China's Merging Stock Markets

China is facing daunting changes. It is set to join the World Trade Organization, is seeking to develop a new trade pact with the European Union, and must deal with pressing internal economic changes.

China's internal economic changes necessitate the need to consolidate the financial system. A step in that direction would be the merger of the Shanghai and Shenzhen stock exchanges.

As China faces globalization it must strengthen and streamline its securities markets. Consequently, authorities are discussing a plan under which stocks listed on the Shenzhen bourse will shift their listings to Shanghai. There is also a proposal for a second board for start-up companies to be opened in Shanghai. This idea has obviously been influenced by the revolution in start-up companies in the United States, as well as with the success of Hong Kong's Growth Enterprise Market.

The path to a single, regulated national stock market in Shanghai has already taken steps in this direction. The central authorities have consistently blocked a campaign by the small Wuhan exchange for recognition as a third official stock market. They have also dismantled numerous over-the-counter trading centres around China. Moreover, the once-sprawling commodities futures trade has been reduced from 14 to three exchanges, to cut down on overlap and tighten regulatory control.

Benefits of merging

The benefits of merging Shenzhen and Shanghai would be considerable. Together they would have 964 publicly traded companies valued at $422 billion at the end of the first quarter of 2000. At the same time, the two stock markets boasted of 89 stock brokerages.

According to Xinhua News Agency, institutional investors had only 0.4% of the 47.5 million trading accounts. A consolidated market would provide a greater scope for institutional investors, ease demand on scarce resources and boost trading liquidity. This would be especially useful as China seeks to float larger corporations, like its sizeable financial institutions.

A merged stock market based in Shanghai would also bolster that city's bid to regain its standing as one of Asia's premier financial and commercial banking centres, a position it held in the 1930s. This, of course, puts Shanghai in a more competitive position vis-a-vis Hong Kong.

Other measures are being undertaken to consolidate and improve China's financial system with an eye to its entry to the World Trade Organization. In May it was announced that foreign financial firms would be allowed to participate in the underwriting of China's treasury bond sales. Like the idea of stock market consolidation, this measure also seeks to make China's markets more global. At the same time, Chinese authorities indicated that the process of opening the treasury bond market to foreign managers will be gradual and selective. China will commence over-the-counter trading in treasury bonds by domestic corporate investors in the second half of 2000.

Reaching international standards

For China to be a bigger player in the global economy, its financial sector must be brought up to international standards. This is one of the country's most difficult challenges. The failure of Hainan International Trust and Investment Corp to make a Y14.5 billion ($138 million) payment on its Japanese Samurai bond in June 2000 indicates that serious problems continue to dog the sector. 

The points of difficulty facing the financial sector stem from the heavy burden of reforming the country's banks, the related issue of state economic enterprise reform (as many such entities owe the banks money), the weakness of many of the international trust and investment corporations and the pressing need to imbue the system with greater transparency and disclosure. Consequently, the push at stock market consolidation is a step in the right direction, but the road ahead is a long one.

Scott B. MacDonald is a Senior Consultant with KWR International, a New York-based investor relations and consulting firm. This article first appeared in the July edition of the KWR International Advisor.

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