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August, 2001 Emerging and Transforming Securities Industry in China --- Markets, Institutions and Legal System |
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Business Intelligence - China
No.7
Executive Summary
| 1. | Major accomplishments over past decade | ||||||
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China's securities markets have grown into an Asian giant in a mere decade. | ||||||
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A securities service sector with a decent scale and breadth has been established. | ||||||
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A legal framework governing securities industry has taken shape. | ||||||
| 2. a) |
Features of China's securities industry Securities markets |
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China's stock market is currently the second largest in Asia following Japan, with 1137 listed companies, 64 million investment accounts, and RMB5400 bn worth of market capitalization as of end-June 2001. | ||||||
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The stock market exhibits a number of distinctive features: co-existence of A and B as well as H shares, large price differentials among these shares issued by similar or even same companies, split equity of listed companies among state shares, legal persons shares and public shares, and overwhelming dominance of retail investors, etc. | ||||||
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China's bond market is also one of the largest in Asia, while it is overwhelmingly dominated by government bonds. | ||||||
| b) | Securities service sector | ||||||
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China's securities service sector consists of 101 securities houses, 2 stock exchanges with 2 securities clearing & settlement companies in Shanghai and Shenzhen respectively, 10 fund managers with 37 investment funds, and a number of other securities intermediary firms including 110 accounting firms, 320 law firms, 130 asset appraisal companies, 2 securities rating companies and 100 securities consulting firms. | ||||||
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The CSRC (China Securities Regulatory Commission) is the regulator of the industry, which is a ministry-level agency directly under the State Council of China. | ||||||
| c) | Legal system | ||||||
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China's legal system governing securities industry is of a 3-tier structure: laws passed by the country's NPC (National People's Congress), regulations promulgated by the State Council, and rules issued by various government departments. | ||||||
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The two laws at the first tier --- the Securities Law and the Company Law, are at the center, the 20 regulations at the second tier serve as the supplement, and the 150 department rules at the third constitute the main text, of the legal system. | ||||||
| 3. a) | The industry is still immature with market defects, institutional flaws and legal weaknesses Market defects |
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The stock market is immature, with rampant market irregularities, price bubble with high PE ratios of listed companies, poor disclosure of information, over-speculative activities, strong policy influences, scarcity of products, and so on. | ||||||
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The price bubble with high PE ratios, and the market irregularities including "bankers"' manipulation of stock market, illegal investment funds and inside trading, are the two most serious defects, which pose potential risks to the stock market. | ||||||
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Meanwhile the corporate bond market is too small and underdeveloped. | ||||||
| b) | Institutional flaws | ||||||
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Securities houses still bear a print of "SOEs" while many of them are involved in market irregularities; investment funds and fund managers are underdeveloped; other securities intermediaries are far from international standards; investors are immature; and listed companies suffer from inherent SOE problems with poor corporate governance. | ||||||
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The poor corporate governance for listed companies as well as for securities companies is the most critical, which is actually a common problem for all Chinese SOEs. | ||||||
| c) | Legal weaknesses | ||||||
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Overall legal framework is still weak, with the Securities Law being just two years old and many supplement regulations and rules remaining absent. | ||||||
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The "financial business segregation principle", the market segmentation of the stock market, and the equity splitting of listed companies, are three major legal obstacles to further development of China's securities business. | ||||||
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Meanwhile, supervision is weak, in terms of comprehensiveness, enforcement and effectiveness. The most important is probably the enforcement, which is in turn attributed to the existence of many legal gray areas or loopholes. | ||||||
| 4. a) |
A more exciting period over next decade A new phase of stock market reform with WTO opening-up |
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China has committed on JV securities houses and fund managers in the WTO deal. More than this, a key step will be the opening of A-shares for foreign investors, with a variant of QFII system at the initial stage. | ||||||
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The opening-up will have both negative and positive impacts. Negative impact would be short-term pains for securities houses and increased volatility for stock market, while positive impact would be long-term benefit on the modernization of China's stock market. | ||||||
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The CSRC is therefore set to pay a balancing act, to press ahead with stock market reform on the one hand, and to control the pace of the reform on the other. | ||||||
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A restructuring of China's stock market is expected over next 5 years, with an unification of the two A-share markets, a merger of the A shares and B shares, an establishment of a second board market, a rapid growth of open-ended funds, and a wave of M & As of listed companies, etc. Meanwhile in the securities service sector, a upgrading of securities houses, an emergence of more fund mangers, an expansion of securities intermediary institutions, and a more rapid and diversified business development with a relaxation of the "segregation principle" for the sector as a whole, are to be observed. | ||||||
| b) | A new development stage of securities markets | ||||||
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Latest correction in China's stock market is a joint result of government's reform efforts and cyclical adjustments. The correction is actually intended by the government. While the correction is near the end, the stock market is likely to continue to adjust in the months ahead. | ||||||
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But a collapse of China's stock market is not anticipated, and on the contrary there should be still large room for the market to grow, given expected continuing robust economic growth, sustainable high domestic liquidity, and accelerating capital inflows as well as the government's capability to control the market. | ||||||
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China's stock market is therefore expected to nearly quadruple over the next 10 years, in terms of market capitalization, with the number of listed companies to double and stock market prices to nearly triple. | ||||||
| Contents | |||||||
| 1. 1.1 1.2 |
Historical Overview --- Major Achievements over past decade Market Development --- China's securities markets have grown into an Asian giant in a mere decade Institutional Establishments --- A securities service sector with a decent scale and breadth has been established |
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| 1.3 2. 2.1 1) 2) 3) 4) 5) 6) 7) 2.2 1) 2) 3) 4) 5) 6) 7) 2.3 1) 2) 3) 4) 5) 6) 7) 8) 3) |
Legal system construction --- A legal framework governing securities industry has taken shape Profile of China's securities industry Profile of securities markets Market size Share structure Share price differentials Listed companies Securities investment funds Investors Bond market Profile of securities service sector Securities companies Fund managers and custody banks Stock exchanges Securities clearing companies The Securities Association of China The regulator --- CSRC Other institutions Legal system Overall framework The Securities Law The Company Law On the issuing of securities On the trading of securities Major trading rules On securities settlement & clearing Legal framework for B-shares The industry is still immature with market defects, institutional flaws and legal weaknesses |
