China Financial Markets: Shenzhen Start-Up Board Rocking

UNCLAS SECTION 01 OF 02 GUANGZHOU 000006 SENSITIVE SIPDIS STATE PASS USTR FOR STRATFORD/WINTER/MCCARTIN/LEE STATE PASS FEDERAL RESERVE BOARD FOR JOHNSON/SCHINDLER STATE PASS SAN FRANCISCO FRB FOR CURRAN TREASURY FOR LOEVINGER/MOGHTADER/CUSHMAN/VANHEUVELEN E.O. 12958: N/A TAGS: EFIN ECON CH SUBJECT: China Financial Markets: Shenzhen Start-Up Board Rocking and Rolling Ref: A) 09 Guangzhou 216, B) 08 Guangzhou 214 GUANGZHOU 00000006 001.2 OF 002 (U) This document is sensitive but unclassified. Please protect accordingly. Not for release outside U.S. government channels. Not for internet publication. ¶1. (SBU) Summary and Comment: The long-awaited "NASDAQ-like" start-up board, ChiNext, completed its first 2 months of operation in positive territory after finally making its Shenzhen debut on October 23, 2009. The new board opened by offering a first batch of 28 companies followed by another listing of 8 more firms on December 25, for a total of 36 listings by the end of the year. High volatility characterized the first two months of operations as the market remains small. The question remains whether ChiNext can truly emerge as China's NASDAQ market for start-ups and high-tech firms, or whether external competition to list Chinese firms overseas and domestic regulators' unwillingness to approve new applications will cause the new board to wither on the vine. End summary and comment. ChiNext Finally Makes Its Debut -------------- ¶2. (U) China officially launched ChiNext, the "NASDAQ-like" start-up board on Shenzhen Stock Exchange (SZSE) on October 23, 2009, after repeated delays and regulatory hurdles (reftels). The board is aimed at funding technology and innovation-driven start-up companies, in line with China's plans to shift its economy from traditional manufacturing towards innovative, higher-value industries. Among the 28 firms that started trading on ChiNext on October 30, twelve are in advanced manufacturing, four are pharmaceuticals companies, six are information technology companies and the rest are service providers. Initial Performance Shows High Volatility -------------- ¶3. (U) The first two months of ChiNext showed "W"-shaped performance and demonstrated the speculative nature of China's equities markets. On their October 30 debut, all 28 stocks gained at least 76% and pushed price-to-earnings (PE) ratios as high as 150. So overwhelming was the rush to buy that regulators temporarily suspended share trading for each of the 28 newly listed companies at different points throughout the day under special rules created to rein in speculative trading on a firm's first day of trading. According to those rules, a newly listed stock whose value fluctuates more than 20% from its opening price will be suspended from trading for a 30-minute cool down period before trading can resume. ¶4. (U) The buying frenzy didn't last long. The second trading day saw 20 of the 28 stocks fall by the 10% daily limit established by the Shenzhen Stock Exchange and were suspended from trading for one day. Fast forward two weeks and the market value of ChiNext had fallen to RMB 127 billion (US$18.6 billion),or RMB 12.9 billion (US$1.9 billion) less than its opening day peak, which represented a short-lived trough for the new board. ¶5. (U) The market then returned to a more growth-oriented track and celebrated its one-month anniversary at a level 3.24% above opening day, at RMB 144.5 billion (US$21 billion). However, critics pointed out that ChiNext performance was exceeded by the main boards in both Shenzhen and Shanghai, as well as the new board's "brother" - the Shenzhen SME board. The three other mainland boards recorded increases over the same one-month period of 6.66%, 9.67% and 7.05%. ¶6. (U) On December 3, the market value of Chinext reached a new high, exceeding RMB 160 billion (US$23.6 billion),its highest value since opening day. In order to rein in speculative trading behavior, the Shenzhen Stock Exchange implemented new measures to restrict accounts that showed "serious abnormal trading." By December 22, just days before the board opened trading for 8 newly listed companies, the total market value of ChiNext fell back to RMB 127.5 billion, nearly reaching its previous low. GUANGZHOU 00000006 002.4 OF 002 New Firms Listed -------------- ¶7. (U) A second batch of 8 companies was officially listed on ChiNext on December 25. However, the first-day performance of the new batch was not as noteworthy as the initial opening, with price increases averaging less than 50%. Media commentary attributed the less dramatic opening day to regulators' ongoing warnings about market risks and irrational PE ratios of ChiNext, which many analysts believe led investors to take more caution when subscribing to the new stocks. ChiNext finished 2009 with a total of 36 companies listed on the board and total market value reaching just over RMB 160 billion (USD 23.6 billion). What's Next - More Listings but How Fast? -------------- ¶8. (SBU) Shenzhen's new board is expected to grow dramatically in 2010, probably in market value, and certainly in the number of listed companies, but the pace of new listings troubles some analysts. Some analysts, including Zhang Yidong of Xingye Securities, criticized the slow speed of new listings, pointing out that "right now a few wealthy individuals can shift a stock up or down by its daily limit, but once the market has grown to 200 or more companies the volatility will be reduced a lot." Supporters of rapid growth also pointed out that the risks of market manipulation and excessive speculation could best be reduced by substantially increasing the number of new listings. A higher ratio of candidate firms was approved in the initial set of listings -- 93.5%. Only 61% were approved in the second batch. If this represents a trend in 2010, the slow pace of new listings could increasingly be a concern. ¶9. (SBU) At the same time, the number of Chinese firms listing on U.S. markets grew at the end of 2009 and show signs of even faster growth in 2010, according to media reports. One such firm, 4-year-old Guangzhou-based budget hotel chain 7 Days Inn, listed on the New York Stock Exchange in November 2009, spurning both the Chinese and Hong Kong stock markets. 7 Days CEO Eric Wu told econoff that U.S. markets are attractive for fast-growing firms like his because regulations are clear, application procedures smooth, and government interactions are predictable, unlike in China where a company's application to list might languish for months or longer while regulators decide whether firms are ready to be traded on one of the country's exchanges. That delay can be costly to private firms like his because they lack access to capital markets and must rely on costly and unpredictable bank financing to maintain growth during any major expansion, Wu said. In a recent Business Week article, Beijing-based NYSE Euronext Chief Representative Michael Yang predicted 2-4 times as many new Chinese listings on his firm's board in 2010 with the other U.S. and European markets also vying for many of the same potential listings. ¶10. (SBU) Comment: Despite growing external competition from foreign boards for new Chinese listings, it appears that authorities will continue to take a cautious approach when allowing new start-up companies to list on ChiNext in order to protect investors from exposure to "irresponsible" companies. The cautious attitude of regulators was apparent in China Securities Regulatory Commission (CSRC) Chairman Shang Fulin's comments at the new board's opening ceremony. "Most of the ChiNext firms are in the high-growth period. We should know that their performance could be unstable, their business model and long-term profit-making ability have not been tested," he said. The successful opening of the ChiNext board shows that regulators are willing to use markets to expand options for firms in need of capital, but the repeated delays that preceded it and signs that the pace of new listings will be slow indicate that regulators' comfort with market forces is limited. End comment. JACOBSEN