Implementing the registration-based IPO system in China: An unfinished journey with improved regulatory efficiency but persisted regulatory uncertainty
Initial public offerings (IPOs) provide an important route for companies to raise capital. Compared to many developed economies which adopt a disclosure-based system for regulating IPOs, China employed a merit-based system over the past two decades. Its recent IPO regulatory reform replaced it with a registration-based system. Under the merit-based IPO system, Chinese authorities used to enforce disclosure-based rules akin to those used in many developed economies, while at the same time conducting substantial examinations on the quality of the disclosed information and expressing value judgments on the merits of proposed IPOs, therefore subjecting market entry to quality control.
Since its inception around the 2000s, the merit-based system regulated several thousand Chinese IPOs. However, this system brought regulatory inefficiencies and uncertainties, causing a long IPO queue. Given that many Chinese issuers are nowadays backed by private equity funds which often use IPOs as an exit route, the merit-based system may have become a considerable barrier. This is the background against which Chinese authorities resolved to implement the registration-based IPO system.
Under the registration-based IPO system, the China Securities Regulatory Commission (CSRC) mainly reviews the disclosed information on a desktop basis to vet IPOs. However, the CSRC retains the power to conduct occasional substantial examinations on the quality of the disclosed information, ie on-site inspections, should it have any concerns about the disclosed information. Moreover, under the registration-based system, the CSRC no longer judges the merits of the proposed IPOs. This distinguishes the registration-based system from its predecessor and the disclosure-based regulatory system in the US (see the table below).
Due to its disclosure-centred nature, the registration-based IPO system is sometimes considered as the Chinese version of the US disclosure-based system, but it may be fundamentally different given China’s state control over the market. Thus, whether the registration-based system can ensure regulatory certainty and efficiency to attract issuers is unclear. Moreover, considering that the Chinese stock market still has numerous unsophisticated retail investors—a situation not substantially different from that before the reform—, the removal of merit judgment in IPO regulation poses a question about how to ensure investor protection under the registration-based system.
In a recent article, we conduct a close examination of the registration-based system in the context of China’s political economy, exploring its functioning in practice, canvassing its progress and problems in accommodating issuers and looking into the landscape and prospects of investor protection. We find that under the registration-based system, the CSRC has transferred some regulatory power to the stock exchanges, thereby integrating stock offering and listing review into a single process. However, due to the political economy underlying it, the registration-based system cannot eliminate the regulatory uncertainties arising from the CSRC’s broad and opaque power. As a result, certain issuers may still lack the confidence to go public in China. Nevertheless, the registration-based system significantly curtails the length of Chinese IPOs. Market data from 22 July 2019 to 31 November 2020 shows that the average time that issuers spent from submitting their IPO applications to floating on the Shanghai Stock Exchange STAR Board under the registration-based system was 228 days, compared to 550 days for listings on the Shanghai Stock Exchange and Shenzhen Stock Exchange Main Boards under the merit-based system in the same period. The improved regulatory efficiency has thus underpinned the recent reform of implementing the registration-based IPO system across all segments of the Chinese stock market starting from February 2023.
The registration-based system relies on a couple of supporting mechanisms, including private gatekeeping functions, mandatory delisting rules and securities class actions, to maintain market integrity. These supporting mechanisms may play an important role in the long run. In the transition era, however, the public regulators’ close engagement in substantial examinations is, we believe, still needed to avoid a regulatory gap in investor protection.
Fa Chen is a Lecturer in Corporate and Commercial Law at King’s College London.
Lijun Zhao is a Senior Lecturer in Law at City University of London.
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