Will China’s NASDAQ Make a Cisco or Google?

After a ten-year wait, the China Securities Regulatory Commission (CSRC) finally has issued a temporary regulation on the administration of initial public offering of stocks by growth enterprises, signifying the coming of age of this market segment in China.

The so-called second-board stock exchange, referred to as a Growth Enterprise Market, or GEM, after a similar exchange in Hong Kong – is most suitable for small- and medium-sized enterprises (SMEs) to raise money, as it emphasizes the growth potential more than the profitability of SMEs that do not have a consistently stellar performance. Thus far, China’s stock market has been geared toward large companies, mostly state-owned, at the expense of SMEs,which are the hungriest for money.

Under these circumstances, many companies operating in the Chinese market – from computer maker Lenovo and “China’s Google” Baidu to solar product manufacturer Suntech Power – have gone to Hong Kong, Singapore, London, and New York to list their stock. Moreover, these companies have had to incorporate outside mainland China to get overseas listing approval from the CSRC.

The establishment of a secondary stock exchange, therefore, is applauded, as it may stop the exodus of promising Chinese SMEs to foreign stock exchanges and give Chinese on the mainland an opportunity to invest and benefit from these companies.

In the meantime, the GEM makes possible the exit of venture capital invested in early-stage enterprises with viable business models. As Apple, Cisco, Google,and Microsoft, among others, are well-known companies listed on NASDAQ, which can be termed a growth enterprise market, the establishment of a Chinese GEM has long been viewed as a necessity of the growth of the high-tech industry in China, although many of the NASDAQ-listed companies are not necessarily high-tech.

However, having a secondary stock exchange is not sufficient to sustain the development of SMEs and the high-tech industry in China. Already there are concerns that without vigorous governance, China’s GEM could become another “casino,”as its main-board “cousin” has been perceived.

Therefore, more important than having a GEM is creating a business environment in which SMEs can grow.  Credit rating, accounting, auditing, and legal organizations should play their roles according to professional standards and ethics. Information disclosure rules should be firmly enforced with trading based on inside information being prosecuted and punished.

The GEM also calls for knowledgeable and intelligent investors who understand the prospects with regard to investing in growth companies – they can expect not only hefty rewards but may face uncertain and unstable performance, risky business operation, and greater-than-average failure of the listed companies.

In this regard, venture capitalists appear to be critical to the success of the GEM as their investment decision represents an initial screening of a company’s risk and reward possibilities.

However, most of the venture capital firms operating in China are foreign entities run by ethnic Chinese managers. Not only have China’s regulatory regimes not been conducive to the operation of domestic ventures;domestic entrepreneurs, with few exceptions, are not seasoned professionals themselves in running business, let alone selecting and funding ventures and getting their hands dirty if necessary.

Thus, a domestic venture capital industry, along with the arrival of a GEM in China, could help put more high-growthcompanies on China’s stock market, driving the nation in the next round ofeconomic development.