September 11, 2017 3:00 pm JST
Fraser Howie

China's stable markets are nothing to crow about

Regulator's claim of victory over financial risk misplaced

An advertising board showing a Chinese stone lion near the headquarters of the China Securities Regulatory Commission in Beijing. © Reuters

The China Securities Regulatory Commission's recent declaration of "effective measures" taken by it and other government departments to stem financial risk in the aftermath of the country's 2015 stock market collapse marks a hollow claim of victory. Regardless of how the market is now moving, to suggest that it is back to "business as usual" is highly misleading.

The CSRC's mid-August statement highlighted several points in claiming that the market has returned to normal: the relatively strong performance of China's main stock indexes this year; comparable price-to-earnings ratios for domestic indexes as compared with those of global markets and the fall of some PE ratios from previous eye-catching highs; stable market operations with healthy volumes trading and settling each day and stocks moving generally within a narrow daily range; and the continuing opening of new investor accounts.

All of these points are true and many even welcome, but they should generally not be the concern of the CSRC which has long confused its role as regulator with that of cheerleader-in-chief for the market.  

The hope a number of years ago was that the CSRC would shake its addiction to trying to manage share prices and focus instead on issues of fairness, transparency, ensuring a level playing field for all investors and developing systems and operational procedures that would guarantee smooth trading, clearing and settlement of trades. By trumpeting those points about the market's current state, the CSRC has made its own job more difficult as investors will continue to look to it as an arbiter of market price levels instead of an arms'-length regulator.

The list of effective measures also belies the fact that the government still owns approximately $100 billion of stock bought in the second half of 2015. This purchasing, both directly and via proxies such as state-owned brokerages, is now seen as having played an important role in bailing out the market.

The success claimed by the CSRC also neglects the complete lack of progress in moving toward a registration-based system for initial public offerings. These days the CSRC seems more entrenched than ever in regulating the flow of IPO approvals.

In addition, China's index futures market has been totally gutted since the CSRC's 2015 intervention, with traded volumes down by over 99%. Nor do its "effective measures" take into account the new practice of micromanaging institutional investors by warning them not to sell during sensitive periods such as National People's Congress sessions.

No smoking gun

To its credit, the CSRC has caught a number of stock manipulators and insider traders who have for years been openly abusing the system and profiting handsomely. Such investigations are long overdue and must continue because there is little to show that anything has changed regarding those who are happy to use their access to privileged information for their own profit.

A handful of cases have also been brought against traders and brokers that have highlighted shortcuts taken on risk management and know-your-client norms.

Overall, though, nothing has emerged to prove any wider plot or conspiracy to bring down the market, as was initially claimed in the aftermath of the 2015 crash when officials talked of "malicious short selling."

Meanwhile, foreign holdings of Chinese stocks are back near the highs seen in 2015. The number of applications for qualified foreign institutional investor status has fallen to a trickle however. This is partly because of the new Stock Connect links with the Hong Kong market that have provided simpler access to domestic shares but daily trading volumes through the links amount to only around 5 billion yuan ($770 million) in a market that can easily trade $50 billion daily.

MSCI did decide in June to include some Chinese domestic shares in its global emerging markets indices but only ones that are accessible via Stock Connect facility. This amounts to a fraction of the 3,000-plus companies listed in China.

The reality remains that foreign capital still holds a tiny piece of the domestic market and there are few drivers in play to extend that. Talk continues of potential major changes to open up markets further to foreigners but nothing will come before the Communist Party Congress in October and even then, as with all Chinese reform, any move will be gradual.

They may declare victory against financial risk but it surely knows much work needs to be done to build a trustworthy market. The post-2015 bailout measures have brought temporary stability to index levels but this kind of success will be fleeting. Creating a trustworthy market will require the removal of moral hazard from the market to make investors responsible for their own investments, the better pricing of capital, the honest and complete disclosure of financial data, and clear rules fairly enforced.

Unless this can be achieved, domestic markets will still be seen as casinos rigged for the benefit of a few. Dynamic companies will still look to list overseas, foreign investors will remain suspicious of domestic shares, and booms and busts will return because the market remains driven by government policy and interference, not economic and corporate financials.

The lack of maturation of China's stock market will not herald any grand collapse or market failure. Instead, as with much in the Chinese economy, it will tell the story of missed opportunity and wasted resources.

Few talk now of the bold reforms announced after the Communist Party Central Committee session in late 2013 or the proclamation then that markets would become a decisive factor in the economy, but with President Xi Jinping's second term pending, some hopeful souls still believe real change is coming. If so, the stock market is not ready to help.

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

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