Securities Markets in China

Securities Markets in China

Prof. Stephen Y. L. CheungDepartment of Economics & Finance

City University of Hong Kong

February 2003

Stephen Cheung Securities Markets in China 2

Content

Brief on Economic Development in China Private Sector Development Stock Markets in China China’s Listed Companies

• Problems and Regulation• Case Studies

Corporate Governance• Case Studies


Country Profile: National Flag


Country Profile: Brief History I

In 1949, Communist Party under leadership of Mao Tse Dong founded People’s Republic of China (PRC)

Political movements through 1950s to early 1970s e.g. Great Leap Forward, the Cultural Revolution

Economic growth was slow


Country Profile: Brief History II

Deng Xiao Ping came to power and introduced a number of economic liberalization programmes

• “No matter whether it is a black cat or a white black, it is a good cat as long as it catches mice.”

• Reform in agricultural sector• Open-door policy to foreign investors• Special economic zones• Rapid economic growth which led to overheating and

social unrest


Country Profile: Brief History III

In 1993, introduced austerity measures to curb inflation which dampened economic activities

Maintained stability of Renminbi after Asian currency crisis in 1997 and economic slowdown prompted pump-priming measures to boost domestic demand


Country Profile: Brief History IV

Growth due to

• Modernization programmes• Open-door policy• Changed incentive system towards market-

oriented economy


Country Profile: Economic Structure

1997 1998 1999

GDP (Rmb b) 7,607.7 7,955.4 8,191.1

Real GDP growth (%) 8.8 7.8 7.2

Inflation rate (%) 2.8 -0.8 -1.3

Population (m) 1,230.0 1,248.1 1,259.1

Exports (US$b) 182.7 183.4 194.9

Imports (US$b) 136.4 134.6 165.7

C/A balance (US$b) 29.7 29.5 15.7

External debt (US$b) 159.2 165.3 164.8

Source: EIU, Country Report: China, 4th quarter 2000


Country Profile: Country RiskMarks Weighting (%)

Political Risk 15.32 25

Economic Performance 9.46 25

Debt Indicators 9.70 10

Debt in Default or Rescheduled 8.36 10

Credit Ratings 6.04 10

Access to Bank Finance 0.06 5

Access to Short-Term Finance 2.32 5

Access to Capital Market 2.80 5

Discount on Forfeiting 2.45 5

Total Score 56.51 100

Ranking Among World• September 1998• March 1999

42

45

Source: Euromoney, March 1999


China’s Emerging Private Enterprise

Importance of the private sector in China

• More than half of economic activity• More than 2/3 if agricultural and collectives

enterprises are counted• During 1991-1997, output 71% and

employment 41%


Number of Registered Private Firms in China

0

200

400

600

800

1000

1200

1991 1992 1993 1994 1995 1996 1997

Th

ou

sa

nd

sChina’s Emerging Private Enterprise


Employment in Registered Private Firms in China

0

2

4

6

8

10

12

14

16

1991 1992 1993 1994 1995 1996 1997

Mill

ion

sChina’s Emerging Private Enterprise


Output of Registered Private Firms in China

0

500

1000

1500

2000

2500

1991 1992 1993 1994 1995 1996 1997

Bill

ion

s o

f R

MB



Net Foreign Direct Investment Flows to China

0

5

10

15

20

25

30

35

40

45

50

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998

Bill

ion

s o

f U

SD



Major turning points in private sector development

• Phase I – 1978-1983 Individual business (getihu)

• Phase II – 1984-1992 Privately run enterprises (siyingqiye)

• Phase III – 1993-Present After Deng’s famous southern tour in September 1992



China’s Trade Reforms in Preparation for Accession to the WTO

• The elimination of import quotas by 2006• The elimination of import tariffs on computers, semiconductors and related products

by 2005• Reduction in import tariffs on agricultural products from 22% to 17.5%• Reduction in import tariffs on industrial products from an average of 24.6% to an

average of 9.4%• A reduction in import tariffs on motor vehicles from 80-100% to 25% by 2006 and

10% for parts• Permission for up to 50% foreign ownership of telecoms and insurance• Permission for importers to own domestic distribution networks• Full market access for foreign banks within 5 years of accession; foreign banks will

be able to conduct local currency business with Chinese enterprises 2 years after accession



