Tspectacle of thousands of people lining the Hong Kong sidewalks for the chance to buy shares in Bank of China (BOC) evoked memories of the great share booms of the early 1970s. In those days, places in the queue for hot new issues were bought and sold, occasionally with triad assistance, and lively secondary markets sprang up in application forms. The atmosphere now is less frenetic – but over a million punters still put their hands up for BOC and the float was a huge success.
Beijing has something else to celebrate. China’s domestic stock exchanges, which appeared headed towards oblivion only 12 months ago, are on the comeback trail. The equity markets have been marginalized from the dynamic economy, beset by weak supervision, corporate corruption, bad debts and lack of liquidity. Some company directors brought a new definition of the phrase "stock taking" to the lexicon as they effectively treated public companies as their private banks.
The biggest headache was that two-thirds – US$250 billion – of the capital of listed companies was locked up by state-owned enterprises and effectively non-tradable.
The China Securities Regulatory Commission (CSRC) took the gloves off last August, slapping an embargo on all new share listings. This meant companies could convert state-held stock into tradeable shares and compensate minority holders for the dilution of their capital with cash or shares. After two earlier failures at cleaning up the market, this effort appears to have succeeded: more than 900 of the 1,334 domestically listed companies have completed the reforms, the CSRC has lifted the listings ban and a number of carefully chosen debutante firms are taking their bow.
On the rise
The boost to confidence from these measures prompted China stocks to leap by 35% or so in the first half of the year. The capitalisation of the domestic A-share market is now US$495 billion. In a classic example of mutual benefit, the 44 China-incorporated H-shares and 87 red chips traded in Hong Kong are worth around US$520 billion and now represent almost 40% of the capitalization of that exchange.
The combined number tops a trillion dollars and is getting on for half of China’s GDP. The stock markets in most developed countries account for up to 100% of GDP – in the US the figure is 130%. So there is plenty of room to move.
China’s famous near-US$2 trillion savings pile is not growing as fast as it once did as funds are being diverted from bank deposit accounts into shares. Retail players are returning, but institutional investors, both domestic and foreign, dominate trading. These include insurance companies, privately offered funds, mutual funds and, importantly, the National Social Security Fund (NSSF).
This is the vehicle set up five years ago with the mandate to help address the chronic US$300 billion under-funding of future state pensions. The NSSF gets its money from the Ministry of Finance and the national lottery. It also clips the ticket for 10% of the proceeds of every Chinese IPO on overseas markets. That seems likely to extend to the domestic market over time as the NSSF seeks to spice up its fixed interest returns with some equities.
In addition, 40 foreign groups, including Goldman Sachs, Citigroup and JP Morgan, have been allowed to invest US$7 billion in the market, and are baying for more.
Trading with integrity
It is not important that the China stock exchanges continue to spiral upwards. What is important is building the integrity of the marketplace and best practices among the participants. The portents are good with emphasis being put on strong corporate governance at the highest level.
The CSRC is not about to abrogate its role as the primary regulator of the stock exchanges. It seeks to attract bigger floats like oil producers, airlines, banks and internet companies to the bourse, and it wants a big hand in the IPO process.
In the past, new share pricings were arrived at in back rooms. And there was a surprising uniformity in that practically every issue went off on a price earnings ratio of 20. In the new era the standard underwriting process and the "book-building" method of testing demand will be used as it is in most financial centers. The success or failure will depend on the track record of a company and its financial prospects, not its perceived political connections.
The director-general of the CSRC’s market supervision department, Hu Bing, told an investment conference that China-listed companies will adopt international accounting standards next year and improve their information disclosure.
Bing said the regulators had taken a broad-brush approach to the capital markets system because "you can’t just fix the tires and not the brakes".
The concept of good corporate governance is all very well but Beijing is left pondering how best to engage workers and management in adhering to lofty standards. The governor of the Central Bank Zhou Xiaochuan is encouraging state-owned banks to implement long-term employee stock option incentive programs. Experience overseas shows that worker share ownership facilitates staff retention and improves productivity.
Many of the biggest and brightest China stars have trooped off to Hong Kong for their IPOs but there are strong indications that some will come home for what amount to secondary listings. Local investors have so far been largely insulated from the manic depressive mood on Wall Street. That should continue – unless the US economy goes completely in the tank.