A CRISIS OF CONFIDENCE
In February, the A-share market kicked off its registration-based IPO system. That, coupled with China’s relaxation of pandemic control measures, was meant to inspire full confidence in the market. However, well into the second half of the year, market confidence can be described as falling off a cliff. Capital markets lawyers point out that under the new IPO system, regulators and market players are still finding their way, while intermediaries, faced with higher "gatekeeper" responsibilities, are also intensifying their efforts to prevent and control practice risks.
Despite the expectation of a strong economic recovery in 2023, the A-share market is underperforming. In July, the Politburo meeting specifically mentioned the need “to revitalise the capital markets and boost investor confidence.” Regulators responded by introducing a series of stimulus measures to salvage the sluggish performance of A-shares, but results have not been as good as hoped.
In fact, some A-share IPO data in the first seven months of the year is even weaker than in 2022, a year badly impacted by the pandemic. Zhang Liguo, chief partner of Grandway Law Offices, tells ALB that: “From January 1 to July 31, 2023, a total of 226 A-share IPO applications were reviewed, of which 197 were approved, a year-on-year decrease of 29.13 percent. The approval rate stands at 87.17 percent, down 3.38 percent compared to the same period of last year.”
According to Caixin, between July and August 22 this year, Shanghai and Shenzhen stock exchanges received zero IPO applications. “Although IPO applications will usually slow down in July, zero applications are extremely rare. Even more surprising is the complete halt of IPOs by unprofitable companies. Since the beginning of 2023, no IPO application from such an issuer has been accepted by Shanghai and Shenzhen stock exchanges,” the publication said. “However, IPOs already under review are progressing normally, and there has not been any across-the-board suspension.”
Xu Jianjun, partner of DeHeng Law Offices and head of its securities practice committee, says market fundamentals remain strong despite the low numbers. “The number of IPO applications and the number of accepted applications remain stable in the first half of this year, and overall response to the registration-based IPO system has been relatively positive. This is a basic judgment of the market.”
In terms of quantity, “as of July, about 210 companies from the three major exchanges in Beijing, Shenzhen and Shanghai have completed IPOs, a year-on-year increase of seven. However, the amount of funds raised has dropped significantly, down approximately 30 percent compared to the same period last year. This is mainly because the number of listings on the Beijing Stock Exchange has doubled compared to last year. The amount of funds raised there per IPO is rather low,” says Xu.
“Regulators and other parties are still finding their feet under the registration-based IPO system, and therefore, one should view some of the happenings on the market rationally and have more patience and confidence in the market.”
Xu Jianjun, DeHeng Law Offices
As of the end of July, the Shenzhen Stock Exchange has had the highest number of approved A-share IPOs, with ChiNext being the most active board. Computer, communications and other electronic equipment manufacturers have seen the most approved IPOs during the same period, totalling 35.
Xu also observes that ChiNext has a better record of successful listings thanks to its higher inclusiveness and market attractiveness. “In fact, the most active listing boards are still ChiNext and STAR Market. For example, in the first half of this year, the total amount raised on the STAR Market has reached 70 percent of the market total, with five out of the top ten IPOs all taking place on the STAR Market.”
“In terms of industries, overall, high-end manufacturing, 5G, new energy vehicles, integrated circuits, semiconductors, high-end materials and biopharmaceuticals still occupy the main market for IPOs. Even within traditional manufacturing, sectors undergoing transformation and upgrading, such as high-end manufacturing and chemical raw materials processing, are the ones that have raised relatively large amounts of money," says Xu.
The rare occurrence of zero IPO applications mentioned above has stirred plenty of market speculation, which, coupled with subdued results of regulatory stimuli, have again shaken market confidence. Faced with recent drastic policy changes in the A-share market, Xu says that this is, in fact, a reflection that market players, regulators and other parties are still finding their feet under the registration-based IPO system. Therefore, one should view some of the happenings on the market rationally and have more patience and confidence in the market.
“Supply and output in the securities market are always dynamic,” says Xu. “During the ‘window of opportunity’ at the beginning of the year, the market had higher expectations for, or rather some misunderstanding of, the registration-based IPO system. Some issuers thought that the registration-based IPO system would simply make it easier for them to go public. As a result, more Chinese companies wanted to get listed on the capital markets, significantly increasing supply.”