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| 3.1 1) 2) 3) 4) 5) 6) 7) 8) 3.2 1) 2) 3) 4) 5) 3.3 1) 2) 3) 4) 5) 6) 7) |
Market defects Market irregularities Weak profit performance of listed companies Poor disclosure of information Over-speculative market Policy influences Price bubble Scarcity of products Weak corporate bond market Institutional flaws Securities companies --- Still bear a print of SOEs while many involved in market irregularities Investment funds and fund mangers --- Underdeveloped Investors --- Majority being immature Other intermediary institutions --- Far from international standards Listed companies --- Suffer from inherent SOE problems with corporate governance far from addressed Legal weaknesses Overall legal framework still weak Segregation of financial businesses Market segmentation Equity splitting of listed companies Discriminatory securities issuing system Weak supervision Other legal weaknesses or gray areas |
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| 4. | A more exciting period over next decade --- A new phase of stock market reform and new development stage of securities markets in China | ||||||
| 4.1 1) 2) 3) 4) 5) 6) 7) 4.2 1) 2) 3) 4) 5) |
A new phase of stock market reform with WTO opening-up Significance of stock market reform in China's future reform program Stock market reform has already picked up steam since July 1999 Expected market opening-up with WTO entry Competitiveness of Chinese securities houses The impact of WTO entry on China's securities industry A balancing act for the CSRC Expected domestic market reforms A new development stage of securities markets Latest correction in China's stock market is a joint result of government's reform efforts and cyclical adjustments While the correction is near the end, stock market is expected to experience continued adjustments in the months ahead But a collapse of China's stock market is not anticipated Longer term, there is still large room for China's securities markets to grow Stock market in China is expected to nearly quadruple over next decade, in terms of market capitalization |
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| 1. 1.1 |
Historical overview --- Major achievements over past decade Market development --- China's securities markets have grown into an Asian giant in a mere decade |
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China's modern securities markets sprouted in early 1980s, with the resumption of the issuing of government bonds in 1981 and the issuing of shares by a collective enterprise in 1982. | ||||||
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While more bonds and shares (local investors-restricted and RMB-denominated, A-shares hereafter) were issued subsequently, it was only in early 1990s that two stock exchanges --- the Shanghai Stock Exchange and the Shenzhen Stock Exchange were launched, marking the formation of the country's modern stock market. | ||||||
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This was followed by the launches of B-shares (overseas investors-restricted and FX-denominated) and H-shares (Hong Kong-listed and HKD-denominated). | ||||||
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A rapid expansion of China's stock market then followed, with the number of listed companies, number of investment accounts, and market capitalization rising to 1137, 64 million, and RMB5400 bn at end-June 2001 respectively.
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As a result, China's stock market has become Asia-Pacific's second largest stock market, second only to Japan, in a mere decade, while dwarfing all other emerging markets in the world.
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The price indices for A-shares have more than quadrupled on both stock exchanges since their launches in early 1990s, albeit with fluctuations. B-share prices however experienced a long period of slump until Feb 2001 when the B-shares were opened to local residents. H-shares performed ever poorer, with a sharper rise and fall before and after the Asian financial crisis. | ||||||
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China's bond market has also developed into one of the largest in Asia, albeit not as fast as stock market.
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The growth of the stock market has even accelerated in past two years, in terms of both stock offering and turnover. | ||||||
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Meanwhile stock price performance shows a 2-year long bull market. But the bull market seems to have ended, with a large correction in stock market prices in past 6 weeks. | ||||||
| 1.2 | Institutional establishments --- A securities service sector with a decent scale and breadth has been established | ||||||
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With the first one emerging in 1987, securities houses were established one after another in late 1980s and early 1990s, hitting 91 at end-1993. The number has since stabilized, due to government control of licenses as well as periodic mergers of some houses. At the same time the size of many houses has grown rapidly, in terms of business volume as well as assets.
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Most Itics (investment and trust companies) are also engaged in brokerage business, being the second player of the broker world. Their numbers peaked in mid-1990s and have fallen since then. | ||||||
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The Shanghai Stock Exchange (SSE) and Shenzhen Stock Exchange ( SZSE) were launched in 1990 and 1991 respectively, under which the Shanghai Securities Registration and Clearing Company (SSRCC) and Shenzhen Securities Clearing Company (SSCC) were established subsequently. | ||||||
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As late as last March, China Securities Depositary and Clearing Company (CSDCC) was launched as the country's central securities clearing company. The existing SSRCC and SSCC are expected soon to become two subsidiaries of this newly established company. | ||||||
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A number of other intermediary companies for securities business have also emerged, including accounting firms, law firms, asset appraisal companies, securities rating agencies and securities investment consulting firms.
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Securities investment funds were first released in 1998, when 6 funds were launched. 27 more such funds have been established since then. Meanwhile 10 asset management companies managing these funds have been set up. | ||||||
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As the regulator of the securities industry, the State Council Securities Committee (SCSC) and China Securities Regulatory Commission (CSRC) were established in 1993, and they were consolidated into one in 1998, keeping the name of CSRC. | ||||||
| 1.3 |
Legal system construction --- A legal framework governing securities industry has taken shape Construction of a legal system for securities industry in China began in early 1990s. The Company Law, the People's Bank of China Law, the Ordinance for the Issuing and Trading of Shares, and the Ordinance for the Management of Corporate Bonds, were enacted on 29 Dec.1993, 18 March 1995, 22 April 1993 and 2 August 1993, to regulate the behavior of companies including the share-issuing and listed companies, the behavior of securities services institutions, the stock issuing and trading activities, and the bond issuing and trading activities, respectively. |
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Over 20 administrative regulations, and about 150 rules, have since been promulgated, to supplement these laws and ordinances. | ||||||
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Against this background, the Securities Law of People's Republic of China, was passed in late 1998 and took effect on 1 July 1999, which together with the Company Law constitutes the core of the legal framework governing China's securities industry. | ||||||
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More regulations and rules have been promulgated to supplement the Securities Law, while a number of old regulations and rules that are in conflict with the Law have been abolished or modified, in recent two years. | ||||||
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As a result, a 3-tier legal framework for China's securities industry has taken shape, comprising laws passed by the country's NPC (National People's Congress), regulations promulgated by the State Council, and rules issued by various government departments.
