• Framework favours new tech companies with cash-burning R&D projects 
• Expect normalization of IPO valuations, post-listing performance 
• Companies falling short of new IPO requirements may flock to M&A 

China has rolled out a registration-based initial public offering scheme across its exchanges in an apparent intention to keep its next generation technology firms in the A-share home market – already competing with the US for the top IPO spot worldwide – while bringing domestic stock-listing practices closer to those adopted in some advanced economies. This, said domestic legal and financial advisory practitioners, will also pave the way for growing mergers and acquisitions (M&A) by Chinese firms.

The new rules give the respective exchanges the authority to vet each issuer’s qualifications, while in the past it was the securities regulator China Securities Regulatory Commission (CSRC) that carried out the task. But other than being just a procedural change, the new regime also emphasizes greatly the importance of routine regulations post a company’s IPO, effectively covering its entire lifespan post listing, from refinancing, restructuring all the way to possibly delisting.

To be clear, the fast-track IPO system is no stranger to Chinese exchanges, among which Shanghai’s STAR Market, Shenzhen’s ChiNext, and the youngest Beijing Stock Exchange have all adopted the regime on a trial basis in the past three years.

This is part of China’s broader reforms, effective 17 February, intended to give its capital markets a shot in the arm as the economy crawls out of three-year’s Covid lockdown. The other pieces of the reforms include new rules on CSRC's filing requirements on Chinese companies’ overseas issuances and listing activities, under which the key change is that companies with a variable interest entity (VIE) structure will need to notify and get a nod from the CSRC prior to overseas listings.

The reforms are widely viewed as a furtherance of Beijing’s effort to channel capital into technology companies and strategic industries in tune with national objectives, several of the advisors said. And financial sponsors would exercise better discernment when it comes to portfolio exit strategies, two financial advisors with Haitong Securities and Zhongtai Securities said. A trade sale will be considered as a more efficient way to offload none- or low-tech entities, as financial sponsors will be seeing shrinking profit from IPO-driven exits, while listed firms will be encouraged to shop for deals at home and abroad under the new framework, the two advisors said.

The first batch of registration-based IPOs are likely to debut on the mainboards of the Shanghai and Shenzhen Stock Exchanges as early as March, according to Jianhai Luan, a partner with Commerce & Finance Law Offices and Yixing Li, a partner with Tian Yuan Law Firm. They could include companies that had already sought the market regulator’s approval before the new system’s implementation, Luan and Li said. Materials of these companies have been transferred to the exchanges for a sign-off over qualifications and will be sent for registration with CSRC afterwards, the lawyers said.

New era for red chips

The reforms open exciting opportunities for red chip companies to be listed on the mainboards, according to Zhoujun Tang, a partner with Zhong Lun Law Firm, Cheng Shen, a senior partner with AllBright Law Offices, and Luan with Commerce & Finance firm.

In China, red chip refers to mainland-based enterprises incorporated internationally, including variable interest entities (VIEs). Until now, central government-owned enterprises, e.g., China Mobile [SHA:600941; HKG:0941] and CNOOC [SHA:600938 HKG:0883], have dominated the list of red chip companies traded on the mainboards, Shen of AllBright said. However their IPOs are of little reference value to non-state-owned red chips seeking to trade on the mainboards, he added.

The reforms have detailed procedures and qualifications for all red chip companies aspiring domestic mainboards listings, Tang said. This means non-state-owned red chips are given the chance to list on mainboards following the reform, Shen said. In the past they typically got listed on the STAR Market.

Red chips believed to be promising for mainboard listings include front runners in their niche sectors and the firms armed with hardcore technologies, Luan said. 

Some interested private red chips are already working with advisors on potential domestic listings, Shen said.

Offshore-listed red chips will also weigh onshore listings, because mainboard listings usually offer richer valuations and greater liquidity, compared to offshore listings, Luan added.

Full list of Chinese Red Chips filed or listed for A-share markets. 

