160 Chinese Companies Listed Overseas in a Year, and A-Shares Missed the Good Companies of the Future Again | 2018's Biggest Business Stories ③

An opportunistic market from top to bottom, where raising money for companies is held hostage to keeping retail investors calm.

Some of this is the result of change already under way — and it will go on reshaping our lives. Some of it is the intervention of forces far less controllable, which force market participants to keep adjusting their strategies. And some of it comes from the companies themselves: once a company reaches a certain size, the question becomes how it squares itself with the public, with consumers, and with state power.

The country you have determines the companies you get. In 2018, as ever, the business world changed a great deal. The year's biggest business stories only confirm it.

Most of the liveliest new companies to come out of the Chinese economy over the past 20 years rushed to go public this year.

Xiaomi, which sold 91.4 million phones in a year; Haidilao, China's biggest restaurant chain; Meituan, the biggest food-delivery company; China Literature, the biggest web-fiction platform; iQiyi, the No. 2 video site; Pinduoduo, which now has more users than JD.com… In the first 11 months of this year alone, 160 Chinese companies went public, raising 246.8 billion yuan between them. Even China Renaissance, which advises internet companies on their listings, rushed to list within the year, becoming China's first publicly traded private investment bank.

Other big companies have filed prospectuses and are working their way through the process — Tencent Music, the largest music service, among them.

Facing a once-in-a-lifetime opportunity, Liu Shiyu, chairman of the China Securities Regulatory Commission (CSRC), said at the agency's annual work conference in early January that it would do "whatever it takes" to keep the good companies at home.

The signal came quickly. Foxconn Industrial Internet, incubated by Hon Hai, cleared the CSRC's listing review in 36 days early in the year, even though it missed several A-share listing requirements. The normal wait is more than a year and a half; Wanda has been waiting nearly three years.

Plans to bring good companies back from overseas came just as fast. The CSRC floated a listing mechanism called CDRs. Robin Li and Pony Ma both said during the March "Two Sessions" that they were studying the policy and were open to returning to A-shares.

CICC, which underwrites listings for the great majority of central state-owned enterprises, expected companies to come back and list within the year. Xiaomi was the first to file a CDR prospectus, in June.

The expectation then was that A-shares would attract not just new companies but new money. After a rocky path, A-shares joined the MSCI index in June, a move expected to draw about US$230 billion of investment over five years. More experienced foreign investors arrived too: UBS Securities, JPMorgan and other banks set up wholly foreign-owned units, and Bridgewater, the world's largest hedge fund, registered its first private fund product in China.

But by the end of the year CDRs had been on the shelf for more than six months, and not one of the internet companies the CSRC was courting stayed on A-shares. Xiaomi, Meituan, China Literature and Haidilao went to Hong Kong. Pinduoduo, iQiyi and Bilibili went to the United States.

Once again A-shares missed an entire generation of new companies. The last time was around the dot-com bubble of the 2000s, when young Chinese internet companies desperate for money to grow rushed toward Nasdaq and the Hong Kong exchange. China.com and Renren have faded since, but that generation also produced the three big portals, Baidu, Alibaba and Tencent — all still active in the capital markets today.

The A-share rally of 2007 pushed PetroChina to a peak market value of 5.28 trillion yuan; China's most valuable companies were all state-owned giants.

Eleven years later, the most valuable Chinese companies are Alibaba and Tencent, not the state-owned giants left standing after all that A-share screening.

The returns have been staggering. Even after subtracting the HK$1 trillion of market value Tencent lost this year, the company is still worth 380 times what it was at listing.

On A-shares, the biggest internet company for several years running was LeEco — which even today ranks among the top ten internet companies on the market.

The Chinese companies that listed abroad this year have all faced questions about being overvalued. Xiaomi's listing valuation slid from US$100 billion to about US$54 billion, and the stock has done poorly since: the latest price is 13.8% below the offer price. Meituan's valuation also fell, from US$60 billion to about US$51 billion. On the Hong Kong exchange, where both listed, about 80% of this year's new companies trade below their offer price.

