CSRCÆs Cha defends her record

Progress is being made, but do the markets need more?

At the China-Singapore Partnership Forum in Shanghai at the end of last week, the China Securities Regulatory Commission's vice-chairperson Laura Cha said market players were increasingly falling in line with the commission's fight to improve corporate governance at listed companies and level the playing field for the private sector. The latter, she said, now made up 20% of the market's total capitalization.

But there have been complaints from some quarters that the CRSC's tough approach last year exacerbated markets hurt by the government's desire to sell off non-tradable state shares. However, Cha argued that, "listed companies welcome the opportunity to disentangle their assets from the controlling shareholder, who often appropriates much of the cash designated for the listed company."

Listed companies are also keen to prevent practices such as IPO proceeds being held in the parent company's bank account, as well as abusive related party transactions, she commented. The worst culprits, she added, were often the state-owned enterprises owned by central ministries, which siphoned cash out of the listed company for their own use.

As evidence of the market's greater acceptance, Cha cited a recent two-pronged investigation by the CSRC. During the first part, listed companies were sent a list of questions by the CSRC on corporate governance matters. Answers to the questions had to vouched for by a majority of the board.

The second part involved onsite visits by CSRC officials. The object of the exercise was education rather than confrontation, and many companies welcomed the opportunity to share information "with enthusiasm", she said.

She also defended the CSRC's record against critics who say the regulatory organization is not properly structured to carry out root-and-branch reform. Critics have, for example, pointed out that the Ying Guangxia case was uncovered by the media, making the CSRC appear as it was playing catch up.

For a long time, the CSRC was understaffed and had no real enforcement powers. Only recently have executives begun receiving prison sentences and personal fines, rather than the company being fined.

Still, the CSRC has played a crucial role in improving the quality of listed companies by selecting them on merit via a listing committee, said Cha, and now also works closely with law enforcement organizations.

Under the CSRC's new system, companies now have a better chance of being listed if they meet certain criteria, although it is not automatic. The CSRC still has the power of veto.

The government's previous role in selecting listing candidates had stunted the role of financial intermediaries in China, Cha said, and she emphasized the need for further improvements in the auditing, legal and accounting fields.

Only that way could the markets regain investor confidence, she said.

Referring to 'China's Enron', the massive billing fraud at what was then considered a high-tech blue chip - Ying Guangxia - she said participants lost confidence, just like in the US after the Enron debacle. But, like in the US, the markets in China would recover as long as investors felt assured the necessary changes were being made.

Securities companies are also being judged on how well they carry out due diligence. If abuses by the candidate are uncovered, the sponsor has points deducted from a 12 point total and their chances of lead managing further IPOs are hurt. They are also restricted as to the number of candidates they put forward, which should encourage them to pick the best ones.

Previously, the government had taken that decision, with little regard for the financial health of the companies involved, leading to many value-destroying companies being listed.

But now, companies that make a loss for three consecutive years are de-listed and their shares traded on an OTC market. 12 Companies have so far suffered that fate, Cha pointed out.

The CSRC was also aware of the importance of the private sector. Cha said there was no discrimination against them in the listing process. She also claimed that private companies now made up 20% of the market's total market cap.

The next step in the reform process was to improve the organization of the mass of material the companies have to reveal under recently disclosure laws.

"Financial information needs to be clearly tabulated rather than buried at the back of company accounts," she said.

She also said that in line with the CSRC's pro-market approach, Chinese companies that wanted to listed abroad are free to go ahead and negotiate directly with the relevant stock exchange. No longer are they be subject to a CSRC veto.

Still, the listing process is not ideal according to Stephen Green, author of a recent book, "China's stock markets: A Guide."

"Although candidates have to face certain performance criteria, which is good, ultimately they are eligible based on a bureaucratic decision rather than on the market," he says.

In China, a company which is accepted by the listing committee simply joins the huge queue of 3000 companies wanting to list. The listing committee controls the rate of listings to prevent an oversupply of shares from companies eager for capital swamping the market. Companies list at a rate of one or two per week.

By contrast, in developed markets, companies compete for scarce and mobile capital directly against each other. Investment banks will only take the underwriting risk if they are sure the company's IPO will make money. That involves listening to the market.

China's different. IPOs generally soar by over 30% on being sold into the secondary market, almost guaranteeing a profit for the underwriter and initial subscribers, a phenomenon partly attributed to the undersupply of alternative investment instruments, and to under-pricing.

That could be due to the controlling shareholder's stake being so large that he's not worried about dilution - that is, about selling his shares off cheap, since he has so many of them, suggests Green

It's not clear what would happen if the 3000 companies were allowed unrestricted access to the market.

On the one hand, the oversupply of shares could flood the market. But if investors felt they could trust company disclosure, and the market was not rigged, investors could make the decision concerning which companies to reward with capital, says Green. For their part then, investment banks, facing the risk of not selling IPO shares, would only bring to market the ones they were sure would raise capital. This market mechanism would be an automatic stabiliser on new issues and would stop any 'flood' of new equities.

And if companies were encouraged to sell off larger stakes, then they would care much more about pricing IPO shares at higher levels, thus reducing underpricing.

So sooner or later, investors would be forced to make decisions concerning company fundamentals rather than just on the share price.

Increased supply would also help China's notoriously high price to earnings ratio to come down. However, such a scheme might run into opposition from the government, which seems determined to prevent the Shanghai composite index from falling below 1500 points.