An Obscure Rule Snaps One of the World’s Hottest Rallies

Shuli Ren

(Bloomberg Opinion) -- What do you do if your stock has doubled in just a few months and your company is bleeding cash? Sell shares, of course.

A recent change to China’s refinancing rules promises to unleash billions of new shares into the market, leaving mom-and-pop investors wrong-footed and snapping one of the world’s hottest rallies. As the coronavirus outbreak worsens, bureaucratic entities from the central bank to the finance ministry have been trying to make it easier for companies to raise money. The securities regulator made no exception: On Feb. 14, it substantially relaxed equity-refinancing guidelines for listed companies.

This Valentine’s Day gift was particularly welcome for the cash-hungry companies listed on the new economy-focused ChiNext board. In the past, only those that were profitable and with dire deleveraging needs were allowed to sell new shares. The universe has now broadened to practically the entire board.

This change, along with interest rate cuts, has propelled the ChiNext to rally 27% this year before Wednesday’s selloff, a rare bright spot amid the virus-related selloffs. New-economy stocks are no longer distressed, investors reason. 

The new regulations particularly favor private placements, or the selling of shares to a pre-selected group of investors. These deals are now allowed to be priced at a deeper discount — from 90% of the 20-day trading average to 80% — and the lockup period for new shares has been shortened to as little as six months from 18 months.

With the new terms much more appealing to investors, company management naturally wants to sell more shares. Eight semiconductor firms have announced private-placement plans, seeking 24 billion yuan ($3.42 billion) of funding. Loss-making TongFu Microelectronics Co., whose shares have doubled this year, said it would aim to raise 4 billion yuan, equivalent to roughly half of its 2019 revenue. Hillhouse Capital Management Pte said it would buy 2.3 billion yuan of shares from drug manufacturer Asymchem Laboratories Tianjin Co. Stocks in the chip, 5G and pharmaceutical sectors have been market darlings this year.

To be sure, the existing rule was a knee-jerk reaction to China markets’ spectacular rise and fall of 2015 and 2016. Established early the following year, it was meant to protect retail investors who bought shares in public market at much higher prices. A longer lockup period also means there’s less selling pressure on the broader market.

Yet the regulations turned out to be too strict, causing a key channel of equity financing to shut down. In 2015 and 2016, more than 20% of listed firms completed private placement deals, with the fundraising peaking in 2016 at 1.7 trillion yuan. After Beijing tightened its guidelines in February 2017, equity fundraising has slumped. The latest easing could spur a revival.

Unfortunately, the same red flags that caused Beijing to act in the first place remain. Combine a private sale with a 20% discount, a short six-month lockup period with a market in upswing, and it’s not hard to imagine that some companies would find ways to manipulate their share prices higher.

Sure, China’s private sector is starved for funding — which is only exacerbated by the coronavirus — and loosening equity refinancing rules could be a nice gesture from Beijing. Still, it’s unclear this is an efficient way to channel money to those in need, not to mention it encourages selling on the Shenzhen Stock Exchange, which hosts the ChiNext board.

Just like consumers who clear masks and toilet paper from supermarket shelves, companies also hoard — in this case, cash. Can you blame them? Consider how often the government flip-flops: A drastic tightening in February 2017, followed by some loosening in November 2018, to a full re-opening of the floodgates this month. If you were a business owner, pinched for funds amid Beijing’s war on shadow banking, you’d likely raise funds whether you need the cash or not. I wouldn’t be surprised if almost every eligible firm on the ChiNext board will want to do private sales.

After the 2015 bust, this index is finally coming back to life this year, as investors ditch their favorite baijiu liquor stocks for chip designers and drug makers. Tread carefully: This Valentine’s Day rose comes with some thorns.

(Updates to include the impact of ChiNext closing levels Wednesday.)

To contact the author of this story: Shuli Ren at

To contact the editor responsible for this story: Rachel Rosenthal at

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Shuli Ren is a Bloomberg Opinion columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.

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