The State Council announced on June 19 that it would expand the New Third Board, an over-the-counter (OTC) market for non-listed companies’ shares, to include all small and medium-sized enterprises (SMEs) nationwide.
One of the experts estimated the number of companies that may list on the board in up to five years at between 4,000 and 5,000, up from the current 200-plus.
Many said they had anticipated a much smaller expansion, limited to companies in all 105 high-tech industrial parks in the country. That would still be impressive progress given that the market now covers only four such zones.
The bigger step shows the government’s serious determination to diversify the capital market and help SMEs finance, said Zhang Yuxi, General Manager of Nanjing Securities’ OTC department.
Regulations for the expanded New Third Board will differ from the old one in several key aspects, Meng Hao, Director of the marketing department of the National Equities Exchange and Quotations (NEEQ), said in one of those meetings. The NEEQ is the firm that manages the New Third Board.
To begin with, the entry threshold of listing will be significantly lowered and companies will not have to meet mandatory financial performance goals when they ask to list on the board.
The new regulation will also lift a ban that says the number of shareholders of a New Third Board-listed company must not exceed 200. The trading mechanism will be diversified to include agreement-based transactions, a centralized bidding method, and a competitive market-maker system.
“The operational details of the market-maker system directly determines the extent to which the New Third Board can contribute to securities firms’ revenue and thus receive the most attention of all firms,” an analyst familiar with the situation said.
As a market maker for a certain stock, a brokerage firm will be obliged to provide liquidity for the stock by quoting both bid and offer prices and using its proprietary capital and stocks for trading with other investors. In return, it makes money off the price difference.
There is as yet no agreement over how large a price gap should be allowed. The NEEQ wanted to cap it at three percent of the sell price, but most securities firms said this was too low.
Higher price spreads will provide a necessary incentive for securities firms to provide the market-making service, an executive of Shanghai Securities said.
He voiced his opinion at a meeting held by the NEEQ and suggested raising the ceiling to five percent. Another broker who attended the meeting proposed an even higher maximum figure of ten percent.
The experts and the NEEQ have also not agreed on the requirement of market makers’ stock positions. A preliminary plan says the amount of a market maker’s stock holding should fall in the range of three to ten percent of the stock’s total capitalization.
That is tougher than the usual requirement of twenty to thirty percent on the secondary market of A-shares, analysts say, because the New Third Board is smaller and thus more susceptible to price manipulation by market makers.
Compared with the centralized bidding method, the market-maker system binds the interests of securities firms with those of the stock-issuing company, said Cheng Xiaoming, General Manager of Western Securities’ OTC department.
In developed markets abroad, “the earnings from acting as a market maker often account for thirty percent or even half of a securities firm’s total profit,” he said.
That prospect, however, would come with challenges, particularly to the stock pricing capability of securities firms.
Aware of the risks, some securities firms have created a separate department for New Third Board businesses responsible for its own loss and profit.