Chinese regulators stomped over Ant Group's dual IPO plans at the eleventh hour last week, potentially delaying it for months and dealing a shock to investors across the globe. 

The severity of that intervention underscores what's at stake for China's domestic exchanges—and by extension the country's investors and private companies—by hosting what was expected to be the world's largest initial public offering to date. 

"[Ant is] one of the first major tests for the STAR board and for attracting foreign investors," said Jeremy Ma, a senior research associate at PitchBook who tracks the Chinese market. Seen as China's version of the Nasdaq, the STAR board is where Ant had planned to make its mainland debut.

China has made sweeping reforms to its domestic exchanges in recent years to make them more accepting of tech and biotech firms. The efforts are already paying off.

Through the first nine months of this year, Shanghai ranked first among global exchanges—both for the number of IPOs and capital raised, according to a report from accounting firm KPMG.

Hundreds more IPOs are on the way. Nearly 550 companies were actively applying to list on Shanghai's STAR Market and Shenzhen's ChiNext exchange at the end of the third quarter, KPMG found.

Even if they pale in comparison to Ant's worth, many of China's IPO hopefuls will command large valuations. The country is home to around 100 VC-backed unicorn companies that are in the median age range for an IPO, according to PitchBook data.

That list includes names like JD Digits, which has also filed for a STAR board IPO, as well as ridehailing powerhouse Didi Chuxing, and social media platform operators ByteDance and Kuaishou.

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Shanghai’s STAR board is increasingly popular due to its relaxed profitability requirements, as well as an approval process that is run by the exchange rather than regulators, said Michael Wu, a senior equity analyst at Morningstar. Those rules make it attractive to tech startups and biotech companies, which frequently go public before they are profitable.

"Shanghai and Shenzhen will be continuing to open up the financial aspect," said Wu. "It's a bit of an experiment for the Chinese regulators." 

Ant's decision to list in Shanghai was likely in part an attempt to signal to the Chinese government that it is "batting for the home team,” said Adam Lysenko, an associate director at Rhodium Group, a research firm that studies China's private sector. 

The company also benefits from a large domestic retail investor base that understands and uses its products, said Wu.

China has spent heavily to build cutting edge semiconductor companies, reportedly allocating around $38 billion to the industry across two state-sponsored funds. It is also home to a growing cohort of consumer tech startups that provide everything from food delivery and finance to online learning and gaming.

The domestic exchanges provide a viable exit path for the country's homegrown industries as well as its investors, who often lament the difficulty of domestic IPOs, said Ma. 

China's official reason for its delay of Ant's IPO was reportedly its concern about risks posed by the company's credit business, which matches borrowers and banks. New regulations would force Ant to provide 30% of the funding on its loans, which could add 540 billion yuan (about $82 billion) to the fintech giant's balance sheet, according to a Morningstar estimate.

Unofficially, the move is seen as evidence of animosity between Chinese regulators and Jack Ma, who owns a controlling interest in Ant Group. Last month, Ma criticized financial regulations for holding back innovation.

The delay follows a series of scandals involving lending companies in China, as well as calls from investors and regulators for greater scrutiny of Chinese companies listed abroad.

Just a few years ago, China was home to a rambunctious peer-to-peer lending industry, but fraudulent activity prompted forceful government intervention. More recently, the accounting scandal involving US-listed Luckin Coffee, China's Starbucks rival, gave rise to calls for greater scrutiny over Chinese companies.

Such scrutiny was evident in the Trump administration's recommendations for enhanced audit rules, which Chinese companies would need to comply with in order to remain listed in the US. As a result, some high-profile Chinese companies that went public in the US have undergone secondary listings in Hong Kong.

But even with these policy hurdles that make the US less attractive, the Shanghai and Shenzhen exchanges face headwinds in attracting the best companies.

In a year when many Chinese companies flocked to Hong Kong or mainland exchanges, the US hosted billion-dollar IPOs from fintech company Lufax, electric carmaker Xpeng and real estate company KE Holdings.

New business formation is another challenge that could affect public markets in the long term.

Venture capital investment in the country has been on the decline since 2018. Despite the government's effective control of the coronavirus and China's ensuing economic growth, year-over-year VC investment has fallen around 5% in 2020, according to PitchBook data. Meanwhile, it has grown by nearly 9% in the US and 5% in Europe over the same period.

"Eventually, you're going to run out of new companies to list—at least at this rate," Lysenko said.
 

Featured image via THINK A/Shutterstock.com

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