IPOs: Regulator Reluctance Drives Ucar Onto OTC Board

Bottom line: The CSRC needs to implement IPO reform, even though it may cause short-term stock market volatility, or risk more market distortions like the recent surge in New Third Board and backdoor listings.

Ucar lists on New Third Board

China’s over-the-counter (OTC) stock exchange notched a notable milestone last week, when a private car services provider with just a year of history made its trading debut with a hefty valuation of more than 40 billion yuan ($6 billion). The impressive valuation for Ucar extended a trend that has seen new listings and valuations explode this year on the Beijing-based National Equities Exchange Quotation (NEEQ) system, often called the New Third Board.

The explosion owes to a number of factors, most a by-product of a sharp slowdown for traditional IPOs on China’s more mature stock markets in Shanghai and Shenzhen due to the regulator’s concerns about market volatility. That same conservatism has prompted a growing number of companies to seek public listings by injecting their assets into existing traded shell companies, again creating distortions and chaos in the market through a process known as backdoor listings.

The regulator’s attempts to stabilize the market are understandable, especially after a huge sell-off at the start of the year that prompted it to indefinitely postpone much-needed reform of the IPO process.

But as the surging number of NEEQ offerings and parallel flood of backdoor listing plans shows, companies in need of funding will always look for alternative ways to achieve their goals and could easily damage the order of capital markets in that process. Accordingly, the regulator would be well advised to lower its interference and let free markets play a greater role in regulating capital raising, even if that means some short-term volatility as markets adjust to those new conditions.

Ucar was founded early last year as an affiliate of Car Inc (HKEx: 699), one of China’s leading car rental companies that is listed in Hong Kong. Despite its late arrival to the private car services game, Ucar is hoping to play in a crowded field that includes the far larger Didi Chuxing and Uber, as well as mid-sized companies like Yidao Yongche.

So Ucar surprised many last week when it not only became the first in its category to become publicly listed, but did so on the NEEQ and attained a hefty valuation in the process. (Chinese article) The company was worth 41.8 billion based on its share price after the listing, becoming the second largest company on the NEEQ, even as it posted a 3.7 billion yuan loss last year.

Ucar was notable for its valuation, since the NEEQ was typically designed to host much smaller companies. But its choice to list on that market, which is closed to most ordinary investors, was nothing unusual in the current climate.

The NEEQ is now host to nearly 8,000 companies, and the number has more than doubled since last October. The board added a staggering 164 companies this month alone through July 25, including 14 that were set to begin trading on Monday. The total listings are more than double the number of companies traded on China’s other 3 main exchanges combined, including 1,153 on the Shanghai Stock Exchange, 1,787 on the Shenzhen Stock Exchange, and 516 on the Nasdaq-style ChiNext.

No Coincidence

The explosion on the NEEQ is no coincidence, since the China Securities Regulatory Commission (CSRC) has sharply curtailed other channels for public listings this year, following a massive sell-off that saw the main Shanghai index lose about a quarter of its value in January. Since then the market has stabilized, though the index is still down about 15 percent for this year.

In response to the early volatility, the CSRC allowed just 61 A-share offerings in the first half of this year raising 28.8 billion yuan, down 67 percent and 80 percent, respectively, from a year earlier. The huge slowdown has not only sent companies hunting for funds on the NEEQ, but also led to the brief surge in backdoor listings earlier this year on the main stock exchanges. The regulator also slammed the brakes on such backdoor offerings, rightly worried about market distortions and other profiteering that comes with such a lightly regulated process.

True financial markets are sometimes scary places due to their uncertainty, occasional volatility and their reflection of real economic conditions that are not always rosy and upbeat. But the CSRC’s attempts to ignore the uncertainty and avoid volatility are ultimately hurting China’s financial markets. Its efforts are creating distortions that not only undermine credibility, but are also resulting in growing financial pressures that will need to be released sooner or later.

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