The conservatives in the Chinese government have been cracking the whip at the China Securities Regulatory Commission (CSRC), China's equivalent of the US Securities & Exchange Commission (SEC). The dismissal last year of the CSRC's free-thinking chairman, Liu Hongru, and his replacement by the more bureaucratically minded Zhou Daojiong - formerly at the policy-making State Development Bank - was the most important sign of a change in philosophy among China's leaders.
This has had serious consequences for the agency, which was set up in 1992 to bring order to China's new securities market. Seven months after Liu's dismissal, the resignation of the CSRC's general counsel and director of public offerings, the US-educated and highly regarded Gao Xiqing, caused alarm. One Beijing banker has referred to the "rise and fall of the CSRC", drawing attention to the way western-educated and open-minded officials are giving way to state planners.
The conservative approach imposed on the CSRC was quickly felt elsewhere in the securities industry. The president of the Shanghai Stock Exchange, Wei Wenyuan, who effectively founded the market and was renowned for his gung-ho approach to its development, was replaced by a municipal planning department official, Yang Xianghai.
The message was clear: Beijing's mandarins were unhappy about the wild volatility and speculative frenzy on domestic exchanges, a disaster for one of the country's premier brokerages on the bond futures market and corruption scandals involving government funds diverted into stock speculation.
"I think Zhu Rongji and others within the government were concerned about what was happening in the markets," says a Beijing-based investment banker. "So Zhou Daojiong, who is a systems man and not terribly well versed in the whole securities area, was sent in to make the whole approach of the CSRC more conservative, to take it more slowly."
A change of personnel will not prove an instant remedy for what the conservatives regard as distasteful disorder. In an immature stock market, where most of the players are still unfamiliar with the written and unwritten rules, order cannot simply be brought about overnight, however diligent the regulators. And the official government view, that China's securities markets are still only "experiments" in capitalism - the implication being that if all does not go well they may be abandoned - further complicates a task whose objectives are in any case vaguely defined.
"There are still elements within the state council, within the government, that don't think securities are such a hot idea," says John Crossman, general manager at Jardine Fleming Securities in Shanghai. "So the CSRC is very sensitive to the fact that people are making a lot of money, losing a lot of money, or the country's reputation is being tarnished. These guys are in the hot seat. And one thing I know about markets is that some people are going to make a lot of money, some people are going to lose a lot of money and reputations are going to get tarnished. I think the CSRC is at a bit of a loss. They're trying to get the genie back into the bottle: they're asking themselves how they can control things; how they can ensure that no one makes a lot of money, that no-one loses a lot of money and that no one's reputation is going to get tarnished. They're trying to come up with a solution that doesn't exist".
The result is a regulatory body which sees its role extending far beyond regulation. The CSRC is not there just to set up basic rules and see they are obeyed. It has a variety of other tasks ranging from deciding which companies are suitable for listing to intervening in the market if companies are not performing well. The interference is not always welcomed.
China's stock markets have grown extremely fast, so whatever the official line on capitalism the regulators would have had difficulty keeping up. As a World Bank report, entitled China: the emerging capital market, points out, since 1990 when the Shanghai Stock Exchange and officially recognized markets in securities were established, "securities outstanding, and the volume of trade, have grown exponentially to the point where China's securities markets rank, in size, in the middle league of emerging markets".
Regulation has always been one step behind growth. Share issues themselves started almost spontaneously, with company stock being handed out unofficially to employees and local citizens. Then the stock markets were set up, at the initiative of local governments in Shanghai and Shenzhen. Other types of exchanges, primarily bond trading centres, soon followed in other major cities. By 1995 there were more than 25.
Glorious days of speculation and volatility followed the take-off of the stock market experiment. In May 1992, the Shanghai A share index achieved the dubious distinction of doubling in a single day, rising from 617 to 1266. In August 1992 a riot ensued in Shenzhen as enthusiastic investors scrambled for an issue that was 600 times oversubscribed.
