Notice on Trade Monitoring and Risk Control for First-Day Trading of IPO Securities Listed on the Growth Enterprise Board

Issuing Date: September 23, 2009

Effective Date: September 23, 2009

With trading imminent on China's much-anticipated Nasdaq-like Growth Enterprise Board—dubbed "ChiNext"—the Shenzhen Stock Exchange, which oversees the new market, has introduced rules designed to control risk and prevent excessive speculation in ChiNext stocks. In most cases, these stocks will be in relatively small, innovative young companies. The China Securities Regulatory Commission (CSRC) began accepting applications for initial public offerings on the Growth Enterprise Board in late July. Twenty eight enterprises had won approval for IPOs by October 20, 2009, with investor interest driving up prices even before trading began in late October.

China Law Update has previously (August 2009) summarized two sets of rules governing the Growth Enterprise Board: theProvisional Measures for the Administration of Initial Public Offerings of Shares and Listings Thereof on the Growth Enterprise Board and the Listing Rules of the Growth Enterprise Board of the Shenzhen Stock Exchange. The Shenzhen Stock Exchange issued the Notice on Trade Monitoring and Risk Control for First-Day Trading of IPO Securities Listed on the Growth Enterprise Board (the First-Day Trading Notice) with the hope of preventing excessive speculation on the first day of trading and correspondingly protecting investors' rights and interests.

In announcing the new rules, the Shenzhen Exchange noted a variety of factors that might make ChiNext stocks particularly susceptible to speculation, and thus to wild price fluctuations, such as the relatively small size of companies, their short earnings history, the innovative nature of some concepts and high investor expectations. In one widely reported gauge of investor interest, the first ten companies approved to trade on ChiNext planned to raise more than twice as much as their initial IPO projections. Initial price-to-earnings ratios were above 55, compared to about 41 for the Shenzhen Exchange's other listings, with some analysts predicting that speculative investors, anticipating future growth, would drive the most expensive listings to PE ratios of 100.

First-Day Trading Guidelines

The core premise of the First-Day Trading Notice is to suspend trading of individual stocks if prices fluctuate excessively:

• Pursuant to the First-Day Trading Notice, if the trading price of an individual stock rises or falls by 20 percent or more, compared to its opening price, on the first day of trading, the Shenzhen Exchange may suspend trading for 30 minutes.
• If the transaction price rises or falls a total of 50 percent or more from its opening price, the Exchange may suspend trading for an additional 30 minutes.
• If the transaction price rises or falls 80 percent or more, the Exchange may suspend trading until 14:57 local time. (The market closes at 15:00.)
• Investors may continue to order or revoke orders while trading is suspended.
• If trading is suspended until or after 14:57, the Exchange would effect suspended transactions at 14:57, conduct a call auction for orders accepted during the suspension, then conduct a closing call auction.

In addition, the Shenzhen Exchange will closely monitor trading accounts. If an account is being used to affect the stock trading price or volume by abnormal transactions such as mass orders, continuous orders or the frequent revocation of orders, the Exchange may impose restrictions on the account and report the case to the CSRC for further investigation and possible penalties.

Conclusion

Expectations for China's Growth Enterprise Board are high, with some officials and analysts hoping openly that ChiNext will spawn Chinese versions of Microsoft or Intel by filling key gaps in China's capital markets and providing support for innovative new companies. On the other hand, several dozen other countries have established their own Nasdaq knockoffs in recent decades, with many of those growth-oriented boards having failed.

Given China's far-from-mature stock markets and the newness of the Growth Enterprise Board, the First-Day Trading Notice may to some extent perform a necessary function in preventing excessive speculation. Whether regulators have sufficient practical experience in formulating and effectively enforcing rules suitable to China, however, remains uncertain—as is the larger issue of whether ChiNext will fully play its intended role in China's multi-tiered capital market.