China stock market

China’s securities regulator moves to suppress investor appetite for loss making companies

PUBLISHED : Tuesday, 04 July, 2017, 4:02pm
UPDATED : Tuesday, 04 July, 2017, 10:49pm

Mainland Chinese investors have traditionally liked to speculate on loss-making companies for a quick profit, but the China Securities Regulatory Commission is doing its best to break this habit.

Although China’s stock market is the world’s second largest with total market capitalisation of US$7 trillion, value investing – picking stocks based on intrinsic value and fundamentals – has yet to take hold in a country where individual investors dominate 80 per cent of trading.

In fact, betting on unprofitable companies is a long-standing tradition among local traders who believe these stocks will become targets for back-door listings and their share prices will soar.

However, such speculative investments may be disappearing as the securities regulator tightens approvals of back-door listings, raises the threshold for individual investors to buy unprofitable companies, and pledges to delist more loss-making stocks, according to Credit Suisse Group and Hengsheng Asset Management.

Of the 20 worst-performing stocks on the Shanghai and Shenzhen stock exchanges in the first half of the year, half were companies with losses for two consecutive years that risked being suspended or delisted, with fish-farming firm Hubei Wuchangyu and Xinjiang Zhundong Petroleum Technology shedding more than 50 per cent of their value.

“The regulatory system has suppressed the poor-quality companies,” said Chen Li, a strategist at Credit Suisse. “So it’s risk off.”

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Hubei Wuchangyu shares plunged 67 per cent in the first half, the worst performer on the mainland’s two bourses of Shanghai and Shenzhen. The company, based in central China’s Hubei province, forecast a further loss for the first six months after two years of annual losses.

Zhundong Petroleum and Winsan Medical Science & Technology have tumbled at least 55 per cent each. A gauge of companies with losses for two straight years fell to a 10-month low in Shenzhen.

Listed companies with two straight years of losses are restricted to a maximum 5 per cent daily movement in stock price to curb speculation, compared with 10 per cent for normal stocks. Companies are suspended from trading after three years of losses, and are delisted in the event of a fourth year of losses, according to current bourse rules.

The latest set back for fans of these stocks are the rules unveiled last week by the Shanghai and Shenzhen bourses stating that investors must hold securities assets worth at least 500,000 yuan for 20 trading days before they can buy shares in companies that are facing delisting. Daily purchases of such stocks cannot exceed 500,000 shares, according to the rule, which came into effect starting July.

That probably means most of China’s 120 million retail investors are ineligible to continue speculating on loss making stocks.

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“Neither the regulatory rules nor the investor structure is conducive to trading such stocks,” said Dai Ming, a fund manager at Hengsheng Asset Management. “The mega-trend of ditching these stocks isn’t likely to change and it’s the direction where Chinese stocks should be heading.’’

The Chinese securities regulator has long been criticised for being lax with unprofitable and poor-quality companies. While the number of mainland-listed companies has expanded to more than 3,000 over the past two decades, only about 50 firms have been delisted.

Regulatory tolerance has fuelled speculation on the so-called shell companies, which acquirers buy to fulfil their listing goals. Once the buyout plans, also known as reverse mergers, are announced, shares of acquired companies immediately surge, generating a quick and handsome windfall for speculators.

The most recent prominent cases involved last year’s back-door listings of China’s biggest courier service firms, including Shunfeng Holdings and YTO Express Group. Shares of the two buyout targets quadrupled after Shunfeng and YTO announced the reverse merger plans.

There are already signs that China’s stock markets are on the path to a more rational investment approach, with companies with solid earnings and reasonable valuations outperforming speculative small caps this year. Blue-chip companies including China Merchants Bank and SAIC Motor have risen close to their all-time highs.

The trend may gain further traction after global index compiler MSCI last month decided to add 222 mainland listed companies, mostly large-cap stocks with solid earnings, to its benchmark indices, a move expected to trigger foreign inflows of US$15 billion once implemented in a year’s time.

“Speculation on shell companies will fade out or even disappear,” said Li Jingyuan, general manager with Shanghai Bingsheng Asset Management in Shanghai. “The market will return to rational and value investing.”