The Chinese authorities decided things were getting out of hand. The local branches of the People's Bank of China (PBOC - the central bank) had been charged with regulation but were clearly not up to the job. Hence the formation in October 1992 of the State Council Securities Policy Committee (SCSPC) and the CSRC, the SCSPC's executive arm. The SCSPC is chaired by vice-premier for the economy Zhu Rongji and is a broad policy-making body which includes most members of the state council (China's cabinet).
Regulation after the event
The CSRC's regulatory purview has grown sporadically in reaction to events. "Since 1991 there has been a whole pile of domestic issues," says Carl Walter, director and chief representative at CSFB in Beijing. "In typical Chinese fashion, they'll start off with a reform like this, but they won't have given themselves the time to create a regulatory infrastructure that would accommodate the rapid development that nobody really foresaw. Because once the door was open, everyone wanted to list. So you had markets, but they weren't regulated on the basis of a standard set of regulations, but by the individual markets or by local governments."
In 1993 the A shares reserved for domestic investors were brought under the CSRC. Authority over futures markets soon followed. But it was only in the middle of 1995 that regulation of the 25 or so exchanges outside the main markets of Shanghai and Shenzhen - mostly bond trading centres - was put under formal CSRC control. Last January the B share market, reserved for foreign investors and previously the responsibility of local governments, followed suit (see box below).
In China, securities regulation does not just mean investor protection. The CSRC cannot model itself on the SEC and leave it at that. The role of the securities regulator is all-embracing. In conjunction with the SCSPC, its supervisor and other government agencies, it has a kind of overall responsibility for the performance of the markets.
The regulators are particularly active in the primary market. Meeting CSRC criteria is not sufficient to ensure a listing. Companies are subject to quotas of listings allocated by province. If a company wants to list on a domestic exchange, it has to lobby provincial government departments in its quest to qualify as one of those selected for a particular province's quota. It is not always commercial criteria that determine which companies are listed. Government priorities and, in many cases, political connections are as relevant.
Once these hoops have been jumped through, and provided criteria specified by the CSRC have been met, the CSRC itself will usually give final approval, and the company will be able to list A shares. But not always - in July 1994, to counteract a long fall in the value of the A share index, the CSRC put a moratorium on new issues. The idea was to raise prices by restricting supply. As the World Bank puts it: "This amounts to unwarranted market manipulation of a major nature."
Ironically, this kind of activity has, if anything, contributed to market volatility. The announcement of the moratorium on listings and a market-support package led to a jump of 122% in the A share index in less than a week. According to the World Bank report, rather than making things run more smoothly "the succession of regulatory events generated by the government" has been "a major contributant [sic] to market volatility".
The CSRC now admits the move was a mistake - it began approving listings again at the end of 1995. But there have been no indications that it will lessen government involvement in the listing process. The government, and not the exchanges, will continue to determine which companies are listed.
For foreign investors, government involvement has been most obvious in overseas listings. Although not subject to quotas, companies are selected for these by the CSRC, in consultation with other central government agencies, and announced in annual batches.
In selecting companies, five-year plans and other government development objectives play a key role. "The State Planning Commission has issued guidelines for foreign investment," says Nie Qing Ping, deputy director of the CSRC's overseas listing department. "What kind of industry is being encouraged, what kind less encouraged - and that is an important consideration in selecting a company."
The selection of companies to bring to market is apparently not considered one of the roles of an investment bank. As a Shanghai-based banker points out: "This is very much a State Planning Commission, CSRC show. None of this nonsense about letting an investment bank actually go out and find a company, and bring it to them, and as long as they go through certain hoops, of course they'll get approval. What do you mean: let those poor ignorant savages do it by themselves? They don't know anything - they don't know like us officials in Beijing, they might make a mistake."
