On May 18th, NASDAQ proposed new rules for IPOs from “Restrictive Markets” that would raise the bar for smaller Chinese companies seeking to complete an initial public offering on the U.S. markets. The new rules formalize the enhanced scrutiny that smaller Chinese companies have received over the past year.
While the new rules do not explicitly mention China, they define restrictive markets as “a jurisdiction that has secrecy laws, blocking statutes, national security laws or other laws or regulations restricting access to information by regulators of U.S.-listed companies.” China is the only country with a significant number of companies seeking to list on NASDAQ that fits this description. The new rules will only impact the smallest issuers and do not indicate that the U.S. exchanges will be less receptive to mainstream IPOs from China, in our view.
The new rules would require that companies from “restrictive markets” (i.e. China) have a minimum offering size of $25 million, or 25% of the value of their securities, in order to be listed on NASDAQ. The securities must be offered on a “firm commitment” basis, meaning that the underwriter must commit to the full amount of the offering, and not use a “best efforts” approach with a rolling close. The rules also will apply to business combinations, such as SPACS, and direct listings involving companies from these countries.
- For the past year, NASDAQ has been informally subjecting small companies from China to more stringent listing qualifications than domestic companies. A number of these micro-cap IPOs have featured a high concentration of investors from Asia, often with some connection to the company, and limited distribution to U.S. investors. As a result, they have had low trading volume and a limited investor following.
- NASDAQ has expressed the concern that the combination of limited liquidity and restrictions to regulators’ ability to enforce securities laws creates heightened risk of price manipulation. Because relatively small trades can have a large impact on these securities’ prices, they may not bear a relation to intrinsic value.
- In our view the rules also reflect a business decision by NASDAQ that listing companies that are likely to be extremely illiquid and may not be successful on the U.S. markets is not in its economic interests. Many of these very small Chinese IPOs are undertaken by companies that may not have the management capacity or be willing to support the ongoing expense of being public. Given the small sums involved, raising capital is often not the primary motivation for the IPO. Management may view the IPO as a path to raise its stature in the industry, access government preferential treatment, or diversify the owner’s wealth overseas.
- We would note that the new rules would have no impact on IPOs by more sizable Chinese companies in the technology, consumer, and healthcare sectors, where there is substantial investor interest and where NASDAQ continues to compete for new listings with Hong Kong and other venues. NASDAQ affirms its belief that “the U.S. capital markets can provide Restrictive Market Companies with access to additional capital to fund ground-breaking research and technological advancements.” These rules enable the exchange to appear to be responsive to investor concerns with limited impact to its bottom-line.
We view these rules as providing helpful clarity to market participants after a period of prolonged uncertainty. Both aspiring IPOs and investment banks now have guidelines establishing NASDAQ’s expectations for approval by listing qualifications. Having an adequate public float is only one aspect of being successful as a public company. We continue to believe that companies and investors need to pay careful attention to accounting, disclosure, and governance issues as essential to longer term success in the public markets.