Abstract: On December 14, 2020, Shanghai Stock Exchange and Shenzhen Stock Exchange called for public opinion on revised delisting rules. The new draft rules are in greater details than past provisions, but considered too lenient on financial frauds. At a recent CF40 seminar on China’s stock listing rules and reform of the delisting system held on December, 23, experts said the introduction of the new delisting rules is an important move amid ongoing registration-based IPO reform, which will boost competition, improve the capital market, and enhance the risk awareness of investors. Meanwhile, they agreed that some of the lenient rules might be ineffective, and proposed suggestions for amendments: first, tighten the lenient provisions to make the rules more practical and effective; second, elaborate the policies on voluntary delisting and delisting accountability; third, support class actions against irregularities to protect investors’ rights and interests.
I. In the long run, the new delisting rules will improve the efficiency of the capital market in resource allocation
Experts agreed that the introduction of the new delisting rules is an important move amid ongoing registration-based IPO reforms, and in the long run, it will improve the efficiency of the Chinese capital market in resource allocation, notably in the following three aspects:
First, it will improve the entire market environment. The draft rules shortened the years required for delisting based on financial indicators. Moreover, the threshold for delisting based on net profit indicator was lowered. These revisions would make it much more expensive for fraudulent companies to retain their eligibilities for listing.
Local governments will also bear higher costs and uncertainties when they seek to protect local companies from delisting through asset restructuring or sales of non-performing assets. Local protectionism’s adverse impacts on the capital market will be impaired.
Meanwhile, investment banks will assess in a more prudent manner the viability and operability of asset sales or restructuring of this sort, significantly reducing speculations while prompting the exit of shell companies.
Second, the new delisting rules will boost the development of high-quality companies while eliminating poorly-managed ones. Resources will gradually concentrate in high-quality listed companies, elevating their liquidity premiums, and making it easier for them to obtain financing.
In contrast, the value of shell resources will plunge, and companies issuing “junk stocks” will become even more illiquid and be driven out eventually.
Third, the new rules will enhance the risk awareness and rationality of investors. A market-based, normalized delisting system will expose investment risks more fully, driving institutional investors to give increasing preference to the stocks of high-quality companies. As a result, the stock market will become more institutionalized.
Meanwhile, putting in place the risk warning board system and improving requirements on investor suitability will enhance risk disclosure and investor protection, thereby improving regulation’s effectiveness and promoting rational investments.
II. Some of the lenient provisions could make the new delisting rules less effective
Experts pointed out that some of the provisions in the new draft rules had failed to meet market expectations by being too lenient; besides, the rules had not set different standards for companies of different scales with regard to the conditions that would trigger delisting. This could make them less applicable and effective.
First, the threshold for the market value and the number of individual shareholders that could trigger delisting are too lax to be actually reached. The new rules stipulate that companies with a market value lower than 300 million yuan for 20 trading days in a row will be delisted; while companies on the main board, SME board and ChiNext who have fewer than 2000, 1000, and 400 individual shareholders, respectively, for 20 consecutive trading days, will be delisted. These standards have fallen short of market expectations, and are very unlikely to be met in reality given that the Chinese stock market is still dominated by individual investors.
Second, the new rules are too tolerant of financial frauds, and fail to set different standards for companies of different scales. Financial frauds are irregularities of very severe nature that can cause serious damage to the capital market. The new rules have provided for both the nature of frauds and concrete quantitative measures. However, these measures are not tailored to companies of varied scales, a factor that makes much difference:
Big companies that are involved in financial frauds may easily report total or net profits that are inflated by more than 1 billion yuan for three consecutive years, but the proportion of the inflated part in their disclosed total or net profits may not exceed 100%.
On the contrary, small companies that cheat may seldom inflate their numbers by over 1 billion yuan for three consecutive years, but the inflated part could account for more than 100% of their disclosed total or net profits.
In general, the standards for financial fraud-triggered delisting are considered too lax to be met in reality, and the new rules are too tolerant of this serious illegal behavior.
Third, there is a lack of provisions for voluntary delisting, especially the institutional arrangements for delisted companies and their investors. Judging from international experience, more of the delisting events are voluntary rather than mandatory. The new delisting rules have specified the conditions that would trigger voluntary delisting, but failed to elaborate on subsequent arrangements. As a result, the new rules can only play a very limited role in guiding rational voluntary delisting of some of the listed companies. In addition, delisted companies are still legally-registered stock corporations. Yet, the new rules have not explained how to register the delisted companies’ shares or how investors continue their trading activities, to the disadvantage of investor protection.
Fourth, the new rules provide insufficiently for the accountability of actual liable parties. Actual controllers and managers can often make huge profits when a company goes public; but if their mistakes or even malicious acts directly lead to the delisting of the company, the board of directors, the board of supervisors and the senior management team shall all be deemed as actual liable parties, and held accountable with joint and several liabilities. Currently, the new delisting rules do not adequately address the issue of accountability after delisting.
III. Suggestions on the amendments of the new delisting rules
To address the above problems, experts advised to improve some of the standards and further elaborate on important issues of concern in the new delisting rules. They proposed the following suggestions:
First, properly tighten the standards for delisting to make the new rules more applicable and effective.
(1) Tighten the thresholds for market value and the number of individual shareholders that would trigger delisting of a company, and introduce to the public in a timely manner the calculation basis for these thresholds.
(2) Tighten the thresholds on indicators such as operating income and costs that would trigger delisting of a company involved in financial fraudulence, with the focus on cracking down on loss-making listed companies reporting false profits.
(3) Indicators on the accumulative inflated profits could be adjusted from absolute values to proportions in actual profits or net assets to match the actual scale of the company.
Second, further elaborate on voluntary delisting and delisting accountability.
Provide policy supports for voluntary delisting companies, such as faster relisting after they are reorganized in the new OTC market. In addition, companies that are delisted because of financial frauds should still be held accountable after the delisting. It’s not only the actual responsible parties, but all related parties including sponsor organizations, accounting firms, and law firms, that are to be held accountable, especially for investors’ losses.
Third, encourage class actions against irregularities to step up legal supports for investor rights and interests.
The new delisting rules should stick to the principle of investor protection, and improve the class action mechanism and its implementation so that investors can bring class actions against irregularities in defense of their legitimate rights and interests at a lower cost. Related provisions in the civil, commercial and criminal laws should be amended at the same time, and coordination with law enforcement agencies such the public security bureau, the procuratorate and the court of justice should be reinforced, so that laws become a powerful weapon to protect investors and maintain the order of the market.
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