Why STAR is crucial to China’s capital market reforms

China's capital markets have undergone significant changes since the commencement of the reforms and opening up-policy. The plan to introduce a new Science Technology & Innovation Board (STAR) is yet another show of commitment to deepen and strengthen the country’s financial markets to make it an attractive financing option for Chinese enterprises, and one that offers investment opportunities for foreigners.

Michelle Qi
Head of Equities, Eastspring China

03 July 2019 | 5 min read

China’s status as an economic powerhouse and the world’s second largest economy1 is indisputable. For China to continue to grow as a modern market economy, an efficient and stable financial sector is a prerequisite. There have been various measures over the years to vitalise the financial markets such as the Stock Connect, Bond Connect and the inclusion of onshore Chinese A-shares by index builder, MSCI and FTSE.

Still, there have been persistent issues with the Chinese A-share market - high volatilities, overly regulated, inefficient Initial Public Offering (IPO) and exit mechanism, lack of new economy names, etc. To solve these issues, the government has carried out a series of reforms which nevertheless have been proved to be ineffective. The new Science & Technology Innovation Board (STAR), announced first by President Xi at the China International Import Expo, and then further emphasized at the Central Economic Work Conference, represents the central government’s determination to deepen the capital market reforms.

More recently, the Vice President, Liu He, head of CSRC, Yi Huiman, and Shanghai government officials together announced the inception of STAR on June 13th. Officials from Shanghai Stock Exchange further confirmed that the first batch of companies will get listed on STAR within two months.

Thanks for subscribing!

Follow us :

STAR’s differentiating edge versus traditional stock markets

A relaxation on listing requirement

In terms of financials, there is no longer a need for a three-year track record of positive earnings; in terms of company structure, it allows those structured as variable interest entities (VIEs) or with multi-share classes to get listed. This will help to attract more new economy names to list on the onshore market.

A reform in trading mechanism

Price limits will be expanded from +/-10% to +/-20%, with no limits in the first five trading days. If this goes smoothly, it will serve as a testbed for a potential reform of the trading limits on the traditional boards. On the traditional boards, the current cap on share price fluctuations on the first day of trading is 44% and subsequently 10% a day.

A higher quality stock pool

STAR will adopt a registration-based system in contrast with the lengthy approval-based system on the current boards. The leading underwriters will also have to be the cornerstone investors which will motivate them to bring forward high quality companies. In addition, STAR will run a stricter exit mechanism to maintain a quality stock pool on an ongoing basis.

A transformation of market pricing

While on traditional boards most IPOs are priced with a cap valuation of 23x price-to-earnings, STAR will impose no limit and let the market determine the issuance price instead. The Green-shoe mechanism will also be applied to reduce the price volatility post IPO.

A higher bar for participants

Only institutional investors as well as those retail investors with rich investment experience (>2 years) and certain assets under management (>Rmb500k) are allowed to participate in STAR. This shows regulators’ clear intention in reducing volatilities where the strong presence of retail investors on traditional boards is believed to be one source of market ups & downs.

A platform for China’s growing number of unicorns

China has already set a target to become a world leader in artificial intelligence (AI) by 2030.2 This STAR is thus aimed at attracting and financing innovative companies (those in areas of high-end equipment, biotechnology & health care, IT, new materials, renewable energy, energy saving and environmental protection) that will drive China’s future AI competitiveness.

In fact, unicorns3 and startups are burgeoning in China. According to a research report4 , the global number of unicorns as of May 2019 totaled 346 with the US having a dominant share of 49.7%. This is followed by China, who boasts 89 unicorns (or 25.7 % of total). The United Kingdom and India rank third and fourth.

Fig 1: Global distribution of unicorns by region4

fig-China-capital-market-reform

The new STAR will become a platform for such unicorns to list and raise funds at home. Moreover, the latest trade spat with the US and the US curbs on its Chinese technology companies may push Chinese government to extend more support to the domestic high-tech firms, i.e. provide greater access to funding through STAR.

Economic and investment implications

Due to STAR’s national-strategic importance, the Chinese government will do its best to ensure all reforms be carried out in an effective manner. Furthermore, if STAR proves to be successful, some of the reforms/experience (i.e. market pricing, wider trading limits) may be extended to the traditional boards at a later stage.

For corporates, this will mean greater access to funding. It will help to rebalance the economy from an indirect-financing to a direct-financing mode; the gearing ratio of Chinese corporates have been much higher than that of US over the years. In terms of percentage of GDP, however, the non-financial corporate debt of US and China was 143% and 74% respectively as at end of 2018.

