One of the most defining moments for the Chinese stock markets came in August 1992, when a riot broke out in the streets around the Shenzhen Stock Exchange. Up to a million people had surged into the city seeking "lottery tickets" in a particularly hot new issue being offered for sale. Many queued for three days to get hold of subscription forms only to find that the five million available had allegedly been sold out in four hours. Disappointed punters went on the rampage and it required liberal applications of police truncheons to restore calm.
This event led directly to the establishment of the China Securities Regulatory Commission only a few months later. The watchdog body was set up under China's State Council and assumed a supervisory role over every aspect of the issuance and dealings in shares. The move was welcomed as evidence that the central government recognized the importance of the domestic securities industry, and intended to exert control over its development.
Hong Kong discovered a long time ago that allowing stock exchanges to be self-regulating is tantamount to leaving a rabbit in charge of a lettuce.
The CSRC has struggled along a troubled road. Rampant speculation followed by ear-splitting crashes is a standard rite of passage for developing capital markets, as is much financial legerdemain.
Harvard economist Dwight Perkins remarked recently that managers of Chinese companies "have not entirely grasped the notion of enhancing shareholder value." I am not sure we needed a Harvard economist to tell us that. The role of the equity markets is to mobilize private capital to fund corporate expansion and boost economic output. In China, the exchanges have scarcely developed from their early role as a vehicle for SOEs to be introduced to market capitalism. Virtually every dollar needed by companies has to come from bank loans.
Two thirds of the capitalization of the 1,400 listed companies on the Shanghai and Shenzhen exchanges is locked up by government controlled entities. These shares are untradable. And that millstone has been hanging around the neck of the bourse since its inception. Recently it has been threatening to drag it beneath the waves. Nine out of ten investors have lost money. There are still some 70 million registered securities accounts in China, but many are now dormant. Understandably, investors are reluctant to buy shares unless there is a reasonable expectation of capital gains or a decent dividend. The stock market has virtually halved in value since its brief peak in 2001. This is in stark contrast to the dramatic surge in the Chinese economy over the same period.
The malfunction of the capital-raising capability of the domestic capital market is more than an embarrassment. It threatens to handicap the country from reaching its full growth potential.
Up to now the deep liquid market of the Hong Kong Exchange has come to the rescue. In the first half of this year alone Chinese companies raised US$8.1 billion from listing state-owned H shares and red chip companies which have the majority of their assets in the PRC. That compares with just 15 new listings in Shanghai together raising US$4 billion.
Hong Kong the financier
For several years, the bulk of the more than US$12.6 billion a year raised by Chinese companies has come from Hong Kong. The pace is accelerating as the brightest Chinese stars get listings on the neighboring bourse.
The Chinese authorities are now pulling out all the stops to breathe life back into their own stricken exchanges. In what amounts to a "big bang" reform the CSRC is pressing for the release of up to US$240 billion in state-owned stock. The controlling shareholders of the larger companies have been told to come up with plans to sell down the bulk of their holdings to the market, and the compensation that will be offered to minority holders.
It is easy to see the theoretical upside. The government gets to reduce its unwelcome liability as the main market stakeholder. Hopefully it will be able raise money to help meet unfunded pension and welfare commitments. Managements will be obliged to pay attention to their private shareholders and become more transparent with their dealings and accounting. The well-run companies will get a higher rating for their shares. Undercapitalised third-rate companies will be left to wither on the vine. Better credentialed IPOs will take their place. Once confidence is restored, investors will return. Even a tiny fraction of the US$1.5 trillion lying around in bank deposits diverted into equities would do the trick. Banks and insurance groups have been given the green light to launch mutual funds and the amount that designated overseas institutions will be allowed to invest in the domestic markets has been lifted to US$10 billion.
But will it work? This could be third time lucky. Previous attempts at converting state-owned shares in 1999 and 2001 flopped. Skittish investors fled on fears that an avalanche of scrip dumped on the market would dilute their holdings. There seems be a more realistic chance of success this time. The measures will be introduced slowly. The formerly non-traded shares will gradually be divested in tranches over a three-year period with initial 12-month escrow periods for the new holders.
It is not important that boom times return any time soon. But the marginalizing of China's security markets must be halted. Unlike mature centers like Hong Kong, China has literally thousands of companies waiting in the wings, which could be brought to the market. Get this right and Shanghai will become the New York of Asia.
Malcolm Surry is former Business Editor of the South China Morning Post in Hong Kong.