NEEQ: the world’s newest bubble

The reigning Chinese Super League champion is Evergrande FC from the city of Guangzhao. Evergrande plays in the 58,000 capacity Tianhe Stadium. Its crest is a bit like Liverpool’s, but angrier.

NEEQ

The reigning Chinese Super League champion is Evergrande FC from the city of Guangzhao.

Evergrande plays in the 58,000 capacity Tianhe Stadium. Its crest is a bit like Liverpool’s, but angrier. The dignified Liver bird is replaced with a screaming, flaming, tiger; YOU’LL NEVER WALK ALONE with BE THE BEST FOREVER.

Anyway, the most interesting thing about Evergrande is that it’s now apparently the most valuable football club in the world. It’s worth about a billion more than Manchester United, at $3.37bn.

I’d never heard of Evergrande until I started looking into China’s National Equities Exchange and Quotations market – NEEQ. The Beijing-based NEEQ is China’s newest stock board, after the Shanghai Stock Market and the ChiNext in Shenzen. It’s going after the booming, buzzy Chinese technology market. And Evergrande FC is one of its big listings.

You might reasonably ask why a parvenu club from a footballing backwater is the most valuable in the world. It turns out to be more to do with the bubbly NEEQ than anything on the football pitch.

Today I want to talk about NEEQ, and what this obvious bubble means for investors on this side of the world.

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Awkward teenager

China’s financial system is still in its awkward teenager phase.

The biggest exchange in Shanghai went through a huge boom and bust last year, and came out more or less flat for the year. It’s meant to allocate capital among companies in the world’s second biggest economy, but it looks a lot more like a casino.

The Shanghai and Shenzhen markets are floating new companies as fast as they can manage, but the demand still way outstrips what they can handle. There’s a backlog of almost 700 companies waiting to launch.

NEEQ is another way for startups to raise money. It’s much easier to get on the NEEQ board than on Shenzhen or Shangai. That’s partly why it’s been able to increase the number of companies listed by almost 300% since January 2015.

NEEQ is modelled on the US OTC (over the counter) Bulletin Board, made famous by Jordan Belfour AKA The Wolf of Wall Street.

On a proper exchange like the NYSE, Shanghai or Shenzhen, the stocks are traded centrally via the exchange. Listed companies have to jump through lots of hoops to get listed in the first place, and they have to disclose financial information to the market every quarter.

It’s much easier to get on an OTC board. Stocks on OTC boards like the NEEQ don’t trade through a central exchange. Instead they’re traded directly between participants. And companies on the board aren’t forced to disclose lots of their financial information.

That makes them a natural home for frauds, scams and dodgy dealings.

A bad deal for investors

OTC boards are useful for tiny startups which need to raise cash, but don’t have the resources to get listed on the main exchange.

But they’re a crap deal for investors. They’re crap for the same reasons equity crowdfunding. Here’s what I had to say about that last month:

Equity crowdfunding’s second big criticism is based on something called “adverse selection”. It’s based on an idea put forward by an economist called George Akerlof – the husband of none other than the Chair of The Fed, Janet Yellen.

Akerlof realised that markets don’t tend to work very well when one side of a transaction has more information than another – asymmetric information in microeconomics jargon. He used the example of the market for used cars. The dealer knows which cars are “lemons” and which aren’t. But the customer doesn’t. So the customer is only willing to pay the lower, “lemon” price, since he doesn’t want to overpay.

The net result is that only “lemons” get sold. The mere presence of inferior goods destroys the market for quality goods when one side of the deal has more information than the other.

So on the OTC markets (and on the equity crowdfunding sites), dodgy companies drive out good companies. An investor can get lucky – like, say, by investing in a Chinese soccer club just before a flood of orders comes on the market. But they won’t stay lucky.

You might not be tempted to invest directly in the Chinese OTC board yourself. But the lesson applies across the board. When companies know a lot more about their stock than the person who’s buying, expect the market to fill with junk.

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