The beginning of this year has seen unprecedented rises in the B-share stock market, with some daily increases of more than 9 percent.

The oft-ignored B shares, the country's foreign currency dominated stock, have not enjoyed such a rise in four years.

The exchanges, one based in Shanghai, one in Shenzhen, climbed 20 percent during the first twenty days of 2006, with a few firms seeing their value rise by as much as 40 percent.

Some analysts claim that this is normal, as investors often buy stock at the beginning of a new year.

However, this is by no means a complete reason to explain what has happened to the market.

Rumours have swirled over the country, claiming the government will merge B shares with A shares.

These followed a rule issued by the China Securities Regulatory Commission (CSRC) on January 4, which allowed foreigners to buy strategic stakes in tradable A shares.

From January 31, overseas investors will be able to buy A shares using China's RMB currency, provided they acquire at least a 10 percent stake in a firm and hold the stock for at least three years.

"The rule is a direct reason why the exchange index has risen," Zhang Qi, an analyst with Haitong Securities, told China Daily.

Zhang said he believed that the opening of A shares to overseas investors may undermine the necessity for B shares. This could benefit investors with B shares, who are gambling they will be merged with A shares or H shares, mainland shares traded in Hong Kong.

There are 112 companies with B shares in China, 54 in Shanghai and 58 in Shenzhen - less than 10 percent of the total number of listed companies.

They were first issued in the early 1990s as a means for companies to raise hard currency from foreign investors. The market uses US dollars in Shanghai and Hong Kong dollars in Shenzhen, and was initially restricted only to foreigners.

However, the government opened the exchanges to locals in 2001 after overseas interest waned, hurt partly by the growth of H shares.

It enjoyed a short boost because B shares were offered at a discount compared to a company's A shares.

But the market lost relevance as China loosened capital controls and opened its much larger yuan share market to overseas institutions.

In 2003, China allowed selected overseas institutions to buy A shares.

Currently, 34 qualified foreign institutional investors, so-called QFIIs, have been licensed to invest a combined US$5.6 billion in local currency shares.

In 2005, the number of B shares traded was less than a quarter of one percent of the volume of trade in local currency stocks.

"With the new rules to introduce strategic overseas investment to A shares, the role of B shares was further marginalized. The existence of B shares appears to be unnecessary," Zhang said. He believes the best solution is to merge B shares with A shares.

However, the destiny of B shares is unclear, as the CSRC has announced no firm decisions.

"The government is still focused on the reform to convert its non-tradable A shares into tradable ones, and obviously it is not the right time for the regulator to look at B shares," said Zuo Xiaolei, chief economist with Yinhe Securities. He is doubtful about a merger.

But scholars and experts have already started to study the possible solutions.

"There are a few possible outcomes: swapping B shares with A shares or H shares; buying back B shares; or the acquisition of B-share firms by A-share companies," Li Yongsen, associate professor at Renmin University of China, said.

However, the public believes that no matter what the solution is, all the above possibilities would benefit B shareholders. That is why the market has risen steeply this year.

There is a possibility that the B-shares plan will follow the same pattern as the conversion of non-tradable A shares into tradable ones.

Companies seeking to convert non-tradable stock must obtain the approval of holders of tradable shares, and offer cash or shares to compensate them for the increase in supply.

Haitong's Zhang suggests trading one B share for one A share.

"B shares usually trade at a discount compared to local currency stock. Currently the difference between the price of a B share and that of an A share is not great so we can just swap one for another."

Zhang believes this method is in line with a principle set down in the new company law: each share should have the same value as another.

That principle is a guideline for the country's on-going securities reform in which China has started to convert about US$210 billion of non-tradable, mostly State-held equity, into common stock that can be bought and sold on the exchanges.

Some 462 listed companies, accounting for about 30 percent of China's total market capitalization, have embarked on a programme to convert their non-tradable stockholdings.

The rule to allow foreign investors to strategically buy A shares is among a series of measures the government has launched this year to support the on-going reform.

On the same day that that was announced, another innovative rule was issued, aimed at encouraging public company managers to better run their firms by rewarding them with bonus shares.

The measure, released by the CSRC, allows directors, supervisors, top-level managers and key technology experts in a listed company to be rewarded with the company's shares if they have contributed to increasing the company's profits.

"Only by rewarding managers with bonus shares can they be motivated to run companies better," Lu Xingqian, a senior manager at China Merchants Securities, said.

"Most shares in listed companies in China are State-owned and individual managers, no matter how well they ran their companies, could not own these shares. A lack of rewards has been a major cause of bad corporate governance," Lu said.

With the new rule, managers are expected to make as much profit as possible for their companies and for themselves.

The effect of the above two rules was immediate; on the day they were issued the Shanghai and Shenzhen stock exchanges both saw their indexes climb. This reflected the public's increasing confidence in the market as China's securities reforms start to take effect.

However, it is still too earlier to say whether the country, after suffering four bear years, is going to improve.

Some analysts worry the boost will not last long.

"The time is coming when listed companies will need to disclose their annual financial reports. The number of bad performing companies is predicted to be high," Lu said. "The public's confidence in the market will probably be affected by this.

"Besides, on the macro level, the government will take measures to rein in the fast-growing economy. As a result, most listed companies will not improve much."

In addition, companies that have completed converting all their non-tradable shares will be permitted to issue new shares by the CSRC.

This year there are also expected to be new IPOs, which were suspended on all exchanges on the mainland last year.

"All that might put pressure on the capital market," Lu said, hinting the market will not revive until 2008.

The country's capital market, nevertheless, has no doubt reached a turning point.

At the very least, the system regulating the market has undergone a thorough reform. The application of the new company law and securities law has provided improved guidelines.

The problem is when the market will start its upturn. To make that happen as soon as possible, the CSRC has been issuing a series of rules to clear any obstacles that are hampering a healthy and orderly market.

It hopes the markets will be a place that rewards investors and raises capital, instead a speculative bourse solely for gamblers.

Hopefully, QFIIs and foreign strategic investors will inject capital to the market.

Overseas capital injected into domestic banks shows there is already interest and confidence in China's economy and its listed companies. Surely, there is no reason that the capital market will not benefit from this.

(China Daily January 27, 2006)