Capital market reforms on right track
(Alexander Wan and Selina Lo)
2005-11-25 06:17

Clear visions for industry efficiency, better pricing, definition of risks amid others are what China needs for its capital market development, said Kevan Watts, Chairman of Merrill Lynch International Inc at the 18th China Daily CEO Roundtable on November 18 in Beijing.

The roundtable, with the theme "Capital Market Reforms - Visions, Process and Imperatives", involved senior officials from China Securities Regulatory Commission (CSRC) and China Banking Regulatory Commission (CBRC) together with some 30 CEOs and senior executives from global financial institutions.

Visions

"Financial systems dominated by banks cannot work anymore. They need to be more flexible and sensitive to prices and risks," said Watts, who has decades of extensive industry experience in Europe, the Middle East, Africa and the Asia Pacific and is also the honorary chairman for the roundtable.

He started discussions with an assessment of China's inherent financial systems structure. "A system based on banks is not sustainable. Financial services all over the world have revolutionized through information technology."

He quoted year-end 2004 figures to support his statement. "Only 2 per cent of financial assets in China was recorded in securities firms. About 4 per cent is owned by insurance companies. In 2004, the capital market industry as a whole lost 50 billion yuan in value and brokerage revenues dropped by 45 per cent. China's capital market is very small in size today."

The role of banks

Peter Schmidt, General Manager of Dresdner Bank AG Beijing Branch, testified to China's dependence on banks.

"Around 70 per cent of the finance of Chinese corporations involves Chinese banks. We need independence of Chinese corporations in banking."

Besides achieving a better balance with a less-bank-dependent structure, Norman Warner, President of Warner Financial Corporation in Canada, suggested channeling good-performance assets more efficiently.

"One area I see that needs improvement is the disposal of non-performing assets," Warner proposed.

"Instead of having a brand auction where they're auctioned in large blocks, it might be better to deal with the individual companies more carefully. Quite often, there is maybe only a small percentage of (the large blocks) that are of interest to the buyer, and the others are not dealt with as they could be."

Warner claimed the end product would be better for the market if more specialists were involved with disposal of the units. He said bringing in new management could be one step and he hoped to see many more products available for investors in 5 years' time.

Non-tradable shares

Watts commended the Chinese Government's efforts to eliminate non-tradable shares. "I think the CSRC themselves backed by the government have reformed about 200 companies by eliminating non-tradable shares and they expect to have completed a further 100 companies by mid-2006, which will then represent 80 per cent of the market capitalization. Dealing with that is absolutely critical because the capital market will not develop otherwise."

He also thought China's vision should include making non-tradable shares tradable under the Asia market's capital trade.

Institutional investors

Furthermore, to ensure what he called a "vibrant condition in the industry" and "market functionality," Watts stressed the importance of enlarging the base of institutional investors.

"What China needs almost more than anything are domestic institutional investors." Watts reiterated this many times. "The market is full of individual investors... who have brought in a lot of money over the last 4 or 5 years. But individual investors need a lot of advice when investing in equities. Institutions, on the other hand, can pool funds to create diversified risk and devote time and effort to research. Institutions are much more focused on long-term return despite short-term performance measurement."

He furthered his argument by citing South Korea as an example. "South Korea is quite an advanced industrial economy and has many global corporations. In my view, South Korean companies sell at a marked discount to their true value because South Korea has not developed an institutional investor base, so the true value of those companies is not adequately reflected in the market. At the next stage, a QDII proposal will help to develop an institutional market in China."

Another way to increase capital flow in the long-run would be to develop the State's pension funds, an area where most Asian countries need improvement.

Pension fund

"The total pension fund in China is only 100 billion yuan (US$12 billion), not much for a big country like China. Corporate-funded pension schemes are a long-term value investment. It's a natural source of institutional investment of capital," Watts explained.

He also pointed out that structural issues over the equity market in China have led to a divergence between the onshore and offshore markets, which cannot be used as a sustainable model.

"We need to work towards a system in which they can raise money at home and abroad at similar prices," Watts argued.

He added optimistically: "I think there is an opportunity now for the correlation between Chinese and offshore markets to be much closer, and to develop both markets."

Investors confidence

In addition to domestic reforms on institutional and capital market structure, Peter Schmidt of Dresdner Bank urged the Chinese Government to take measures to boost investors' confidence.

"We must step up the information system where people who want to buy bonds are sure that the information is reliable, because we cannot evaluate whether these figures are reliable or not," Schmidt remarked. "The first step would be to establish some kind of bond market where Chinese companies have to be pushed to offer the right management."

Barry Livett, Project Co-ordinator Director of the Security Industry in the EU-China Financial Services Cooperation, agreed.

"The good quality of the companies listed can promote pricing and dessiminate growth both domestically and overseas," Livett added.

But perhaps the most debated topic was the role and participation of foreign firms in the China market.

QFII

Speaking not only for Merrill Lynch, which is still waiting to set up its securities joint-venture in China, but also for other foreign financial firms in China's capital market, Watts confessed that they are doing what they can but they would "prefer to have more rather than less."

"Most foreign firms are very pragmatic. We recognize that the Chinese authorities have all the control and we're doing what we can do." Watts continued, "I do not think the banks in this world would like to have minority stakes - they're doing it because they don't have a choice. It's in the instinct of every senior manager to have 100 per cent control and ownership because it's about our profitability and accountability."

Wang Jiansheng, Principal Investment Officer of IFC, who has worked with the management of many Chinese banks and financial institutions across China, held a more moderate view, what he called "a convergence of the views in Chinese thinking and foreign thinking".

"I think the Chinese Government recognizes that Chinese financial institutions need to improve in management, and also foreign expertise. Today we will see more and more foreign banks willing to take minority stakes in Chinese banks and participate actively in management because of the opportunities, and we see steady improvement in management, in corporate governance and in foreign co-operation."

"But I think they (the Chinese Government) will need a while to see how foreign firms should co-operate in this environment," said Wang. Standard Chartered Bank's Chief Representative, Lyn Kok, also agreed the government was taking steps to open up the domestic market little by little.

Pace of market opening

"First, we've got to open up the domestic market before we invite foreign players to come into it. Obviously, the question is in the timing, how fast you open up to the international market in terms of allowing other people who want to buy fixed income bonds to play more fully in the market, and allow a much more transparent interplay," said Kok.

But in spite of the efforts of China's regulatory bodies, almost all the delegates acknowledged that accessibility to foreign participation remains a complicated and sensitive issue due to the wider political issues involved and the fact that China's financial industry and market are still underdeveloped.

"China has done in 15 years what took most Western markets a century to achieve, and I think the CSRC has taken commendable steps to restructure the capital market in China," said Livett.

"There are a lot of issues with the fixed income market and the equity market in China today, given the little time it has had to get where it is," said Watts.

"The regulators' focus on different issues is absolutely right, the reforms they focused on are absolutely right.""But the CSRC and the CBRC cannot create the industry by themselves," Watts continued.

"They can put the framework in place, namely good securities values, good institutional values, good banks, good bank management and good investors. But to develop it is about a lot of things: time, education, technology, increased transparency, more accountancy - a lot of things which have to be developed and work together."

While the roundtable delegates agreed there are still many areas that need to be strengthened, they also believed that effective reforms and market maturity was only a matter of time.

"China is very valued internationally. I would expect China equities to be seen as more favourable assets because of the growth prospects in China relative to the rest of the world," Watts said.

 
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