A decade after the initial proposal and following years of anticipation, the launch of China's growth enterprise market (GEM) is finally within view.
The country's top stock market watchdog -- the China Securities Regulatory Commission (CSRC) -- published rules governing listings on the board at the end of March, and they take effect on May 1. Meanwhile, more rules on auditing committees and sponsors have also been released.
The exchange will focus on small, finance-starved innovative start-ups with strong growth potential. The move has been widely applauded by venture capitalists in China, but some investor representatives worry that too many of the companies listed will be high risk.
They also voice skepticism over the GEM's prospects, given the poor track record for similar efforts in other countries. Yet one thing seems clear as the market gets ready for take-off -- the pool of candidates for listing on China's GEM will likely be large.
Supporters, such as Wang Shouren, Secretary-General of the Shenzhen Venture Capital Association, believe that launching the GEM will more effectively allocate financial resources and "promote the transfer of resources to productive uses, which will be an important driving force for a second industrial revolution."
He also believes that "now is good timing" for the launch. With hundreds of billions of dollars of stimulus in the pipeline, and the Shanghai Stock Market Composite Index rallying gradually to above 2,300, "investor confidence is on the rise." That's certainly better than late 2008, when the index fell to nearly 2,000.
Joe Tian, Managing Partner of DT Capital, a venture capital and private equity company based in Shanghai, agrees this is a good time for the launch, and notes that demand is high for the kinds of issues most likely to come to market.
"The demands for financing for public companies or to exit in the public market have just accumulated to the degree that they cannot be ignored by decision makers," Tian notes. "It's certainly a good thing. The more exit channels there are, the better for our returns, and the greater the value of investments. It's as simple as that." Tian acknowledges, however, that funds denominated in foreign capital will not benefit directly.
Companies can't wait
The new regulatory measures stipulate a range of conditions for issuers: Either cumulative net profits in the preceding two years must be at least 10 million yuan and growing, or net profits in the most recent year must be at least 5 million yuan, with revenues of at least 50 million yuan, and revenue growth of at least 30% in the past two years.
In addition, the total issued share capital must be at least 30 million yuan, and the issuing company ideally should have its business focused in just one main area. The GEM will also establish criteria for risk tolerance of investors on GEM. Further layers of detail are expected to be released soon, including listing application documents and prospectus guidelines.
Expect a large pool of companies to be eligible for listing on GEM. Ba Shu Song, vice chairman of finance for the State Council's Development Research Center, noted during a recent program broadcast by China Central Television that the country's "direct financing mechanism is not very well developed." As a result, a huge number of companies meet the GEM's financing criteria. "Based on the current standard, we have at least 3,000 to 5,000 (eligible) companies, and almost 10,000 enterprises that are financially ready for listing on the GEM."
Shenzhen city alone has 1,100 companies that meet the GEM's financial requirements, while around 100 companies have started restructuring to meet the guidelines and 35 companies are now in the pipeline, according to Shenzhen officials.
In Hunan province, roughly 100 companies are ready to apply for GEM listing, while over 50 have signed pre-listing guidance deals with security firms. In Jiangsu province, 130 companies have already signed deals. Ping An Securities has placed more than 100 companies in the pipeline, says Xue Rongnian, company president, and nationwide it has at least 1,000 companies waiting to get listed on GEM, estimates suggest.
Will the GEM help solve the difficulties Chinese small and medium enterprises (SMEs) are facing regarding access to finance? Shanghai-based Fisher Zhang, manager of a Hong Kong investment fund, thinks the answer is "yes," at least for some companies.
"The banks don't lend them the money. Private equity is insufficient. Underground lending is not legal. So they can only go to the GEM. But with a narrow pipeline for the GEM, not every company that is hungry for money will be able to get it there." The Gem also opens up a new channel for domestic investors, who have limited investment options.
But don't expect the launch of the GEM to be anything like a cure-all for SMEs' financing problems. At the Boao Forum, an executive meeting on China's development that took place in mid-April, Yao Gang, vice president of the China Securities Regulation Committee, said if SMEs can improve themselves and optimize resource allocation through the capital markets, that will boost many other industries.
Add in greater involvement by venture capital and private equity funds in the market, and the net result is a large, positive ripple effect, Yao predicts. Yao, like many government officials, believes that that the success of the GEM cannot be judged simply in terms of the amount of capital raised, nor by how many companies are attracted to the market. Instead, look for more general, wider positive effects on the economy when judging success.
Despite the palpable air of excitement in the venture capital world, however, many market participants and observers also see potential pitfalls ahead. "China's stock market is like roller coaster -- it gets bumpy fast and then plummets, with few returns for the investors in average terms," notes Zhang.
"The companies listed on the GEM will mostly be mediocre ones, and they will already be priced at a premium in the primary market. My view is that there will be some value for investors in the near term, but I am not sure about the long-term value."
"It might not be as ideal as we imagine," Zhang cautions. "Regulation on our main board is not yet well-established, but the GEM will place higher demands on regulatory capabilities due to the high-risk nature of the listed companies. Those small and risky companies need stronger and stricter regulations."