Western investment banks are keen to underwrite more IPOs on China's Shenzhen exchange this year as a surging economy turns the once insignificant market into a fundraising hotbed.
The moves by UBS, Deutsche Bank and others into Shenzhen will raise competition for little-known local players such as Ping An Securities and Huatai Securities, who have underwritten IPOs worth billions of dollars, and driven down high fees.
The Shenzhen Stock Exchange is the smaller of the mainland's two exchanges and includes the Nasdaq-style ChiNext start-up market. Shenzhen experienced an unprecedented initial public offerings (IPOs) boom last year, easily raising more money than the bigger Shanghai exchange.
Foreign banks have until now focused on underwriting big IPOs in Shanghai, partly due to the lack of transparency on the ChiNext market.
Even China's top investment banks such as state-owned CICC and Citic Securities have been cautious because of the variable quality of companies seeking an IPO in Shenzhen.
But many global banks are now widening their targets to IPOs by small- and medium-sized enterprises (SMEs) in Shenzhen, a booming metropolis next to Hong Kong that was a sleepy town surrounded by rice fields only 30 years ago.
Two, three years ago, these IPOs would not be on their radars, said Terence Ho, who leads the IPO operation in Greater China at consultancy firm Ernst & Young.
A decade-long, uninterrupted economic boom has created an insatiable hunger for capital among a growing army of SMEs in China. The Shenzhen exchange has been the key beneficiary given small-sized IPOs cannot be launched on the Shanghai exchange, which focuses on mature, blue-chip companies.
Last year, companies raised $44 billion via IPOs on the Shenzhen market, more than the $25 billion in Shanghai, according to Thomson Reuters data.
Last month, 32 Chinese companies raised $4.05 billion in Shenzhen. By contrast, 5 firms raised $2.6 billion in Shanghai.
Based on the number of companies, Shenzhen was also the most popular IPO market in China, with 43 percent of Chinese firms going public in Shenzhen, up from just 4 percent in 2006.
The total market value of companies listed on the Shanghai Stock Exchange stood at $2.76 trillion, compared with Shenzhen's $1.26 trillion.
The Shanghai Composite Index .SSEC has fallen 4 percent in the past one year, while the Shenzhen Composite Index .SZSC has gained 12.9 percent.
CAUTIOUS APPROACH TO SHENZHEN IPOs
All foreign investment banks operate in China through joint ventures. Ten foreign banks have set up JVs, including major players such as Morgan Stanley (MS.N), JPMorgan (JPM.N), Goldman Sachs (GS.N) and Deutsche Bank, but all have largely stayed out of the Shenzhen IPO market.
As a result, local players Ping An Securities, Guosen Securities and Huatai topped the 2010 IPO league table.
UBS clinched only two A-share IPO deals in Shanghai, worth $991 million last year while Deutsche Bank had six deals in Shenzhen worth $641 million.
By comparison, Ping An pocketed 38 IPOs in 2010 with a combined deal value of $5.14 billion while Guosen and Huatai each raked in 31 deals worth $4.82 billion and $3.85 billion, respectively, Thomson Reuters data show.
Shenzhen IPO issuers, which already pay banks higher-than-average underwriting fees, have in recent years proved that they too are capable of raising billions of yuan after a surge of investor interest in growth stocks drove valuations to unseen levels.
Banks typically earn fees of 4 to 7 percent for a Shenzhen IPO, significantly higher than the 1.5-2.4 percent range they get in Shanghai and the 1.7-2.6 percent in Hong Kong, according to Thomson Reuters data.
Overseas investment banks are gearing up for increased Shenzhen opportunities. UBS has said it will treble its China research team as part of a broader expansion of its investment bank operations in China as it aims to get a bigger share of the ChiNext IPO market.
While competition could lead to lower fees for certain deals, the quality of new listings may also be compromised due to increased competition for new business, said Wang Aochao, analyst at UOBKay Hian in Shanghai.
Regulators may become more cautious about approving new IPOs, resulting in a more rigorous review process for IPOs, he said.
Introduction of such stringent listing criteria could temporarily slow the IPO pipeline but it will help its sustainability over the longer term, analysts say.
The Shenzhen exchange plans to establish an exit mechanism for companies that fail to meet regulatory requirements after listing, a move that will boost market transparency and help spur participation by Western banks who have to meet stricter due-diligence than local counterparts.
But the key to success in underwriting IPOs in China is having a strong team of sponsors -- qualified financial advisers whose duty is to make sure information provided in an IPO prospectus is truthful and accurate. Under Chinese regulations, all IPOs must obtain the endorsement of two qualified sponsors.
Analysts say that unlike in some other markets where global banks can expect an edge over local players, they would have to work just as hard as local competitors to build a track record in getting IPO approvals from the securities regulator.
For the issuers, that is bigger attraction than global reputation.
The biggest hurdle to an A-share IPO lies in the process of winning the regulatory approval. The international investment banks' global reputation and distribution network are of no value to these IPOs, said Ho at Ernst & Young.