Still, Fang Zhou, a partner at JunHe Law Offices, said some technical details related to the new regime require clarifications, including how China’s enterprise accounting standards will be applied to red chips. Clarity will come with practical guidance as the new breed of A-share listees grows, he added.

In addition to red chips, the new regime will also benefit companies with weak performance in certain financial thresholds, as the criterion of “continuous profits in the past three fiscal years” is removed for mainboard listings, said Guiyang Chen, also a partner with JunHe Law, adding companies that reported losses in recent years due to the Covid-19 pandemic may benefit from the new rules.

M&A activity set for comeback 

Of the IPOs priced since 2022, STAR Market listings took an average of 345 days from filing to pricing, while Shanghai mainboard listings took 580 days, based on Dealogic data.

As the process becomes simplified and expedited, IPOs will not be considered rarities on stock markets, which means IPO valuations will edge closer to actual ones, the two financial advisors said. And as the new framework allows market forces to determine IPO prices eventually, that will limit the room for arbitrage for private-round investors, Shen at AllBright said.

With the price gap between pre-IPO and IPO tightening, financial sponsors will likely lock in lower profit from exits during IPOs, which have so far remained a primary exit route for many financial sponsors, the same two financial advisors added. 

As such, down rounds will no longer be rarity or impossible. It’ll be possible that IPO prices will slide below the pre-IPO round mark, especially when the listing candidates are from an overpriced industry where quality targets are few, Shen said.

The STAR Market and the ChiNext have seen such price bubbles burst over roughly the past four years. Around 30% of IPOs last year on these two boards went below offer prices as they debuted, as per local media reports.

The streamlined IPO process is friendlier to pre-profit tech firms burning cash on research and development projects, especially in state-backed strategic industries such as biotech, chips, AI, and renewables, which the tech-heavy STAR Market and the high-growth ChiNext have welcomed since they launched, the two financial advisors said.

Again, the new listing framework is not for everyone.

For companies that fall short of IPO eligibility, they might need to consider alternatives to help their financial sponsors exit, Shen said, adding M&A may hence increase. 

Non-tech sectors such as real estate, alcohol and catering may find it harder to raise money from the public capital markets going forward, as the requirements for market cap and financial indicators on the mainboards have been raised, while the ChiNext and the STAR Market are favouring firms with tech prowess, the two financial advisors said. 

Traditional sector companies generating an annual revenue below CNY 50m will also find a mainboard listing increasingly challenging, Shen at AllBrigt said.

Almost all the companies eligible for mainboard listings from across sectors have floated shares, Shen said. And the new rules are unlikely to unleash a significant number of new opportunities for mainboard IPOs, Li with Tian Yuan opined.

Even for companies already listed, more onerous disclosure requirements may lead some to delist eventually.

“Such strengthened rules and oversight – under the disclosure-oriented rulings, we might even see class actions targeting illicit acts, as seen in US markets – will result in a higher probability of delisting”, the financial advisor at Haitong added.

Traditional small- and medium-sized enterprises (SMEs) might face challenges retaining advisors for IPO, the Haitong financial advisor said, noting advisors will be tasked with more responsibilities to ensure the sufficiency and accuracy of corporate disclosures for IPOs under the new rules. Stakeholders, including financial sponsors and IPO advisors, will take a more prudent and careful approach selecting candidates for IPO advisory, he said.

Concerned about shrinking profits from public floats, higher compliance costs, and the mainboards’ tougher financial requirements, some corporates with financial sponsors may consider trade sales more seriously, Haitong's financial advisor opined.

As part of the registration-based IPO reform, Chinese regulators also eased controls on listed companies’ major asset restructuring, including simplifying the filing process and lowering the filing requirements, a financial advisor at Huatai United Securities said, noting this gives listed firms more leeway in medium-sized M&A activity without necessitating regulatory filings.

As corporate dry powder has piled up over the last three years, the new changes are a welcome move for Chinese corporates seeking to release their pent-up demand for growth as the country’s borders reopen.