industry faces challenge
is no denying that China has achieved a considerable feat in establishing
the basic infrastructure of a securities industry within the space
of 15 years. However, there are numerous structural impediments
that persist in China's securities markets which prevent them
achieving the objective of allocating capital efficiently and
functioning as a proper market mechanism. Many of the problems
stem from the situation inherited when the theoretical foundations
of the market were laid, and others relate to the restrictions
resulting from the current environment in China.
of developing a market where the most deserving efficient companies
were awarded with funding opportunities, a quasi-market structure
evolved to carry on financing those companies with the most urgent
socio-economic problems aligned with the strongest government
connections. Faced with minimal or no deposit interest from bank
savings, China's savers were galvanised to channel their savings
into pre-dominantly lacklustre investments, spurred on by artificial
first-day trading closing prices and the misconception that the
investments were essentially risk-free, because the markets were
promulgated by the authorities.
the directing of funds to large State-owned enterprises did not
adversely affect the fledgling securities markets. That is not
the case now. A trend of diminishing dividend yields, poor investment
opportunities, dire corporate performance, management malfeasance
and the recurrent abuse of minority shareholders has led to the
gradual stagnation of China's markets and a significant loss of
confidence amongst the investing public. The state of creeping
crisis in China's markets was adequately reflected earlier this
year when China's stock market indices measuring company share
price performance paradoxically hit four year lows whilst the
economy continued to power ahead.
condition of China's domestic markets has become so severe that
local companies are now resorting to outsourcing their fundraising
requirements to China's offshore market in Hong Kong and to other
international exchanges. The domestic markets currently remain
closed to new initial public offerings and secondary market fund-raising
whilst the problems associated with the state remaining a major
shareholder of untraded stocks are addressed. This in turn has
exacerbated the woeful situation in the securities industry whereby
most domestic intermediaries already financially undermined by
ill-conceived guaranteed investment return schemes, poor proprietary
trading and limited broking commission-oriented revenue models
have lost a key source of income.
problems which need addressing if the fate of China's securities
industry is to be improved generally fall into the categories
below. Fortunately, the local regulator with responsibility for
the securities markets, the China Securities Regulatory Commission
(CSRC), has already undertaken a comprehensive programme of reform
to address many of these ailments but many enhancements still
need to be introduced.
many retail investors recently have lost money through investing
in China's stock markets, strong efforts need to be made to reassure
potential investors that fundamental structural improvements have
only have investors had to worry about selecting the right investments
from the limited portfolio available in China's markets, but there
are also concerns over the ability to have the trades executed
properly. The fear of having funds tied up in accounts with a
broker that collapses or where the funds are purloined by unscrupulous
staff is a strong deterrent to placing trades in China's markets.
undertaken through the EUFSCP has enabled the CSRC to strengthen
its intermediary monitoring and supervisory capabilities. In the
past year the CSRC has undertaken a high profile ruthless programme
of closing down some of the 132 securities firms that have misappropriated
client funds or failed to demonstrate that they have sufficiently
robust systems in place to be able to manage their securities
business effectively. It has also enforced the segregation of
client and proprietary funds within the remaining firms, in order
to safeguard the interests of investors.
failings in the market can partially be attributed to an insufficiently
broad skills base within the securities firms and a lack of technical
competence. Also, there was a failure of the intermediaries to
manage the expectations of the investors sufficiently and a lack
of sophistication amongst the investing public or appreciation
of the risks associated with investing in the equity markets.
frequent complaint by both retail and institutional investors
is the absence of a sufficiently broad enough range of quality
investments for consideration. This problem is compounded by the
fact that companies which no longer qualify for listing are not
de-listed from the exchanges and there is no facility for bankrupt
companies to be liquidated, leading to the perception that China's
markets comprise largely of companies that would not qualify for
investment in more developed markets.
is reported that Chinese savers retain up to 40% of their earnings,
but little of this is currently targeted at the stock markets.
