Thursday 5 February 2009

Securities: Financial Innovation Drifting into Doldrums

China’s enthusiasm for proposed financial innovations has waned considerably in the months since the stock market turned bearish.

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Guanyu said...

Securities: Financial Innovation Drifting into Doldrums

China’s enthusiasm for proposed financial innovations has waned considerably in the months since the stock market turned bearish.

Qiao Xiaohui and Li Qing, Caijing
3 February 2009

Lock-up periods will end in 2009 for more than 680 billion shares in Chinese companies, a mountain of stock as high as what’s currently tradable on the entire A-share market.

But ending lock-ups for stock in major, state-owned enterprises will not necessarily release these shares to common investors. That’s because, in the current environment, SOEs lack a strong incentive to decrease self-owned stock.

The apparent backtracking for unlocked stock reflects what appears to be a broader delay for some aspects of financial innovation in China, where a slumping stock market has cast a shadow over reform efforts in areas such as IPO pricing and margin lending.

Regulators have contributed to shifting attitudes toward innovation. In the area of SOE stock, for example, state asset authorities across the country have called for controlling sales of the soon-to-be-unlocked shares. And many SOE managers will be discouraged from cashing in stocks because the move could undermine their decision-making power.

Regulators have already influenced trading in unlocked stock as part of an overall government effort to strengthen the stock market, which has been sliding since late 2007. For example, the China Securities Regulatory Commission (CSRC) last April started limiting sales of newly unlocked shares to wholesale traders.

In the area of IPO reform, Caijing learned that securities regulators are studying proposals aimed at reforming the stock-price inquiry mechanism -- the system currently used for setting share prices prior to IPOs. Window guidance may be eliminated, and a future price bidding system may follow market-oriented procedures.

However, some observers say these proposals would involve only small, technical changes. They say real reform should focus on abolishing the IPO review system tightly controlled by securities regulators and replacing it with a system of recordkeeping.

The fairness of China’s IPO system has long been questioned, with criticism reaching a new height during PetroChina’s listing process in November 2007. Critics note institutional investors are favoured in IPOs, grabbing the bulk of IPO stocks, even though small investors pay far more per share than institutional investors.

Another gripe is that administrative intervention in pricing is common, leading to distortions, such as steep price increases throughout an IPO’s initial trading day.

But chances are slim that the existing IPO system will be fundamentally reshaped in 2009.

Another delayed innovation would create a system for stock and margin lending. The State Council hoped to launch a pilot project in October, but the ailing global financial environment forced a suspension. Now, regulators have decided to allow stock lending but hold off margin lending, adopting a system that runs counter to international standards.

Other innovations put on a back burner since the market slump began include market stimuli that had been planned for the first half of 2008. These remain shelved, although some may see light as small- and medium-sized enterprises seek ways to overcome financing hurdles.

What’s become clear over the past two years is that government interventions in the market are often ineffective. Even macroeconomic policies designed to prevent the economy from falling have had no fundamental impact on the market. Policies that directly address the equity market have had only brief impacts, since stock prices are ultimately based on value.

Many observers have concluded, therefore, that policy rescue strategies are no longer effective, and it would be unwise for regulators to try again.

Meanwhile, investors are anxious for action. Dai Lining, an international consultant to CSRC, said investors suffering major losses in the current bear market are now urging reform. In addition, some market players are calling for regulators to intervene with new market-rescue strategies, despite questions about their effectiveness.