At the same time, “regulators are stepping on the brakes, hoping to find out what best suits the Chinese capital markets in the present stage. The alignment between the two sides is far from over and has, in fact, entered a stage of ‘tussle.’ For regulators, they hope to meet the financing needs of enterprises, but also demand no mistake. Incidents of financial fraud by STAR Market-listed Amethystum and Sino-Essence have given regulators a serious reminder – if fraud still existed in such a strict market environment and under such stringent issuance requirements, regulation will inevitably need to be tightened. In addition, stock exchanges and the China Securities Regulatory Commission (CSRC) are also adapting to the new system, and the implementation of the registration-based IPO system also requires trial and error.”
Further, Xu believes that the recent perceived "tightening of IPO review" is also attributable to objective reasons. “Due to the pandemic and the weaker-than-expected economic recovery, the actual performance of some companies has fallen below what is disclosed in the statements and performance sections in their IPO applications to the point where they could not meet, or only barely meet, the new listing standards. Such companies will definitely not see their IPO applications approved.”
“The A-share market has been extremely active in the past few years, with around 500 IPOs each year. In fact, there is a ceiling to the supply of top enterprises on the market. In other words, generating so many quality enterprises every year is impossible. Therefore, it is very necessary for us to lower expectations for the next few years," admits Xu.
As the market and the new registration-based IPO system continue to align, there have also been significant changes in lawyers’ work and the challenges lawyers face this year.
“On February 17, the CSRC promulgated relevant rules to fully implement the registration-based IPO system. At the same time, stock exchanges and other relevant agencies issued supporting rules for implementation, covering aspects such as issuance conditions, registration procedures, sponsorship and underwriting, major asset restructuring, regulatory law enforcement and investor protection. All of these developments will naturally have an impact on the work of IPO lawyers,” shares Zhang.
“The registration-based IPO reform is to hand over the right of choice to the market. Therefore, the new system has raised higher requirements on the professional competency and practice quality of IPO lawyers.”
Zhang Liguo, Grandway Law Offices
According to him, the rules with the biggest impact include those on "streamlining and optimising the conditions for issuance and listing,” “improving review and registration procedures,” “improving the system for major asset restructuring of listed companies,” and “further reinforcing regulatory law enforcement and investor protection.”
In addition, at its core, “the registration-based IPO reform is to hand over the right of choice to the market. At the same time, regulators are tightening the role of issuers as the parties primary responsible for information disclosure and the responsibilities of intermediaries as gatekeepers," explains Zhang. “Against this backdrop, the new system has raised higher requirements on the professional competency and practice quality of IPO lawyers. Accordingly, the practice risks of IPO lawyers have also increased.”
Xu has also noticed changes in lawyers' work given the new concept of the registration-based IPO system and its detailed rules. “First, the pace of work has become more intense. The new IPO system has significantly shortened the approval queue and issuance cycle, posing bigger challenges to lawyers' work pace and response speed. In the past, lawyers could spend time slowly polishing many projects, but now work is results-oriented. In addition, the registration-based IPO system emphasises information disclosure and its completeness, authenticity and accuracy, which means that lawyers must rely on limited time and energy to meet higher requirements.”
He also sensed the strengthening of lawyers’ responsibilities. “The CSRC has released the Detailed Rules on the Practice of Law Firms for Engaging in Services of the Initial Public Offering and Listing of Shares, which not only clarify the scope of responsibilities, due diligence requirements, etc. but also put forward higher requirements on the compliance and improvement of the internal control systems of securities law firms.”
“On the whole, although the number of successful IPOs has decreased in the first half of the year, securities lawyers have been kept busy and are, in fact, under greater pressure than before,” concludes Xu.
With the increasing responsibility and pressure of IPO lawyers, Xu says that firms practicing securities law have invested more tangible resources and energy to “strengthen risk control, including significant investment in IT and human resources in the face of prior inspection and post-accountability by regulators.”
Specifically, “we have done work on several fronts. First, all the work outputs of lawyers, including information disclosure documents and working papers, need to be better and more comprehensively organised internally. Second, most larger securities law firms are in contact with top IT companies to explore the integration of AI tools and securities legal services, hoping to leverage powerful tools to complete some of the work to improve efficiency and save manpower.”
“Third, we are also exploring the possibility of institutional innovation with some leading insurance companies. For example, one insurance company may soon launch a product that targets IPO issuers. If an IPO project causes the issuer and intermediaries to bear liabilities for civil compensation due to specific reasons, this event may be claimable by the insurance company.”
In addition, non-governmental associations and organisations, including securities and lawyers’ industry associations, “are also working around the clock to formulate standards.”
Under the registration-based IPO system, several securities disputes involving intermediaries bearing joint and several liabilities in the first half of the year have triggered keen market concern. Zhang believes that securities lawyers should put more risk prevention measures in place.
