Shenzhen's long-awaited second board – an over-the-counter stock market designed to raise funds for Chinese technology and high-growth companies – has once again been left standing at the altar. First mooted as long ago as 1999, plans to open the new exchange have been repeatedly postponed, despite equally frequent high-level assurances that trading was about to commence. Now it seems that the suspension may be more permanent in nature.
This follows from comments made in November last year by National People's Congress vice-chairman Cheng Siwei, who stated that a second board would need about 300 listings to create a sufficiently active market and that China currently lacked enough mature technology companies to meet this quota.
Cheng's statements came on the heels of similarly negative remarks from a sceptical Premier Zhu Rongji to the effect that the government needed to clear up irregularities in the A-share market before launching the second board. This led analysts to conclude that a high-level decision has been made to postpone the new board's creation indefinitely. According to one well-placed source, postponement is likely to mean until after Zhu retires from government in 2003.
The reasons behind the government's indecision are partly the result of political in fighting. However, there are also practical factors. In addition to the problems of widespread price manipulation and excessive valuations, last year's spectacular crash of the US Nasdaq market, which serves as the model for the second board, has tempered enthusiasm in Beijing for what is likely to be an even more volatile trading forum.
The postponement of the second board also leaves Shenzhen's A-share market blowing in the wind. The original reasoning for basing the second board in Shenzhen was that it would serve as a trade-off for the government's plan to abolish Shenzhen's main board, which the government intends to be absorbed by the bourse in Shanghai. As a result, authorities banned new listings in Shenzhen from September 2000. Now this plan, which would doubtless cause significant disruption to implement, may also be in deep freeze.
Proposal to lift listings ban
In his November speech, Cheng Siwei suggested that Shenzhen's listings ban may be partially lifted to allow a 'high-tech sector' to be established on the A-share board, which could then be transferred to Shenzhen's second board when it is eventually set up. There has been no clarification as to how exactly this would work – in particular what criteria would be applied to choosing listing candidates. But it seems unlikely that the A-share move to Shanghai would be allowed to be completed if it also meant transferring its nascent body of high-tech listings to Shanghai as part of the market reorganisation.
Although Zhu's reasoning for preventing the opening up the OTC market is not without some substance, there are pitfalls in this approach. First, many Mainland companies that would otherwise look to list in Shenzhen are instead likely to seek refuge on Hong Kong's own secondary board, the much maligned Growth Enterprise Market.
Second, although the main reason for the delay is supposedly to allow time for reforms to trading practices on A-share markets, it is plausible to suggest that opening the second board would actually be the best way to introduce more important reforms. This is because the rules by which the new board will be regulated are more or less in line with international norms. Among these:
-the exchange would be self-regulating, with minimum political interference;
-listing candidates would be chosen on merit, rather than political connections;
-companies would be able to use the capital raised to invest in their businesses, rather than (as currently happens) to pay down their existing debt;
-there would be no state or 'legal person' shareholdings; all shares would be issued to real investors or retained by the listed companies. This would have a huge positive impact on corporate governance standards.
Such a market would be efficient and at a stroke eliminate many problems that are far more serious than those that the government is attempting to combat by keeping the board on ice. By highlighting the main markets' shortcomings, the second board would increase the chances of motivating authorities to introduce similar types of reforms to the A-share markets.
Finally and most important, the absence of the second board makes it harder for Chinese industries to raise money, especially companies in the private sector, where the government is most concerned to stimulate growth. Private companies generate more than 50 percent of China's industrial output, but remain starved of investment capital. Currently, the sector receives less than 1 percent of bank lending and is effectively excluded from the country's capital markets.
Indeed, public or private, the suspension of new issues on the Shenzhen Stock Exchange meant that total capital market funding raised last year by Chinese companies on the domestic markets fell by 30 percent, to Yn53.2bn from Yn82.6bn in 2000.
As a result, China's industries will have to continue to rely on bank lending, which contributed about 85 percent of the nation's corporate funding requirements in 2000, as the most important means of raising capital. The Chinese corporate bond market has been slow to develop, issuing just Yn8.3bn in new capital in 2000, or just 0.6 percent of new bank financing over the same period.
Although China's state-owned banks have plenty of capital to lend, they also suffer from serious structural issues that continue to make them an inefficient way to channel new capital into the economy.
The upshot is that the government is now stuck in a no-man's land. Merger of the A-share markets is stalled. Shenzhen's main board has been turned into a lame duck, incapable of proper operation. And the consequences of postponing the second board seem likely to be worse than the potential downside to letting it open. The better course would be to proceed at full speed, but that seems unlikely to happen any time soon.