Executives are once again praising the ruler of China’s capital markets: The China Securities Regulatory Commission. In late April the CSRC signaled that it was preparing to allow another wave of companies to go public on the Shanghai and Shenzhen stock exchanges after a two-month hiatus.
The regulator has long been a rainmaker of sorts, tightening restrictions and delaying IPOs when liquidity is low in the market then allowing a flurry of listings when conditions are good. In an unprecedented move, the CSRC halted all IPOs for about 14 months starting in November 2012; more than 900 companies got caught up in the queue before the pipeline was cautiously opened again this January. In the first two months of the year 48 firms went public before a new freeze occurred.
This wasn’t how the market was supposed to reopen. Since November, policymakers have discussed implementing a “registration-based” system for IPOs, meaning a system that would diminish CSRC’s godlike role in approving IPOs. In a registration-based system, on par with the top exchanges around the world, companies would merely need to meet a list of criteria before coming to market. In March, the regulator said it would push through the system this year.
But there is more to changing the way in which companies go public than simply opening a registry for listing, says Zhou Chunsheng, a professor of finance at Cheung Kong Graduate School of Business. Zhou, who has worked for both the CSRC and the US Federal Reserve, spoke with China Economic Review on the underlying challenges facing China’s capital markets, which permeate the country’s judiciary and even society at large. Before the CSRC can successfully push through real reform, investors will have to, among other things, stop “betting on stupidity,” which, as Zhou describes, is a quick race to the bottom.
Looking at the way the mainland market has performed since IPOs restarted in January, how would you appraise its performance? What has changed?
Frankly, I’m not very positive on the performance of the capital market in China. China set up the Shanghai and Shenzhen markets more than 20 years ago but the two markets didn’t do well. From a financing perspective, sometimes they say ‘no refinancing, no IPOs because we have to stabilize the secondary market.’ But on the other hand, especially retail investors, most of them lost money for a long time, for years. Possibly, you can make more money by investing in financial products from banks.
Do you think pausing IPOs for a year has had a positive impact on the market?
I don’t think so. They shouldn’t do that: Pause then reopen. The market can make its own decision. Now it’s a bear market, it’s going down. So I will not try to IPO now. I will wait. If the capital markets in China are really market oriented, investors, enterprises and corporations, they can make their own correct decisions. The CSRC may think that if the market is in a downward trend then we must help the market by reducing the amount of financing, such as pausing IPOs or slowing down IPOs.
Part of it was trying to improve liquidity in the market as well, right?
Yes. Some investors say, ‘Well the CSRC is making the right decision because they are trying to stabilize the market.’ I don’t think this kind of policy works in the long run.
When you say we suspended or paused IPOs, in the future you have to reopen it. This will bring some negative impact to the market.
It seemed like the CSRC was trying to work out some problems with the market, some fundamental problems. Lots of people thought that when the market reopened, regulation for companies that are listing would be lower. Have you been following along with the regulations of companies that have IPOed during the past few months?
Yes, I have paid some attention to that.
Is the CSRC sending signals that they are preparing for a registration-based IPO system? From my perspective, it seems like regulation has been increased on some of the latest listings.
Possibly, you are right. They say, in the future we will change the IPO system to a registration system. This is market oriented reform. But right now the CSRC is not doing that, for whatever reason.
What do you think some of those reasons are?
The CSRC, in China, this is a government agency. So, [CSRC head] Xiao Gang [and other leaders], they have quite a few vice chairmen or vice presidents or whatever. They are all government officials. They pay a lot of attention to the comments of their bosses.
So there’s a bureaucracy problem.
Yes. Also, they pay attention to the investors as well, to cater to the preferences of investors’ short-term needs.
So as the CSRC transitions toward the registration-based system – and they have said they will do this…
That’s true. They have said they plan to do this.
So what kind of obstacles will the CSRC run into as they try to do this? You’ve already mentioned one, which is bureaucracy. Are there others?
Sure. I think before we do that we have to strengthen our legal system, and the trust of the people, the investors, in the system. Even in the current situation, the market is highly regulated by the CSRC, but there are still a lot of wrongdoings by investors, inside trading or whatever.
Also we know that accounting information of public companies is not that reliable, even though the CSRC tries to improve the quality. We try to improve the quality of information disclosure but after so many years it’s still a serious problem. That’s why there are many people who say, ‘Chinese investors are very speculative.’ Why? Because they don’t trust the public companies.
There’s a Chinese word called ‘bosha.’ I’ll explain: I’m an idiot but you are an idiot as well. So I bought a bad stock but I can pass it to you at a higher price. Then I can make money [even though it was a bad investment to start with] … It means to gamble on stupidity, or someone being stupider than you.
Interesting phrase. Has any progress been made in dealing with these kinds of problems?
Sure. I think the CSRC has made some progress. But we call that a trust [problem]. It’s a social issue in China. It’s not just a stock market issue in China. It’s a social phenomenon that exists in the whole society. It exists in food safety issues. We have fake medications. We can also see this kind of issue in the stock market. If we cannot solve this issue…I mean, these issues exist everywhere, in Hong Kong and the US and London stock exchange. But it’s not so widespread.
I think in China the situation is more serious. If we cannot solve this, if we cannot improve the quality of information disclosure, if we cannot effectively punish the wrongdoings in the stock market, then the stock market in China will not perform very well, will not be trusted by long-term investors. That’s why many measures that have been taken by the CSRC have not been very effective. Because they have not solved the fundamental problem.
And this is a cultural problem?
Well, it’s related to culture but I strongly believe that it’s related to the whole legal system and enforcement of the law. Sometimes, in China, [for example] I know you. You are the regulator or you have the power. I won’t catch you; I’ll catch someone else. We call that ‘selective enforcement.’ You know what I’m saying. This is a social issue. So the reform of the Chinese stock market is closely related to the reform of our social system, our legal system.
We are making progress. We are making very good progress in many aspects. But these kinds of issues, we need mo
re time to deal with this.
Okay. So my final question is about how, when people talk about the implementation of a registration-based system, there needs to be a legal followup to that.
Because if you suddenly give a list of requirements, and any company can list as long as they meet those requirements, then there needs to be a strong legal followup. So the question is: How coordinated is capital markets reform with legal reform? Is there strong coordination right now?
I should say there is coordination right now but I don’t believe the coordination is so strong. CSRC is a government agency. It only takes care of the capital market. It’s not very powerful in the bureaucratic system. The Supreme Court and the People’s Congress, of course they are much more powerful. So I guess we have to make good preparations before we do this kind of thing, or else some companies will cook up their numbers, saying they make a lot of profit and that they have a very good business model. They encourage investors to buy their stocks and then they take the money away.
China has such a huge population. China has millions of companies. Do you know the number of companies in China?
I have no idea. What’s the number?
If we count all the companies, including small and micro businesses, we have possibly 30 million businesses or enterprises. This number is bigger than the population of some European countries. That’s why China is somehow different from other countries. Such a large population. Such a large number of businesses. That’s why it’s very difficult for regulators to monitor all of them and for investors to get to know them. So you can imagine that if we switched to the registration system, it’s very difficult … This is possibly the correct way to go but it takes time.
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