Trading Up

The financial and high tech industries gear up for the expected expansion of the OTC exchange

Li Yabin， the senior relationship manager of Nanjing Securities (南京證券)， has been busy this year travelling around China to meet directors of high-tech parks and companies who might be interested in listing on China’s over-the-counter (OTC) stock market. Although the market is not yet open to new companies — regulations for this have not even been issued — Li and other executives at his company are focused on signing and servicing clients hoping to list on the exchange.

Li’s company believes an expansion of the OTC can significantly raise its position in the sector by handling companies interested in listing. Rumors about the new market have led to greater volatility on China’s other exchanges. Prices for stocks on the Growth Enterprise Market (GEM) have dropped because it is expected that investors will have more opportunities to buy into similar small cap high-tech companies on the new exchange. Meanwhile， prices of some listed high-tech companies have soared because it is believed that qualified high-tech firms located in national high-tech industrial development zones will be the first ones allowed to list before regulations expand to include unlisted Chinese companies in other sectors. For instance， the stock price of the Suzhou High-tech Park (蘇州高新) has nearly doubled over the past six months.

Consolidation

The OTC market first began in China in 1992， and by 1997 there were more than 100 different OTC markets operating in different cities across the country. Following the Asian financial crisis， China’s regulators decided to close those markets due to fear of excessive volatility. In 2001 a private equity OTC exchange was established for high-tech companies located in the Zhongguancun National Innovation Demonstration Zone. Dubbed the ‘new third market’， it was intended as a financing platform for unlisted startup companies to raise funds. Initially， most of the companies who sought to list on this market were government related， but gradually some private companies began to list there as well. Reforms made to the market’s operation in 2009 made it more attractive to both companies and investors， and trade volume increased from RMB 290 million (USD 44.6 million) in 2008 to RMB 480 million (USD 73.9 million) in 2009.

A total of 82 companies have listed on the OTC exchange so far， with three eventually transferring their listings to other exchanges: Join Cheer Software (九其軟件) is now listed on the SME board， while Beilu Pharmaceutical (北陸藥業(yè)) and Century Real (世紀(jì)瑞爾) are now listed on the GEM. Most companies on the exchange are from sectors such as information technology， manufacturing， computers and renewable energy. The total net profit for companies on the exchange reached RMB 909 million in 2010， an increase of 41% from 2009. When the market opens up to new listings， analysts expect the total trade volume of the OTC market will reach RMB 500 billion over the next three years.

SPECULATING ON THE FUTURE

“The expansion of the OTC market is a necessary part of building China’s multi-level capital market，” says Tang Chuan， an analyst with CITIC Securities (中信證券). Shang Fulin， Chairman of the China Securities Regulatory Commission， stated that expanding the OTC market will be a top priority this year. A draft plan for the expansion was submitted to the state council in the middle of last year， but it has not yet finished the research and comment phase so regulations have not yet been issued.

The lack of a formal plan has not stopped those in the finance industry from speculating on the regulations for the expanded OTC. One area of concern is whether securities brokers will be able to quote both a buy and sell price to clients that allows the brokers to profit on the bid-offer spread， as is common in western capital markets.

It is also unclear how many high-tech parks will be included in the pilot expansion of the OTC. There are currently 84 high-tech parks in China and more than 40 locations have applied to the government for such designation. All high-tech parks are said to be actively helping their companies prepare for listings on the OTC market.

Gui Haoming， an analyst with Shenyin Wanguo Securities， believes that it’s logical that companies in high-tech parks should be the first allowed to list when the OTC market is expanded. However， he believes that when the final regulations are issued， only 15 to 20 high-tech parks will be chosen for the pilot expansion， in order to ensure that there will be at least 50 new companies who will list on the OTC exchange. In the coming two to three years， more high-tech parks will be added to the program to accelerate the listing speed.

Regardless of the final regulations， there seems to be universal agreement among those in the financial industry that expanding the OTC exchange is an important step in building a more mature capital market in the country. “Not every company can meet the requirements of the GEM， so the OTC market plays an important role as it gives small companies time to learn and regulate their corporate governance，” says Luozhuang， Managing Director of Tsinghua VC (啟迪創(chuàng)投).

It is believed that small and medium-sized enterprises (SMEs) will draw the most benefit from developing the OTC exchange. “China has over RMB 70 trillion in savings and we still mainly rely on bank loans for financing. Over 53% of financing comes from loans，” says Chen Dongqi， Deputy Director， Macro-economy Research Institute， NDRC. “If we want to change this structure and lower the risk， then equity finance is very important. The new OTC market will give SMEs the opportunity to take part in equity finance quickly because the scale of new OTC will be very big. However the quality of listed companies is also very important.”

“There are over 20，000 SMEs in Zhonggguanchun Park， and over 10，000 SMEs in Suzhou Park. They are small but innovative and they put much more focus on technology RD. They need an equity finance platform to support their quick growth. The new OTC market should be this platform，” says Chen Yongfei， Managing Director with the OTC Market Department of Gold State Securities (金元證券).

Zhang Yunfeng， Managing Director of the OTC Market Department with the Shenyin Wanguo Securities (申銀萬(wàn)國(guó)證券)， also points out some advantages of the OTC market， “First， the listing cost is low. The cost is only around RMB 1 million， which is about 15% of one normal GEM listing. Second， the listing procedure is quick. Because the listing on OTC does not require approval， the process will be very quick， only two to four months. Third， success percentage is nearly 100%. When there is one security firm that is willing to be your sponsor， it means you have nearly achieved success listing on the OTC.”