Problems

• Unclear property rights• Hybrid forms of ownership• Rent-seeking activities• Collusion between local government and

enterprises



Employment Growth Rates by Type of Employment

-40

-20

0

20

40

60

80

100

120

140

160

1991 1992 1993 1994 1995 1996 1997 1998

Pe

rce

nta

ge

SOECollectivesForeignDomestic Private



Share of Private Sector in Total Industrial Output in China

0

5

10

15

20

25

30

35

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997

Per

cent

age



Share of Private Sector in Total National Employment in China

0

2

4

6

8

10

12

14

16

18

20

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997

Per

cent

age



Financing needs/ Level of risk

Time

High risk

Bank finance

Low risk

Growth

Going public IPO

Development finance

Early stage finance

Seed capital

Family

Idea development

Business creation

Business development

Industrial production

SME Large Company


Financing private enterprise

1. Start-ups and younger firms• Insider finance• Trade credit• Family and friends

2. As the firm grows• Venture capital• Banks and finance

companies3. Mature stage

• Public equity and debt markets


Financing Private Enterprise

1. Access to bank lending As of 1998, private sector’s loan <1% of

total lending The figure is low, compared with the

sector’s contribution to employment and GDP

Policy lending




2. Access to private equity Lack a developed, organized private equity

market for long-term capital China had 92 venture capital in 1999 Insurance companies and pension fund not

permitted to invest in non-listed securities




3. Access public equity market Private firms have limited access to stock m

arket Quota system and size requirements In 2000, 11 out of 976 companies In 1998 & 1999, only 4 non-state IPOs



Stock Markets in China: History I

Foreign securities houses in 1869 and Chinese securities dealers appeared in 1880

Stock Association of Shanghai established in 1891

Issue of bonds in 1894

Commercial Association of Stocks established in 1914 in Shanghai

Shanghai market opened officially in 1920 , which mainly dealt with government bonds; thereafter stock markets established in Beijing, Tianjin, Guangzhou, Nanjing, Suzhou, Ningpo


Stock Markets in China: History II

All stock markets were closed when Communist Party came into power in 1949

In couple with open-door policy, Third Plenary Session of 11th Central Committee of Communist Party of China got idea of reestablishing securities markets in 1978

Revised securities markets with issue of state Treasury bills in 1981

Local enterprise bonds followed suit in 1982


Stock Markets in China: History III

State-owned financial enterprises issued financial bonds and development of primary share market began in 1984

State enterprise corporate bonds issued and PBOC initiated and authorized over-the-counter market for secondary trading in Shanghai in 1986

Developed market for trading state Treasury bills in Shanghai and Wuhan in 1988

Stock Exchange Executive established to formulate development of a national stock exchange in 1989


Stock Markets in China: History IV

Securities Trading Automated Quotation System (STAQ) commenced operations in 1990

Shanghai Stock Exchange opened in 1990 and Shenzhen Stock Exchange opened in 1991

B shares first listed and traded in 1992

National Electronic Trading System (NET) started operations and H shares issued in Hong Kong, and N shares listed in New York as American Depositary Receipts (ADRs) in 1993


Stock Markets in China:Securities Regulatory Framework

China SecuritiesRegulatory Commission

Shanghai / ShenzhenStock Exchanges

Shanghai / ShenzhenSecurities Markets

State Council

State Council Securities Policy Committee

Shanghai / ShenzhenSecurities Regulatory Office

People’s Bank of China


0

500

1,000

1,500

2,000

2,500

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Ind

ex

-100%

-50%

0%

50%

100%

150%

200%

Pe

rcen

tag

e C

han

ge (

Ba

se Y

ear

: 199

2)

Shanghai "A" Index Shanghai "B" Index Shenzhen "A" Index Shenzhen "B" Index

Shanghai "A" Index % Change Shanghai "B" Index % Change Shenzhen "A" Index % Change Shenzhen "B" Index % Change

A Shares B Shares

Stock Markets in China:Index Performance (Mainland)


0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

1993 1994 1995 1996 1997 1998 1999 2000 2001

Inde

x

-90%

-80%

-70%

-60%

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

Per

cent

age

Cha

nge

(Bas

e Y

ear:

