Taking Stock of China's Financial Reforms Agenda

[Barun Mitra]

Taking Stock of China's Reforms
Beijing is still far too reluctant to allow its equity market to
function normally.
By CARL WALTER And FRASIER HOWIE

20 Feb 2014
http://online.wsj.com/news/articles/SB10001424052702304104504579377720301591450

If China's leaders are as serious as they say they are about economic
reform, the country's stunted financial system will be at the top of
their priorities list. So it's worth checking in on the stock market
to see how President Xi Jinping's economic program is going. Answer:
not well.

Fixing the broken process for reviewing and approving initial public
stock offerings deserves its place among 300 items on Mr. Xi's to-do
list released after last year's Communist Party Plenum. The banks
increasingly are in financial distress, burdened by hundreds of
billions of dollars in potentially unproductive lending, and
entrepreneurial private-sector companies need new sources of cash. The
stock market should be such a source.

Beijing has never fully accepted stock listings as a vital means
toward the end of efficiently allocating capital. Since 2000, more
than 1,600 companies have listed in the domestic stock market, an
average of two per week, and the total number of listed companies in
China is now nearly 2,600. Yet that's a drop in the bucket compared to
the size of China's economy. And for long periods--most recently 14
months in 2012-13--Beijing blocked any new IPOs at all.

That suspension has been lifted for now. January saw 52 companies
issue prospectuses, 43 of which completed their listings before the
lunar new year holiday at the end of the month. But there's plenty of
reason to wonder how lasting this new openness to listings will be.

The most recent IPO suspension had reformist roots. Then-new CSRC
chairman Guo Shuqing in 2012 tried to provide greater transparency on
the IPO process, for the first time making public the list of
companies that had filed listing applications. But this might have led
to a little too much transparency, as when the highly respected Caixin
magazine published an expose about the CSRC's listing watchdog, the
Public Offering Review Committee, whose members allegedly were targets
of attempts by some applicant companies to wine, dine or bribe their
way onto the market.

This prompted the IPO suspension as the CSRC promised a revised, more
market-driven approach to managing IPOs. The CSRC heightened its
scrutiny of listing applicants. Following on this work, the commission
also imposed record fines and suspensions on a number of domestic
securities firms accused of helping companies fiddle their books to
meet listing requirements.

The first sign of trouble came when Mr. Guo's tenure was abruptly cut
short when he was relegated to a post in Shandong. In the Chinese
system, this inevitably leads one to suspect he had stepped on too
many toes and that his reformist zeal was not exactly welcome.

And now there are more causes for concern in the listings that came to
market in January under Mr. Guo's successor, Xiao Gang. On the
positive side, January's 43 listings raised a total of 27.3 billion
yuan ($4.5 billion), and were oversubscribed by anywhere from 21 to
176 times. The new shares also were clearly welcomed by the secondary
market.

But 10 of those offerings saw timing and pricing changes to their
originally announced deals, although only one cancelled the offering
entirely. Such changes were unheard of in previous years. The CSRC
then felt the need to investigate 13 deals to ensure compliance with
new rules trying to limit listing prices to prevailing industry
averages. Both of these are notable irregularities.

Meanwhile, the CSRC's concern about frothy trading in new issues is
impeding normal market functioning and price discovery. Before any of
the January IPOs came to market, regulators limited the possible
IPO-day price increase in any listing to 44%. If prices rise beyond
that level, a trading halt kicks in for the rest of the day. This is
on top of existing limitations on one-day price gains. All of this
thwarts the price-discovery role of the market, and mutes what should
be a strong signal to regulators that demand for new shares exceeds
the trickle of new issues being allowed to come to market.

The thread running through all of these moves for many years has been
Beijing's fear of allowing the stock market to work as it's supposed
to at facilitating capital flows. While there is plenty of scope for
the CSRC to boost its capacity to ferret out frauds and genuine
irregularities, authorities still spend too much of their time worried
about questions such as the supply, demand and pricing of shares that
should be left to the market to decide--indeed, that the market
supposedly exists precisely for the purpose of answering.

Unless Beijing shows some willingness to step back and allow the stock
market to function free of overregulation, its other reform efforts
will remain in doubt. Entrepreneurial private-sector companies are
being denied access to funds and are being forced into the shadow
banking market, bankers are unable to build businesses or advise
companies properly, and investors are denied opportunities to exercise
their own best judgment in pursuit of profit. That's not the
rebalanced economy Beijing has promised to create.

Messrs. Walter and Howie are the authors of "Red Capitalism: The
Fragile Financial Foundation of China's Extraordinary Rise" ( Wiley ).