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.

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.

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

Disclaimer Strictly Private and Confidential. For Institutional, Wholesale or Professional Investors Only. Not for distribution to the retail public. This document is produced by Eastspring Investments (Singapore) Limited and issued in: Singapore and United States by Eastspring Investments (Singapore) Limited (UEN: 199407631H).


This document is solely to be used for informational purposes only and is not intended for anyone other than the recipient. This information is not 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. This document may not be copied, published, circulated, reproduced or distributed without the prior written consent of Eastspring Investments.


Information herein is believed to be reliable at time of publication but Eastspring Investments does not warrant its completeness or accuracy and is not responsible for error of facts or opinion nor shall be liable for damages arising out of any person’s reliance upon this information. Any opinion or estimate contained in this document may subject to change without notice.


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. The information contained herein does not have any regard to the specific investment objective(s), financial situation or the particular needs of any person.


Where included, benchmark and index data included in this document are provided for illustrative purposes only. The portfolio and/ or services mentioned do not formally track any such benchmarks or indices and no representation is made as to relative future performance or tracking deviation. You should note that investing in financial instruments carries with it the possibility of losses and that a focus on above-market returns exposes the portfolio to above-average risk.


Performance aspirations are not guaranteed and are subject to market conditions. Higher yielding investments can produce income at the expense of capital growth or the capital value of the investment. High volatility investments may be subject to sudden and large falls in value, and there could be a large loss on realization which could be equal to the amount invested.


Eastspring Investments (excluding JV companies) are ultimately wholly-owned / indirect subsidiaries of Prudential plc of the United Kingdom. Eastspring Investments 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. 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 is also registered with the US Securities and Exchange Commission as a registered investment adviser. 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. In marketing Eastspring Singapore’s services, the Adviser’s employees also may make recommendations about securities that constitute investment advice. Eastspring US does not contract directly with any prospective client, nor does it have any discretion over client assets, nor does it trade, deal or direct trading in any security, client account or fund. Eastspring US does not receive or retain any assets or securities, nor does it serve as a custodian or direct any custodial decisions. Additional information about Eastspring Investments is also is available on the SEC’s website at www.adviserinfo.sec.gov