Fast track to riches on the mainland's IPO gravy train

SCMP June 11 2007

Karl Marx may have been wrong in preaching that capitalism contained the seeds of its own destruction. But the version of it flourishing on the mainland now may well contain the seeds of destruction of the bona fides of the regime. The seeds are being well fertilised by western financial institutions, and watered by the global liquidity bonanza.

One reason why Beijing has not come down harder, and sooner, on the stock market bubble, is that it fears a surge of urban unrest if enough people lose enough money. But there is another, unspoken, reason for its reluctance. It was hinted at ever so obliquely by the World Bank recently, when it criticised the pricing of many initial public offerings on the mainland (and by implication, some mainland companies which have listed in Hong Kong).

Underpricing has led to huge losses in state revenue and corresponding gains to those acquiring shares at, or before, the IPOs. The big gains made by new issues have also given the impression that money is easy to make in stock markets, thus attracting millions to rush to open trading accounts.

Some underpricing is normal. Companies being listed would rather get a little less than market value rather than risk the ignominy of a discount when trading begins. However, on the mainland, IPOs have become by far the easiest way for party and government insiders to get rich quickly without apparently breaking any laws. They get allocations for the IPOs with loans from state banks.

A similar, if less dramatic, tendency has been present in Hong Kong issues. Here, the major beneficiaries, other than the mainland insiders and investment banks, have been local tycoons and their related companies. They have received huge pre-IPO allotments, which create a shortage of stock available for the public, a stampede for subscription forms and ludicrous levels of oversubscription, leading to massive price premiums when trading begins. Even if the insiders are locked in for a period, they almost invariably end up with massive profits at the expense of both outside investors and state revenues.

There are many officials still waiting their turn on this gravy train who will be upset if government measures prick the stock bubble and undermine investor belief in IPOs.

But one should not just blame the mainland. The underlying cause is an international money and speculative glut. The Shanghai market is just the most extreme.

Fitch, the ratings agency, has noted that instead of using derivatives to offset risk, international banks have in fact been taking on more risk themselves by selling risk protection to non-bank institutions.

Beijing's Blackstone deal makes matters worse by giving the biggest private equity player a huge addition to its equity base which can then be leveraged. The China connection may also give it even easier access to borrowing and add to the respectability of leveraged private equity, even while Blackstone itself is selling shares (but not votes) to outsiders.

But Blackstone did not create the money supply now sloshing around the world, or the ultra-low interest rate environment on which their industry thrives. This derives from the massive US current account deficit, Japan's absurdly low interest rates and Beijing's refusal to run interest-rate or currency policies reflective of its economic circumstances.

For the mainland, a US$3 billion investment in Blackstone may be peanuts. But it suggests that Beijing has inadequate awareness of the inter-relationship of global bubbles, of which Shanghai's is now the most conspicuous. Former US Federal Reserve chairman Alan Greenspan also seems myopic. It may be fair for him to forecast that the Shanghai market will collapse at some point. But one could say the same about the opaque derivative and hedge-fund markets feeding the global boom.

It cannot last, but those mainland insiders are right to be impatient to get their IPO feed before it's too late.





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