China’s top stock-market regulator Xiao Gang Turns Gray as China IPO Freeze Precedes New Rules

Xiao Turns Gray as China IPO Freeze Precedes New Rules

Four months after taking over as China’s top stock-market regulator, Xiao Gang showed up at a government meeting in July with gray hair at his temples.

The salt-and-pepper look provoked debate, even poetry, on China’s Weibo microblog service. Commentators argued whether the challenges of overseeing Asia’s worst-performing major stock market had aged him or if he had stopped dyeing his hair.

Xiao, 54, is stuck between more than 700 companies waiting to raise funds and Chinese leaders led by Xi Jinping who have pledged to clean up corruption. The China Securities Regulatory Commission, under pressure from investors to avoid exacerbating a 25 percent slump in the Shanghai Composite Index (SHCOMP) since July 2010, is drafting rules to curb misconduct that would establish stiff penalties for investment banks before ending an almost 10-month freeze on initial public offerings.“He has to walk on a tightrope to balance it out,” said Fang Fang, JPMorgan Chase & Co. (JPM)’s head of investment banking for China, in a July 17 interview in Beijing. “There’s fear that these listing candidates could potentially flood the market.”

The 83 companies whose IPO applications have been cleared by the CSRC listing committee and are pending final approval may raise a combined 55.8 billion yuan ($9.1 billion), according to June estimates from Ernst & Young LLP. Those include Shaanxi Coal & Chemical Industry Group Co. and China Postal Express & Logistics Co., the regulator’s website shows.

Shanghai Slump

Companies may postpone offerings when the ban is lifted because stock prices are down. If they go ahead, the IPOs may drive the market even lower, irking investors who have already lost money. The Shanghai Composite Index has dropped 13 percent this year, making it the worst-performing among 13 emerging and developed markets in Asia, on concern that a slowdown in the world’s second-largest economy is deepening.

Xiao, who succeeded Guo Shuqing as head of the securities watchdog in March amid a top-level leadership transition, plans to resume IPO approvals after the new rules, aimed at boosting protection for investors, go into effect. The former Bank of China Ltd. chairman is taking steps in his new role to further Premier Li Keqiang’s pledge to open China to market forces.

The CSRC regulations, published in draft form June 7 on the agency’s website, call for penalties against banks and their employees for transgressions such as including inaccurate information in a prospectus and poor risk disclosure, or when companies post a drop of more than 50 percent in profit in the year after an IPO.

‘Bold Measures’

Under the new rules, the regulator could suspend equity underwriting by a securities firm for an unspecified period if key data is omitted or misleading or falsified information is published in the prospectus. Legal advisers and auditors also could be held accountable. Changes to important data or conflicting information could lead to an application’s rejection and the bankers on the deal being barred from filing new applications for a year, according to the draft guidelines.

“It looks like Xiao is willing to take bold measures,” said Zhang Qi, a Beijing-based analyst at Zero2IPO Group, which provides research and data on China’s venture-capital and private-equity industries. “Investment banks will need to be even more scrupulous and cautious, and their costs may increase as bankers will need to put in more time and effort.”

The securities watchdog, which has been reviewing public feedback on the draft, hasn’t said when the new rules will be implemented and IPOs allowed to resume.

Disrupting Expansion

The freeze on first-time share sales, started in October, has disrupted the fundraising plans of companies such as state-owned China National Nuclear Corp., budget carrier Spring Airlines Co. and more than a dozen regional lenders.

“Dragging on with the IPO halt will impact companies’ expansion plans because they’ll run out of money to fund growth,” said Wei Tao, an analyst at China Securities Co. in Beijing. “It’s especially bad in new industries, where companies don’t lack demand for their products but have no money to invest.”

The market freeze also has been a blow to investment banks, whose revenue had soared as China became the world’s biggest market for IPOs in 2010 with a record $71 billion raised, surpassing the U.S.’s $54 billion that year and Hong Kong’s $53 billion, according to data compiled by Bloomberg.

