A long-expected draft reform plan on China’s “New Third Board” (NTB) came to light last Friday, giving more details on dividing the market into two tiers to allow more mature companies with good liquidity to trade separately from the others.
The tier management system, which will come into effect on June 27, is set to reduce information collection cost for investors and pave the way for delivering favorable policies to more competitive companies.
China’s NTB became a nationwide trading platform three years ago. Designed to gather investment for companies which have not yet gone public, its listing requirements are set to allow smaller companies to participate in the financial market. However, in the past three years, the number of firms listed on the NTB has grown dramatically to 7,394, compared with less than 3,000 A-share listed companies in total. The conditions of these companies vary greatly because the threshold for the market is relatively lower than that of the A-share market. Some of the NTB-listed companies have either never been traded at all or have traded for a while before suddenly becoming empty shells.
In order to enhance liquidity of the NTB and facilitate capital allocation of investors, China’s regulator has decided to distinguish the best stocks from the average, and will divide the companies into two levels, namely the base level and the innovation level.
Companies hoping to be selected into the innovation level must meet one of three sets of criteria, namely 1) net profit and return on net assets ratio; 2) revenues, compound growth rate and capital stock; or 3) market value, shareholders’ equity and the number of market makers and qualified investors.
According to the current criteria, around 16% of the listed companies on the NTB will be selected into the innovation level.
Impact of the tier-management on A-share market
The public holds different views toward the new rule’s influence on the A-share market.
Some analysts believe that the tier-management system will not be very influential on the A-share market since the NTB is not set up as a springboard for companies to be transferred later to the main board. The over-the-counter NTB is aimed to facilitate fundraising for small-sized firms, which are yet qualified to be listed on the A-share stock market.
Others who oppose to this opinion believe that existing investment funds in the stock market would flow to some of the companies selected into the innovation level because they have better profit growth prospects than their A-share listed counterparts.
More favorable policies to be expected
NTB regulators have set a 5-million-yuan threshold to bar against most retail or small-sized institutional investors. This admittance restriction, which was designed to protect investors, has been deemed as the culprit behind the liquidity shortage of the NTB.
By implementing the tier-management system, the two levels would be able to adopt different investment thresholds.
In addition, more market makers are expected to enter the NTB market. For now, only 85 brokerages have market making licenses, falling far shorter than demand considering the large number of companies listed on the NTB. Demand is expected to be increased even more after the implementation of tier-management because it sets higher requirements on pricing the companies labeled as “innovative”. The new rule also regulates that private equity funds are allowed to take part in market making business.
Market analysts also expect a better and more detailed delisting mechanism for the NTB.