Newly generated regulation has provided a motherboard for transparency and maturity in China’s capital markets, but are they ready for foreigners to plug in? Richard Li explores the key issues

Something most undesirable recently occurred on ChiNext, China’s NASDAQ-style board of high-growth and startup enterprises. After amending its 2011 performance report, Beijing Easpring Material Technology became the first ChiNext company to incur a full-year loss.

There was more bad news to come. As reported by Shanghai Business newspaper, a study of first-quarter performance predictions published by ChiNext companies indicates that more and more are suffering losses, or at least a decline in performance.

All this while investors are still smarting from big declines in A-share market value. According to China’s A-share Market Value Report for 2011, published by the China Centre for Market Value Management, the total value of the market plummeted almost 20% last year.

China's markets have struggled to recover from a lacklustre 2011.

The negative news of late may lead many to recall familiar issues with China’s securities market – false or incomplete information disclosure, weak regulation, sponsors negligent of their responsibilities and so on. And with recent accounting and disclosure failures on overseas markets – notably the NASDAQ – by Chinese companies, market watchers may not be surprised to see domestic markets declining.

So is the latest news the first obvious symptom of an incurable cancer within China’s capital markets?

Not according to Zhang Liguo, the chief partner at Grandway Law Offices. “All things are developing on the right track. I’m quite optimistic about the future of China’s capital markets,” he says. And he may be right. 2011 was, after all, a year full of troubles for the global economy: a crawling recovery in the US, the succession of falling dominoes from the European sovereign debt crisis, high inflationary pressure in an overheating Chinese economy, etc. How could China’s capital markets be expected to remain immune from the world’s economic malaise?

The fact is, despite some bad news, they fared much better than markets elsewhere. And now both the regulators and the stock exchanges have put plans in place to improve trading and transparency. On 29 April, the Shanghai Stock Exchange issued a draft plan for improving its delisting mechanism. On the same day, the Shenzhen Stock Exchange published its draft plan, with the same purpose, for its main board and SME board.

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According to Hong Kong’s South China Morning Post newspaper, the core of these improvements is the requirement for maintaining a positive asset value, as a result of which about 50 companies may be delisted by the end of 2012.

Just a few days before the draft’s release, the Shenzhen Stock Exchange published its ChiNext Listing Rules (2012 revision), which came into force on 1 May. In the revised version, the rules concerning delisting “show zero tolerance to non-compliance”, says Gu Yingying, a lawyer at Run Ming Law Office.

The rules “have enriched the delisting mechanism of ChiNext”, notes Carl Yang, a lawyer at Beijing DHH Law Firm, while Lin Zhong, a partner at Chen & Co Law Firm, adds that the new delisting policies “stick more rigidly to the survival-of-the-fittest principle”. Gu concludes that under the new listing rules, “more than 10 companies will face the risk of delisting”.

According to Fang Litang, a senior partner at Beijing DHH Law Firm, three more reasons for delisting are added to the mechanism: 1) the company has been publicly censured by the Shenzhen Stock Exchange three times in the past 36 months; 2) the closing price of the company’s shares has been below the par value for 20 consecutive trading days; 3) the company’s net assets at the end of the past two years have been negative as a result of the retroactive adjustment to its previous yearly financial reports, due to material prior-period errors or false records in those reports.

“To have entry and exit at the same time shows the marketisation of China’s securities market, and investors can tell the share price and value in a more rational way,” says Wang Xiaoming, a partner at Dacheng Law Offices in Beijing.

Lin advises in-house counsel to have a good grasp of the ChiNext delisting mechanism, “to avoid the consequence of delisting, or to do a reasonable assessment of their expectations about listing on ChiNext”.

The strengthening of the delisting mechanism does not necessarily imply that companies listed on ChiNext have been doing badly in recent years, as some might think.

According to the 2011 Self-regulation Report, published by the Shenzhen Stock Exchange, last year there was only one case in which disciplinary action was taken against a ChiNext company. “It can be inferred that after all the regulatory efforts made by ChiNext in 2010, the compliance situation has been improved and come under control,” says Shi Xin, an associate at Lantai Partners in Beijing.

Zhang agrees. “Companies listed on ChiNext have been doing well these years in terms of compliance,” he says. “It is inevitable that some companies still fail to comply with the information disclosure requirements. Even the US GEM board cannot get rid of such problems.”

The improvements to the delisting mechanism will have a strong influence on the strategy of backdoor listing. Bao Huifang, a partner at Beijing Kangda Law Firm, thinks that it is now almost impossible for poorly performing ChiNext companies to achieve a backdoor listing. “For those ChiNext companies having a very poor performance but a seriously overestimated value in the past, they face a very serious situation in future,” she says.

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“The review criteria for the resumption of listings have further lessened the feasibility of backdoor listing,” adds Liu Rong, a partner at Guantao Law Firm in Beijing.

Liu thinks the current development of delisting rules for main board companies is likely to refer to the ChiNext delisting mode. She advises in-house counsel at companies seeking a listing to “get familiar with the relevant revised listing rules as soon as possible”, and “be aware of the influence of the revised rules when verifying the feasibility of the proposed listing path”.

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