Paving the cornerstones for an registration-based listing system

Stanford professor on how ready China is for a new type of IPO mechanism

China's plan to move away from an administrative approval-based initial public offering (IPO) system will give market forces a greater say and improve capital allocation, but parallel reforms should also be implemented to ensure the new system would function, Joseph Piotroski, associate professor of accounting with Stanford Graduate School of Business, who studies China's capital market, told China Daily.

"If the government is serious about making sure economic growth is driven by innovation and entrepreneurship, younger and smaller companies need access to the equity market," Piotroski said.

"The great thing about a registration-based system is the government does not screen out who can or cannot go to market, instead it will be based upon full and fair disclosure of information, and (based upon that) the market decide whether a company should receive funding, that the market decide how much money they are going to raise, and at what price."

On Nov 6, China's securities regulator said it will end a four-month moratorium on IPO, triggered by the dramatic index slide over the summer. The country's top legislature is reviewing the amendment of the Securities Law, which is expected to introduce a much-anticipated registration based IPO mechanism.

But according to Piotroski, whose research focuses on corporate financial reporting practices, a sound institutional and regulatory framework is at the center of ensuring the mechanism really work; among the chief factor is information disclosure.

"When you look at China's information disclosure environment, first, it has improved over time, but the problem is still opaque, which puts a registration based system at risk," Piotroski said.

He noted China Securities Regulatory Commission (CSRC) has made regulations on information disclosure and corporate governance. "The laws are on the books…the problem is the frequent practices do not align well with those standards, so if a registration based system is going to work, the CSRC needs to move away from a gatekeeper and move towards an enforcer. Much like the Securities and Exchanges Commission in the United States or Financial Conduct Authority in London," Piotroski said.

"They have to say that we are not going to dictate who can play this game. We're going to enforce the rules of the game. As enforcers, the CSRC need to impose "credible penalties" on financial misreporting, corporate malfeasance, and on majority shareholders' behaviors that are value destructive such as napping transparency, napping any forthcoming value-relevant information."

Piotroski suggested other governing mechanism that is China-specific. For example, China's securities law stipulates a unique requirement of "independent directors" on board to protect the interest of minority shareholders.

"In reality, they are legally independent but have relationships with controlling shareholders. They are not independent in decision making. That type of conflict needs to be solved if you have a registration-based mechanism."

Piotroski thinks the current information requirement on listed firms should be supplemented with context-specific information, for example, the definition of related-party transactions, or under what "special events" firms are compulsory to report.

"You can't change the system overnight. You can't change political preference overnight. But you can do things like opening the market for foreign investors, broader-base institutional investors, higher net-worth individuals overseas, which would bring critical analysis into the marketplace."

Piotroski refrained from giving a time frame on when a registration-based system will materialize, saying the key is implementing reforms along the introduction of the system.

"The government seems serious on promoting mass entrepreneurship and rebalancing the economy. The only way to make that happen is to let those firms like tomorrow's XiaomiXiaomi or Huawei get funded."