(Yu Zhiyuan) In September 2012, the China Securities Regulatory Commission promulgated the Supervision & Management Measures for Non-Listed Public Companies (the “Measures”), and the Measures came into effect January 1 2013. The Measures could be adopted as a fundamental regulatory rule of the OTC market of the security market in China. On January 31 2013, the overall regulatory rules for the three new boards, the Interim Management Measures for Liability Limited Companies for the Share Option Transfer of Medium and Small Sized Companies in China (the “Interim Measures”) was also published. The system construction of the OTC market has stepped into a substantial phase. Considering the large scale of the OTC market has the ability to exert great influence on the OTC market among multiple countries; it deserves people’s attention concerning its prospects and challenges in the future.

I. A Brief History of Three New Boards

The main board of the security market is usually led by large-scale companies, and in China it also covers small and medium-sized enterprises board (the “SME Board”). The smaller-scale companies, which mainly consists of innovative high-tech companies, has formed the Two-Board Market, also known as the Growth Enterprise Market (the “GEM”). Therefore, more medium and small-sized companies could not be listed on the market for transactions, but were limited to to over the counter transactions. Therefore, the market thereby formed could be called the Three Boards. In the 1990s in China, in order to solve the problem of circulation over the legal entity shares of state-owned enterprises China established STAQ and NET, which is also called the Three Board. For this reason, the new Three Board originally referred to the share transfer system enacted by the securities companies in Zhong Guan Cun in Beijing, which developed from the listing of companies in the Zhong Guan Cun Science Park. With the market expansion in August 2012, the system was put in place in Tianjin’s Binhai Park, Wuhan’s Donghu Park and Shanghai’s Zhangjiang Park. In the coming future, it could be foreseen that more and more high tech parks will be involved in the board. Currently the New Three Board is officially called “National Medium and Small Sized Companies’ Share Transfer System,” which is operated by the China Small and Medium Sized Company Share Transfer Co., Ltd.

II. The Prospects of the New Three Board

In the industry, some call the New Three Board, namely the Share Transfer System of China’s Small and Medium Sized Companies headquartered in Beijing, the “Beijing Exchange Market,” whose primarily rivals are the Shanghai Exchange and Shenzhen Exchange Market. In essence, however, the share transfer system for medium and small sized companies all belong to the OTC market, whose rules for transactions are slightly different from the Shanghai Exchange and Shenzhen Exchange. For this reason, this analogy is neither entirely fair nor accurate. Regardless, the New Three Board does have very prosperous prospects for future development.

The first reason can be determined by looking at the development rules among the capital markets. The scale and number of exchange transactions and OTC transactions appears to be  pyramid-shaped, in which mature large-scale companies occupy the One Board, many innovative companies comprising the Two Board, and more medium and small-sized companies seeking the financing channels in the OTC market. And yet, the current capital market in China is far from being what many people would describe a “mature” structure, and in addition to the eye catching IPO, most medium and small-scale companies have not yet found more and better ways to secure financing. As confirmed subsequent to an exploration of the financing system by the supervising and regulatory authorities, the finance market in China is drawing closer to becoming a mature or more normative structure in the securities market. The New Three Market, as promoted as an OTC market by the Securities Regulatory Commission, regardless of its scale or the numbers of listed companies, will surely witness great growth and development in the future.

The second reason: in recent years, we have seen the development of a kind of barrier lake in the IPO of the main boards, resulting in most applications that are filed not being approved. Therefore, as an alternative mechanism, the New Three Board, especially when considering the gains in return of investment institutes like PE, can be considered another method through which one can chase financing channels over the failure of IPO. The switch or alternative mechanism between the New Three Board and the main board or GEM board has also provided the conditions for companies listed in New Three Board to enter into a higher capital market.

The development of the New Three Board has benefited mainly from the policy support of the supervising authorities, but this also depends on the development of the transaction system. It has been widely adopted in the industry that the New Three Board demands and also shall carry out market maker system for the transaction activation in it, and according to the Interim Measures, it has also provided that the market-maker system is one of the options of the market. Taking into account current trends, the market-maker system must go, and for this reason, the degree of activity of the New Three Board will of course be greatly improved. However, transaction activity is one of the necessary conditions for quicker market development.

Whether being listed on the New Three Board is attractive to companies is another main standard to be determined by taking into considering its prospects. Due to the fact that the New Three Board is the only existing OTC transaction system supported by the authorities, it alone sets demands and requirements for companies applying for a listing. For this reason, those who have succeeded in being listed can improve their public image and fulfill the directional financing. Furthermore, in order to meet the conditions set for a listing, higher requirements would be established in terms of company governance.

III. The Challenge of the New Three Board

First, one of the main challenges facing the New Three Board is competition in the market. Currently, almost all regions in China appear to be keen on setting up and developing local OTC markets. Shanghai has also established a share trust transaction system in February 2012. All these locations concentrate on listing shares of non-listed public companies, and the transactions appear to be quite similar in respect to function and trading model as compared with the New Three Board; in addition, they are not limited to the parks or the industries. To further consider support from local governments in the local trading system, the New Three Board will more or less face several challenges as well as competition. In determining the current degree of development of a few of these companies and markets, several OTC markets could face an issue where no adequate companies would actually exist to even be on a board. On the other hand, we can say that development of the local trading market also has its own kind of value, and for this reason, it can be estimated that competition will exist to some extent between the local trading market and the New Three Board, and this is something that could become a national issue in the coming years.

Second, the other challenge mainly comes from the listing fees. According to conservative estimates in the industry, the annual expenditure for those would like to be listed on the New Three Board would be at least RMB 1.5 million Yuan, and the cost could occur in the coming several years. Although the cost appears to be vastly reduced as compared with costs for IPO, considering most potential listed companies in the New Three Board would be medium or small sized companies, local government subsidies could ease the pressure companies will feel with respect to securing enough funds to be listed.

Third, in the long term, information disclosure and supervision will be another important task for the construction of the New Three Board. Despite information disclosure and supervision being common and lasting problems in the capital market, and the spate problems breaking out on the main board market, such as the OTC market, makes one question whether the New Three Market will be successful maintaining a system with good oversight and strict discipline. To be traded in the share transfer system as a medium or small sized market in China could also be a good chance for listed companies to improve their image and develop their governance structure. But once scandals or lawsuits in the newly established nationwide OTC market come to light, the Chinese capital market will face another period of fluctuation. The judicial system and the lawyers therefore should assume greater liability in the constriction of it.

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You Yunting：86-21-52134918  youyunting@debund.com/yytbest@gmail.com

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