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| 2. 2.1 1) |
Profile of China's securities industry Profile of securities markets Market size Capitalization of China's stock market totaled RMB5400 bn at end-June 2001, which is equivalent to about 60% of the country's GDP, making the market the second largest stock market in Asia Pacific following Japan (see Exhibit 3). |
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Meanwhile bonds outstanding valued at RMB 1950 bn at end-2000, which renders China's bond market also one of the largest in Asia (see Exhibit 6). | ||||||
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Trading volume of the stock market is also among the largest in Asia, with annual turnover recording RMB6083 bn in 2000. | ||||||
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The stock market and bond market raised RMB155 bn and RMB452 bn for Chinese companies and the Chinese government in 2000, respectively. | ||||||
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Cumulatively, the stock market and the bond market have raised more than RMB600 bn and RMB1900 bn for Chinese companies and the government respectively.
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| 2) |
Share structure The share structure with the co-existence of A, B and H shares represents one of the distinctive features of China's stock market from the stock markets in other countries. |
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A-shares dominate the market, in terms of either number of shares issued, capital raised and market capitalization. B-shares are the smallest among the three, indicating that the government's aim to attract foreign investment through B shares has not been very successful. | ||||||
| 3) | Share price differentials | ||||||
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A related feature is large differentials in prices among these shares issued by the listed companies with similar or even same business and operating performance.
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This is also illustrated by the average PE ratios being currently around 50, 25 and 10 for A-share, B-shares and H-shares, respectively. | ||||||
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Over 90 companies have issued both A-shares and B-shares, and over 20 issued both A-shares and H-shares. Even for these listed companies, A-share prices and B-share prices (or A-share prices and H-share prices) are largely divergent. A-share prices were higher than B-share prices by over 300% before the B-share opening last February, and still by 100% for the time being, for these companies. The gap between A-share prices and H-share prices is even larger. | ||||||
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Such a phenomenon is apparently attributed to different investors and currencies involved in these shares. This is in turn due to different perceptions of China's companies between local investors and overseas investors, as well as to limited investment options for local investors. | ||||||
| 4) |
Listed companies
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By type of shares, A-share companies are apparently dominating; the companies issuing A shares only account for over 80%, while the sum of the companies issuing A shares only, issuing both A and B shares, and issuing both A and B shares accounting for near 95%, of total listed companies. |
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By equity structure, 37% and 27% of the shares of the listed companies are held by the state and legal persons (enterprises and institutions) respectively, which are non-tradable or only traded very thinly, while tradable public shares being only 35%. This represents another distinctive feature of China's stock market. | ||||||
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By industry, majority of listed companies are manufacturing firms, while wholesale and retailing sector accounting for 10%, and transportation, real estate, power & gas & water, and social services for near 5% each, of the total.
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By region, listed companies are concentrated in eastern coastal areas, with the 10 eastern provinces and municipalities accounting for 65% of the total. | ||||||
| 5) |
Securities investment funds
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| 6) |
Investors Securities investment accounts have exceeded 60 million. But with many ones holding several accounts, the number of investors is estimated at 20 million. |
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Individual retail investors are overwhelmingly dominating, holding over 99.5% of the accounts, with less than 0.5% for institutional investors, by statistics. | ||||||
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This ratio is somewhat misleading, however, because many institutional investors hold a number of accounts in the names of individuals. | ||||||
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Meanwhile the market share for institutional investors is obviously much higher their account share.
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| 7. |
Bond market China's bond market is dominated by government bonds, which account for over 95% of total bond issuance. Corporate bonds only have a less than 5% market share. |
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| 2.2 1) |
Profile of securities service institutions
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According to the financial business segregation principle stipulated in the Securities Law and Commercial Bank Law, Itics, for which securities dealing has been part of business for a long time, should stop the business. But this would take some more time to materialize. | ||||||
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The only JV investment bank in China --- China International Investment Corporation, is granted the right to engage in securities underwriting, but not trading. | ||||||
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For bond dealing, a number of banks, securities houses and other non-financial institutions have been specified as the government bond first-tier dealers, while finance companies of selected enterprise groups are granted the right to underwrite corporate bonds. | ||||||
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The securities houses are dominating in both securities underwriting and trading activities, with a 65% market share, while the share for the Itics being about 35%. | ||||||
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Most securities houses are shareholding companies or limited corporations, with other institutions, mainly state-owned, as shareholders. This is also the case for the Itics, while the government has a larger stake in the latter. | ||||||
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The 101 securities houses are divided into 2 categories in terms of business coverage ---- comprehensive securities companies which can conduct brokerage business, securities business on its own account, securities underwriting business and other securities business verified by the CSRC, and the brokerage houses which can only be engaged in brokerage business. | ||||||
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They can also be divided into 3 classes by size. The first class refers to the large sized and nationwide houses, such as Shenyin-wanguo, Guotai-junan, Yinhe, Huaxia, and Nangfang, etc.; the second class is those medium sized which are controlled by a large financial conglomerate or an enterprise group, including Zhongxin, Guangda, Zhaoshang and Haitong, etc; and the third includes those small sized and local houses that have close links with local governments and enterprises. | ||||||
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The revenue structure of the securities houses is heavily reliant on trading commission fees and return from trading activities, while the latter refers to the return derived from the securities investment on their own accounts.
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Securities houses have been profitable in China. The securities houses recorded RMB29.2 bn in operating income and RMB7.8 bn in profits, in 1999, while operating income of the whole securities companies is estimated at RMB40 bn. | ||||||
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Top 10 securities houses account for around 70% of primary market and 1/3 of secondary market, in terms of underwriting volume and trading volume respectively. They also account for about 50% of assets and operating income, and 60% of profits, of the securities houses. | ||||||
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Their profit performance is better than other houses, as illustrated by ROE and ROA.
