China’s new third board likely to see its first ‘demotion’ of innovative firm

Mainland China’s “new third board” has hit a speed bump after Mmloo.com, an online shopping platform for electronic products, looks likely to become the first company demoted to a lower level of the over-the-counter (OTC) equity trading market.

According to its sponsor Dongxing Securities, Mmloo.com was warned by the securities regulator that it could be downgraded to the “basic level” of the OTC market after its major shareholders were found to have irrationally used its funds.

The news came less than three months after the China Securities Regulatory Commission (CSRC) divided the OTC market into two levels.

Mmloo.com’s major shareholders Liu Wentai and Song Youling borrowed a combined 143 million yuan worth of funds from the listed company in 2015.

It was seen as an unusual and irregular behaviour by the securities regulator because shareholders borrowing such a large amount from a listed firm could hamper the development of the company while hurting other shareholders’ interests.

Reform delays make mainland China’s ‘new third board’ a magnet for small companies seeking cash

“It is a signal that the OTC market has to conduct a cleanup campaign to ensure its long-term development,” said He Yong, vice president of investment consultancy New Third Board Club. “Many other punishments for sponsors and new third board-listed companies will happen soon.”

In June, the OTC market was divided into “innovative level” and “basic level” with large-cap and profitable companies categorised as innovative firms which have the potential to be directly transferred to the Shanghai and Shenzhen stock exchanges in future.

More than 900 companies traded on the new third board, officially called the National Equities Exchange and Quotations, were designated by the regulator as “innovative companies.”

The total number of companies listed on the OTC market exceeded 9,000 last week as the market grew on a fast track to support technology startups under government directions.

Beijing delayed the implementation of a registration-based initial public offering (IPO) system on the Shanghai and Shenzhen stock exchanges this year to shore up investor confidence, but it took a positive stance on the new third board, letting thousands of small firms raise funds on the OTC market which was officially launched in 2013.

But a listing bonanza on the new third board sparked worries about fraud and irregularities that could undermine long-term growth of the market.

On mainland stock exchanges several listed firms were found to be so-called “cash cows” for their parent companies, with the majority shareholders borrowing money from the listed arms to pump into other projects.

More than 20 companies listed on the OTC market reported zero sales for the first half of this year, prompting the regulator to tighten oversight on the firms.

“The OTC market will continue to grow fast due to increasing financing demands from small businesses,” said Shen Ye, a Shanghai-based hedge fund manager. “But it’s also important to kick cheaters and liars out of the market.”

Retail investors are barred from trading on the OTC market unless they own equities worth at least 3 million yuan.

The central government hopes the capital market, including the new third board, will play a bigger role in reinforcing the growth of technology start-ups, giving them a wider access to capital.

A stock market rout last year deterred the CSRC from taking drastic steps in liberalising the markets.

The registration-based system that could largely facilitate company fundraising on the stock exchanges was put on ice to control the pace of fresh equity supply.

Consequently, the OTC market has become the primary listing venue for cash-hungry businesses.

Market watchers speculated that the new third board would likely see its first company directly transfer to the Shanghai or Shenzhen bourse within one year.

But the pending downgrade of Mmloo.com to the “basic level” is seen as a warning from the CSRC that the regulator will step up policing of the board.

[email protected]