Even more surprising have been the CSRC's attempts to exert control over backdoor listings - Chinese companies registered overseas which then try to list on an international exchange. In one case the CSRC even asked the US SEC to block a listing, apparently unaware that this was none of its business - or the SEC's for that matter. The CSRC has also shown its disapproval of backdoor listings by putting pressure on the investment banks involved. This includes telling Chinese companies waiting to get approval that a certain investment bank is not in favour.
Several other aspects of the overseas listing process have been subject to CSRC interference, such as the pricing and timing of issues. For example, the CSRC has been left to enforce a state asset control bureau stipulation that companies cannot list at below net asset value, whatever condition the markets - or the company - are in. But it also offers more subjective advice. According to the CSRC's Nie, if a company is planning to list at what the regulator considers a low price, "we do make it clear to the company that they should be concerned about the low p/e ratio and that it might be better to wait for the market to improve".
It is not that the CSRC is acting in bad faith. As Nie points out, in selecting companies, the needs of international investors are taken very seriously. In the case of timing, pricing and the selection of underwriters, the CSRC's experience can be crucial for Chinese companies which have no idea of what is involved in listing internationally. The problem is that this advisory role is not one usually undertaken by a regulator. Not surprisingly, the CSRC does not see itself primarily as a regulator. As Xie Shikun, deputy division chief of the CSRC's department of international operations, points out: "For the overseas listings, we do have some regulatory functions, but we play a very important role in educating, advising, and coordinating. So we are educator, adviser, coordinator and, last of all, regulator."
Rather symbolically, the then chairman of the CSRC, Liu Hongru, was present in New York when Huaneng Power International, one of China's largest independent power producers, was listed there. Not long after, the State Council dismissed him, citing as a major shortcoming his undue emphasis on overseas markets at the expense of regulating the domestic exchanges.
Liu's supporters say he only concentrated on overseas listings because it is so difficult for the CSRC to get a well-regulated market going inside China. The fact that the CSRC is a relatively new institution has not helped. As a Beijing investment banker remarks: "It's a very typical Chinese approach just to set up an organization and give it a very vague sort of mandate, and then let it fend for itself and see what happens, and then make adjustments. But it makes it very hard for the guys put in to run the thing".
Bond wars
One of the biggest problems has been bureaucratic turf wars, since other government departments have proved reluctant to give the CSRC authority in areas they regard as their domain. Take, for example, the bond futures scandal - the most damaging incident yet for the reputation of China's securities markets, certainly from the point of view of officials in Beijing. One of the country's premier brokerages, Shanghai International Securities Company (Sisco), lost virtually its entire capital when a punt on a central bank inflation-index announcement went badly wrong.
Sisco had gone well beyond authorized trading limits. Unfortunately, the CSRC had never had much say in the market. Although formally in charge of futures, it had been reluctant to interfere in the government bond futures market for fear of offending the finance ministry, which had claimed bond futures as its own turf. After the incident, the CSRC was quickly given authority over bond futures. Although it probably cost him his job, CSRC chairman Liu Hongru was philosophical about the scandal, saying it took events like this to move things forward in China.
Bureaucratic differences do not always have such dramatic effects, but they have often made it extremely difficult for the CSRC to carry out its job effectively. On a day-to-day basis, by far the most problematic relationship has been with the central bank, the PBOC, which until 1992 regulated the securities markets. The CSRC is heavily reliant on the PBOC because the bank is still responsible for authorizing all financial institutions, including securities brokerages. Although the CSRC can fine brokers, it can never exact the ultimate penalty of revoking their licences.
Unfortunately, the CSRC has not had much luck at working in tandem with the PBOC. According to one CSRC official: "When we go and investigate certain financial institutions, because of the fact that historically they are under the PBOC, they say, 'we need an order from the PBOC'. Then we go to the PBOC and they don't want to help, because they don't like us, because they still feel resentful that our establishment took away their power."
These sorts of differences have been among the main obstacles to a formal securities law - a rather striking example of the regulatory gaps that remain. The law is apparently in its tenth draft, but still generating controversy.