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| 2) |
Fund managers and custody banks
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Custody banks for the funds are Big Five banks in the country. Somewhat surprisingly, the weakest ABC (Agricultural Bank of China) takes care of 7 funds, the most among the five. | ||||||
| 3) |
Stock exchanges
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The SSE and SZSE account for 54% and 46% of listed companies, 56% and 44% of market capitalization, 53% and 47% of the number of listed shares, and 57% and 43% of total capital issued in the country, respectively.
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The two exchanges adopt a modern organization structure with a membership system. The members are qualified securities houses and other financial institutions that are allowed to conduct securities dealing business. The SSE and SZSE have 306 members and 326 members as of end-2000 respectively. | ||||||
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But the membership is more nominal than real at this stage. The members neither funded the exchanges nor elected their senior management. The two exchanges were funded by the PBOC, while currently their operations are directly under CSRC's supervision with presidents and vice-presidents being appointed by the CSRC. They are actually semi-government organizations. | ||||||
| 4) |
Securities Clearing Companies
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These two companies are currently subsidiaries of the SSE and SZSE respectively.
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While it is funded by the two stock exchanges, the business of the CSDCC is directly under the supervision of the CSRC. | ||||||
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It is worth noting that the technological level for securities trading, clearing, settlement and registration in China is one of the highest in the world, being relatively newly established. | ||||||
| 5) |
The Securities Association of China
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All the securities companies in the country are required to join this association, according to the Securities Law. | ||||||
| 6) |
The regulator --- CSRC
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Its basic functions and responsibilities are to formulate, according to law, regulations and rules governing the industry, and exercise supervision over the implementation of these laws, regulations and rules. | ||||||
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The CSRC has one Chairman, four vice-chairmen, one Secretary General, and two deputy Secretaries General. Currently Chairman is Mr. Zhou Xiaochuan. One of its Vice-chairmen (women), Ms. Laura Cha, is the former Vice chairwoman of the HK Securities and Futures Commission, who has just been appointed to this position by the central government in an effort to bring in modern securities system to China. | ||||||
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It has 13 functional departments, 4 subordinate bodies, and 9 regional offices in key cities, 2 subordinate supervisory branches and 25 local regulatory offices.
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| 7) |
Other institutions There are also about 110 accounting firms, 320 law firms, 130 asset appraisal companies, 2 securities rating companies, and 100 securities consulting firms that are providing different aspects of securities services to listed companies, securities houses, investors, fund managers, and so on. |
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| 2.3 1) |
Legal system Overall framework In the 3-tier legal framework for China's securities industry, the two laws at the first tier --- the Securities Law and the Company Law, are at the center, the 20 administrative regulations serve as the supplement, and the 150 departmental rules constitute the main text. |
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| 2) |
The Securities Law The Securities Law is the cardinal law governing the country's securities industry, providing guidance in the form of law to standardize the issuing and trading of securities, regulate the business behavior of securities dealing companies and protect lawful rights and interests of investors. |
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The law is comprised of 12 chapters, major ones addressing the issuing of securities, trading of securities, stock exchanges, takeover of listed companies, securities registration and clearing companies, and securities regulatory authority in Chapter 2, 3, 4, 5, 6, and 10 respectively.
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| 3) |
The Company Law The Company Law is enacted in order to regulate the business behavior of the companies in China in general. Thus it provides a legal guidance for general behavior of listed companies. |
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Furthermore the law has a special chapter --- Chapter 4, on stock issuance of shareholding companies. This chapter regulates the stock issuing and listing activities of the companies, particularly it provides the conditions on issuing and listing stocks for the companies. | ||||||
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Meanwhile, Chapter 7 and Chapter 8 of the law address the mergers and splitting, and bankruptcy and liquidation of the companies respectively, which are also related to securities business. | ||||||
| 4) |
Regulations and rules as well as related laws The 20 regulations and 150 rules supplement and substantiate the Securities Law, from different perspectives of regulating listed companies, regulating securities institutions, and regulating securities issuing and trading activities, respectively. |
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Among them, the regulations on securities issuing and trading activities are probably the most important, which have been under review in recent years as the stock market reform picks up steam.
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| 5) |
On the issuing of securities --- From examination & approval to verification Prior to the Securities Law taking effect on 1 July 1999, public offering of shares was subject to an "examination & approval" system, under which the offering was subject to CSRC's approval while the approval subject to offering quota and limit to the number of issuers with offering prices being capped by P/E ratios. |
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Two shortcomings of this old system are apparent, that is giving various government agencies a key role in the approval and hence selection process, and favoring SOEs. | ||||||
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This system has been replaced by a "verification" system, according to the Securities Law. Under the new system, stock offering is free from the quota and limit as well as price cap. The application for it by a company will be reviewed and referred by a securities company, examined by the Public Offering and Listing Review Committee, priced based on market demand, and verified by CSRC. | ||||||
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The Public Offering and Listing Review Committee is composed of professionals from the CSRC and experts from outside the CSRC. It has been restructured with its members extended from 34 to 80, 73% of which are now non-CSRC members. | ||||||
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The committee will examine the applications for share issuance according to law, and in theory any application that satisfies the statutory conditions prescribed in the Company Law and other conditions stipulated by the State Council should pass the examination. | ||||||
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The CSRC will verify the applications based on the results of the examination. | ||||||
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Technically, stock offering only via exchange trading network has also been changed to a new way of offering via exchange trading network in combination with other means of placement in secondary market, to balance the supply-demand situation in primary and secondary market. | ||||||
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The statutory conditions for issuing shares are set in Chapter 4 of the Company Law.
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| 6) a) |
On the trading of securities Listing of securities --- Also from examination & approval to verification The "verification" system also applies to the listing of shares, while CSRC may authorize a stock exchange to verify the applications for the listing. |
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The statutory conditions for the listing as well as de-listing are also set in Chapter 4 of the Company Law.
