New board marks steps forward in openness

Cliff Sheng
After detailed rules for the Science and Technology Innovation Board (STIB) were unveiled last month, discussions in the financial community became extremely heated. 
Cliff Sheng

Cliff Sheng, Partner, Co-head of Financial Services of Oliver Wyman China

After detailed rules for the Science and Technology Innovation Board (STIB) were unveiled last month, discussions in the financial community became extremely heated. They centered on the potential impact on the capital market; on listed and to-be-listed companies; and on red chips, including overseas-listed tech companies that plan to issue shares in the A-share market.

Here, we look at the STIB from a fresh perspective, by considering its links with the Chinese government’s aims and working approaches.

The government has adopted a systematic approach to major projects, which is reflected in three strategic principles.

The first is a top-tier design. Internationalization of the renminbi, the Belt and Road, and adjustments in China’s internal economic structure — all have been carried out through a top-down, step-by-step approach.

The second feature is problem-solving orientation. When problems occur in a top-down design, they are addressed through practical measures. This has led to a change of course in some policies, with new ones replacing the old. The advantage is the ability to flexibly adjust a system designed under a top-down approach so that it can adapt to actual situations.

The third principle is bottom-line mindset, which the government has repeatedly emphasized. This means that core values and risk controls must not be sacrificed. By clearly identifying the bottom lines when designing something from the top down, many problems have been discovered and resolved. The launch process of the STIB and its ongoing progress have reflected this feature.

We think the launch of the STIB has been highly consistent with the working approaches of the current government:

Top-tier design to bring about fundamental change

The central concept of the top-tier design is to develop a healthy, multi-layered capital market that effectively supports the real economy and provides direct-financing channels for assets with higher risks and potentially higher returns. Since 2004, China has been trying to develop such a capital market with several boards under different names and formats, including the SME Board, the Strategic Emerging Board, and the New Third Board. However, these did not perform satisfactorily, as they did not bring about a fundamental change in the way companies were listed.

Changes were needed in the listing and registration-based systems to give investors incentives to behave in an efficient and rational manner. The STIB touches an essential part of the trading mechanism: the delisting arrangement. This did not happen under past changes, so it is a great improvement.

A problem-solving oriented approach

The second principle of the government’s approach is to be problem-oriented. The timing of the STIB’s launch was a bit surprising. Although the STIB had been mentioned repeatedly, it was launched suddenly, and detailed rules were formulated shortly afterwards. There had been different opinions over how the plan should be formulated, as well as predictions of what would be in it. These included whether Variable Interest Entities (VIE) or Chinese Depositary Receipts (CDR) would be available, and whether there would be a daily trading range. Behind the scenes, regulators had to consider and balance three core challenges:

First, the disconnect between China’s emerging economy and its current domestic capital market had to be addressed. Fast-developing high-tech companies have different profitability and ownership structures, and the new assets they generate and the incomes these assets yield are not directly related to the current domestic capital market through any form of stocks or bonds. So these companies’ typical approach is to seek overseas listings, or to aim to be acquired by large ecosystem players such as Baidu, Alibaba, Tencent, and – known collectively as the BATJ. But in fact, the BATJ are also overseas-listed companies, so even that approach gives high-tech companies more connections with overseas capital markets. From the perspective of debt, current Internet financing is essentially a market of non-public, non-standard alternative bonds or subordinated bonds. It is mainly handled by Internet-based platforms, and it hasn’t built any connections with the capital market system involving a major role for equity exchanges. The government has always intended to resolve this issue.

The second issue was the efficiency of the domestic capital market, especially the A-share market. The A-share market was originally created as a trial, and it only offered limited support to the economy compared with the large banking and shadow-banking systems. Many of the policies and rules formulated in the past were not sufficiently market-oriented, which caused lots of problems over the years. The launch of the STIB will trigger various adjustments, which will help to foster development of the main board as well.

Third, the capital market needs to be kept relatively stable. China’s capital market is dominated by individual and retail investors. So changes in market rules or the emergence of a new market will pose challenges to stability in terms of liquidity and market capacity. That makes it important to distinguish between different types of investors and to educate them accordingly.

When drafting their plan for the STIB, regulators had to strike a balance to resolve these three core problems. The announced details and the degree of openness marked a large step forward, and the approach is the most market-based so far. This is reflected in the registration system, the profitability and institutional requirements for listing candidates, the cancellation of the trading limit, and the delisting arrangement.

Information disclosure for high risks and returns

The third principle is to draw red lines and make sure they are not crossed. The STIB has very high requirements for information disclosures and transparency. If a company violates the rules, it will likely face delisting. This indicates that both the government and regulatory authorities hope to create a market with relatively high risks and returns, a high degree of transparency, and a high quality of information disclosure.

Investors may notice two other issues related to the positioning and status of the STIB and the Shanghai Stock Exchange.

First, the STIB needs a strong implementation capability as well as a sound framework. The Shanghai Stock Exchange plays a key role here, and its capabilities are crucial in regard to all three of the government’s principles: the top-down design, the problem-oriented approach and the drawing of red lines. Recently, the Shanghai Stock Exchange has worked hard to improve its corporate management structure and has made some substantial adjustments. We are very confident in the role the Shanghai Stock Exchange is playing in the launch of the STIB.

The second issue is the comparison between the Shanghai Stock Exchange and Nasdaq, which is known for its listing of digital companies. However, they have different origins. Nasdaq started as an over-the-counter market and was initially dominated by market makers. Of course, the rapid development of the US capital market meant that many kinds of infrastructure had been well established, so the liquidity and transparency of the OTC market could be established easily and quickly. Then, as its market capacity expanded, Nasdaq was transformed from an OTC to an exchange-based market. In contrast, China is not taking a path like this – that is, letting the market develop of its own accord from the bottom up. Instead, China is adopting a solution in line with its own national approach.

The emergence of the STIB on the Shanghai Stock Exchange is a huge boost for China’s overall financial structure and for a multi-tier capital market. It is also crucial as one pillar of Shanghai’s “Two Centers” plan to become both an international shipping center and an international financial center.

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