CSRC and other regulatory authorities have recently introduced
a joint initiative to support moves by listed companies to convert
illiquid, untraded legal person and state-owned shares into fully
tradable shares. The proposals tabled so far are for the newly
converted shares to remain subject to a 'lock in' period, thus
removing a key concern of investors that their holdings risked
being diluted without compensation.
the market mechanism available to investors does not provide a
derivatives market to enable trading risks arising from share
positions to be hedged or for trading strategies to be executed
international investors can gain an amount of exposure to China's
growth potential by investing in Chinese stocks or China-related
businesses listed on the Stock Exchange of Hong Kong and other
international exchanges, the range of investments is not as great
as that available through the domestic 'A' share markets. Accordingly,
it is to the benefit of international investors to have access
to China's domestic markets and to the benefit of China to have
alternative sources of investment to replace the withdrawn local
funds. This has been achieved by the CSRC implementing a system
through which selected international firms are able to invest
a controlled amount of local currency into the domestic markets;
the system is the Qualified Foreign Institutional Investment (QFII).
CSRC has made commendable progress in addressing many of the earlier
problems that have plagued the markets here, but there are still
some much needed reforms that have to take place if the exchanges
here are not to be rendered obsolete.
reforms which should still be undertaken include:
of the regulatory environment with other regulatory commissions
to ensure regulatory arbitrage is avoided and that comprehensive
supervisory coverage is maintained, especially across multi-disciplinary
financial services (e.g. asset management spanning the securities
and insurance industries; derivatives; securitised assets).
the investor education programmes which have been implemented
previously to raise the awareness and understanding of the investing
public about how stock markets work and to enable them to start
to assess for themselves the potential risks associated with different
investment instruments. Part of the aim should be to change the
current pervasive 'casino mentality' many retail investors have
to one of responsible planned strategic investment.
of international involvement in China's capital and securities
markets by providing clearer guidance of the parameters within
which new entrants operate and the approval processes and timetable.
If China is serious about increasing international participation,
it could include the official publication of all securities markets
regulations in English (albeit with the Chinese versions remaining
precedent) rather than relying upon the ad hoc provision of unofficial
versions of rules by locally-based law firms.
a greater degree of involvement of foreign firms in China's securities
industry so that a greater infusion of needed capital and technical
expertise can take place. Given the extent to which there is reputational
risk associated with international securities firms engaging in
merely minority stake purchases of domestic firms, the authorities
should consider the framework under which majority control is
attainable. Although the scope for international equity stakes
to progress beyond the 33% limit was not addressed by the World
Trade Organisation accession agreement that comes fully into force
at the end of 2006, it is in China's interest to accelerate a
relaxation of the shareholding restriction and thus benefit from
a rapid strengthening of its securities industry.
CSRC and SAFE should work together to increase the limits of foreign
investment through the QFII scheme, and to relax the qualifying
threshold criteria to enable more reputable firms to participate.
CSRC should strengthen its Listing Committee further to enable
it to consider a greater volume of listing candidates. This would
enable the consideration of a greater number of private entrepreneurial
for listing, and help to dilute the current base of often undesirable
CSRC should explore encouraging the international holding companies
with extensive China operations to list on the domestic 'A' share
markets. This would enable the local operations of multinationals
to raise RMB funds for local application, and the listed shares
could provide currency for rewarding domestic customers and staff
members. The added benefit is that having such companies listed
locally would help develop China's own stock markets whilst providing
role model companies that would inculcate good standards of corporate
disclosure and corporate governance. The relatively lower fund
raising costs would demonstrate the advantages to the cost of
capital of having balanced debt/equity capital structures and
equitable treatment of shareholders.
PRC government should capitalise upon the recent RMB denominated
bonds, so-called 'Panda bonds', issued by various international
donor organisations to explore making a number of its own issues.
The borrowing from the international markets could fund the development
of its pensions and social security industry. If the issuance
programme was structured carefully to incorporate a broad range
of maturities it would be possible to create a government yield
curve from which corporate debt issues could then be priced. This
would then allow a corporate debt market to be created to compliment
the revamped equity markets.