The internet companies that listed in 2000 faced the same doubts. Some have since disappeared. But among those that survived, even Sohu — the weakest of the three big portals, and the one that fell away completely this year — is worth US$3.3 billion together with Sogou, the company it incubated, or 7.3 times its market value in its first year as a public company. The year after Sohu listed, the dot-com bubble burst, but the money it had raised in its IPO carried it through a change of business and into profit. Measured from its market value the year after listing, Sohu is up more than 70-fold.

By comparison, the SSE 50 Index, made up almost entirely of large industrial central state-owned enterprises and state banks, grew only 2.5-fold over roughly the same period.

The companies going public now reach into every corner of Chinese consumption. The Chinese internet industry went from nothing in 20 years to the point where even Silicon Valley began arguing over who the "WeChat of the West" would be; if any company in it could still grow on money raised from the stock market, it has most likely already listed in Hong Kong or the United States.

Over the past five years, driven by capital and 1.4 billion consumers, China has produced more than 30 new companies worth over US$1 billion — so-called unicorns — second only to the United States and far more than the rest of the world combined. The ones still private are only Toutiao, Didi, Zhihu, DJI, Lufax and a few others, plus an increasingly marginal Douban and a cornered ofo and LeSports.

It isn't only the internet, either. Promising young companies in traditional industries haven't stayed on A-shares. Because of certain unwritten regulatory requirements here, even Haidilao, the biggest company in its industry, listed in Hong Kong — and restaurant groups like Xiabuxiabu, Tang Palace and Daoxiangcun went before it.

Stability measures, triggered by one market drop after another, cost A-shares the liveliest Chinese companies of the past 20 years

The late 1990s brought China's first wave of internet startups. The three big portals were founded one a year, in 1996, 1997 and 1998. Pony Ma, Jack Ma and Robin Li founded Tencent, Alibaba and Baidu in 1998, 1999 and 2000.

Venture capital back then did not hand out hundreds of millions the way it does today for bike-sharing or Didi. After a few rounds of venture funding, a young company had to go to the stock market for money — and raising money is the stock market's most basic job: a company lists, takes money from investors, and pays them back as it grows.

But the A-share market's fundraising machinery was not built for these companies. At first, new shares were issued under a "regional quota system," with local governments handing out listing quotas within their own jurisdictions. It was a market entirely run by policy, without even a mechanism for delisting, and it existed to finance state-owned enterprises. Or, in the words of Shang Fulin, who later chaired the CSRC: "There's a real problem with how China's stock market is positioned. It used to exist to bail state-owned enterprises out of trouble."

The bar to list at the time — net profit of 30 million yuan for three years running, with revenue above 50 million yuan — was one that essentially only state firms could clear.

In 1999 the Party Central Committee and the State Council issued the Decision on Strengthening Technological Innovation, Developing High Technology and Realizing Industrialization, which promised support for venture capital and high-tech companies and, when the time was right, a dedicated high-tech board on the existing Shanghai and Shenzhen exchanges — what later became ChiNext.

Then the Nasdaq bubble burst and everyone panicked. ChiNext was shelved for nine years, and the first generation of internet companies missed A-shares entirely — even though most of them raised less than US$100 million, no more than state-owned enterprises were raising on A-shares at the time.

Not until 2009, after the split-share structure reform and a swing from bull to bear market, did ChiNext officially open. The companies that listed on it early were small, but they stood for new business models and new industries: Aier Eye Hospital, Wangsu Science & Technology and the like.

ChiNext still did not fix the underlying problem with listing on A-shares. It required profits; the net-profit bar was only slightly lower than the main board's. Add restrictions on share structures and the queue to list, and by 2014 Alibaba and JD.com still went to the United States to go public.

After missing those companies, the Shanghai Stock Exchange used the 2014 upswing to propose a Strategic Emerging Industries Board: companies could list while still losing money, and the CSRC would only judge whether an applicant met the legal requirements, rather than assessing the business's prospects itself and deciding on that basis whether it could even apply. In 2015 the People's Bank of China's China Financial Stability Report said the board would launch on the Shanghai exchange.

Dozens of U.S.-listed Chinese companies borrowed money to buy back their shares and delist, preparing to come home: Qihoo 360, Focus Media, WuXi AppTec, Shanda Games, Giant Interactive, Dangdang, Momo, Youku Tudou, JOYY, Perfect World. iQiyi, which listed on Nasdaq this year, was also preparing to list in China through that board.

