The China Securities Regulatory Commission announced a new policy towards the end of March, allowing the two newly-established investment funds the privilege of subscribing to five per cent each of initial public offerings (IPOs) of A-shares, denominated in the local currency. The regulator had hoped this would solve two problems at a single stroke: to channel individual savings to the investment funds and thus foster a new breed of institutional investors; and to curb the usual IPO frenzy in the market by stipulating that the funds must hold the new issues for at least six months.
But the plan backfired, the allocation privilege immediately triggering a wave of speculative buying. The Jintai Fund listed in Shanghai and the Kaiyan Fund in Shenzhen had to publish notices in Shanghai Securities News, detailing the general risks in investing in the funds, the funds' intentions of holding the new issues long-term and their ultimate goal of achieving steady returns for investors.
These warnings had little effect as both funds soared over consecutive days, hitting the daily 10 per cent price swing limit imposed by the CSRC across all shares and funds.
The CSRC was forced to suspend the preferential policy within a week of announcing its introduction. This embarrassing switch bears witness to a regulator struggling to govern an immature market where government intervention, rather than rule of law, prevails.
To its credit, CSRC's limitations in being able to tackle the shortcomings of the market are not entirely of its own making. CSRC reports directly to the State Council. rendering it an instrument of the central government.
CSRC came into being eight years ago to regulate China's new securities industry. The commission has branches at municipal and provincial levels which report not only to its Beijing headquarters but also to various local governments where branches are located.
Its brief to pace the development of the Fast-growing market gave rise to a national Juota system, an administrative measure to allocate' listing opportunities based on a com-3any's geographic location. Under this arrangement, the merits of an individual corn take second place to its location. Qingiai, for example, might be granted a quota for one company to be listed even though there is no suitable candidate from within that province. Successful application depends less on the fundamentals of a company than on its ability to influence CSRC and government officials.
A recent high profile incident further exposed the limits of CSRC's effectiveness. It involved the Shenzhen-listed Hainan Minyuan Modern Agriculture Development, whose top 10 shareholders include China Welfare Fund for the Handicapped, headed by the late paramount leader Deng Xiaoping's son Deng Pufang, and Shenzhen Nonferrous Metals Finance under the umbrella of China Nonferrous Metals Corp., which until early this year was controlled by Deng's son-in-law Wu Jianchang. The listed company in question refused to help the regulator to trace the whereabouts of five of its former directors who approved its fraudulent 1996 financial accounts.
CSRC discovered through its own year-long investigation that Hainan Minyuan inflated its accounts by about Yn 1.2bn from illegal real estate transactions in Beijing, where most of its owners are based. But in a curious statement by the regulator published in China's top financial newspapers, the company was deemed to be 'under no obligation' to help CSRC find the missing directors.
The regulator seems to be caught between various political forces working behind the scenes. Its determination to police the market and its authority within the industry was undermined by this extraordinary statement, which effectively urged the missing individuals to surrender of their own accord. This decision not only spared the company its moral and legal obligation but also the public its right to know whether the company's politically well-connected owners played any role in the scandal.
China's new premier Zhu Rongji has endorsed a plan to merge CSRC, the State Council Securities Committee and the part of the People's Bank of China which regulates non-financial institutions. The pending merger would allow CSRC to become the country's sole regulator.
Mr Zhou Zhengqing, CSRC's chairman, was quoted as saying that his priority for 1998 was to create `a central, unified supervisory system'. He is considering re-organising local branches into a regional network cutting across geographic boundaries so that it becomes free from the influence of local governments. There is also talk of abolishing the quota system for listing applications.
At best, these measures will centralise regulatory powers, rather than free the market from government interference. Until the regulator ceases to be the securities arm of the central government, its role as the industry's watchdog will be compromised by political forces.
But establishing the rule of law is taking a long time in a country where the Communist Party is used to having the final say. This is the underlying reason why, for example, the Securities Law is still in the making after eight years of drafting.
The need for change
The National People's Congress, the country's legislative body, was told by the vice-chairman of its Standing Committee in April that important legislation regarding conduct in a market economy had to be delayed due to a lack of practical experience in China, disagreement among parties with a vested interest and the inherent difficulty of the subject matter = namely bankruptcy, state assets, futures trading and securities.
The lack of practical experience may be a lesser problem. Bills are usually drafted by professionals commissioned by the government and presented to the Congress for debate and endorsement as law. The current dearth of financiers and lawyers in the legislative body means high quality debate on such specialised areas is a rarity. But this could change in due course through the selection process for sitting in the Congress.
The need for such a change and ultimately for speeding up legislation has been highlighted by the recent economic crisis in Southeast Asia. Chinese officials have acknowledged the need to put the legal infrastructure in place before the financial sector is liberalised, in order to avoid a similar crisis. The World Bank has offered its help. Rule of law will be top of the agenda for discussion when US President Bill Clinton visits China in late June, according to a White House spokesman.
All these external forces may help facilitate the transition to a market economy ruled by law. But the ultimate question remains for the Chinese leadership: when Premier Zhu Rongji called for help from British financiers during his April visit, was he prepared to relinquish his power to intervene? "