The China Securities Regulatory Commission (CSRC) has recently solicited public opinions from the society on the “Guidance Opinions on Further Reforming and Improving New Share Issuance System (Draft for Comment)” (hereinafter referred to as “Guidance Opinions”) to further strengthening the market restraint mechanism and improve the price inquiry system. The spokesman of the CSRC accepted an interview on relevant issues.

Reporter (R): Could you introduce the new share issuance system?
A: The new share issuance system refers to a series of systems and relevant arrangements regarding the pricing, underwriting and offering of new shares in IPO. The pricing mechanism, a core of the new share issuance system, consists of the following two parts: firstly, to confirm the new share issuance price, namely, price discovery; secondly, to sell the new shares to the investors through certain ways. The two parts restrict and depend on each other, constituting the essence of the price forming mechanism.

According to the general principle of the stock market, the pricing process has the following characteristics: firstly, it is a game played by issuers, investors and underwriters for their respective interests; secondly, the investors participate in the pricing by quoting and subscription, and the quoting and subscription information shows the investors’ offer; thirdly, the allotment scheme and result confirmed according to the quoting and subscription intents are the important part of the price forming process; fourthly, the price fixed finally is the price accepted by the issuers and approved by the investors, with the underwriters’ efforts to balance buyers and sellers. The common basis for these characteristics is that the participants make decisions and assume risks by themselves.

R: What are the characteristics in terms of the evolution of China’s new share issuance system?

A: China’s securities market, getting off to a late start, is greatly different with overseas mature markets. The new share pricing mechanism is strongly controlled by the administration in the early stage due to the limitations of the economic, social and legal systems at that time. The “Company Law” in 1993 and the “Securities Law” in 1998 both stipulated that the new share issuance prices should be approved by the securities regulatory authority. Before 2005, because such market participants as the investors and intermediaries were immature and the market mechanism was underdeveloped, the buyers can not effectively restraint the sellers. To protect the investors, the CSRC managed the prices of new shares by restricting the upper limit of the P/E Ratio in a lawful way, which played a positive role in protecting the investors and developing the market on that market condition. But its disadvantages are standing out with the market development, as it is far from adapting to the market-oriented price forming mechanism, and the functions of the primary market in price discovery and resources distribution are not fully brought into play.

The “Securities Law” (amended in 2004) canceled the regulation that the issuance prices of new shares should be verified and approved by the regulatory authority.  According to adjustment to the law, the CSRC conducted significant reform towards the stock issuance method. The price inquiry system launched in early 2005 no longer verifies and approves the prices of new shares, but fixes the issuance prices through the accumulative tenders and inquiries to qualified institutional investors, a common method in developed markets. Therefore, the market participants, or the judgments and intentions of the buyers and the sellers, are guided to the confirmation of issuance prices. It has initially realized the diversified pricing of companies in different trades and types, marking a positive stride towards the market-oriented pricing. Meanwhile, to prevent the excessively high issuance prices, necessary administrative guidance is provided for the final pricing of some new shares’ issuance. Since its implementation, the price inquiry system has been adopted by 284 companies to confirm the stock issuance prices, including a batch of financial, energy and transportation enterprises key to the national economy. The simultaneous issuance and listing of “A shares and H shares” is also realized. The pricing function of the capital market and the efficiency of capital allocation have been remarkably improved, so as to effectively back the sound and rapid development of the national economy.

R: Could you introduce the background of reforming and perfecting the new share issuance mechanism?

A: With Chinese enterprises’ positive attitude to the mechanism improvement and financing through the capital market as well as the more prominent status of the capital market, many market participants, experts and scholars have suggested to further reform and improve the existing share issuance system for the greater development of the capital market. The CSRC has highly valued these suggestions and actively conducted investigations and researches.