Then A-shares crashed in the summer of 2015. The CSRC suspended new listings for a time, and that same year the line about "establishing a strategic emerging industries board" was cut from the 13th Five-Year Plan.

This year's CDR program repeated all of it.

Internet user growth has peaked, venture investors need exits: for these and other reasons, internet companies listed en masse this year, raising money for the hard shift from burning cash for growth to turning a profit.

Early in the year the Hong Kong exchange rewrote several listing rules specifically for this batch of companies, letting biotech firms with no revenue list, and letting companies with dual-class share structures list. The latter is common among internet companies: put simply, a founder's shares carry more votes than an investor's, so the founder can give up most of the equity in exchange for more money to grow the business while keeping control of the company.

The CSRC's answer, also early in the year, was to roll out CDRs in a hurry. CDR stands for Chinese Depositary Receipt: a company already listed abroad can place newly issued shares with a custodian bank designated by a depositary institution, and the depositary then issues CDRs backed by those shares inside China and raises money from domestic investors.

An unlisted company needed to meet only one of three conditions to apply to issue CDRs and raise money on A-shares:

1. Revenue of at least 3 billion yuan in the most recent year and a valuation of 20 billion yuan — the valuation not simply a number investors put on it, but one worked out using the income approach, the cost approach, market multiples and other methods;

2. In the most recent year, research staff making up more than 30% of employees, more than 100 invention patents tied to the main business, main products ranking in the top three by market share, and so on;

3. Major significance for the national innovation-driven development strategy — a company meeting none of the quantitative criteria could still list if it passed review.

In theory, even a company with no revenue and no profit could list.

But the CSRC still weighed in on what companies were worth. After Xiaomi, the first CDR applicant, filed in June, how regulators should value a fast-growing company with thin net profit became a problem all over again. Xiaomi's CDR listing on A-shares was put on hold.

In the second half of the year, as causes at home and abroad drove A-shares into a crash, the whole CDR system was shelved. The story that had once suspended ChiNext and the Strategic Emerging Industries Board whenever the index fell played out again.

While everything stopped on A-shares, Xiaomi listed in Hong Kong at a market value of US$46.5 billion, roughly 320 billion yuan. Over the first 11 months of this year, 160 Chinese companies listed in Hong Kong and the United States; only 101 listed on A-shares.

Layer upon layer of control has instead made A-shares a market that rewards speculation

A-shares missed a crop of companies, and the Shanghai Composite fell to its lowest point since the 2015 crash. With the market down, new policies were floated, the biggest of them the year-end proposal to set up the STAR Market and pilot a registration-based listing system.

Under a registration-based system, the CSRC would only judge whether an applicant meets the legal requirements, rather than judging a company's quality or prospects itself and deciding whether it can list, as it does now. In theory, new companies would flow into the market continuously, money would no longer pile into a limited pool of stocks, and junk stocks, shunned by a market left to choose, would eventually be forced out.

That regulation should shrink and the market should decide which companies are good is a basic assumption of stock markets worldwide, and it has been in circulation around A-shares for more than a decade. Fang Sanwen, a veteran investor and founder of Xueqiu, has been saying so since 2010.

Academics say the same. A paper examining cases of Chinese securities regulation notes that the securities regulator's own survey found most market participants thought there were too many administrative approvals, which lowered how efficiently they could operate. Liu Peipei, a researcher at the Shanghai Stock Exchange's Development Research Center, argues that excessive intervention has done great damage to the stability of the securities market, because listed companies, investment institutions and retail investors alike have to watch not only company performance but also rules that change overnight.

Even the CSRC, in its work outlook for 2008-2012, proposed simplifying approvals further, loosening controls and handing more business decisions to the market. Last month the Shanghai exchange said publicly that it would stop using "window guidance" — verbal warnings and the like — to "regulate" how investment institutions buy and sell stocks.