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| b) |
Continuous disclosure of information There are requirements for listed companies to release information annually and semi-annually as well as immediately when a major event occurs. |
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| c) |
Prohibitive trading actions
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| d) |
Major trading rules Listed stocks, bonds and other securities must be traded publicly on the stock exchanges. Trading must be conducted via bidding. Trading must be spot trading. Securities houses can not provide funding to customers. Mandating can be conducted via counters, telephones, screens or computer terminals. |
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| 7) |
On securities settlement & Clearing The recently published "Provisions for Clearing & Settlement of Customers' Securities Funds" represents a significant improvement in the management of clearing & settlement of securities funds in China, which makes the rules on the clearing & settlement much clearer. |
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It stipulates that securities companies must deposit customers' clearing & settlement funds into the clearing & settlement company or custody banks; the clearing & settlement company must deposit the standby clearing & settlement funds into clearing banks; the use of the securities accounts is exclusive; customers funds can only be transferred between the clearing & settlement accounts and the standby clearing &settlement accounts; and securities companies must submit monthly reports on customers' transaction records to the CSRC. | ||||||
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There are some differences in the settlement & clearing system between SSE and SZSE. For securities settlement & clearing,
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For fund settlement & clearing, the SSE adopts a "3-tier clearings" system, with the first-tier clearing taking place between Shanghai Depositary & Clearing Company and an outside-Shanghai clearing centre, second-tier clearing occurring between the outside-Shanghai clearing centre and an outside-Shanghai securities house, and the third-tier between the securities house and an investor. The SZSE's system is centralized, such that every securities house has a specialized account with it, with a certain amount of balance, and the account is cleared every trading day. | ||||||
| 8) |
Legal framework for B-shares Legal framework for B-shares is currently provided by the State Council Provisions for FX-denominated Shares of Shareholding Companies, rather than by the Securities Law. |
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B-shares' issuing and trading is subject to the supervision of PBOC/SAFE (State Administration of Foreign Exchanges), as it is related to FX management of the country. | ||||||
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The B-shares are also traded on both stock exchanges in Shanghai and Shenzhen. But there are some differences in the issuing, trading and clearing & settlement of the B-shares between the two exchanges, as well as between the A-shares and B-shares.
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| 3) | The industry is still immature with market defects, institutional flaws and legal weaknesses | ||||||
| 3.1 1) |
Market defects Market irregularities Irregularities are rampant in China's securities markets. The most obvious and serious is the phenomenon of "bankers" (big money holders)' manipulation of stock market prices and profiting from it. The "bankers" may be securities companies, and may also be big investors, listed companies, investment funds and fund mangers. Often these parties collude with each other to manipulate. |
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The second obvious irregularity is the large number of underground private investment funds and the large amount of money they have raised. What is more serious is that about half of the money are estimated to have illegally obtained from banks, and been used to perform the "bankers"' manipulation of stock market, colluding with securities houses, listed companies or other securities intermediary institutions. | ||||||
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Insider trading, false information and rumor spreading by those connected to securities houses and listed companies as well as other securities related institutions occur from time to time, and often disrupt the markets. | ||||||
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Insider control is also prevalent, from which large shareholders rig the control of listed companies and profit from it at the expense of small investors. | ||||||
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There were hundreds of illegal securities trading centres in the country illegally undertaking off-exchange securities trading activities for non-listed shares, until 1997 when they were shut down. | ||||||
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Illegal use of customers' deposits by securities houses used to be a serious problem, while it has been largely checked these years. | ||||||
| 2) |
Weak profit performance of listed companies
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Meanwhile about 9% of the listed companies, that is 85, were loss-making in 1999, among which there are 49 ST (Special Treatment) and 8 PT(Particular Transfer).
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| 3) |
Poor disclosure of information Despite an improvement in recent years, disclosure of information for listed companies remains poor, in terms of reliability, standardization, accuracy, coverage, timeliness of releasing, and genuineness. |
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False reporting is a serious problem for some listed companies, and the recently exposed "Ning Guan Xia" fraud is one of the examples. | ||||||
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While the principles of accounting in China are already consistent with those of international accounting standards, accounting practices are still inadequate in many respects. | ||||||
4) |
Meanwhile, only a few listed companies have engaged international accounting firms.
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5) |
The rumors' roles are largely related to inside trading and false information. Policy influences One characteristic of China's stock market is government influences on the market. The Chinese government seems to be inclined to keep the stock market prices at a level it desires, while investors appear responsive and sensitive to what the government says. |
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The government influences are exercised often in a way of publishing editorials in government-controlled newspapers or sending some government officials to make public comments to express the government's stance as well as predictions on market movements. This works in China. | ||||||
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The government's stance is always a compromise of maintaining a healthy development of the stock market in light of building a modern stock market, and preventing stock prices from a large fall in view of both protecting investors and creating better fund-raising environment for SOEs. | ||||||
| 6) |
Price bubble
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7) |
More worrying is that a high PE ratio is also shown on some loss-making companies. Scarcity of products Products of China's securities markets are mainly spot share and bond products. Many securities products and businesses such as derivatives, M & As, stock index, margins and fund sales, etc., which are a important part of securities business and a large source of revenue for international investment banks, are virtually absent in China. |
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A result of this is the overwhelming dominance of broker fees and on-own-account securities investment return in the revenue structure for Chinese securities houses, as shown earlier. | ||||||
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Meanwhile the products of shares and bonds are very limited in China as compared to those in international capital markets. | ||||||
| 8) |
Weak corporate bond market
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The weakness is attributed to the tiny corporate bond market. Corporate bonds account for only 5% of total bond issuance, and their issuance was actually shrinking in most times of the 1990s. | ||||||
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The secondary market for corporate bonds is even smaller, with listed bonds being only 2% of their issuance. | ||||||