“First is to focus on business screening and control project quality throughout. Before accepting a project, lawyers should already conduct preliminary investigation and risk analysis. During a project, lawyers should design work processes based on the project’s characteristics and industry attributes, and continuously track, manage, and serve project operations. Upon project completion, lawyers should review work outputs to ensure no quality issue.”
“Second is to improve the construction of internal control and compliance. Third is to focus on building up professional competency and comprehensively improve the quality of practice. Fourth is to strengthen professional ethics and reinforce the independence of securities lawyers.”
Zhang tells ALB that Grandway has always focused on capital markets as its core practice and has established clear management systems in areas such as practice management, conflict of interest, project management and archives management. For securities legal services in particular, the firm established a nearly "ruthless" internal review mechanism as early as in the 1990s.
Given the new trend of tightening regulations, Grandway is also “working to continuously reinforce internal self-inspection and self-correction, refine work guidelines, standardise legal documentation templates, and improve other optimisation mechanisms to further raise the quality and efficiency of securities legal services, and prevent and control risks of such services.”
DEALING WITH ANXIETY
Amid rapid changes in capital markets services since the beginning of this year, Xu has also observed something else. “In the past few years, the capital markets practice has been very popular among young lawyers. With increasing regulatory requirements and intensifying practice challenges, we have felt a certain degree of anxiety among the profession.”
“For example, in the resumes we have recently received, many law school graduates state straightaway that they are not interested in capital market practice. This is because news has been spreading in law schools that securities practice is hard, with very frequent business trips, endless paperwork and higher regulatory pressure, making it unattractive among young lawyers.”
Xu thinks this is all very normal. “In recent years, the securities industry has enjoyed extremely rapid and booming development. As a result, investment banks and law firms have attracted a large number of young people. For example, the investment banking department of a securities firm, which used to have one or two hundred people, has now expanded to one or two thousand people. Changes in the IPO market will definitely lead to a process of adjustment, and those who are unable to adapt to the changes may voluntarily exit the market. All of these are normal.”
During recent exchanges, Xu has repeatedly relayed several key thoughts to young lawyers. “First, securities legal practice will always be a major practice area with long-term prospect. This is because turning to the capital market is inevitable during the growth of a top enterprise. For lawyers, this means there will always be room for imagination in this securities market. Moreover, securities legal services impose higher requirements on lawyers, which can help them achieve personal development and become better and better.”
“Second, in the current market climate, it is all the more important for lawyers to build up capacity, search for new business highlights in the industry, and serve the entire lifecycle of listed companies. Young lawyers with very good industry competency can still provide valuable services for clients.”
“Therefore, young people should change their mindset to build up better legal services capabilities. They cannot just work to ‘put icing on the cake’ while being unable to ‘send in the calvary’. Capital markets legal services need to match the entire lifecycle of enterprises and should be diverse, comprehensive and integrated. Our young lawyers still feel confident after listening to these thoughts," says Xu.
Recent economic fluctuations have also made firms and lawyers, especially securities practitioners, realise that "merely focusing on a single practice area has a negative impact on a firm’s stable revenue generation and long-term development, so business diversification will definitely be the future trend," says Zhang.
However, diversification does not necessarily mean blindly expanding the size of the firm. “The core of business diversification is based on changes in client needs. It is necessary to start from the actual situations of the firm and form 'tailored diversification of leading practice areas'. Only by doing so can the firm have a strategic direction for longer-term growth.”
According to Zhang, “after years of service and word-of-mouth reputation, Grandway has earned a high degree of trust from hundreds of listed company clients. Clients also need more comprehensive and multi-level professional legal services. Guided by client needs, we have introduced and nurtured mature and specialised lawyers and teams in dispute resolution, intellectual property, real estate and construction engineering, compliance, taxation, and other capital markets-related fields.”
Zhang shares that in the first half of 2023, Grandway continued to integrate quality professional strength and resources, and established five major practice groups and three major industry research committees, so that "we divide work while cooperating and coordinating with each other, to effectively promote synergy between diversified practice areas and the capital markets practice.”
To Xu, although many larger firms in China, including DeHeng, started in the securities practice, they have, after three decades, "developed comprehensive practice area set-up and service capabilities without any visible weak area, so there is no particular sense of anxiety.”
On a closer look, however, "there are indeed ups and downs in different practice areas... We will closely monitor relevant changes and have ongoing discussions to respond to market changes with more flexible internal systems," says Xu.