Shanghai's STAR Market, one of the world's youngest and most expensive trading venues, will likely need more than a few mega-IPOs to challenge Hong Kong and the U.S. as the preferred listing destinations for Chinese technology startups and new-economy companies, experts say.

The Science and Technology Innovation Board, as the startup market is formally called, is China's response to the Nasdaq, which is still home to some of the world's biggest technology companies. After its debut in July 2019, the STAR Market has become a popular alternative for Chinese IPO hopefuls seeking to avoid the additional scrutiny in the U.S. amid tensions between Washington and Beijing.

The upcoming offering by Ant Group Co. Ltd., which will be launched in Shanghai and Hong Kong simultaneously and is reportedly seeking more than the record US$29.44 billion raised by Saudi Arabian Oil Co. in 2019, could significantly boost the startup board's global ranking by IPO proceeds this year.

Still, the STAR Market will have a long way to go before it unseats Nasdaq or the Hong Kong stock exchange in terms of market liquidity, investor base, valuation and trading infrastructure.

"A landmark offering will likely improve the liquidity of the platform, and encourage more companies to list there," said Dickson Ng, a partner of Hong Kong corporate practice at law firm Eversheds Sutherland. "However, due to China's capital flow restrictions, the board will likely attract mostly domestic investors and foreign investors which already have a license to trade onshore."

Louis Lau, a partner of capital markets advisory group at KPMG China, added that the Shanghai board has "to evolve in order to become more efficient, well-regulated and attractive to both issuers and investors."

Off to good start

With a history of slightly more than a year, the STAR Market has done quite well — and quickly — on the IPO front.

Between Jan. 1 and Sept. 15, it hosted 103 IPOs, raising a total of US$25.22 billion. As of Sept. 15, there were nearly 400 IPOs in the pipeline, including Ant, the mobile payments offshoot of Alibaba Group Holding Ltd.

The STAR Market was a close second to the Nasdaq, which hosted 105 IPOs that raised a total of US$29.86 billion as of Sept. 15. The Shanghai board even surpassed the Hong Kong stock exchange, which raised the most proceeds from IPOs in 2019. In 2020, the city hosted 84 IPOs that raised US$10.45 billion as of Sept. 15.

"The STAR Market has offered an attractive option to many of China's new economy companies, as evidenced by its success to date," KPMG's Lau said. "The Ant Group's IPO will be an iconic deal for the STAR Market, further signifying its status and competitiveness among global leading exchanges and is set to attract more quality and sizable tech companies to follow its path."

Liquidity, valuation issues

Still, the STAR Market is behind the Nasdaq and Hong Kong stock exchange in terms of liquidity and market size, which are important considerations for companies while deciding where to list, experts say.

As of Sept. 18, the market capitalization of 175 STAR-listed companies totaled US$104.63 billion. That was less than 0.1% of the Nasdaq's August-end market capitalization of US$17.251 trillion, and about 2% of the Hong Kong stock exchange's market capitalization of US$5.476 trillion.

The STAR Market's daily turnover on Sept. 18 stood at US$4.52 billion. It was about 1.3% of the Nasdaq's Sept. 18 turnover of US$352.02 billion, and about a fifth of the Hong Kong stock exchange's daily turnover of US$23.45 billion on Aug. 31, the latest data available.

In part due to retail investor-driven frenzy, as of Sep. 18, the STAR Market was trading at a trailing earnings multiple of 93.55x.

"Demanding valuation level of the STAR board that may lead to potential bubble and market corrections," said Bruce Pang, head of macro and strategy research at China Renaissance. "Investor mix needs to see more institutional investors with a longer investment horizon and fundamental-driven investment philosophy."

SSE STAR 50 Index, the benchmark index of the STAR Market, rose 36.5% this year through Sept. 15. It outperformed a 24.7% gain of the Nasdaq Composite and a 15.8% decline of the Hang Seng Index in Hong Kong.

Going offshore

Despite the efforts of homegrown exchanges, many Chinese companies may still prefer offshore listings in the foreseeable future.

"Compared with the A-share market, Hong Kong has a broader coverage by sell-side firms, more flexible fungibility and more convenient access to foreign capital and an international investor base," Pang said. "Some Chinese companies may still want and need access to U.S. dollar capital raising and thus prefer to remain offshore-listed."

Pang added that, most of the Chinese "unicorns" — privately owned companies worth at least US$1 billion — have corporate shareholders holding weighted voting rights. These companies, if seeking offshore listing, are likely to go to the U.S. as such corporate structure is not allowed in Hong Kong for now. The Hong Kong stock exchange, which only allows individuals, not corporations, to hold such rights, is reviewing the rules.