With an US$8 trillion gross domestic product (GDP)¹, China represents the second-largest economy in the world, ranking just behind the United States. An International Monetary Fund (IMF) projection indicates that GDP growth in China in 2013 will reach 8.25 percent², an increase from the 7.75 percent growth reported in 2012. Along with the rapid growth of China’s economy, there has also been significant progress made by the financial sector in the country over the past two decades. Currently, the capital market platform in China is made up of the Shanghai and Shenzhen Stock Exchanges (both established in 1990), three commodity exchanges, and a financial futures exchange. Today, the market capitalization of the four largest commercial banks in China is US$723 billion.³ Total market capitalization of domestic equity issues at the Shanghai Stock Exchange is US$2.5 trillion, as of December 31, 2012, the seventh highest in the world.⁴ In terms of share-trading value, the Shanghai Stock Exchange and the Shenzhen Stock Exchange rank fourth and fifth in the 2012 global stock exchange size ranking, respectively.⁴

Based on the experience of other economies, a recent study conducted jointly by the World Bank and State Council of China⁵ has identified a number of required reforms for China’s financial sector. The study considers these changes in the financial sector essential in order for China to progress in its next phase of development from a manufacturing-focused society to a modern high-income economy by 2030. The proposed changes include moving towards market-determined interest rates⁶ and foreign exchange, expanding the access to capital markets, and strengthening the regulatory and supervisory framework to international standards.

This article gives a short summary on the securities regulatory framework adopted in China and some of the recent change initiatives that have been implemented.

Financial services regulatory landscape in China

The regulatory model in China is organized by sector under the corresponding national agency: the China Banking Regulatory Commission for banks, the China Insurance Regulatory Commission for the insurance industry, and the China Securities Regulatory Commission for the securities industry.

Securities regulatory and supervisory change initiatives

The Chinese Securities Regulatory Commission (CSRC) outlined its commitment⁷ to enhance regulatory effectiveness as part of the implementation of its 12th Five-Year Plan (2011−2015). Change initiatives include:

The new IPO review process – Regulatory emphasis has been changed from controlling market access (i.e., focusing on the IPO filer’s profitability) to ensuring high-quality information disclosure in IPO reviews. There is tightened scrutiny on pricing for IPOs, improved pricing mechanisms among all market participants, and measures to reduce speculation of new shares on the secondary market.

Revamped delisting system − Market-oriented criteria have been added to the securities delisting review process. Measures adopted include a risk warning system and a preparation mechanism on delisting. Failed companies are allowed to re-list after restructuring.

Dividend policy directives − While the listed company maintains full control of their dividend policy, the CSRC encourages companies to establish an ongoing cash dividend policy and a clear and transparent decision-making framework on dividend policy.

Zero tolerance for trading violations − The CSRC announced stepped-up market inspection and enforcement efforts to ensure zero tolerance for insider trading and other securities and futures trade violations. Charges and administrative penalties are levied on non-compliant issuers.

Coordinated standards for corporate bond trading − The CSRC established a coordinated set of regulatory standards for corporate bond trading activities in both the interbank market and the exchange-traded market and improving cross-market law enforcement actions.

Challenges and opportunities

Over the next two decades, the pace of reforms in China’s investment industry will be affected by factors such as dedicated resources and continued policy emphasis. Currently, however, the following local market conditions may slow the pace of change in the near term:

State ownership − A high percentage of listed companies are state- or family-owned. State-owned shareholders account for 58 percent of capital stock in the market, and the single largest shareholders of all domestic listed companies hold an average of 37 percent of all outstanding shares. Evolving practices in corporate governance will need to consider this fact.

Foreign exchange controls − It has been reported that the Chinese Government plans to achieve gradual full convertibility of the renminbi under the capital account. Significant progress has been made by the Chinese government, with currency exchange allowed with markets such as Hong Kong, Taiwan, South Korea, Australia, the U.K., and Singapore (Table 1 outlines the share of currencies used in global payment)⁸. Without full convertibility of the currency, risk management and product pricing may be compromised.

Audit standards − Strict adherence to internationally accepted accounting and audit standards is essential for China’s further development in its capital market activities, including IPOs, cross-border investments, mergers and acquisitions, and corporate reorganization reporting.

Investor protection − Continued emphasis on strong investor protection as well as communication and education at a local level are all required for the substantial retail investor base in China. In January 2013, it was reported that there are 78 million local retail investors in China trading in the A-shares market, with a total of 168 million trading accounts maintained.⁹ Retail savings capital is substantial due to the high household savings rate, at over 40 percent of GDP on an annual basis. According to 2012 statistics, annual household savings amount to US$3 trillion for the year, which ranks among the highest in the world.¹⁰

To Toronto

Perhaps a good illustration of the complexity of globalized capital market activities can be made with regard to the enforcement of issuer standards. In December 2012, the Toronto Stock Exchange Group (TMX) released a consultation paper to solicit comments from market participants on emerging market issuer requirements.¹¹ It cites two potential areas of concern regarding emerging market issuers. The first is financial reporting−related issues such as adequacy and process of internal controls and demonstrated experience of key finance members (CFO, auditors, and audit committee). The second is legal issues related to ownership title and business licensing requirement capacity.

ENDNOTES

1. IMF 2012 estimates. National Bureau of Statistics of China 2011 GDP measurement was about US$7.5 trillion.
2. “Country and Regional Perspectives,” International Monetary Fund, World Economic Outlook, October 2012, pg. 71, www.imf.org. Overall growth in Asia in 2013 is expected to be 5.75 percent, according to the same report.
3. Bloomberg data as of March 26, 2013, on Shanghai Stock Exchange Composite Index – Industrial & Commercial Bank market cap US$236 billion, China Construction Bank market cap US$204 billion, Agricultural Bank of China market cap US$151 billion, and Bank of China market cap US$132 billion.
4. “WFE 2012 Market Highlights,” pages. 6, 9, The World Federation of Exchanges, www.world-exchanges.org.
5. “Building a modern, harmonious, and creative society,” World Bank and Development Research Center of the State Council, People’s Republic of China.
6.  China’s central bank, the People’s Bank of China, announced on July 19, 2013 (www.pbc.gov.cn) its approval of removing the lower limit on bank lending rates. While the limits on interest rates charged for individual housing loans will be maintained, this is considered to be a major first step towards liberalizing market interest rates (www.chinadaily, July 20, 2013).
7. The China Securities Regulatory Commission Annual Report 2011, www.csrc.gov.cn.
8. Society for Worldwide Interbank Financial Telecommunication (“SWIFT”), June 2013 statistics, www.swift.com.
9. Speech of the Chairman of China Securities Regulatory Commission, Mr. Guo Shuqing, Asian Financial Forum in Hong Kong, January 14, 2013, www.csrc.gov.cn.
10. Speech of the Chairman of China Securities Regulatory Commission, Mr. Guo Shuqing, “Carry out Explorations and Creative Development in a Proactive and Prudent Manner,” May 7, 2012, www.csrc.gov.cn.
11. “Consultation paper on emerging market issuers,” Toronto Stock Exchange and Toronto Venture Exchange, December 2012. Emerging market issuers are defined as issuers with significant connection to a jurisdiction outside of Canada, the U.S., Western Europe, Australia, and New Zealand.