For equity investors, these reforms result in a larger investable universe. It will not only attract more global investors into the onshore market but also provide more investment options for onshore institutional investors such as the pension funds and asset managers, to diversify their investments for a better risk-return profile.

For Use with Professional Clients / Qualified Investors Only. Not Approved for Further Distribution or Use with the General Public.

Interesting reads

Japan’s small and mid-caps: An overlooked opportunity

China: Awaiting the catalysts

Asia ex-Japan equities: Prospects for higher returns as corporates “value-up”
ARTICLE ASIA CHINA EQUITY THOUGHT LEADERSHIP STAR BOARD TECHNOLOGY

Sources:
1 Based on nominal GDP in 2018
2 Goldman Sachs Global Investment Research, The State Council
3 A unicorn is defined as a start-up worth more than US$1 billion
4 CB-Insights_Global-Unicorn-Club_8 May 2019

The information and views expressed herein do not constitute an offer or solicitation to deal in shares of any securities or financial instruments and it is not intended for distribution or use by anyone or entity located in any jurisdiction where such distribution would be unlawful or prohibited. The information does not constitute investment advice or an offer to provide investment advisory or investment management service or the solicitation of an offer to provide investment advisory or investment management services in any jurisdiction in which an offer or solicitation would be unlawful under the securities laws of that jurisdiction.


Past performance and the predictions, projections, or forecasts on the economy, securities markets or the economic trends of the markets are not necessarily indicative of the future or likely performance of Eastspring Investments or any of the strategies managed by Eastspring Investments. An investment is subject to investment risks, including the possible loss of the principal amount invested. Where an investment is denominated in another currency, exchange rates may have an adverse effect on the value price or income of that investment. Furthermore, exposure to a single country market, specific portfolio composition or management techniques may potentially increase volatility.


Any securities mentioned are included for illustration purposes only. It should not be considered a recommendation to purchase or sell such securities. There is no assurance that any security discussed herein will remain in the portfolio at the time you receive this document or that security sold has not been repurchased.


The information provided herein is believed to be reliable at time of publication and based on matters as they exist as of the date of preparation of this report and not as of any future date. Eastspring Investments undertakes no (and disclaims any) obligation to update, modify or amend this document or to otherwise notify you in the event that any matter stated in the materials, or any opinion, projection, forecast or estimate set forth in the document, changes or subsequently becomes inaccurate. Eastspring Investments personnel may develop views and opinions that are not stated in the materials or that are contrary to the views and opinions stated in the materials at any time and from time to time as the result of a negative factor that comes to its attention in respect to an investment or for any other reason or for no reason. Eastspring Investments shall not and shall have no duty to notify you of any such views and opinions. This document is solely for information and does not have any regard to the specific investment objectives, financial or tax situation and the particular needs of any specific person who may receive this document.


Eastspring Investments Inc. (Eastspring US) primary activity is to provide certain marketing, sales servicing, and client support in the US on behalf of Eastspring Investment (Singapore) Limited (“Eastspring Singapore”). Eastspring Singapore is an affiliated investment management entity that is domiciled and registered under, among other regulatory bodies, the Monetary Authority of Singapore (MAS). Eastspring Singapore and Eastspring US are both registered with the US Securities and Exchange Commission as a registered investment adviser. Registration as an adviser does not imply a level of skill or training. Eastspring US seeks to identify and introduce to Eastspring Singapore potential institutional client prospects. Such prospects, once introduced, would contract directly with Eastspring Singapore for any investment management or advisory services. Additional information about Eastspring Singapore and Eastspring US is also is available on the SEC’s website at www.adviserinfo.sec. gov.


Certain information contained herein constitutes "forward-looking statements", which can be identified by the use of forward-looking terminology such as "may", "will", "should", "expect", "anticipate", "project", "estimate", "intend", "continue" or "believe" or the negatives thereof, other variations thereof or comparable terminology. Such information is based on expectations, estimates and projections (and assumptions underlying such information) and cannot be relied upon as a guarantee of future performance. Due to various risks and uncertainties, actual events or results, or the actual performance of any fund may differ materially from those reflected or contemplated in such forward-looking statements.


Eastspring Investments companies (excluding JV companies) are ultimately wholly-owned / indirect subsidiaries / associate of Prudential plc of the United Kingdom. Eastspring Investments companies (including JV’s) and Prudential plc are not affiliated in any manner with Prudential Financial, Inc., a company whose principal place of business is in the United States of America.