What seemed like a match made in heaven has turned out to be nightmares for some investors who sought to participate in the growth of China - the world`s second largest economy. China`s long drawn out listing process has many companies which need funding hanging in the air, and have sought to raise capital in other markets. As recent as June this year, more than 800 companies are on the waiting list to go public on the A share market. On the other hand, foreign bourses continue to attract Chinese companies to list on their exchanges to offer greater value, diversification, and development of their capital markets.

Korea Exchange (KRX) has been courting Chinese companies to list on the Seoul stock market but several black sheep have caused investors severe losses and are giving KRX-listed China stocks a bad name. Problems include inflated assets, embezzlement of funds, inaccurate corporate filings, and fraudulent transactions etc. These accounting frauds have prompted KRX to strengthen their examination of foreign companies seeking to list in Korea. The problems with these bad apples are not unique to Korea.

S-Chips (Chinese companies listed in Singapore Exchange) were once the darlings of many investors in the early 2000s. In 2004, more than 40 China-originated businesses raised more than S$900 million through initial public offerings (IPOs) on the SGX and enjoyed an average price increase of 21% over their issue price by January 2005. The picture turned out very differently by the end of the decade. Many corporate scandals including embezzlement, forgery and accounting fraud surfaced in 2009 which led to sharp declines in share prices. As a result investor confidence have been damaged and regulators have tightened listing requirements ever since.

In the U.S., NASDAQ has also enhanced scrutiny on Chinese listings since a 2009 boom of China-based companies using it exchange abruptly crashed in 2011, creating a massive fraud pile up. More than 50 U.S. listed Chinese Companies were either delisted or halted from trading in 2011 and 2012 based on claims of fraud and other violations of U.S. securities laws. A number of others were the target of short sellers and changed auditors more than once in some cases. Many of these Chinese companies entered the NASDAQ through reverse mergers which allowed them to gain access to U.S. capital markets quicker, cheaper, and lesser scrutiny. NASDAQ has similarly adopted stricter rules for listing reverse merger companies.

We believe that there will be many good investment opportunities in Chinese stocks going forward but caution should be exercised as with all investments and should not be made solely on an interesting concept or idea. While due diligence should be done prior any investments, we believe that the stakeholders (regulators, auditors, and investment banks etc.) in the IPO process should conduct a higher level of scrutiny and hold a higher level of accountability in order to protect the investment community from fraud.

By Dave Wang, Equities Analyst, Truston Asset Management Singapore

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