Listings in new third board in China hits record, but investors stay away due to chaotic rules

The National Equities Exchange and Quotations, an over-the-counter market in mainland China known as the third board, hit a milestone last week when its listed companies hit 3,000, surpassing the combined 2,800 companies listed on the Shanghai and Shenzhen stock markets.

But there is little to celebrate as turnover is thin and a lack of regulation means the third board is far from becoming a success. Opening shop about 10 years ago for firms delisted from Shanghai and Shenzhen, the platform was supposed to give startups and outfits with no business track record to speak of a venue to raise funds. Only selected brokers and individual investors with more than 5 million yuan can trade on the market.

The number of companies listed has grown at a dizzying rate since there were only 2,500 listed by May. Part of the reason for the sharp rise in listings is because of falls in the Shanghai and Shenzhen markets, prompting the China Securities Regulatory Commission to suspend all initial public offerings in the two markets and forcing companies to list on the third board which is not covered by the IPO ban.

The problem for the third board though is its liquidity. Its average daily turnover is only about 500 million yuan and that once dropped to a low of 352 million yuan on July 15. This represents only 0.03 per cent of the combined average turnover of the stock exchanges in Shanghai and Shenzhen at 120 billion yuan.

The third board would allow companies to appoint brokers to act as market makers to stablise prices. 

The thin business may be due to the fact the trading rules of the third board has failed to maintain an orderly market. In terms of volatility, third board stocks are not capped by daily trading limits so some stocks may swing 300 to 400 per cent a day. In Shanghai or Shenzhen, shares have a 10 per cent daily limit move. The volatility has discouraged long term investors in the third board.

The third board also allows traders to negotiate a price for the deals that could be substantially different from the market price. Two traders can do a deal for a stock at 1 yuan even though the price in the market is 100 yuan. This may be used to avoid paying taxes because a low price means lower stamp duty and capital gains taxes. This is not allowed in Hong Kong where the stamp duty depends on the market price.

Beijing seems to believe no regulation is a way to support the new third board for start-ups but the many questionable trading rules discouraged investors from trading the market. For the new third board to succeed, Beijing should look at the trading rule book of Hong Kong Exchanges and Clearing on how to maintain a fair and orderly market.

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