on its debut last Monday, before finishing with a gain of 1,061%. Yet there are reasons to believe that China may stay the course this time.
For one thing, the government is under increasing pressure to create a viable alternative venue for technology companies as the environment for Chinese enterprises in the U.S. sours. The Trump administration has proposed delisting Chinese companies that fail to meet U.S. audit standards by 2022 . While Chinese regulators have offered concessions in an attempt to break the impasse, there’s no guarantee that a resolution will be reached.
That’s the context in which China is easing bureaucratic restraints and moving to a freer system with the potential to create a deeper, more liquid and more vibrant market at home. Besides relaxing price curbs, ChiNext — like its sister market in Shanghai, the Star board — has moved to a registration-based IPO system. This moves the Chinese market closer to the listing mechanism used by Nasdaq. Instead of the securities regulator acting as a gatekeeper and vetting companies before they are allowed to list, the registration system permits any company meeting certain criteria to pitch to investors provided all relevant information is disclosed.
Authorities have already shown a greater tolerance for volatility since the Star board started operations in July last year. The first 25 companies to go public on the Shanghai tech-focused market surged an average of 140%. Companies in strategic industries favored by the government, such as chipmaking and biotech, have done even better. Semiconductor Manufacturing International Corp., the world’s biggest IPO so far this year, rose more than 200% on its July 16 debt. Jack Ma’s Ant Group, which is planning a $30 billion joint IPO in Shanghai and Hong Kong, may create even more fervor.
The enthusiasm generated by the ChiNext and Star markets is an indictment of how authorities have managed listings on the Shenzhen and Shanghai main boards. Regulatory oversight has allowed political considerations to influence the process. The result has been share markets that too often have been moribund, stuffed with plodding (though well-connected) state-owned enterprises that struggle to capture the imagination of investors. Faced with that failure, officials have sought to micro-manage demand, even shutting down the IPO market completely on occasion.
Officials are right to be concerned about extreme price movements in a young and exuberant market where herd behavior is rife and manipulation may be relatively easy. The accounting scandal at Nasdaq-listed Luckin Coffee Inc. is a reminder of the unscrupulous behavior that can flourish even among high-flying companies. Experience shows, though, that heavy-handed bureaucratic controls aren’t the answer.
A combination of U.S. hostility and domestic necessity is finally pushing China’s stock market in the direction it needs to go. It may not look like it yet, but this is progress.
–With assistance from Zhen Hao Toh and Jia Qi Li.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Nisha Gopalan is a Bloomberg Opinion columnist covering deals and banking. She previously worked for the Wall Street Journal and Dow Jones as an editor and a reporter.
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