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With Great Power Comes Great Responsibility

by | October 22nd, 2012 | 11:05 am

Why China’s command and control equity markets are no fun

When Guo Shuqing took over as head of the China Securities Regulatory Commission (CSRC) in October, there was great hope that he would push forward more reforms to make equity markets – only accounting for 3.6 percent of total financing today – a better source financing for the majority of firms.

For the most part he has come through on this promise: streamlining the listing process, calling for more dividends for investors, cracking down on insider trading, allowing more foreign institutional investors to enter the market, better pricing for IPOs, and delisting poor performing companies, etc.

However, one area where he has not done so well is in reducing the tendency for state intervention to prop up markets. The government’s asset managers or state-owned enterprise groups own stakes in the numerous state-owned enterprises listed on mainland exchanges – accounting for 68 percent of all listed companies in 2011. While the majority of their shares have become tradable since 2006, there is still a large overhang of non-tradable shares owned by the state — the equivalent of 7.4 percent of the Shanghai exchange’s market cap — which have yet to enter the market, unlocking these shares can still affect market expectations.

Last month, CSRC told over a dozen SOEs that they should prop up prices by buying back some of their floating shares. Some speculate that decision may have been political in nature, aiming to juice markets in the lead up to the meeting of the 18th party congress in November. This would effectively remove tradable shares from the market for a period of time, leaving investors unclear when and how they would be released back into the market.

The action is nothing new. Major state-owned institutional investors like the National Council for Social Security Funds (NCSSF) and Central Huijin are often used to stoke demand for equities in the bad times. Central Huijin in particular has been engaged in almost annual buybacks of major banks since 2008 to prop up markets – including a recent round of share purchases in October of this year. CSRC also periodically reduces or even cancels its stamp tax on stock transactions to stoke trading – a measure it was rumored to be considering this year.

CSRC’s call for more state intervention this year is disappointing, and perhaps a step back for Guo Shuqing after implementing so many much needed reforms. Although such buybacks may have short-term benefits to investors or even make room for the listing of better performing private companies, in the long run these actions simply make investors more concerned with the decisions of regulators than the valuation of companies and undermine the effectiveness of equity markets as a source of financing in China. Perhaps this may explain why Chinese equity markets remain a minimal source of capital for the majority of firms over two decades after the opening of the Shanghai Stock Exchange.

Comments (5)

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  • Abdul you may be correct about the intentions of regulators to control markets due to fear of speculation. Releasing or removing state-owned non-tradable shares can affect the value of existing shares if there is some degree of uncertainty regarding when and how many will be released or removed – this often appears to be the way the state is managing its ownership in China. Although releasing all of these shares into the market may reduce the value of shares for existing investors in the short run, ultimately it would remove uncertainty from the market making it more likely that shares would be priced according to market fundamentals. However, as you point out, the flip side of market prices is the state would no longer be able to directly intervene to adjust the booms and bust cycles of markets, it would have to rely instead only on indirect regulatory mechanisms.

    Ryan Rutkowski October 23, 2012 | 9:22 am


    How would raising the tradable shares by the 7% the government controls affect the overall participation on the stock market? if no investor can trust the government of China to not intervene whenever it wants, the secondary market will remain as passive as it is. China, i believe is intentionally doing this to prevent the effects of speculation that could derail the economy in the view of the State.

    abdul October 23, 2012 | 6:49 am


    party controlled state may be effective (at least documented for the last 30years) in most economic sectors for its effective accumulating and distriubting resources. But, surely, it is not effective in equity markets, where law may play a dominant role.

    xiaoli October 23, 2012 | 12:53 am


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