We have noticed that there are wide discussions on the improvement of the new share issuance mechanism among market participants. For example, some market participants report that the quotations of some inquirees are not prudential or serious, with such distorted circumstances as high quotation without buying and low quotation with buying at high price. According to some investors, the institutions can participate in the offline allotment and the online share issuance, obtaining a lot of allotted shares with their capital strength, while the individual investors usually have less capital. The underwriters hold that the allotment fully based on capital is to the disadvantage of fostering investors who hold their shares for a long time, and the issuers and the underwriters should be allowed to choose long-term investors conducive to their development strategies. Some market participants also believed that the A-share market is more of a retail-investor market, where the small and medium investors are enthusiastic about buying new stocks, without much risk awareness. In terms of the great spread between the primary market and the secondary market, market participants interpreted differently. Some think high issuance prices lead to even higher prices on the secondary market, while others think excessively low issuance prices cause the great spread, compared with the secondary market. It has aroused concerns and reflections of various parties.

In the emerging and transitional Chinese capital market, the reform and improvement of the new share issuance mechanism, a process of continuous adjustment and optimization, can not be accomplished at one move. Compared with the pricing under the strict administrative control, the price inquiry system has undergone a significant reform. But as the real economy puts forward higher requirements to the capital market, the inherent requirement of a more market-oriented inquiry system is becoming more prominent. Objectively, we should continue to reform and perfect the new share issuance system on the basis of summarizing the experience in the price inquiry system.

In addition, after the operation of the price inquiry system for over four years, the reform is faced with a sound market basis as the capabilities of market participants have been improved, the underwriters have gained rich underwriting experiences and the institutional investors are more competent in pricing.

R: Could you introduce the general consideration and basic goal of reforming and improving the new share issuance system?

A: Since last year, the CSRC has thoroughly investigated issues concerning the reform of stock issuance system, heard opinions of various market participants, analyzed the issuance systems of major overseas capital markets, and formed the idea of the issuance system reform.

The general idea is as follows: efforts should be made to realize the more market-oriented new shares pricing and foster the market restraint mechanism, promote such market participants as the issuers, the investors and the underwriters to perform their duties, and lay more emphasis on the participating intentions of the small and medium investors. The specific considerations are as follows:

1. The quotation restraint mechanism for price inquiry and subscription should be perfected to form a more market-oriented price forming mechanism. While reinforcing the restraint of price inquiry and share issuance, administrative guidance should be reduced for the new share pricing to fully reflect the true intentions of both sides of supply and demand in pricing.

2. The share distribution mechanism in the pricing process should be more flexible to facilitate an even stronger restraining power of the investors towards the issuers. Lead underwriters should be pushed to perform their duties diligently in the issuance, further clarify the principles of and bring more flexibility to such stages as allotment and lock-up in the pricing process, streamline the underwriting mechanism, enhance the issuance efficiency and consolidate the internal balance mechanism.

3. The online issuance mechanism should be optimized, and share distribution should properly favor the small and medium investors with subscription intentions, so as to relieve the situation of new share subscription by enormous funds and raise the lot-winning rate of share subscription by the small and medium investors.

4. The mechanisms of clawback and issuance termination should be improved. The mechanisms of clawback and issuance termination are further defined, and in the clawback mechanism, the offline pricing institutions should assume more responsibilities. When the issuers and the investors can not reach an agreement, the issuance can be terminated, and the issuance can be re-launched within the validity period of the verification and approval documents.

5. More emphasis will be laid on risk alerts of new share subscription to clarify the risks in the issuance market. Special notices should be published on the new share issuance, and the investment idea should be further emphasized to distinctively disclose the risks of the primary market.

The target of the reform is as follows: efforts should be made to optimize the price discovery function of new shares and strengthen the internal balance mechanism of the buyers and the sellers, improve the effectiveness of the allotment mechanism; on the premise of clarified risks, attention should be paid to the participating intentions of the small and medium investors; risk awareness of the primary market should be remarkably intensified.

R: What are the aspects that the main idea and measures of the “Guidance Opinions” targeting at?

A: The new share issuance system has an extensive influence. To ensure the smooth progression of the reform, reduce the uncertainties in the reform and further foster the market mechanism, by taking into consideration the force of the reform and the acceptance of the market, we will launch various reform measures by way of implementing by steps and improving gradually. The “Guidance Opinions” defined that four specific measures would be launched at the first stage upon comprehensively analyzing the present market situation.

The four measures are pertinent. The first is truthful quotation and subscription. Institutions should quote true prices and quantities with no contradiction, inquirees should strictly perform self-regulation and the underwriters should make checks.

