CHINESE brokerages will start making markets this week on China’s New Third Board, its leading over-the-counter (OTC) exchange but one long derided as a dead-end market populated by small little-known, opaquely managed firms.

    The move has revitalized interest and trading volumes have exploded, but analysts warn of significant risk.

    Most of the 66 brokerages so far approved to make markets — a business that requires deep cash reserves and sophisticated risk management skills — have little experience.

    Market makers quote both a buy and sell price and guarantee share availability by holding shares themselves in inventory, which requires careful real-time management.

    For brokerages, it means extra profits, while China’s policymakers hope the liberalization will boost liquidity in an exchange that can provide capital for small innovative firms, needed for the next phase of economic expansion.

    But, analysts fear that brokerages’ inexperience coupled with inadequate disclosure by listed companies could led to trouble for an exchange already saddled with image problems.

    “Like all OTC markets — including... America’s Bulletin Board and Pink Sheets — China’s Third Board suffers from inherent fundamental flaws,” said Peter Fuhrman, chief executive at China First Capital.

    “Liquidity and valuations are persistently low and disclosure is spotty. If it was designed to be a solution to the problem of erratic mainstream initial public offering [IPO] policy and approvals on China’s main Shenzhen and Shanghai stock exchanges, the Third Board must be judged a major disappointment.”

    Regardless of critics, trading volumes on the exchange soared almost 700 percent in May when Chinese media first reported the advent of market makers, ChinaScope Financial data show. Foreign investors are unable to trade on the exchange.

    An analysis of daily data from the National Equities Exchange and Quotations (NEEQ), which runs the New Third Board, shows that August volumes are set to surpass May’s record. Transactions worth 1.16 billion yuan (US$188.63 million), as of Aug. 19, were nearly double July’s total, while the volume of shares traded has more than tripled month on month.

    Smaller private companies in China are the country’s biggest aggregate employers and generators of gross domestic product, but they have difficulty getting bank loans and even more difficulty getting regulatory approval to list on major markets or issue bonds.

    However, while dozens of local governments have created OTC markets to help match firms with investors, the lack of market makers and lack of a clear upgrade path to major exchanges has caused most firms and investors to steer clear. But that may be about to change.

    “The expectation is that the Third Board can be an entree onto the growth enterprise board for select small companies,” said Brian Ingram, chief investment manager at Russell Ping An Investment Management.

    “If the board does serve that purpose, it’s likely to see pretty rapid growth, and the catalyst for that growth is the fact that regulators are allowing brokerage houses to serve as market makers.”

    Brokerages hope it will boost in profits, something they need badly, having struggled since 2010 as investors steadily switched out of Chinese stocks, among the world’s worst performers, in favor of housing and high-yielding wealth management products.

    Investors enthusiastically trade small, volatile shares listed on the ChiNext board, so some predict a revitalized OTC board will attract similar speculative interest, further supporting liquidity. (SD-Agencies)