"One of the main problems has been how much power it has and what is the scope of the CSRC's authority?" says CSFB's Walter. "How far does it go? Does it include everything? Does it include currency options, for example, or government bond options, or commodities? Does it relate to treasury bond trades down in Shanghai or is that the ministry of finance's problem? And I think you have a lot of bureaucratic differences over that."
The problem won't go away in the near future. "It's because of the overall situation in the country," says Gao Xiqing, the former CSRC general counsel and director of public offerings, "because we have been in the reform process for the past 17 years. But during this time, the reform has been going in sectors, one after the other. Now it's finally reached a stage where you need an all-out overall change of the whole structure, and it hasn't changed yet. And because it hasn't, often we can't afford to offend other government agencies. Because if we offend the PBOC or ministry of finance, then they'll make life difficult for us. So we have to try to negotiate."
The regulator is in a dilemma. Although trying to assert itself, it cannot afford to step on any toes. According to Gao, the CSRC has to try to build consensus and avoid confrontation: not exactly a good starting point for meting out rebukes and punishments. "The problem is that being non-confrontational and being consensus-building is always much easier than being confrontational," says Gao. "And because of that, it feeds on itself and, eventually, it becomes impossible to punish anyone."
Another major difficulty has been lack of staff. At present the CSRC boasts only about 130 staff and that, says a CSRC official, "includes the chauffeurs, the secretaries, janitors, everyone. We have maybe 40 to 50 professionals doing the job." There has been talk of boosting this to 200 - the maximum the CSRC is allowed according to the government's departmental quotas - but progress has been slow. As a Beijing-based banker points out: "The CSRC has twice the responsibilities of other regulatory bodies and less than half the staff."
Privately, CSRC officials agree it is a problem. "American-style enforcement is basically impossible here," says one. "The SEC has over 2,700 people doing it with very highly trained specialists and also very high-tech equipment." What's more, the CSRC is in Beijing, nearly two hours by air from the Shanghai market, and even further from Shenzhen.
The result is a decidedly stop-gap approach to enforcement. "We basically start our investigations based on complaints," says a CSRC source. "Something major happens, people all complain about it, then we start an investigation. Otherwise we can't go out and really do anything. We don't have the capacity."
The capacity problem could perhaps be remedied: among government agencies the CSRC has the advantage of being able to offer above-average salaries. But its philosophy would still be a problem: it seems to have become too concerned with asserting itself within the government hierarchy and drafting rules, to attend to the details of enforcement.
"A lot of people at the CSRC say 'we need this power' or 'we need that power'," says one CSRC source. "I say we already have much more power than we can handle ... If we used the power of the law to its full extent, you would need 300 people to carry it out."
More rules than adherence
As Jardine Fleming's Crossman points out: "This is a criticism of the legal process all over China. There's heaps and heaps of regulations, tons and tons of rules. And you're supposed to be following them all - but, of course, you can't. And people will tell you: 'You don't have to follow that rule; that's not a big deal.' The feeling is that as long as people aren't getting killed, and money isn't getting stolen from widows and orphans, it's OK."
This kind of attitude certainly contributed to the bond futures debacle last year. One broker says: "People like Imro [financial regulator] in London and the SEC in the US have enforcement powers, and if you step over the line, they come out after you. In China, they may or they may not. It depends. They let Shanghai International Securities go wild on the bond futures markets: they were breaking rules that were written down in black and white for quite some time, and everybody knew about it. But the regulator said: 'It's not causing chaos in the market, we're not going to shut them down.' But under normal circumstances on the Chicago exchange, you're closed down."
Unfortunately, other aspects crucial to the smooth functioning of the securities markets also don't involve murder or theft - they are about more mundane things such as disclosure. For example, publishing annual reports.