Secondly, administrative guidance should be reduced and more emphasis will be laid on the selection by the market. In fact, during the market downturn in 2008, administrative guidance was not necessary for most IPOs, while frequent administrative guidance during the market overheat in 2007 effectively prevented quite a few cases of issuance at excessively high prices and curbed the market bubble. However, the participants quote prudently in large-cap stock issuance and the administrative guidance is rarely used, showing the rational feature of the market. Therefore, the administrative guidance could restrain the overheated market, and a more rational market after great adjustment lays a foundation for reducing the administrative guidance.

Thirdly, the measures favor the small and medium investors with intentions of buying stocks, which is pertinent to the market request of increasing the lot-winning rates of small and medium investors. What needs to be stressed is the risk of new shares, and for example, the prices of about one-fifth of new shares drop below the issuance prices in the international developed market. In China, though historically only a few enterprises’ witnessed their stock prices dropping below the issuance prices on their first trading days, such situations are common not long after the listing. In 2008, the prices of more than 60% of the new shares dropped below the issuance prices. The “Guidance Opinions” is meant to properly favor the small and medium investors with stock purchase intentions but not those without such intentions. It is expected that the investors should prudently and scientifically make purchase choices, instead of gambling.

Finally, regarding a lot of incorrect understanding of the stock market, the “Guidance Opinions” requested the issuers and the underwriters to clarify the risks of the primary market by issuing special announcements, so as to caution the investors who don’t understand the stock market, the issuers or the risks. And investors should avoid the issuers suspected of merely plundering.

R: You mentioned the new share issuance has risk as the prices may drop below the issuance prices, so what are the benefits for the small and medium investors?

A: I just explained the risk of new shares and the meaning of favoring the small and medium investors with stock purchase intentions. So will the new shares benefit the small and medium investors? On one hand, from the international experiences, there’s no absolute guarantee for the return of new shares, and the risk of new shares will be higher with the sluggish economy and stock market. But in share issuance on the overseas markets, the issuers and underwriters usually reserve some space for the secondary market in new share pricing, maintain a good investors’ relationship and establish a long-term credit of the issuers to lay the foundation for future development and financing. So in the long run, most new shares will have premiums after listing. On the other hand, in China, historically most new shares had significant returns after listing, better than the average performance internationally, but there are also cases of high premiums internationally. With the more market-oriented pricing mechanism, new shares’ returns tend to be trimmed, and positive returns will be more uncertain.

One major reason for promoting the reform step by step is to gradually foster the market mechanism and participating subjects so as to form a positive investment cycle among issuers, underwriters and investors as well as an orderly relationship between the primary and the secondary markets. It is believed that the investors will have proper expectations and judgment of the profit and risk of new shares after the reform and continuous improvement. Regarding the fostering of mechanism, among the three subjects of the issuers, the underwriters and the investors, the restraint of investors needs to be strengthened especially, which is essentially the best protection for the interests of the investors. To understand that the restraint of investors should be strengthened by themselves and can not be replaced with administration powers or other powers is important for both the reform and development.

R: Previously some market participants suggested using such methods as “allotment based on the market capitalization” and “one lot per person” to increase the lot-winning rate of online subscription by the small and medium investors, which have not been adopted by the “Guidance Opinions”. What is the main reason?

A: The issuance method of allotment based on the market capitalization was adopted in the market environment characterized by equity division, and only holders of floating shares could participate in the allotment based on the market capitalization, while holders of non-floating shares can not, so the small and medium investors can get more allotted shares by this method. If allotment based on the market capitalization is adopted after the equity division reform, as all the shares are floating shares and can be allotted, the newly-issued shares will be mainly allotted to major shareholders instead of the small and medium investors. So allotment based on the market capitalization is not pertinent.

As for “one lot per person”, such issuance method is occasionally used for retail investors during the large-cap stock issuance on some markets based on the actual situation that the number of retail investors is relatively low. Usually shares of not more than a certain proportion are allotted by this method after most part of the issuance amount is allotted to the institutions. As there are a great number of retailer investors on the A shares market with over 0.1 billion accounts opened on the Shanghai Stock Exchange and the Shenzhen Stock Exchange, no company could issue shares according to “one lot per person”, so this suggestion is not feasible.

