China's sustainable economic development requires the backup of a more efficient capital market, according to a Xinhua Far East China Ratings report.

China's capital markets have developed rapidly over the past 30 years, with the overall market being greatly improved and playing an increasingly important role in the economy.

The market size is growing and systems are gradually being updated. Investors are becoming more mature, and the legal system, regulatory framework and trading rules have been established.

Nevertheless, China is still an emerging entity and some issues in the market need to be addressed to achieve greater efficiency. These include an unbalanced financing structure, a lagging fixed income market, an insufficient amount of institutional investors, and the need to improve the quality of information disclosure and drive market innovation, says the report.

"There is large room to improve for China's capital market," said Chen Chung-Hsing, vice president and head of Xinhua Finance Ratings.

Currently, China's capital markets are not fully functional as a means of capital allocation, with the major reasons being insufficient information disclosure and market operational inefficiencies.

The actual level of information disclosed is insufficient and the quality needs further improvement, says the report. Listed companies do not voluntarily disclose information and tend to adhere to government policies. Management Discussion and Analysis (MD&A) focuses more on current business profitability, lacking prospective views and discussion of strategy and potential risks. The timeliness and truthfulness of information still needs further improvement.

In terms of the detailed reports, there is no systematic consistency between prospectuses, scheduled reports and provisional reports, which to some degree can be attributed to different methods adopted by different regulatory institutions for each type of information disclosure. Inconsistent regulatory frameworks dampen the effectiveness of regulatory bodies.

The regulation regime and methods need to be further updated, says the report.

In the initial stage of development, moderate government intervention is helpful to cultivate the market, as in the case of China. With the development of the market going in-depth, it is still of great necessity for the government to changing its supervisory principles and adopted methods.

The current capital markets in China are still heavily regulated. By strict regulatory control of market access, market operations, business permits and product launchings, market innovation and further development are restrained to some extent.

Moreover, the evolvement of regulation policies is not consistent due to lack of mature experience, which further dampens efficient market operation.

Transformation and development of China's securities industry, and enhancement of its credit profile, will depend on continuous improvement of China's capital markets and gradual market deregulation.

"We anticipate that transformation of financial institution business models, continuous improvement of the regulatory environment, development of multi-layer capital markets, increasing importance of institutional investors, improvement of market information disclosure, and quickening of the opening of markets will all fundamentally influence development of the capital markets," said Chen.

With the development of China's financial market as well as its overall opening-up to foreign investment, the mode of separation is gradually breaking down with financial holding companies appearing in the market.

The future emergence of universal banks or financial holding companies will have a fundamental impact on the current competitive landscape of China's financial markets.

Meanwhile, the regulator should relax the stringent approval requirements for traditional business and normal projects, in favor of fair competition. The regulations should also encourage market innovation. While access to new products is conducive to diversify market supply, optimize securities firms' income structure and strengthen their risk bearing capacities, the pace of the relaxation needs to move forward gradually.

"For instance, in new shares offering, it is not yet realistic for China to fully adopt a registry system. Implementation of a registry system requires a well developed information disclosure system and a relatively mature securities market," said Chen.

"China's securities markets are still in the growth stage, and in the current environment would tend to encounter certain risks under a registry system. We propose that China's regulator at the current stage loosen the verification for additional share issuance. The registry system could be adopted for companies which have been listed for some time, whose amount of additional share issuance is within some range, and whose operations are relatively stable."

With further perfection of capital markets and opening-up of financial supervision, financial products will be more diversified in the future, benefiting the securities companies' profit model by reducing their degree of income concentration and mitigating the operational risks arising from market fluctuations.

Historical Development Of China's Equity Market

Embryonic stage (1978-1991)

1990, Shanghai and Shenzhen Stock Exchange formed;

Primary and secondary market nurtured and prospered.

Expansion stage (1992-1998)

1992, China Securities Regulatory Commission established. A unified regulatory framework ensured a rapid expansion of securities companies;

1993, the trial of equity listing was expanded nationally;

1995, Commercial Bank Law defines a separate operation pattern for different types of financial institutions;

Up to 1998, the number of securities firms reached 90, with the number of outlets reaching 2412.

Systematic development stage (1999 to present)

1999, implementation of Securities Law set up the legal structure of the industry;

Starting from 2001, securities companies' reorganization and M&A start, while some are forced to close;

2005, reform of non-tradable shares begins.

Source: Xinhua Far East

(Shanghai Daily June 2, 2008)