Call to account
Rather than opting for an artificial, short-term boost, the CSRC should instead try to bolster its stock markets by deepening ongoing reforms that can improve investor confidence.
It is unsurprising that confidence in Chinese firms is weak, given the recent slew of widely publicized accounting scandals. Caterpillar’s Chinese unit Siwei and China Public Procurement are just two of many firms that have appeared at the center of financial fraud maelstroms.
China’s poor accounting practices have historically kept larger institutional investors away from Chinese stock markets. In 2011, Societe Generale said they would avoid Chinese IPOs in part because they could not rely on the published financials of the candidates.
“There is a pretty serious issue with false reporting,” said Tian of Morgan Stanley Huaxia. “Typically, many [Chinese companies] use internal transactions, or create fake transactions and record them in the financial statements in order to meet requirements for listing, as they have to show growth.”
To deal with these accounting irregularities, the CSRC has introduced measures during the hiatus to tighten China’s IPO approval process. The regulator requested on January 8 that the auditors and accountants for listing hopefuls review their clients’ financial statements and said they would carry out spot checks. Then it began cracking down on violations during last year’s IPOs and fined sponsors on January 28.
These steps will go some way towards improving investor confidence. “It will not be 100%, but it’s definitely an improvement, yes. The measures will improve the overall quality of the candidates,” said Zhao Xiaohong, a capital markets partner at Chinese law firm King & Wood.
The tighter supervision of accounts will also have the added benefit of attracting institutional investors, such as Societe Generale, whose presence will help relieve volatility in mainland markets. According to CNBC, retail investors account for 80% of the turnover at the Shanghai and Shenzhen stock exchanges, whereas institutional investors tend to dominate exchanges in developed countries. In contrast to retail investors, who pursue short-term gains that cause stock prices to fluctuate, most institutional investors adopt a long-term buy-and-hold approach that leads to greater stability.
However, some regulators are getting in the way of the CSRC’s self-proclaimed goal to tighten accounting practices and bring the country’s finance system up to global standards. In May last year, the Ministry of Finance essentially shut out international auditors by demanding that four of the largest global auditors spin off their mainland operations to Chinese partners. It also restricted such firms from hiring overseas staff, a seemingly protectionist move on the part of Beijing. To instill global trust, the government should instead be pursuing the opposite path and widening the scope of work done by international auditors who adhere to recognized standards, not reducing it.
An efficient stock market that breeds investor confidence – one where shareholders don’t need to worry over potential fraud – hinges on the availabil
ity of verified financial information. Beijing needs to comprehensively strengthen its supervision of the accounting practices of Chinese firms, both those that are seeking to list and those that are not. Otherwise, the hundreds of firms queuing for IPOs that finally do gain approval to list will have waited in vain, as they step onto an exchange that performs just as poorly as it did before.