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All the three parties involved are responsible for the weakness of corporate bonds --- the government, whose approvals are too strict for risk concerns, the corporate which see bond issues as liabilities while not being willing to pay interests, and the investors who prefer short-term investment to long-term investment. | ||||||
| 3.2 1) |
Institutional flaws Securities companies --- Still bear a print of SOEs while many involved in market irregularities All the Securities companies in China, except the Yinghe Securities Company that is still wholly state-owned, are now shareholding companies or limited corporations. But they remain state-controlled, albeit with varying degrees, in the sense that the government is still one of the major shareholders while the rest of the shareholders being other state-owned institutions. |
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While performing better than the SOEs in other industries in terms of market orientation, productivity, incentives and profitability, they still bear a print of SOEs with weak corporate governance, abuse of power, loose financial disciplines and other SOE problems. | ||||||
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As regards business performance, China's securities companies still lack justified business innovations, as reflected in the duplications of business for all the securities houses, on the one hand, and show unjustified aggressiveness resulting in market irregularities on the other. | ||||||
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They have played an important role in the "bankers"' market manipulation, and are also involved in illegally financing big investors, misusing investors' deposits, and buying and selling without funding through securities repurchase business, etc. | ||||||
| 2) |
Investment funds and fund managers --- Undeveloped Securities investment funds and fund management companies have a very short history in China, and hence are an immature while emerging sector. |
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All the investment funds are close-ended funds. Without the possibility of the redemption by investors, these funds as well as their fund managers are operating in a rather traditional mode, and are in small scale. Their revenue source is mainly additional shares issuing, while interest income, which should be a major source of revenue for securities investment funds, is very small. | ||||||
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Meanwhile it should be noted that there exist several tens of thousands of private-running securities investment funds, which raise money from customers, mainly companies, and act as agents for them to conduct securities investments using the money. Their existence is illegal in China at this stage, but the amount of money they have raised is huge, which is originally estimated at about RMB300-500 bn while a recent report by the PBOC puts the estimate at a much higher amount. | ||||||
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Needless to say, these illegal private investment funds are even far from standards, and are a major culprit for market irregularities. | ||||||
| 3) |
Investors --- Majority being immature Official institutional investors are still a tiny sector in China in terms of both number and market share. Many large-sized companies including insurance companies and insurance funds, are still institutionally not allowed to enter stock market. |
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Those underground institutional investors are obviously of lower quality, involved in illegal trading. | ||||||
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Meanwhile many of the majority investors --- individual investors are retired or step-down workers, who lack sufficient knowledge of securities markets and analytical skills for securities investment, and hence are rumor-following immature investors. | ||||||
| 4) |
Other intermediary securities institutions --- Far from international standards Being new in China, accounting firms, law firms, asset appraisal companies, securities rating companies, securities consulting firms are far from international standards. Many of them fail to perform in terms of just justice, neutrality and independence, and are also responsible for the irregularities with incorrect or even false appraisals, non-standard or even fake certificates, and reckless account checking, etc. |
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They also fail to function as they should in terms of the roles their ratings play in the securities issuing and trading. | ||||||
| 5) |
Listed companies --- Corporate governance far from addressed While also related to the country's economic cycle, overall poor profit performance of listed companies and their involvement in market irregularities are ascribed to the slow progress in corporate governance improvement. |
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For most listed companies, corporate governance issues are far from addressed, including ownership structure, shareholder right, the relationship between the Board of Directors and the Board of Supervisors, accountability, transparency, financial disciplines, risk controls, incentives, and personnel development, etc. | ||||||
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The key issue among them, is the ownership structure, which has bearing on all other issues as well as the insider control problem for many listed companies noted earlier. | ||||||
| 3.3 1) |
Legal weaknesses Overall legal framework still weak The Securities Law is just two years old, and effective implementation of it would take more time. Meanwhile many supplement regulations and rules to it are yet to be formulated. |
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More importantly, many regulatory restrictions remain and hinder further development of China's securities markets. | ||||||
| 2) |
Segregation of financial businesses The Securities Law, as well as the Commercial Bank Law and Insurance Companies Law, sets the segregation of securities business from other financial business as a principle. |
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While this principle has played an important role in containing financial risks, especially during the period of Asian financial crisis, it is increasingly becoming an obstacle to further development of China's securities business. | ||||||
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Unavailability of bank financing that securities companies suffered for a long time is responsible for their shortage of funds, and in turn scarcity of business and products, though the financing is now restrictively available. The financing is still not available for investors. | ||||||
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Meanwhile many banks are complaining about being unable to engage in securities dealing business, and many insurance companies about being denied access to stock market. | ||||||
| 3) |
Market segmentation The A-shares, B-shares and H-shares are traded on different markets with different currencies and investors, and with different pricing, leading to a segmented stock market in China. This is clearly due to the non-convertibility of the RMB on capital account. |
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Meanwhile physically, there are two stock exchanges, located in Shanghai and Shenzhen respectively, which are bound to affect optimal capital flows as well as reduce operational efficiency of the stock market. | ||||||
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In addition to the two stock exchanges, there were also STAQ (Securities Trading Automatic Quoting System) and NET (National Electronic Trading System), which provided off-exchange securities trading mainly for legal person shares, before 1997. The trading volume never became substantial. Such systems were shut down in 1997. Thus the legal persons shares have been virtually non-tradable like state shares. | ||||||
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Also a central securities clearing & settlement system is yet to be established, with two clearing & settlement systems operating separately. | ||||||
| 4) |
Ownership splitting of listed companies Ownership of listed companies is split quite equally into 3 different shares, with publicly traded shares only accounting for 35% while non-tradable state shares and legal persons shares accounting for 30% and 35%, of the ownership, respectively. |
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This is an outcome of the ideological heritage prevailing at the early development stage of China's stock market that public sector should hold absolute majority of the stake of listed companies. It is stipulated in the Company Law that legal person shares should not be below 35%, while state shares were thought should have a similar share. | ||||||
