China backs CSRC's A-share reform plan

The government and the communist party put their weight behind the A-share reform plan.

China's most sophisticated and occasionally most reviled regulator, the China Securities Regulatory Commission (CSRC), finally got the heavyweight support it needed Wednesday morning after key government ministries issued a joint circular extending the recent stock market reforms to the rest of the market's 1,300 companies.

Apart from the CSRC, the signatories comprised the State-owned Assets Supervision and Administration Commission (SASAC), the Ministry of Finance, the Ministry of Commerce and the People's Bank of China.

Observers say this is a crucial sign that the CSRC-sponsored plan has been fully adopted by the top levels of the Party and government.

The commission has been under intense pressure from an investment community enraged by collapsing stock prices, since the reforms focus on a sell-off of the government shareholding, hitherto un-tradable, which comprise two-thirds of the country's $450 billion stock market capital.

That has caused skepticism about the CSRC's experiments being rolled out beyond the small number of existing pilot companies, given the central government's fear of antagonizing small shareholders.

The CSRC, staffed by numerous US-educated finance specialists, wants to unify management incentives with minority shareholder incentives through the sell-off. Once all shares are tradable, managers will be forced to keep shareholders happy by increased returns or suffer a higher cost of capital. Managers will no longer have the huge ownership buffer of non-tradable shares to ward off hostile takeovers and raise cheap capital.

So far, 46 pilot companies have been put forward for the reforms, comprising a varied selection in different industries. This was to enable the CSRC and the market to garner experience in the process, say observers

Observers say that the extension of the reforms to the whole of the broader market and the numerous government signatories to the document, show that the top echelons of the central government will now provide essential momentum to the reform process.

"It's no longer just the CSRC trying to do everything on its own. This is (president) Hu Jintao and (premier) Wen Jiabao backing the reforms," says one fund manger at a European fund management company in Shanghai.

"This is very important for dispelling any doubts in the market that the authorities is half-hearted about the reforms, or that they will back-pedal," he says.

One example of the new commitment is that the approval for the process will be delegated to the provincial governments instead of being done by the centre. Since the top echelons of the communist party are now behind the reforms, the pressure on the hitherto reluctant provincial authorities (who will lose cash cows and employment creation vehicles) to back the sell-off will be huge.

"If they don't toe the line, they risk being sacked," says one fund manager, adding that decentralization to the provinces will also prevent bottle necks at the centre.

The government has further facilitated the reforms by increasing the attraction of A-shares through excluding companies which have H- and B-shares from compensation payments. Foreign investors could thus sell H-shares and buy A-shares, a process helped by the increase in the Qualified Foreign Institutional Investment quota from $4 billion to $10 billion this year, and the recent revaluation of the renminbi, which means that Chinese shares are cheaper than they were in the past. In addition, the government has reduced the supply of new shares by freezing new IPOs and limiting the sell-off through lock up clauses.

Some observers warn against euphoria, however.

"Although the Shanghai composite index (covering A and B shares) has improved since it fell through 1,100 points in July, that's mainly on the back of government assistance. Longer term, there is no sidestepping the fact that the state share reform will increase total supply, which will then lead to downward pressure on prices," warns Peter Alexander, principal of Z-Ben, a Shanghai-based asset management consultancy.

Wednesday, the Shanghai composite index finished at 1,167.137, up 17.18 points, or 1.49%.

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