China's securities regulator grappling with IPO woes

China's latest IPO reform seems "helpless" to suppress overpricing and cash outs in initial public offering operations, and a flood of IPOs in March will drag down the well-performing ChiNext Index, a senior analyst said.

"Based on the current situation, it seems likely that the new regulation will have no impact on taming high prices, high PE ratios and high financing volume during the IPO process," said Chen Li, chief China strategist at UBS Securities.

The benchmark Shanghai Composite Index has fallen roughly 4.9 percent year-to-date following the China Securities Regulatory Commission's resumption of IPO approvals in late December.

The CSRC halted new offerings for 13 months in order to rid the index of fraud and insider trading and to boost investor confidence.

Analysts said investors have complained about new shares being overpriced and about the aggressive reduction of shares by original stakeholders, saying that the CSRC's new regulations have failed to protect them.

Facing criticism and a battered market performance, the CSRC on Sunday announced tighter supervision over IPOs, saying that any company that priced its IPO at a premium for its industrial peers in the secondary market, measured by respective price-to-earnings ratios, should publish repeated risk warnings for three weeks before taking online subscriptions from retail investors.

The CSRC also said it would conduct spot checks of book-building and road shows - the processes by which banks assess demand for offerings and then market the sales.

Any issuer or major underwriter that applies undisclosed information during its road show may see share issuance suspended and be subject to other punishment.

As a result, five Chinese companies announced Monday they would postpone taking subscriptions,

The first round of IPOs in January and February are expected to revitalize small-cap shares and boost the ChiNext board. New IPOs are expected to be priced at 30 times to 40 times their earnings per share, which is high but quite reasonable compared with the 60 to 80 levels seen in 2010, Chen said.

But in March, the securities regulator is set to increase the supply of new shares in order to bring down offering prices.

Also, to facilitate the upcoming shift to a registration-based IPO system, the regulator will accelerate the pace of new offerings to clear out a backlog of IPOs.

The market will see 15 to 20 new offerings per week between March and June, which will pressure the valuation of the Growth Enterprise Board, he added.

The benchmark Shanghai Composite Index lost roughly 7.5 percent in 2013, marking another year of decline.

On the other hand, ChiNext Index, the Nasdaq-style board tracking China's growth enterprises, had soared by 83 percent year-on-year at the end of 2013.

"Investment has been favoring GEB shares and other small caps. But as new offerings overflow from March, we believe revaluations will unfold from the GEB to other themes, and opportunities may shift to other sections," Chen said.

Li Kefei, head of China equity capital markets at UBS Securities, said big State-owned companies that have low price-to-book ratios are most likely to be the first to try out preferred shares, a concept that was introduced by the CSRC in its latest reform guidelines published in November.

Chinese regulation prohibits companies with price-to-book ratios below 1 to issue regular shares, so issuing preferred shares gives such companies a way to raise funds.

One of the key goals of the reform is to keep high issuing prices in check.

Li believes that more new shares listed this year will end up trading lower than their issuing price, a phenomenon that is relatively rare in China's stock market, which Li described as emerging yet transforming.

He said the phenomenon is normal in mature markets.