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This leads to the "same stocks, different rights" problem, which is a major culprit for the minority public investors being unlikely to exercise effective supervision of the listed companies. | ||||||
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Meanwhile the state shares of listed companies are poorly represented in the Boards of Directors, with either an absence of their representatives or the representatives being unable to exercise shareholder right properly in terms of both defending state assets and allowing for autonomy of the companies. | ||||||
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Such an inadequate ownership structure is largely accountable for the poor corporate governance of listed companies. | ||||||
| 5) |
Still discriminatory securities issuing system The old "examination & approval" system for stock offering is apparently biased in favor of large sized SOEs against non-state and small & medium sized firms, resulting in overwhelming dominance of large sized SOEs for listed companies with less than 1% non-state listed companies. |
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With the launch of the new "verification" system, such a situation should change in theory. The listing of the Yongyou Software last February is an example. However, the new system still suffers a "quantity control" problem as will be discussed shortly while effective implementation of it would take time. Thus it is difficult to see a significant change in near future. | ||||||
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Given this, before the second board is launched, the chance for non-state and small & medium sized enterprises to list in main board market is still limited. | ||||||
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Meanwhile bond issuing is still subject to the "examination & approval" system, which would continue to keep non-state and small & medium sized firms out of bond issuance for some time. | ||||||
| 6) |
Weak supervision In line with the emerging nature of the industry, supervision over the securities industry in China is weak, in terms of comprehensiveness, enforcement and effectiveness. |
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First of all, the supervisory authority had not been unified until 1998. The securities houses and the two exchanges houses had been subject to the supervision of the PBOC and Shanghai and Shenzhen governments respectively, until 1998 and 1997 when they were reallocated to the administration of the CSRC, while the CSRC/SCSC has been the regulatory and supervisory authority for the industry as a whole since early 1990s. | ||||||
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As to the supervision over shareholding/listing companies, there are two major problems. The first is general supervision over these companies as SOEs. In this regard, the roles of the state shares, and the functions and responsibilities of the Board of Supervisors, have never been clearly defined. As a result, the problems of loss of state assets, corruption and irregularities and poor performance have failed to be supervised and checked. | ||||||
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The second problem relates to the supervision over their activities in securities issuing and listing. The weakness in the supervision in this regard lies in regulatory ambiguity on the irregularities in these activities, which have never been defined clearly and specifically enough. | ||||||
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The problems for the supervision of securities companies are similar. The securities companies suffer from the general supervision problem related to state shares, given almost all the securities houses are state-controlled. As regards the supervision over the securities issuing and trading activities for securities companies, the problem is similar, that is, comprehensive and enforceable regulations which clearly define various irregularities in the securities dealing activities as well as the punishments against these irregularities are yet to be formulated. | ||||||
| 7) |
Other legal weaknesses or gray areas On the issuing of securities, the newly introduced "verification system" is in principle close to the system applied in many other countries, but in practice is still some distance away from it in some ways at this stage. First, there is still "quantity control" on the aggregate number of shares to be issued, and hence there is still room for government agencies to exercise influences. Second, though the government is not involved anymore, the pricing for the share issuance is determined by the negotiations between the underwriting securities houses and share-issuing companies, while the intermediary institutions have little say. Actually many countries have moved or are moving to an even less restrictive "registration" system. |
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On the M&A activities, two regulatory restrictions are major obstacles, that is buyer cannot raise funds from banks, and the majority stake by the state and legal persons makes the government to have a big say in the M&As. | ||||||
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On the derivative product development, the spot-trading restriction on securities trading, the limitations on the funding link between securities market and banks, the lack of margin system, and weak institutional investors, clearly make the development difficult. | ||||||
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On the institutional investors, the disallowance for many social insurance funds to participate in stock market, and lack of open-ended investment funds, are major hurdles. | ||||||
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On the opening-up of A-shares to foreign investors, the RMB non-convertibility on capital account is the major concern, and a system to facilitate the opening-up without RMB's full convertibility is yet to be designed. Before such a system is introduced, the upcoming second board market will not be able to attract foreign investors, so that foreign venture capital will remain away from China's rapidly growing high-tech sector. | ||||||
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On the de-listing system, the current ST and PT system fail to encourage performers and punish non-performers, while the de-listing system prescribed in the Securities Law is yet to be improved to be effectively implemented. | ||||||
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On the accounting, auditing, asset appraisal, investment rating and consultancy firms, regulations and rules are far from established. | ||||||
| 4. | A more exciting period over next decade --- A new phase of stock market reform and new development stage of securities markets in China | ||||||
| 4.1 1) |
A new phase of stock market reform with WTO opening-up The significance of stock market reform in China's future reform program The achievements made over the past decade have laid a foundation for building a modern stock market in China. But given the weaknesses of the market as against the importance of stock market for a modern market economy, and hence for the rapidly reforming Chinese economy, a more radical stock market reform towards a more market-oriented and internationalized stock market is called for. |
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| |
Meanwhile the reform is also spurred by other reforms being undertaken by the government. SOE reform is the most important, while unaccomplished, reform for China. Now the most fundamental and critical issue confronting the SOE reform is how to rationalize SOEs' ownership structure. Getting more of them listed in stock market is considered the best way to achieve this target at the present stage. In light of this, a larger, healthier and more functioning stock market is the prerequisite. |
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The restructuring of the SOEs is inevitably accompanied by asset restructuring as well as capital injection, in which stock market is also expected to play a key role. | ||||||
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Another pressing task for China is to reinforce the country's pension and unemployment security system, given the increasing unemployment rate and aging population in the country. A feasible and relatively handy way of fulfilling this is to sell the state shares in listed companies, and pour the proceeds from the selling into the social security system. A much more improved stock market is again in need. | ||||||
| 2) | Stock market reform has already picked up steam since the Securities Law took effect on 1 July 1999 | ||||||