But on one hand, among the new companies incubated over these 20 years, not many chances are left for A-shares. Of those that have grown to $10-billion-plus valuations in recent years, iQiyi, Pinduoduo, Xiaomi, Meituan and Haidilao all went to New York and Nasdaq this year. Tencent Music has filed to list in the U.S. as well. What's left is Toutiao, Ant Group, Didi, DJI, Lufax and Bitmain — and Bitmain is in the middle of a crisis. Among smaller companies, even more have left.

On the other hand, attempts at this kind of opening up, and their failures, have come round in cycles through 20 years of A-shares.

Whenever the market rallies, regulators want to open it further, bring in new mechanisms and attract livelier companies. More often, the new policy arrives just as the market crashes, and regulators intent on stability water down, delay or drop the once-ambitious reform plans in order to placate retail investors.

Wu Zhipan, director of Peking University's Financial Law Research Center and one of the drafters of the Banking Law, has said publicly that of all China's markets, the stock market is relatively the most transparent and the most open to public scrutiny.

But as the country's most important market for direct financing, A-shares were built from the top down over many years, rather than evolving out of contest among market players. The system is rooted in the administrative apparatus and carries all sorts of political goals and the will of officials. Some decisions are not the regulator's own to make.

In the end, what regulators care about most is stability. The stock market, Wu Zhipan has said, may be the market most closely tied to China's political stability: "The rise and fall of the stock market cannot determine the country's development, but it can broadly be read as a barometer of the national picture, so keeping the stock market healthy and stable is critical."

So every slump brings new stimulus, and every overheated stretch brings cooling measures. Yet there is no standard for what counts as a slump or overheating; that should be for market participants to decide, not regulators. Regulators tacitly let leveraged money into the market in 2014, then demanded deleveraging a year later, triggering a crash — and then would not let state-owned brokerages sell shares to stop their losses. Hedging tools such as short selling were banned outright.

The more intervention, the more room for speculation. From listing to secondary offerings to mergers and restructurings, and even the "national team's" market rescue, there is room for rent-seeking at every step.

This year Changsheng Biotech ground to a halt over a vaccine-fraud scandal, and the CSRC all but wrote a new delisting rule tailored to it — yet the stock still hit its daily limit up for seven sessions in a row. Under strict listing review, a company with no operating value at all is still worth something once it is listed: another company can buy it and use it as a shell to reach A-shares through the back door. Investors here pay more attention to that kind of opportunity than to whether a company is any good.

Across 2016, investors on the Shanghai and Shenzhen exchanges held a stock for an average of 52 and 44 days. The words they use in stock forums are mostly "market manipulators," "dumping," "cornering the market," "subscribing to new issues," "shell speculation" — words you rarely hear in the U.S., Japan or other more mature markets. Even on Wall Street, seen across America as the embodiment of short-termism and greed, the average holding period on the NYSE in 2016 was 8.3 months: a low for the exchange in nearly a century, but still seven times longer than on A-shares.

In fact the U.S. Securities and Exchange Commission (SEC) rarely reaches into how the market runs. It relies on the Securities Act of 1933 and the Securities Exchange Act of 1934, together with later additions that kept up with the times — the Investment Company Act of 1940, the Insider Trading Sanctions Act of 1984 — to set out what companies are legally responsible for, and it has built a set of listing standards far lower than A-shares'.

In that environment, the ups and downs of the U.S. market are almost always self-correcting: up too much, it slips back; down too far, it climbs again.

Historically, the SEC and the Federal Reserve have stepped in only during the Great Depression crash of 1929, the leverage- and program-trading-driven crash of 1987, and the crash of the 2008 financial crisis, steadying the market with measures such as presidential statements and buyback funds for listed companies. After the recent sharp falls in U.S. stocks, Trump, always ready to find someone to blame online, pointed only at expectations of Fed rate rises, never at the SEC. Nobody there thinks the SEC should intervene in the market casually.

Under the securities rules and trading systems of Hong Kong and the United States, companies list quickly. Some collapse, some vanish. But a great many, because they had the chance to raise money, have grown tens or even hundreds of times over.

And after 20 years of A-shares actively picking out the good companies, the most valuable companies on it are still state-owned banks, energy firms and insurers. Nothing has changed.

Charts / Shuya Zheng

Cover image / Fortune; the long cover image has been cropped.