COMMENTARY: China Modernizing Its Stock Exchanges in Bid for Stability, Credibility

Multiple moves are aimed at luring more foreign funds, keeping top-flight domestic firms from listing in New York or Hong Kong.

Mark Melnicoe
    Apr 13, 2019 5:05 AM  PT
COMMENTARY: China Modernizing Its Stock Exchanges in Bid for Stability, Credibility
author: Mark Melnicoe   

Chinese securities regulators have been taking a number of measures lately to modernize the country's main stock exchanges – a sorely needed effort to bring stability and credibility to the country's $6 trillion markets.

A lot more foreign money could and should be pouring into Chinese equities well into the future, given the country's unique blend of rising technological prowess and a massive middle class that is gaining in spending power.

But a lack of trust holds many foreign investors back, given the numerous scandals that have engulfed the markets. These range from companies cooking their books with fantasy numbers to regulators micromanaging markets during times of high volatility.

Now, numerous actions are under way to upgrade and expand the exchanges, which may also help boost economic development.

Steps Moving Forward

Since President Xi Jinping announced last November that China would create a new high-tech board, similar to Nasdaq, building that exchange has been moving ahead extraordinarily quickly. China's securities regulator released final rules in early March, and by the end of that month, there were already three firms getting feedback - a mere five working days after they applied.

The board's rules more closely mimic those on Wall Street and other Western bourses than do rules for the bigger Shanghai and Shenzhen exchanges. The idea is to get Chinese tech companies to list on the board instead of in Hong Kong or New York, where it's less onerous and the exposure to overseas investors is greater.

Amid a cooling economy, the need for more money coming into China's markets has grown. Listing on the high-tech board, which will be part of the Shanghai Stock Exchange, will open China's most innovative and high-quality companies to Chinese investors.

In another move, regulators have issued a new set of guidelines to ease standards and increase transparency of the review process for IPOs. Many of the new rules are similar to those set up on the fledgling high-tech board. But it remains unclear whether China is moving toward a full registration-based system for all IPOs, which would simplify the process while removing regulatory hurdles.

The Caixin news portal quoted several investment bankers as saying the rules indicate a "more market-driven direction" for the IPO market. This clearly is aimed at keeping quality Chinese tech companies from initially listing overseas, as has been common. Chinese companies have proven their ability to create sensational IPOs. In fact, the biggest IPO of all time was Alibaba's $25 billion listing in 2014, which took place on Nasdaq.

Stock Indexes Respond

While the new high-tech board action is taking place in Shanghai, the Shenzhen exchange is not standing still. It's launching two new indexes to track the performance of businesses registered or headquartered in the Greater Bay Area region, which recently put out a massive economic integration plan.

The area covers nine cities of Guangdong province plus Hong Kong and Macau. As part of China's Greater Bay Area development plan, the launch of the two new indexes is aimed to reflect business performance in the region and diversify investment options, Caixin reported. The GBA has some serious political clout behind it, and this move may boost China's reform efforts in the south.

Meanwhile, Chinese regulators are openly trying to lure Taiwanese companies to list on the new high-tech board in Shanghai. More than 30 Taiwanese firms are listed on China's mainland bourses, and the welcome mat is out for more. "Equal treatment" has been promised to those who wish to land on the high-tech board, spokesperson Ma Xiaoguang said this week at a briefing of the Taiwan Affairs Office of the State Council in Beijing, as quoted by Caixin.

More foreign funds are about to start entering China's domestic stock markets in any case, as MSCI, the leading provider of indexes, is about to increase the China weighting in its emerging markets and other indexes.

Last month, an asset management industry group said regulators should loosen limits on foreign stock ownership in advance of the MSCI move.

"If these limits are not removed, we are afraid that FIIs (foreign institutional investors) may not be able to invest in some of the listed companies, particularly the small cap companies," the Asia Securities Industry & Financial Markets Association said in a report.

More Modernization Ahead

Total foreign ownership in a China-listed company is capped at 30 percent under Chinese law. MSCI said it was removing one company from its China indexes and lowering the weighting of Midea, a major appliance manufacturer, because of investability issues under the rules, Reuters reported last month.

Further market reforms in China may be coming, especially if MSCI gets its way. In announcing the increased weightings, the firm strongly urged greater moves toward international standards.

"We encourage the rapid realization of (reform progress), including permitting the listing of index futures and other derivatives on onshore and offshore exchanges to help address international institutional investors' growing needs for further risk management tools, as well as making further improvements in the settlement cycle, trading holidays and omnibus account structures."

China, of course, has relied on help from industrialized countries in building and reforming its economy over the past four decades. Between trade negotiations with Europe and the U.S. and calls for financial market reform such as that from MSCI, China may have little choice but to cooperate, at least for a while longer, if it wants to continue its historic modernization.