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Capital market reform catalyst for China's restructuring

To Chinese investors' disappointment, the stock market remained listless in the first half of this year, offering no hint that major indices may begin to end the bearish cycle soon.

Experts say this reflects urgent need to reform the capital market to give full play to its critical role in allocating resources and accelerate the country's economic upgrading.

The benchmark Shanghai Composite Index, which tracks larger listed companies, dropped more than 3 percent in the first six months, defying the steady upward trend of the country's economy.


The stock market is clearly not an angel for individual investors, as the index has been stuck in a lengthy bearish cycle since August 2009, down from 3,478 points to around 2,000 at present.

In many investors' minds, the Chinese stock market has decayed into a gambling den where companies make fortunes overnight just by being listed, not a platform for investment and corporate financing, far from what the government wants.

However, many small and medium-sized enterprises (SMEs) are eager to capitalize on the market to get financing, as bank loans are usually expensive for them, if not impossible, due to relatively high risks.

Yang Renchao, 37, who now runs a software company in China's southern most Hainan Province, knows the difficulties from first-hand experience.

Before starting his own business in 2007, Yang spent more than 10 years in Zhongguancun, the Beijing technology hub dubbed China's Silicon Valley.

He saw how developing high-tech firms was very difficult, partly due to the difficulty of getting finance. "I worked for at least four companies that went bankrupt in only two to three years," he said.

Yang's Hainan Hongyuan Taisi Science and Technology Co., Ltd., is witnessing strong performance at present, prompting the entrepreneur to prepare to try to acquire finance from the country's SME equities exchange system to help expand his business.

In some senses though, the stock market has failed to meet the needs of both investors and companies in recent years.


Being aware of the contradiction, the Chinese government has explored to reform the capital market, especially the stock market.

China is pursuing a registration-based initial public offering (IPO) mechanism, a multi-layer equity market, high-quality listed companies, an improved delisting system, as well as just and equitable market order, according to a guideline issued in May.

Wang Lianzhou, economist and honorary chairman of the International Investment and Management Association under Peking University, said the fundamental reason for the capital market's weakness is its insufficient support of the country's real economic activities.

"The real economy is the foundation, while the capital market should serve it," Wang said.

On the stock market, problems of insider trading and inflated figures appear frequently due to the approval-based IPO system and insufficient supervision and punishments.

Wang's views were echoed by Kuang Xianming, director of the Research Center for Economy at the China Institute for Reform and Development, who said that insider trading and the lack of investor protection have eroded investors' confidence.


Kuang said the capital market reform serves as an accelerator for restructuring and upgrading of the real economy, as the market is a significant platform for allocating financial resources.

"Based on realities of other countries, the more developed a capital market is, the faster the country's economic upgrading process will be," he said.

As China is confronting a pressing task to steer its economic growth onto a balanced and sustainable path, there is urgent need for the capital market to become more market-oriented, in his view.

The government should reduce administrative intervention in the capital market to allow market forces to play the decisive role, especially in terms of market entry and exit. "It should only firmly control systematic risks," according to Kuang.

Wang also said the government should enhance supervision but relax administrative grips to unleash market forces during the capital market reform.

Excessive reliance on indirect finance, mainly bank loans, has also been a restraint for economic upgrading, and the government has announced a rise in the proportion of direct financing.

Kuang said boosting the proportion of direct financing will benefit the country's industrial upgrading as it will support the growth of new strategic industries.

"Generally speaking, new strategic enterprises originate from SMEs, which have difficulty getting bank loans due to great uncertainty," he noted.

In China, new strategic industries include the sectors of energy conservation and environmental protection, new information technology, biology, high-end equipment manufacturing, new materials, new energy and new-energy cars.

Those sectors are crucial for industrial structural upgrading, energy saving and emission reduction, raising people's living standards and adding jobs, according to a national plan.

The development of direct financing, including stocks, bonds, venture capital and private equity, will provide funds for those companies with a mechanism to spread risks and share benefits, in turn pushing forward the country's economic upgrading, Kuang said.


© LEHMAN, LEE & XU 2014.
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