Both the suggestion of “allotment based on the market capitalization” and that of “one lot per person” are aiming to increase the lot-winning rates of the small and medium investors. Though the two suggestions have not been accepted, the “Guidance Opinions” took into consideration the intentions of the suggestions and aimed to increase the lot-winning rates by such methods as separating the online and offline channels and setting an upper limit to the online subscription.

R: Some market participants suggested increasing the online issuance proportion of new shares to satisfy the subscription needs of the small and medium investors, others suggested launching the offering of stock shares to increase the supply and realize the so-called all-floating issuance. Have these suggestions been considered in this reform?

A: According to the international experience, the institutional investors, more capable of pricing and recognizing risks, could form stronger restraint over the quotations of the issuers, so institutional investors usually participate in the pricing of new share issuance. And to let the institutions assume the responsibilities corresponding to the pricing and avoid random pricing, generally over 90% of the total issuance amount are allotted to the institutions. After considering the special conditions of China, the current practice is to offer most new shares (50%-80%) online. If the proportion is further increased, there will be great doubts about the authenticity of the pricing by offline institutional investors, and furthermore, the internal mechanism of the stock market may be affected. Therefore, we keep the current regulation of the online and offline issuance proportions unchanged.

The offering of stock shares, common in the overseas mature markets, will increase the supply of new shares on the first trading day, reduce the market manipulation factors and lessen the accumulation of shares with sales limit if it is launched in China. But it is inappropriate to exaggerate the effect of the offering of stock shares. Firstly, the relationship between the reasonable pricing and the amount of floating shares is influenced by many factors. The pricing of new shares is essentially the pricing of a company planned to be listed, and the pricing object is all the shares of the company, so the key is how to judge the value of the company itself. Secondly, after the equity division reform, the new share issuance after the “complete separation of new shares from the old ones” is all-floating issuance, and the sales limit of some shares is not contradictory with the all-floating issuance. The overseas mature markets often impose a lawful or conventional sales limit period of 6 to 12 months on controlling shareholders and strategic investors, and the duration of the conventional sales limit, not legally mandatory, depends on the agreement with the issuers and the underwriters. The sales limit aims at maintaining the stability of corporate governance structure within certain period. Thirdly, the offering of stock shares refers to the sale of shares by original shareholders for cash, and the capital flows to the original shareholders but not the listed companies. As it is different from the actual conditions in China’s market for a long time, it takes time to unify the understanding. Besides, there is legal limitation on the offering of stock shares. We will continue to thoroughly study the offering of stock shares and launch it at a proper time till the market conditions are ripe.

R: After the issuance of the “Guidance Opinions”, what are the issues requiring attention of market participants in the new share issuance?

A: The wide coverage of the new share issuance system requires all market subjects to clarify their roles and responsibilities as well as perform their duties. All market participants should deepen the understanding, respond to the reform and implement various reform requirements.

Issuers should foster the right idea of issuance and listing, actively fulfill the information disclosure obligations, rationally quote in share issuance and bear in mind the long-term investor relations maintenance. Lead underwriters should perform their duties diligently, honestly and faithfully as well as safeguard the long-term and fundamental interests of the buyers and the sellers. They should make improvement and adaptation of their work in organization, personnel, system and technology to continuously upgrade the professional services. Inquirees should bring into play the functions of professional institutions and guide the market rationally by obtaining the materials in an earnest, prudential and professional way, making analysis and judgment as well as pricing rationally. Small and medium investors should strengthen the risk consciousness, buy stocks in the principle of prudence and resolutely avoid blind investment.

During China’s development and practice in more than ten years, many investors have learned the lesson that investing at one’s own risks is not in word but the actual principle and result of the market. Following a more market-oriented new share pricing, the risks will be higher as the prices of some stocks may drop below the issuance prices, so the investors should be more cautious.

R: What are the arrangements for the new share issuance?

A: The new share issuance will be arranged after the opinion solicitation and official promulgation of the “Guidance Opinions”, so all relevant institutions should understand the contents of the “Guidance Opinions” as soon as possible. At the beginning period of implementing the reform measures, we will detail various arrangements, pay attention to the opinions from the market and steadily carry out relevant work.