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China needs an all-weather market watchdog

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An investor looks at a stock board at a brokerage in Beijing on Sept. 8.   © Reuters

The problem with markets is that they often act in ways that governments or regulators do not like.

     Never has that been truer than over the past few months in China. First, the country's stock and then its foreign exchange markets sent international investors into panic mode, as the fallout from the collapsing share price bubble drove global shares and emerging-economy currencies lower.

     In such volatile times, it is essential that investors and policymakers have as much information and meaningful analysis as possible. Trying to distinguish signal from noise is far from easy in developed markets, but it is even more complicated in the case of China, where so much activity and policymaking takes place behind closed doors.

     Chinese censorship is no secret, with many topics being strictly taboo. The financial press has remained relatively free, with a number of well-known media outlets doing some excellent reporting to shed light on the opaque world of Chinese decision-making. Yet those days may be numbered, with the recent televised confession of a financial journalist sending a very worrying sign.

     According to the clip, the journalist wrote a story in late July about the possible withdrawal of government support from the stock market, based on private conversations and using his subjective judgment. That is almost the definition of value-added journalism.

     That the story was effectively true -- within weeks, the government announced that it was withdrawing or at least limiting its ongoing stock market support -- was irrelevant to the authorities. The message is clear: Do not write anything that could be construed as negative by the market or that could dent confidence in the government's rescue efforts.

     At the same time, a number of brokerage executives, as well as a former China Securities Regulatory Commission official, have been detained in relation to possible insider trading. Details of the actual charges remain sketchy.

     If the regulator is now clamping down on market malfeasance, the glaring question is where has it been for the past months and years? Chinese markets are notorious for insider trading, pump and dump strategies and outlandish corporate claims, yet the regulator has been remarkably inactive. It is not that it has done nothing, but its measures have done little to change the nature of the market over the past decades.

Someone to blame

At the beginning of July, the government made it clear it was looking for those responsible for the market's collapse. Yet nothing has so far come to light that would even suggest there are such people.

     Information is limited, but many of the regulator's charges and penalties relate to activities in July and are connected with the government's own bailout; that timing would be well after the market started to decline.

     The reality is there will be no guilty party responsible for the fall. But if it looks hard enough, the CSRC will be able to find numerous examples of violations of trading limits, illegal financing or even of insider trading, all of which have become commonplace practices while the regulator seemed to have been looking the other way.

     Strong enforcement of existing rules and laws is welcome and long overdue, but taking action now, after the horse has bolted, reeks of a political clampdown to stifle discussion about the past few months and will deter some legitimate trading. Could this really mark a change in mindset by a more emboldened regulator? As long as it is seen as not only market policeman but also market cheerleader-in-chief, the results will be minimal.

     The role of the regulator is in some ways very simple. It is there to ensure a fair and transparent marketplace, in which investors and brokers abide by the published rules. That, of course, means taking a tough line on stock manipulation, insider trading and creating a false market.

     Until now, the CSRC has failed to do that. When the market is falling, the regulator is expected "to do something" to prop it up, and when it is rallying it is too often unwilling or unable to clamp down on excesses. Independence of action is essential for proper regulatory enforcement, but is sadly difficult to achieve in China.

Rules on the fly

Not only has enforcement been haphazard but the authorities are now making rules on the fly and in reaction to market moves. This is the worst possible approach to rule-making.

     After clamping down on all index futures trading in July, the China Financial Futures Exchange drastically reduced the number of positions that could be opened in a single day, only then to revise the limit down by 90% a mere five days later. This, frankly, is incompetence and sends a very poor signal to the market. Not surprisingly, trading volumes fell more than 95%. The market may be open, but trading not so much.

     Regardless of the Chinese government's economic track record over the past few decades, its ability to regulate and absorb market volatility has been severely shaken over recent months. The inability to provide a consistent and clear message has left investors' portfolios gutted. Anyone who did not sell in early July, believing in Beijing's assurances of market support, will now be nursing losses.

     Stock prices and exchange rates will rise and fall, that is the nature of markets. China is mistaken if it thinks that controlling that movement is its main challenge.

     Building a strong, independent market regulator that will enforce clear rules -- in good times and bad -- has to be a focus for President Xi Jinping's government. Pointing fingers at journalists or even corrupt officials and brokerage executives may provide some short-term comfort to those in charge, but it is not a long-term solution. If China wants to be a global financial leader, then much work needs to be done.

Fraser Howie is the co-author of "Red Capitalism: The Fragile Financial Foundation of China's Extraordinary Rise." He has worked in China's capital markets since 1992.

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