Spread of registration-based IPOs means changes on A-share main board

The landscape for Chinese securities firms is set to be reshaped as a registration-based initial public offering system is expected to be more widely adopted and extended to the A-share main board, where more large-caps and industry juggernauts are listed, industry experts said.

On Friday, the China Securities Regulatory Commission, the country's top securities watchdog, released the official trading mechanism and rules to adopt registration-based IPOs throughout the A-share market. It was 16 days after the CSRC rolled out the draft version.

Such registration systems, generally, shift the financial enforcement system from requiring prior approval and evaluation before IPOs to a system that focuses on requiring companies to fully disclose all material facts to investors. Such systems also sharply increase the penalties for false disclosure or nondisclosure.

The system was used experimentally for the technology-heavy STAR Market at the Shanghai Stock Exchange starting from July 2019. In August 2020, its use was encouraged on the Nasdaq-style ChiNext at the Shenzhen bourse. The Beijing Stock Exchange, seen as a place to nurture technologically advanced small and medium-sized enterprises, has implemented the system since it was officially launched on Nov 15, 2021.

With planned expansions, the system will be implemented at the A-share main board.

Data from market tracker Wind Info shows that the total market capitalization of the companies listed on the main board at the Shanghai and Shenzhen bourses reached 70.25 trillion yuan ($10.2 trillion) by the end of 2022, accounting for 80.05 percent of the total A-share market cap. The main board heavyweight sectors include finance, property, steel and oil companies.

The total market cap for the STAR Market in Shanghai, where "hard technology "companies such as chipmakers and biomedicine companies are listed, came at 6.13 trillion yuan as of Dec 31, 2022. The combined market cap of ChiNext companies in Shenzhen, which feature integration of traditional industries and state-of-the-art technologies and business models, reached 11.31 trillion yuan at the end of 2022, according to Wind Info.

The IPO process will be simplified under the new system, with approval given by the Shanghai and Shenzhen bourses, so more IPOs are anticipated. Securities firms' income will naturally increase as their IPO underwriting and sponsoring businesses grow, according to GF Securities experts.

Securities firms' incremental revenue generated from expanded main board businesses is expected to reach 13.8 billion yuan in 2023, according to GF Securities. The investment banking business is anticipated to contribute an additional income of 4.6 billion yuan, while that of brokerage and margin trading business is expected to come in at 4.4 billion yuan and 4.8 billion yuan, respectively.

A consensus has been reached among market mavens, who anticipate that leading securities firms should take an even bigger share in investment banking businesses, including securities underwriting, stock trading, mergers and acquisitions advising, private equity investment and reorganization.

Chinese securities firms are accustomed to making much of their profit from underwriting and sponsoring businesses, said Yang Fan, chief policy analyst of CITIC Securities. But under the new IPO system, they are expected to extend their business to private equity investment and co-investment at the upstream end and market making and equity pledge financing on the downstream end.

According to CITIC Securities, a total of 65 securities firms took part in A-share IPO project underwriting and sponsorship last year, while the top three firms accounted for 45.1 percent of the annual revenue.

In the short term, the wider adoption of the registration-based IPO system will benefit securities brokerages for which investment banking business makes a bigger contribution to their annual sales and that have many IPO applications in the pipeline, Yang said.

In the long run, however, brokerages' investment banking services will link primary and secondary markets under the new IPO system, depending on applicant wishes. Leading securities firms that have built their strengths in all major aspects are expected to see substantial growth, she added.

Securities firms that have expertise in margin trading businesses are also likely to leapfrog their competitors under the new IPO system as the related margin trading rules have been optimized, said Chen Fu, chief nonbanking financial analyst at GF Securities.

Margin trading is when investors borrow money to buy stocks. "Under current margin trading rules, the duration for which stocks can be borrowed and related interest rates are both fixed. The new rules allow stock lenders and borrowers to negotiate to fix borrowing terms and rates on their own," Chen said.

At present, margin trading applications are received during trading hours, and transactions are made when daily trading is closed. But once the new rules take effect, such trading would be made on a matchmaking basis during trading hours every day, Chen added.

With greater flexibility, margin trading is expected to be more active. Securities firms with strength in that business, including CITIC Securities, Huatai Securities and Guotai Junan Securities, would likely see faster growth, he said.

Competition among securities firms is expected to intensify after the implementation of the registration-based IPO system throughout the A-share market, according to Chen Li, chief economist at Chuancai Securities. It is expected that large securities firms would take the upper hand amidst fiercer competition, given that they can access more resources and are generally more mature businesses.

Fifty-two public securities firms made a total income from underwriting business of 32 billion yuan in 2022, with CITIC Securities as the largest single earner at 5.1 billion yuan of income from that source, according to Hithink RoyalFlush Information Network Co Ltd. Ten brokerages saw underwriting income of less than 40 million yuan each, including Huajin Securities and TF Securities.

That does not mean that small and medium-sized brokerage firms will be taken over, experts said. A smaller securities firm could build itself into a boutique firm focusing on key industries or certain geographic areas, for example, to survive the expected stiffer competition, according to Wang Chen, general manager of the investment banking department of Guoyuan Securities.

Indeed, Hefei, Anhui province-based Guoyuan has directed much of its attention to information technology, smart manufacturing and environmental protection companies based in the Yangtze River Delta region or the Guangdong-Hong Kong-Macao Greater Bay Area.

Zhang Qicheng, chairman of Caitong Securities, agreed that differentiated development paths and specialization in specific industries will help smaller securities firms stand out from their peers. The Hangzhou, Zhejiang province-based firm has focused on companies in Zhejiang in order to provide financial services throughout a company's entire life cycle, he said.

Foreign investment banks have applauded the progress. Qian Jing, general manager of Morgan Stanley Securities, said that foreign firms have established a great deal of knowledge about registration-based IPO systems, which have been implemented in overseas markets for a very long time. Qian said they can provide more precise valuation and pricing based on their overseas experience and crosschecks to help Chinese companies meet their goals in the A-share market more easily.

Sun Lijun, co-head of global banking at UBS Securities, expressed his satisfaction at being able to see the maturity of the Chinese investment banking industry under the new system.

Investment banks in China will have to accelerate their transformation to focus more on pricing and sales, while strengthening their capabilities in industry research, Sun said. They will need to be able to discover the companies with true value and formulate reasonable pricing. Over time, the institutions will be prepared with a greater product portfolio to meet targeted companies' different financing needs throughout their life cycle, he said.