The coincidence of the debut of new IPO shares and the unwinding of once non-tradable shares yesterday has put the Chinese stock market to a critical test.

How the market will respond to these changes will largely define the success of the country's share-merger reform launched last year.

Shares in China CAMC Engineering Co, the first Chinese firm to launch an initial public offering after the recent lifting of a year-long ban, were predictably much sought after on their first trading day.

Despite the considerable chill caused in the market by the central bank's announcement last Friday that it would raise reserve requirements for commercial banks, shares in China CAMC Engineering Co leapt by 332 percent.

These new shares ushered in a new phase for the country's 16-year-old stock market. From now on, newly issued shares will all be tradable in the secondary market.

That marks a long-awaited end to the old split share structure featuring a huge amount of non-tradable shares owned by State or legal entities.

Non-tradable shares had been allowed to exist as a compromise in the early years, when the stock market was introduced partly to facilitate the reform of State-owned enterprises. They accounted for two-thirds of all Chinese shares.

Yet, as the domestic stock market has developed, the split share structure has been increasingly found to be a drag that has prevented the market from assuming its role of channelling funds to the best-performing companies. The existence of a large amount of non-tradable State shares has posed a lingering threat of a glut of cheap stocks, while undermining public supervision over majority shareholders.

Now, by stemming the source of growth, the debut of new shares has put the lid on non-tradable shares.

But that is only half of the solution to a split share structure. To rid the Chinese stock market of non-tradable shares, the unwinding of existing State shares is of equal importance.

Yesterday's sale of once non-tradable shares in Sany Heavy Machinery represents the beginning of the end of the lock-up period for shares in listed companies which have carried out share-merger reforms.

As compensation, the majority shareholders usually provide owners of tradable shares with some free stocks or cash while promising to lock up State shares for a certain period. Sany was the first domestic company to complete the reform.

It is estimated that by the end of the year, a total of 12 billion such shares could potentially come onto the secondary market, worth over 70 billion yuan (US$8.7 billion).

The increase in stock supply will undoubtedly put downward pressure on share prices, despite the bullish performance of China's stock market so far this year.

A marginal rise in Sany's share price yesterday is not a cause for celebration. It is still too early to judge the impact of the potential sale of once non-tradable stocks on the market.

The volatility of the Chinese stock market resulting from changed macroeconomic conditions may make it hard to tell investors' attitude towards such sales. But the securities authorities need to watch carefully. Only when these once non-tradable shares are smoothly floated can the country's stock reform be called a victory.

(China Daily June 20, 2006)