Across The Border

Why small investors might have little to cheer about the change of guard at China’s securities regulator

PUBLISHED : Tuesday, 08 March, 2016, 10:53am
UPDATED : Tuesday, 08 March, 2016, 10:53am

Chinese equity speculators have been hit by a double whammy in the recent reshuffle of the country’s securities regulator.

As newly appointed China Securities Regulatory Commission (CSRC) chairman Liu Shiyu looks into ways to steer the stock market out of the woods, those hoping to take advantage of the wild price swings in small-cap stocks to strike it rich have reasons to feel disappointed.

Liu, a former vice-governor of the central bank and the head of Agricultural Bank of China, replaced

Xiao Gang at the helm of the regulatory body in late February after the latter failed to rein in the market that has been in the throes of unprecedented volatility since mid-June.

The change portends policy adjustments by the CSRC to restore investor confidence. It is widely believed that Liu would shelve the long-awaited launch of the Shenzhen-Hong Kong stock connect scheme and delay a registration-based initial public offering (IPO) mechanism as he is expected to focus on assessing the market situation and the impact of the planned liberalisation moves.

READ MORE: Bank chief made head of China’s securities regulator after months of turmoil in stock markets

“All policies are now focused on stopping the downward trend,” said Dong Jun, a Shanghai-based hedge fund manager. “But speculative retail investors won’t be happy.”

On Friday, the benchmark Shanghai Composite Index was 44.4 per cent shy of the close on June 12, when the market went into the tailspin that it is yet to recover from.

A slumbering stock market is not only a stumbling block for the leadership to deepen economic reforms but also poses a threat to social stability in a country where stock markets are driven by millions of retail investors.

The only bright spot amid the marked gloom has been the small companies listed on the SME (small and medium-sized enterprises) board and start-ups traded on the ChiNext market at the Shenzhen Stock Exchange.

A cross-border trading arrangement linking the Shenzhen and Hong Kong stock exchanges was widely expected to debut in mid-2016 as part of Beijing’s efforts to internationalise the capital markets.

But sources close to the CSRC now say the regulator is unlikely to receive a go-ahead from Liu anytime soon owing to concerns about capital outflows that have come to mark the mainland Chinese markets of late.

READ MORE: Meet the veteran banker tasked with bringing order to mainland stock markets as new securities regulator chief

On Friday, companies listed on the SME board were trading at 50 times their earnings and start-ups on the Nasdaq-like ChiNext at more than 72. In contrast, Shanghai-listed companies’ PE stood at 14.4.

“The high valuation on the SME board and ChiNext market definitely reflects a bubble and an overly optimistic mood,” said Zhou Lin, an analyst at Huatai Securities. “But many investors believe the volatility in small-cap stocks created opportunities for making a fast buck.”

Small-cap stocks are the darlings of retail investors in mainland China as funds darting in and out of them make them ripe for speculation.

A Shenzhen-Hong Kong stock connect scheme would allow overseas investors to directly buy shares of companies listed on the SME board or ChiNext. Analysts had predicted technology firms would be chased by overseas investors looking to profit from China’s transition from an export-driven economy to one led by innovation and consumption.

“On the mainland, there’s still ample cash for investment,” said Jianbin Gao, a PwC partner. “Investors want to find lucrative projects and promising technology firms to pump money into.”

The buying spree in technology stocks in the past years stemmed from the belief that some of the companies in information technology, pharmaceuticals, and new energy would become profit stars in the future.

Expectations of a capital influx into the small-cap stocks mounted in the past months amid talks of the stock connect programme, with investors outside China joining in the rally. Apart from stock connect, the proposed registration-based IPO mechanism, is also likely to be put on ice. Such a mechanism is expected to open the floodgates of new shares thanks to an easy approval process. That, in turn, could erode interest in the Shenzhen market as Chinese investors tend to bet on new stocks, which are allowed to rally on their debut by more than the 10 per cent ceiling set for existing stocks.

READ MORE: China’s loss is Hong Kong’s gain, as CSRC drags its heels on IPO reform

“It’s time to cool the buying frenzy on the SME board and the ChiNext market irrespective of a Hong Kong-Shenzhen stock connect,” said Ivan Li, a dealer at Everbright Securities. “Their fundamentals and growth potential do not seem to be strong enough to support the current prices.”

Going by the results of the companies that have reported their earnings for the last quarter of 2015, SME board firms posted a year-on-year profit rise of 12.3 per cent in the three months, down from the 23.4 per cent seen in the first three quarters.

Profit growth of ChiNext-listed startups in the fourth quarter last year also slowed to 20.2 per cent, 3.2 percentage points lower than the year-on-year rise in the first nine months.