Chinese companies don't take this requirement very seriously. The World Bank document for the year ended 1993 says that, by July 1994, only 75 of the listed mainland companies had submitted annual reports deemed acceptable by the CSRC. Fourteen companies had failed to submit a report at all, and five saw fit to submit a newspaper clipping instead.
Crossman says: "They don't understand this: the company did not come out with an annual report. They say: 'What's the big deal?' I say: 'The big deal is that I cannot sell these shares to anyone and I have got clients who are hopping mad.' This is the worst fear of every investor - that they buy a share and never hear about the damn company again. They had some problems or the auditor quit, or someone's daughter got married. There's always an excuse. I reply: 'It doesn't matter if someone's daughter got married: the important thing is that the annual report should have come out on time. We should suspend the shares.' They reply: 'That's very harsh. We have to think about what if people want to trade those shares?' "
There are signs even in the A share market, where shares are bought by individuals typically not very concerned about the kind of company they are buying into, that investors are getting fed up. Gao Yang, a legal consultant at Clifford Chance in Shanghai, says that there are letters in the local press from investors reporting some companies that have not fulfilled disclosure requirements.
Analysts close to the CSRC say that fears about the details of enforcement are being raised inside the agency, with middle-ranking officials complaining that their leaders don't fully understand the issues. "There's a lack of necessary knowledge about how the market works," says one official. "The securities market is a highly technical one. If the leaders in charge of the whole thing, making decisions as to how and whom to punish, don't understand, then you have problems. When we send a report saying: 'We have the following suggestions to punish these people because of this and this', and they don't understand it, and it's difficult and time-consuming to explain. But problems in securities need to be dealt with immediately, otherwise the market repercussion is there."
The CSRC says it is now dealing with disclosure and surveillance. For example, the Shanghai exchange has been told to set up more market surveillance, including on-line monitoring that will later be linked to Beijing.
The CSRC has also devolved some of its power to provincial and municipal regulatory agencies. In March it announced that daily surveillance of trading and investigation of irregularities which are not of national importance, or which involve sums of less than Rmb3 million ($360,000), would be carried out by local regulatory bodies that have been involved with securities from the start, when stock markets were still local initiatives.
Not that this is really a long-term solution. These agencies are not CSRC branches but rather arms of local governments and, as such, may be less loyal to Beijing than to their own immediate superiors. As Zhang Ning, deputy director of the Shanghai Securities Administration Office, points out: "In terms of the relationship between the local regulator and the central regulators, there is no direct administrative control. For example, I and other directors of this office are not nominated by the CSRC - we are nominated by the local government." According to Clifford Chance's Gao: "There has for a long time been talk that it should be run on a national basis, but the practice is still unchanged".
Many issues remain to be addressed. The main message of the changeover in personnel at the CSRC is that the government has decided that the only way to address current problems is to slow down securities market expansion. For example, there has been a reduction in the number of listing approvals. The CSRC also says new stock exchanges are unlikely to be approved.
The bureaucratic slogan that has been selected to characterize these changes is one comparing the virtues of "standardization" (meaning improved regulation) with "deve-lopment" (meaning market growth). The former is to be favoured over the latter.
The more sober atmosphere has not gone down well with market participants, who accuse the CSRC of being heavy-handed. A particular bone of contention has been the CSRC's habit of shutting down markets when difficulties arise. This approach has been particularly prevalent in the case of commodities and futures markets. According to an official at the Shanghai Stock Exchange: "It has given the impression that whenever the CSRC finds something wrong, something against its regulation, it will naturally close it. But that is not the best way to develop a market."
Others agree that holding back development is not necessarily a solution. One former CSRC official says: "They want to stop the water and ensure there's no flood. So they keep building the dam higher and higher. But eventually there will be a major disaster." That may be an extreme view. Considering the speed of growth, there's much to be said for consolidation.
Improvements have already been made. For example, when A share listing restarted last year, the lottery system of share allocation, which had been a major cause of frenzied share-buying, was done away with.
