The New Third Board: China's NASDAQ?

The agency share transfer system, also called the Third Board market, is a share transfer platform on which securities firms approved by the Securities Association of China and qualified to act as lead underwriters for the agency system provide, by electronic trading, a standardised transfer service for unlisted joint stock companies.

Like NASDAQ in the United States, China's New Third Board arose to regulate the over-the-counter market and to provide a platform through which small and medium-sized enterprises could raise funds. It began as support for high-tech enterprises in the national high-tech parks, being formally launched on 23 January 2006 and at that stage confined to companies in Zhongguancun; in 2012 the first expansion of the pilot added the Shanghai Zhangjiang High-Tech Industrial Development Zone, the Wuhan East Lake New Technology Development Zone and the Tianjin Binhai High-Tech Zone; and at the end of 2013 the New Third Board scheme broke through the limit of the pilot national high-tech zones and was extended to all companies that satisfy its conditions.

Some companies want to list on the New Third Board as a preparation for a later transfer to another board. There is in fact no need. First, a New Third Board company that wishes to transfer may still do so only by an initial public offering and listing on the exchange market, and the conditions for that offer are no different from those for any other company. Second, China will gradually form a multi-tiered capital market comprising the main board, the growth enterprise board, the over-the-counter quotation network and the property rights market, each tier supporting and complementing the others, a company being able to move up or down. A transfer is a company's movement between securities markets of different tiers and a bridge between them. The New Third Board is itself an important member of China's emerging OTC (over-the-counter) market and has unlimited potential. OTC, rendered in Chinese as the counter market or off-exchange market, is trading in equity conducted outside the stock exchanges, a market in which securities are traded by negotiation. If the main board is Peking University or Tsinghua, the New Third Board is certainly not their attached high school but the Central Academy of Drama or the Beijing Film Academy. Can one say that Peking University and Tsinghua stand on a higher tier than the Central Academy of Drama and the Film Academy? Consider why Microsoft has never transferred from NASDAQ to the NYSE.

Consider further whether a transfer is really necessary.

Compared with the main board and the growth enterprise board, the New Third Board has a low threshold and no profit requirement, but its legal issues have become steadily more important: standardised operation, standardised governance and the priority given to disclosure matter more and more. In 2014 the New Third Board became busier than ever before and companies rushed to list. One cannot help asking where its peculiar appeal lies.

It lies in the market-making system just announced and introduced. NASDAQ, established in 1971, faced the same difficulties of trading, financing and liquidity at the outset. Every stock listed on NASDAQ must have at least two market makers quoting it, and the more sizeable and actively traded stocks often have forty or forty-five.

The market-making system follows from the New Third Board's place in the market. The main board serves companies in traditional industries, whose future earnings are comparatively easy to predict and whose value is easy to judge, so that investors may simply value them on the information the listed company discloses. The New Third Board serves innovative companies, in technological innovation, cultural creativity and business-model innovation, whose future earnings fluctuate sharply and whose disclosed information can hardly reflect their future accurately; ordinary investors are not able to analyse an innovative company for themselves, and although such companies may be required to disclose more, that in practice achieves little. What is needed then is an expert, particularly where the expert is himself the sponsor that brought the company to market, and more importantly an expert who, under a particular institutional constraint, is "forced" to disclose honestly the result of his analysis of an innovative listed company's value, expressed in the form of a two-way quote. The market maker is such an expert.

The market-making system may be understood by taking foreign exchange trading as an example:

Foreign exchange trading: the Bank of China

Features: it issues buying and selling offers at the same time, at any time, without limit on quantity, to any counterparty

Renminbi against the US dollar: dollar buying price 7, selling price 7.21

The ordinary investor: if he suspects the price is too low he buys; if it is too high he sells to the Bank of China

Conclusion: there is no need to doubt the genuineness of the Bank of China's quotes

At the end of August 2014, forty-two lead underwriters and forty-three listed companies were to take the "first bus" once the market-making system came formally into effect, and the New Third Board's market-making system went live. NASDAQ, after more than forty years of grinding, has become one of the largest stock markets in the world. China's New Third Board is still at the stage of babbling and tottering along, but at least it has set sail; as for what follows, one watches and waits, but with high hopes.

Legal notice: the author of this article is Liu Yanmei, a lawyer at Minton Law Firm; please cite the source when republishing.