Fees Soar

Fees that securities firms collected from underwriting IPOs in China jumped more than threefold to $2.49 billion that year, according to New York-based research firm Freeman & Co. Local brokerages, led by state-backed China International Capital Corp. and Citic Securities Co. (600030), were the main beneficiaries as foreign investment banks, including Goldman Sachs Group Inc., are barred from managing IPOs in China without a local partner.

Since that bonanza, fundraising from IPOs in China dropped to $40 billion in 2011 and $14.4 billion last year, data compiled by Bloomberg show, as plummeting share prices, poor financial results, allegations of falsified data and incomplete risk disclosure spooked investors.

About half of the 870 companies that have gone public in China since June 2009 now trade below their IPO price, data compiled by Bloomberg show. The worst performer is Sinovel Wind Group Co. (601558), whose stock has dropped 83 percent from its IPO price after the wind-turbine maker raised $1.42 billion in China’s second-biggest new stock offering of 2011.

Trade Secrets

In March, Sinovel revised down its reported earnings for 2011 by 22 percent, citing an accounting error, and in May it said the company is being probed by the CSRC for suspected misconduct including inflating earnings and revenue. In June, Sinovel was charged by U.S. prosecutors in a federal court with stealing trade secrets from its former U.S. supplier.

A person who answered the phone at the company’s headquarters in Beijing asked for questions to be faxed. No one responded to those queries. The regulator on July 19 said its probe was still active.

Similar investigations that were part of a crackdown started by Xiao’s predecessor have led to more than a dozen bankers, auditors, lawyers and executives being barred from China’s securities industry since May.

The watchdog that month fined Ping An Securities Co. and suspended the Shenzhen-based firm’s underwriting license for three months, while Minsheng Securities Co. was given a warning and penalty. The regulator also is investigating Guosen Securities Co. and Everbright Securities Co. (601788) for suspected misconduct in IPOs, the CSRC said June 21.

Internal Controls

Ping An Securities has taken steps since 2011 to beef up internal controls, including revising its compensation system, hiring external experts for a panel that screens offerings and committing more people and time for conducting due diligence, the firm said in an e-mailed statement. Shenzhen-based Guosen declined to comment, while spokesmen at Shanghai-based Everbright Securities didn’t return phone calls or an e-mail.

Some bankers said they are concerned that the crackdown, which has already prompted 200 companies to withdraw IPO applications, may go too far. Securities firms shouldn’t be held responsible for verifying the financial information reported by companies, said Ding Xiaowen, the Beijing-based co-head of investment banking at UBS AG’s China securities unit.

“The primary responsibility in accounting fraud should lie with auditors, who are professional accountants,” Ding said. “Fraud must be punished, but fluctuations in a company’s financial performance due to unexpected circumstances should be given tolerance.”

‘Painful Process’

Stringent measures are required to restore investors’ confidence in China’s domestic stock market, said Edmond Chan, a partner at PricewaterhouseCoopers LLP in Hong Kong. He estimated that 50 to 60 companies may sell new stock this year if the IPO suspension is lifted by the end of September.

Xiao’s reforms are necessary for China’s stock market, said JPMorgan’s Fang. The regulator also needs to end the freeze for new stock offerings, he said.

“You have to go through this painful process to come to a more orderly market,” said Fang, who is based in Hong Kong. “If you continue to keep the door closed, it will marginalize the equity market’s basic function of allocating resources efficiently.”

Individual investors in China’s domestic market have mixed feelings toward Xiao and his proposed reforms. On the Weibo service, a blogger named Huang Yongyao likened the regulator’s job to “sitting on a volcano,” since it would be impossible to please both the companies and investors.

Another blogger posted this poem, referring to stocks that trade on Chinese exchanges:

“A-share market keeps falling,

Chairman Xiao’s hair turning white.

Can’t anger the companies,

And the institutions won’t be disciplined.

Sad, sad, sad.”

To contact Bloomberg News staff for this story: Aipeng Soo in Beijing at


About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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