And there are signs that top CSRC's officials have become sensitive to criticisms. As vice-chairman Li Jian Ge points out, with reference to the decision to restart listing of A shares, even though market conditions are still poor: "If the government interferes with the market, it will give investors the wrong signal, whether they make money or lose money." But it will take time for the markets to be convinced.
What's happening to B shares? In January, China's B share market, which is reserved for foreign investors, was put under the control of the China Securities Regulatory Commission (CSRC). B share issues are now to be governed by national regulations and will be approved for listing by Beijing, rather than by regulators at local level.
This should help put the B shares on a more secure footing. According to CSRC vice-chairman Li Jian Ge, the reason the management of the B share market was not centralized earlier was that "the central authorities did not have a clear idea about the prospects for these shares and their direction of development - whether they would exist, or whether they would be cancelled".
Those doubts have now been removed. As Zhang Ning, the deputy director of the Shanghai Securities Administration Office (SSAO), Shanghai's local regulator, points out: "The state has now admitted the legal existence of this B share market which is why, at the end of last year, the central government promulgated a unified regulation to manage the issuing of B shares and the transaction of B shares across the country. So while Shanghai and Shenzhen have less power in managing the B shares, it's a symbol of development."
Few foreign brokerage companies that had set up in China to participate in the country's B share market seriously believed that their business might be terminated from the Chinese side. Still, the paltry number of issues and their relatively small size - most of the major Chinese companies slated for listing were sent to Hong Kong and New York - has meant that it hasn't been a particularly attractive market. Shanghai has fewer than 40 B share listed companies, with total capitalization of about $1.4 billion and Shenzhen has fewer than 30 companies, valued at approximately $1.2 billion.
"Most brokers are not making money," says Dominic Yee, associate director at WI Carr in Shanghai. "They can't make enough in commission in the secondary market because B shares are too illiquid."
Investors are also disappointed. According to Yee: "Most investors in B shares have lost money, and a lot of the China funds' B share weighting is very small, because there are not so many good stocks. H shares [Chinese shares listed in Hong Kong] and red-chip shares offer better liquidity than the B share market."
But is the CSRC's takeover of the B share market likely to lead to any radical changes in this regard? According to vice-chairman Li, it may at least alleviate the problem: "We have noted the poor liquidity and thin trading of B shares," he says.
"At the moment, we are drafting detailed implementing rules for the B shares, which are now under final revision and are expected to be promulgated in the near future. I don't think the promulgation of these rules will change the current situation of the B shares, but it will help to improve the situation."
Li adds: "The minimum requirements for candidate companies will be raised in terms of net assets and capital. More B share companies will be listed, and the size of the B share companies will be larger than the previous companies."
On the down side, the CSRC's decision to draft national B share regulations seems to indicate that the distinction between B shares and A shares reserved for domestic investors will be maintained, ruling out the possibility of foreigners being able to participate in a decent-sized market in the foreseeable future.
In contrast to previous statements that A and B shares might be merged when the renminbi becomes convertible, the CSRC now says that, even after that, the two are likely to be kept separate.
According to Li: "Even if the currency of a country is fully convertible, that does not mean that foreign investors can buy shares of the country. Take Switzerland, for example: registered shares can be bought only by national investors."
There are also technical obstacles to a merger. For example, A shares trade at a substantial premium to B shares. However, the biggest problem is fear of a Mexican-style crisis. Having witnessed the China boom of 1993 and 1994, followed by the bust since the end of 1994 - when, according to one CSRC official, "we didn't change at all" - the CSRC is acutely sensitive to the fickleness of international investors.
It appears that the CSRC will not allow foreign investors a share in the domestic market until a formula for limiting the potential damage of rapid inflows and outflows of foreign capital has been worked out. CSRC officials say they have not yet come up with a strategy, but that various possibilities, such as limiting foreign ownership in companies to a specified proportion, are being considered. - SR |