199

3)

HK Red Chip Index HK H-share Index HK Red Chip Index % Change HK H-share Index % Change

Red Chip

H Share

Stock Markets in China:Index Performance (Hong Kong)


Stock Markets in China: Shanghai I

Summary StatisticsSummary Statistics 1999 2000 2001

Market Capitalization (Rmb$b) 1,458.1 2,693.1 2,759.1

Market Turnover (Rmb$b) 424.97 848.13 838.21

Number of Company Listed 484 572 646

Market P/E (%)• A Shares• B Shares

NA

38.13

NA

32.95

58.22

6.04

37.12

37.71

10.04

Shanghai Composite Index 1,366.6 2,073.5 1,646.0

Shanghai B-Share Index NA 28.71 37.91


Stock Markets in China: Shanghai II

Number of Listed SecuritiesNumber of Listed Securities 2002

A Shares 701

B Shares 54

Funds 25

Treasury Bonds• Spot• Repurchase

16

9

Others 14

Source: Shanghai Stock Exchange: www.sse.com.cn


Stock Markets in China: Shenzhen I

Summary StatisticsSummary Statistics 1999 2000 2001

Market Capitalization (Rmb$b) 1,189.07 2,116.01 1,593.2

Market Turnover (Rmb$b) 396.43 760.62 608.11

Number of Company Listed 463 514 508

Market P/E (%)• A Shares• B Shares

41.14

37.56

NA

30.59

56.03

5.71

36.30

39.79

10.38

Shenzhen Composite Index 402.18 635.73 475.94

Shenzhen B-Share Index NA 53.58 84.66


Stock Markets in China: Shenzhen II

Number of Listed SecuritiesNumber of Listed Securities 2002

A Shares 450

B Shares 54

Funds 16

Corporate Bonds 3

Treasury Bonds• Spot• Repurchase

15

2

Source: Shenzhen Stock Exchange


0

5,000

10,000

15,000

20,000

25,000

30,000

Do

llars

(10

0 M

illio

n lo

cal c

urr

ency

)

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Year

Shanghai A Shanghai B Shenzhen A Shenzhen B Red-chips H-shares

Stock Markets in China:Market Capitalization


Stock Markets in China:Number of Listed Company

0

100

200

300

400

500

600

700

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Year

Nu

mb

er

Shanghai A Shanghai B Shenzhen A Shenzhen B Red-chips H-shares


Stock Markets in China: Structure of Paid-Up Capital in 1996

Shanghai (m) Shenzhen (m)

Negotiable:

A Shares 14,132.23 12,712.25

B Shares 4,542.77 3,212.39

H Shares 6,984.18 1,403.53

Non-Negotiable:

State 28,355.62 14,446.19

Legal Person 19,373.08 14,351.61

Other 1,500.21 1,156.60

Source: Fundamental Analysis of Chinese Listed Companies 1997


Stock Markets in China:Categories of Shares

Shares held by the State• Nation• State enterprises which own company

Shares held by legal person• Companies, unit or communities


Stock Markets in China:Comparison Between A and B Shares

DifferencesDifferences A Share B Share

Currency-Denominated Rmb Foreign

Listing Approval CSRC SPC or SC

Investors Local Chinese Nationals Non-local Chinese Nationals

Offerings Public / Private Private through Offshore

Brokerage Firms Local Authorized Local / Foreign

Trading Volumes High Low

Volatility High Low

Settlement T + 1 T + 3


Stock Markets in China:Future Development

Developing regulation and securities markets

Active stock market

Active government bonds and overseas issues

Active in commodity futures but weak in financial derivatives

products

QFII

QDII

CDR


China’s Listed Companies

Problems and Regulation

• Fall of the stock market• Most have forecast warning and losses• ‘Changing faces’• Newly listed companies recorded losses• Examples: 銀廣廈、猴王、關百文等


Fast growing market in 2000• 139 newly listed companies• Market capitalization to GDP is 54%

In mid 2001• 169 companies have forecast warning and loss

es in July 2001• 45 were IPOs or just issued additional shares



Causes of the problem

• Unsound corporate governance structure• Inadequacy of accounting standards• Poor accounting and auditing services• Lack of proper litigation system• Poor law enforcement



