Regulatory uncertainty clouds 'third board'
The mainland regulator has unveiled rules governing the new electronic equity transfer system and begun to vet applications from small businesses, but uncertainty stalks the "third board" as investors await more clarity.
The China Securities Regulatory Commission has been touting the need for a national-level over-the-counter market for small companies to help them move up the value chain. The authorities expect the new market, known as the National Equities Exchange and Quotations, to attract about 2,000 cash-hungry small firms.
"The regulator thought it could make better use of the idle cash to support small businesses through the third board," said Zhang Junyao, an owner of a battery maker. "But it has to convince small firms and investors of its effectiveness and benefits."
A market dedicated to small businesses is also seen as an efficient way to tackle the shadow banking system, through which trillions of yuan is funnelled.
In Wenzhou, the heart of the mainland's private enterprises, illegal private lending has helped thousands of small firms expand their businesses in the past decade. But a lack of regulatory oversight caused the parallel lending industry to collapse in 2011, leading to suicides by dozens of loan operators and underscoring the need for an institutional mechanism to help small businesses access funds.
The CSRC was initially looking at expanding the electronic equity transfer market from Beijing's Zhongguancun, China's Silicon Valley, to the whole country to help small firms with their financing. But since that market is for technology start-ups with intellectual property rights, it was not considered suitable to meet the needs of cash-strapped small manufacturers.
The third board would "help upgrade the country's industrial mix enshrined in the principle of protecting investors' interests", said CSRC spokesman Deng Ge.
There are more than 8 million small firms on the mainland ranging from shoemakers to electronic device manufacturers. For long, they have been at the receiving end of a skewed banking system, with state-led lenders reluctant to extend credit to them.
The mainland has suspended initial public offerings on the main board in Shanghai, the SME board and the Nasdaq-style ChiNext market since October 2012 to stem fresh equity supply from draining cash from existing holdings. This has only exacerbated the financing difficulties of private businesses.
The regulator has lifted the ban from this month and reformed the listing mechanism, subjecting issuers to greater public scrutiny. But it has not clarified how to regulate the firms listing on the third board, saying only that market-making rules would be implemented in the second quarter to ensure ample liquidity.
Normally, an OTC market implies a loosely regulated, high-risk environment where investors can easily lose money at the hands of unscrupulous market makers who quote both a buy and a sell price to profit on the bid-offer spread.
The CSRC requires individual investors to deposit a minimum of 5 million yuan (HK$6.3 million) in their trading accounts before participating in the third board, hoping a higher threshold for retail investors will help ward off volatility.
Thousands of stock investors on the mainland have been duped by unscrupulous companies in the past two decades despite Beijing's pledge to weed out irregularities.
"The rich still have plenty of cash on hand to invest," said Ray Lu, an investment manager at Hotung Ventures. "But few of them understand the risks of the new market, let alone institutional investors."