China's CSRC under pressure

How will the China Securities Regulatory Commission (CSRC) react to the criticisms emanating from last week''s Beijing Securities Summit?

An extraordinary sense of gloom surrounding the securities market has emerged from a top level finance conference held last week in Beijing. The gathering of leading financial executives was notable also for being the venue for CSRC chairman Shang Fulin's first big speech.

But other than promising that China's 130 securities companies were on track to be given permission to issue bonds publicly and by private placement, Shang didn't announce any new market boosting measures. That promise, long in the works, failed to spark the markets which saw thin trading of RMB4-5 billion in volume on both the two exchanges on the days of the summit, while the Shanghai Composite index dropped below the psychologically important 1500 mark.

Despite economic growth averaging 8% over the last two years, the market's last high was 2200 in June 2001.

In fact, the markets are in a very serious condition, say observers, who point out that they are not fulfilling any of their three functions of raising capital, pricing capital and acting as a barometer of the general state of the economy.

Figures show that China's stock market could, rather alarmingly, be slowly dwindling away.

For example, the ratio of the funds directly raised in the capital markets to all funds raised has actually fallen to 5% compared to 8% in 2001, according to figures from the central bank. And last year, according to figures from the CSRC, 122 companies raised RMB78.8 billion ($9.39 billion), only 67% of what was raised in the previous year. In the first half of this year, only 58 companies have issued shares, raising just RMB32 billion, or around 80% of the amount raised last year for the same period.

Such was the depth of the gloom at last week's conference that the chairman of Galaxy Securities talked of the 'marginalization' and imminent 'third world' nature of China's financial system unless the problems in the system were fixed.

It looks as if the old fight between the 'pro-market' China Regulatory Commission, as it is characterized in China, and those in favour of a continuation of the old system, where huge profits were made on the back of fraud, price ramping and official tolerance of a bubble mentality, is set to continue.

But while nobody denies the old system was marred by dishonesty and its focus on listing the most fragile of China state owned enterprises, some say that the CSRC has come in with too rigid a mandate.

One example is the commission structure. Last year in June the floating commission was introduced. The idea behind it was to reduce transaction costs. But the actual result was different, argue some: "The market obviously hasn't been stimulated, but it does mean nobody can now make a profit," one banker said at the conference.

Another grouse refers to the listing procedure, which is determined by committee elections at the CSRC. This gives the committee enormous power, and there have been rumours that committee members, despite their anonymity, have been 'nobbled'. Some observers point out that it's hard to see this system as a break away from the previous model of providing provinces with quotas determining the number of companies they could list.

And to add insult to injury, securities houses have been banned from collecting interest from the cash deposits put forward by their clients. This directive by the central bank is actually part of a wider plan to ensure the naming of accounts by their real owners. But again, observers say that regulators are driving the process too strictly and fast, and they will ultimately scare investors from the market.

Others point out that while the CSRC seems to presiding over its own apparent demise, in contrast, the China Insurance Regulatory Committee and the China Banking Regulatory Committee are growing in stature. The former is presiding over a market growing at a very vast clip and the latter oversees the biggest concentration of funds in the financial system, far outweighing the funds in the capital markets.

The decline in direct financing is not of course, just a problem for the CSRC, it's also a problem for the whole economy since so much of the systemic risks fall on the banks - rather frail vessels, as has been widely reported, for such trust.

The main victims of this situation are the securities companies, and sector reports estimate that the whole sector in the first half of this year saw a reduction of 5% on its stock trading, 44% and 47% respectively on fund and bond trading and that underwriting revenue was only 40% of the same time last year. In 2002, the sector made a loss as a whole of RMB 2.6 billion from 51 companies in the red.

Of course, the CSRC is in an impossible position. On the one hand, its young technocrats want to introduce a first class capital markets system. But to do that it has to rout out many of the existing ills - potentially crippling market confidence in the process. Indeed, corporate governance was one of the focuses of the summit, with an emphasis on finding ways of preventing the brokerage houses misappropriating customer funds.

"The whining is coming from the securities companies who have benefited for so long from a rigged market," says Carl Walter, author of 'Privatizing China', a recent book on China's stock market. In fact, he believes that the CSRC needs to go much further.

"Legal person and state share prices need to be priced with reference to the market, rather than off net asset value - otherwise, what's the point of having a market," he points out with reference to the two thirds of market capitalization held in different categories of so-called non-tradable state shares. The government is desperate to sell these off to raise capital, but every time it threatens to do so, the market tanks on the back of fears huge new supply will dilutre the value of existing holdings.

Walter adds that the CSRC could be much tougher on bad companies, only 12 of which have been delisted for persistent loses It could also allow new companies to sell state shares into the market, rather than just new shares as at present. This would also help to solve the problem of the state share overhang.

But his main concern is the power of the vested interests. "It's not clear whether the CSRC has the political muscle to push these reforms through. The top securities companies get too many benefits from the old system, " he says.

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