Cleaning Up the Chinese Stock Exchange?

By Scott B. MacDonald

The issue of transparency and disclosure has been a major point of concern in any discussions about China’s economic development. Indeed, lack of disclosure is often cited as a major risk in doing business in China. This is something that was repeatedly brought up in Beijing’s efforts to gain membership in the World Trade Organization. In November, the China Securities Regulatory Commission made a move to diminish some of these concerns, announcing changes in rules pertaining to delisting companies that trade on the Shanghai and Shenzen stock markets. Although there remains much to be done to improve transparency and disclosure in Chinese markets, the new measures, if implemented, will be a positive step.

Pressure to tighten rules and regulations on China’s stock exchanges derived from criticism that the authorities have allowed loss-making firms to continue trading, despite their inability to restructure without government support. Indeed, it is acknowledged that a number of listed companies either falsify profits or are not expected to ever generate returns for investors. Moreover, in some cases this has led to circumstances where investors bet heavily that the company will be bailed out by the government, especially considering that almost all listed firms are state-owned enterprises, a status that provided political leverage in initially getting listed. Consequently, political connections have at times meant more than market realities. For a China seeking to demonstrate that it can be a member of the WTO -- poorly working and influence-peddling dominated stock markets are not acceptable.

The new rules will go into effect on January 1, 2002. Under the new guidelines, companies will be suspended from trading for six months as soon as they record three straight years of losses. If they fail to turn a profit during this period they can be delisted by either the Shanghai or Shenzhen exchanges. Currently there are 15 companies thought to run the risk of being put on probation for six months, while another 50 companies are thought to be questionable with a dismal track record of two years of losses.

While the move to tighten rules and regulations and standards for China’s stock exchanges is positive, the real test comes in how rapidly the authorities will move to close companies that violate the law, either through intentional misrepresentation or just plain bad business practices. The track record is not encouraging. However, this year there were encouraging signs, as seen in the delisting of three companies, a trend which we hope will accelerate moving forward. Announcing rules and regulations is one thing, implementing is another. As China enters 2002 as a future member of the WTO, the whole world will be watching.