Main problems with listed companies

1. Information disclosure is untrue Prospectus, listing, right issue, and annual

reports; major left-outs, false statements, and misguiding information

Change the purpose of the funds raised False appraisal, financial, and manipulation

of share prices




2. High-risk companies Until April 2001, 62 ST and PT companies,

6% of all listed companies Some companies with good financial data, b

ut very risky, example 銀廣廈




3. Controlling shareholders Connected parties transactions Listed companies provide loan guarantee fo

r controlling shareholders ‘ATM’ machine for controlling shareholders,

example 猴王事件


Stephen Cheung Corporate Governance in Hong Kong

48

Corporate Governance

Characteristics of Asian Equity Markets

• Single majority shareholder• Family control• Lack of institutional investors• CEO and chairman are not separated• Underdeveloped corporate control market


Corporate Governance

A Successful Market Depends On:

• ‘Good’ Regulatory Framework• Quality Listed Companies• Quality Intermediaries


Corporate Governance:‘Good’ Regulatory Framework I

Small Shareholders

• Look for short-term capital gain

• Ignore issues of corporate governance

• Do not pay attention to shareholder’s right

• Inadequate shareholder protection


Example

• Hong Kong listed companies 75% registered overseas Different requirements

• Class Action

• Contingency Fee

Corporate Governance:‘Good’ Regulatory Framework II


Corporate Governance:Quality Listed Companies I

A successful market does not depend on:

• Number of listed companies• Market capitalization

Depends on:

• Number of good listed companies• Liquidity• Ability to attract funds


Corporate Governance:Quality Listed Companies II

Relation between director’s pay and company’s performance

• Sample period: 1991-1995• 10% director’s pay > company’s earnings• No relation


Corporate governance

• Independence of the Board

• Problem Connected parties transactions Information disclosure

Corporate Governance:Quality Listed Companies III


Enhance independence of the Board

• Recruitment details of independent non-executive directors

• Greater transparency Financial Non-Financial

• Performance evaluation

Corporate Governance:Quality Listed Companies IV


Suggestions

• Licensing for directors

• Director’s education

• Scorecard for corporate governance Investors Pressure

Corporate Governance:Quality Listed Companies V


Intermediaries

• Accountants

• Auditors

• Lawyers

• Financial Analysts

Corporate Governance:Quality Intermediaries I


Example

• A News on 23 December 2002

• 3 listed companies were involved over a suspected scam of making bogus business transactions and inflated revenue

• Arrested by the ICAC

• Including accountants and financial consultants

• Inflated turnover

Corporate Governance:Quality Intermediaries II


Corporate Governance:Quality Intermediaries III

Yue Fung International Holdings HK965

0

5

10

15

20

25

20

01

/1

20

01

/3

20

01

/5

20

01

/7

20

01

/9

20

01

/11

20

02

/1

20

02

/3

20

02

/5

20

02

/7

20

02

/9

20

02

/11

$12

$1.05


Corporate Governance:Quality Intermediaries IV

Gold Wo International Holdings HK090

0

1

2

3

4

5

6

20

01

/4

20

01

/5

20

01

/6

20

01

/7

20

01

/8

20

01

/9

20

01

/10

20

01

/11

20

01

/12

20

02

/1

20

02

/2

20

02

/3

20

02

/4

20

02

/5

20

02

/6

20

02

/7

20

02

/8

20

02

/9

20

02

/10

20

02

/11

20

02

/12

$0.836

$0.08


Corporate Governance:Quality Intermediaries V

Fu Cheong International Holdings HK916

0

0.05

0.1

0.15

0.2

0.25

20

02

/3

20

02

/4

20

02

/4

20

02

/5

20

02

/5

20

02

/6

20

02

/6

20

02

/7

20

02

/7

20

02

/7

20

02

/8

20

02

/8

20

02

/9

20

02

/9

20

02

/10

20

02

/10

20

02

/11

20

02

/11

20

02

/12

$0.198

$0.038


Self-Regulation• Effectiveness?

Independent Investigation Committee

Corporate Governance:Quality Intermediaries VI


Conclusion

Market creditability

Investor confidence

Ability for further funding

Ability to attract quality companies

~ The End ~

Thank you

Documents

Securities Markets in China