| a) | Major reform initiatives in 1999 July --- PBOC and the Ministry of Finance (MOF) issued a circular to allow banks to extend loans to those with government bonds as securities, kicking off bank financing for securities companies. July --- CSRC announced new rules for stock offering and its pricing, which substantiate the newly introduced "verification" system prescribed in the Securities Law. August --- PBOC announced to allow selected securities houses and fund managers to enter inter-bank market, providing another channel for securities dealing companies to access banking funds. August --- The State Council approved the "Ordinance for CSRC's Public Offering and Listing Review Committee", stipulating the functions and working procedure of the committee with the new "verification" system. December --- CSRC published new and stricter standards for annual reports of listed companies, which also requested the annual reports to be released on the international web-sites specified by the CSRC. |
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| b) | Major reform initiatives in 2000 February --- CSRC issued the "Notice for New Public Offering to Secondary Market Investors", launching the new mode of stock offering via both exchange trading network and placements. February --- CSRC and PBOC jointly promulgated the "Provisions for Securities Companies to Borrow Bank Loans with Stocks as Securities", giving securities companies access to banking funds with stocks as pledges for working capital purposes. March --- CSRC issued the "Verification Procedure for Stock Offering", elaborating the new verification procedure. March --- CSRC announced provisionary rules for on-line securities trading, in order for the on-line trading business to develop healthily. March --- The China Insurance Regulatory Commission (CIRC) approved the applications of 4 insurance companies to invest in stock market, while with a ceiling of 10% of total assets, paving way for insurance companies to enter stock market. May --- SSE and SZSE began to implement the revised "Rules for Listing", which includes more detailed rules on the behavior of listed companies. July --- CSRC made public "Moral Standards for the Profession of Securities Analysts", to regulate the professional behavior of securities analysts. September --- SZSE issued the "Consulting Documents on the Rules for Second Board Market", starting the preparation process for the launch of the second board. October --- CSRC promulgated the "Provisions for Open-ended Securities Investment Funds on a Trial Basis", giving green light to open-ended investment funds in China. For the year as a whole --- CSRC intensified crackdown on market irregularities, shutting down 26 illegal securities trading centers and 41 trading sites involving 520 companies and 3.4 million investors. |
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| c) | Major reform initiatives in 2001 February --- CSRC and PBOC jointly announced to open B-shares to domestic residents, taking a somewhat surprising and bold move to unveil prelude to stock market reform in 2001. April --- The PT Shuixian (Shanghai Narcissus) company was de-listed, which is the first de-listed company in the country, signaling the beginning of the working of the de-listing system. May --- CSRC published the "Provisions for the Management of Customers' Trading Settlement Funds", tightening the management of securities clearing & settlement business. June --- CSRC issued two related notices for regulating trading activities of securities investment funds and the establishment of securities fund management companies respectively, making a step forward towards standardizing the country's investment fund sector. The latter gives green light to the institutions other than securities houses and Itics to launch securities investment funds. June --- CSRC announced to allow qualified SOEs to engage in future trading activities in overseas markets, to meet increasing demand for hedging purposes by companies. June --- The State Council promulgated the "Temporary Provisions for Selling State Shares for Social Security System", kicking off the sell-off of state shares. It stipulates that future IPOs and listings must include the sale of state shares equivalent to 10% of the proceeds to be raised, the state share prices must be set at market prices, and the proceeds raised from the selling must hand over to the country's social security system. June --- CSRC unveiled draft regulations for the management of securities companies, which is the first document to regulate the country's securities companies in a comprehensive way. It allows securities companies to set up subsidiaries, and to engage in various investment bank businesses. Meanwhile it requires the securities companies to appoint independent directors, while setting various financial requirements for these companies. July --- The National Social Securities Fund announced its plan to invest in stock market for the first time. As a result, the fund has become an investor of Sinopec in its IPO on 8 August 2001. July --- PBOC issued 29-article Provisional Regulation on Commercial Banks' Intermediate Businesses, giving more room for banks to conduct fee-based operations including some investment banking-related businesses such as derivatives dealing, acting as agent for securities dealing, and acting as trustees for investment funds, marking a step further towards universal banking. July --- The Ministry of Foreign Trade and Economic Cooperation (MOFTEC) issued a circular to allow foreign-invested joint-stock limited companies to list on China's stock market. July --- The sell-off of the state shares kicked off with 4 companies selling 10% of their new share issuance as state shares, at the same prices as those for the 90% other shares. July --- In the meantime, however, in contrast to these liberalization moves, a serious campaign to crack down on illegal bank financing of stock market investments, as well as illegal FX flows to B-share market and capital flight to Hong Kong stock market, was launched. The illegal bank financing mainly refers to 1) securities companies use the banking funds obtained with stocks as pledges for working capital purposes to conduct securities trading, and 2) companies and individuals use banking funds obtained for other purposes to conduct securities trading. |
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| 3) |
Expected market opening-up with WTO entry
|
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|
Not committed does not necessarily mean will not happen. A higher degree of foreign ownership in JV securities firms and the participation of the JV securities firms in A-share trading and B-share cross trading, are expected to follow if the committed opening-up goes well. | ||||||
|
The key step for stock market opening-up relates to the opening of A-share market to foreign investors. While not mentioned in WTO agreement and hence not committed, it is believed that the opening is only a matter of time, as it is in China's own interest in terms of modernization and sustainable development of its stock market. | ||||||
|
While the question is the timing and the institutional arrangements for the opening, major concern is the RMB's full convertibility. RMB's convertibility on capital account is not a requirement of WTO. Hence it is totally up to the Chinese government when to make this move. A sensible way for the government regarding the timing is likely to be that the move will be made only when it is judged not to disrupt the economy, society and markets. Given that RMB's non-convertibility would be the last defending line for market and economic stability after WTO entry, the RMB is not likely to become fully convertible in next 5 years. Hence a full opening-up of China's stock market is not anticipated until 2005. | ||||||
|
However, a variant of QFII (Qualified Financial Institutional Investors) system is expected to be introduced to deal with the issue. Hence the opening is likely to be made possible 2-3 years after WTO entry when overall market opening-up and reforms in the context of WTO accelerate while the full RMB convertibility issue being put on the government's reform agenda. It is likely that the full convertibility will start with the stock market opening-up. | ||||||
|
The merge of A-shares and B-shares are also something that will happen sooner or later, while it is also related to the RMB convertibility. The B-shares' opening to local residents last February indicates that the merger is already under the consideration of the government. It is likely to take place together with or just following the introduction of the variant of the QFII system. And this is likely be followed by a merge of A-shares and H-shares some time later. | ||||||
