“The enforcement of the new rule will raise the quality of China’s capital market by weeding out poorly run companies,” said Yi Bin, an analyst at Huaxi Securities. “Market resources will be skewed towards high-quality companies after the removal of dodgy companies.”

Under the proposed terms, companies reporting an annual loss and revenue of less than 100 million yuan (US$15.3 million) for two straight years will be booted out, shortening the rule from three years. Stocks that trade below a market cap of 300 million yuan for 20 consecutive days will also lose their listing status, the exchanges said.

The Shenzhen exchange had to halt the trading of three small-cap companies in September after a massive price surge, which the bourse said was not supported by fundamentals. One of them surged almost sixfold within less than three weeks.

Cleaning up the membership lists could help the government’s efforts to draw more private savings into the capital market. Yi Huiman, the chairman of the China Securities Regulatory Commission (CSRC), recently said boosting fundraising is among the watchdog’s top aims under a five-year plan.

While China’s market is already the world’s second largest after the US, it is still fraught with problems that are endemic to emerging markets: excessive speculation and a large army of individual investors that like to chase stock rallies blindly.

The delisting ratio remains extremely low compared with other major markets. Only 125 companies have been removed from the Shanghai and Shenzhen exchanges since 1999 – a delisting ratio of just 0.36 per cent versus 6 per cent in the US, according to data from Huatai Securities.

That is likely to change soon after the enforcement of the tougher rules to weed out dodgy companies.

The likelihood of more delistings has already had an effect on the mindset of investors, who have been busy dumping stock in those firms that are in the firing line. A gauge of 216 companies that are candidates for delisting has lagged behind the benchmark index with a 3 per cent loss this year, according to data provider Shanghai DZH.

Chinese VIE companies: an ‘existential risk’ to global stock investors

Until now, local punters had their reasons to take a gamble on unprofitable or dodgy companies. Those firms can often be a target for back-door listings, and once a reverse merger is clinched, their share prices typically skyrocket.

Such risky plays are blamed by the authorities and scholars for the misallocation of financial resources and mispricing by giving premiums to companies that do not deserve such valuations.

The regulator’s campaign to improve the quality of listed companies began last year with the introduction of a registration-based system for new applicants. It gave investors more sway in the pricing of new stocks and allowed listing candidates to be appraised more on their corporate disclosures.

By opening the door to a better calibre of company – many of them part of China’s new economy – that reform was designed to address the front end of the process.

The latest rules represent a shift of focus to the exit end. The regulators had been accused of being too lax when it came to expelling companies that no longer qualified for listing status, partly to protect the interests of state shareholders.

“The registration system and the new delisting rule are the important steps to improve the system of China’s capital market and push ahead with the financial supply-side reform,” said Shen Yandong, an analyst at Wanhe Securities. “That’ll create a good system at the ends of both entrance and exit to raise the overall quality of listed companies.”