An Inflection Point in Chinese Capital Markets

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An Inflection Point in Chinese Capital Markets JC de Swaan Caijing Magazine July 3rd, 2009

The institutional development of Chinese capital markets has lagged – while a growing body of academic literature has demonstrated the positive linkages between the development of capital markets and economic growth, China has managed to grow at a breath-taking 10% CAGR over the last 30 years despite lacking commensurately developed capital markets. Several announcements in the past months suggest a potential shift – China may be finally paving the way to modernize and open up its capital markets, a process that has been long in the making. This time however, a date has been set with the announced objective of turning Shanghai into a global financial hub by 2020. In order to achieve that goal, several seminal changes will need to take place. Foremost among these will be convertibility of the Rmb and opening up of equity capital markets to foreign investors beyond the tightly controlled QFII program in existence. A set of domestic-oriented reforms, including a broadening of financial service offerings, will also be critical to the transformation. While the US-borne financial crisis has triggered much soul-searching in developed economies and a vigorous debate on reforms of financial institutions, it has had none of that effect in China. If anything, it appears to have accelerated plans to reform Chinese capital markets. At a high level, this can be seen as part of a broader effort to assert China’s naturally evolving role as a major economic power. Closer inspection suggests that Beijing’s support of that ambitious goal may owe as much to concerns that a modernized domestic financial system may be increasingly critical to mitigate the impact of structurally slower export growth going forward as to rising confidence in its financial sector reformers, whose oft criticized cautious and gradualist approach may have helped spare the Chinese banking system from the recent fate of its Western peers. The Rise of Chinese markets Up to the financial crisis, Chinese equity markets experienced a surge of interest, both in the international investor-friendly H share market in Hong Kong and the domesticallyfocused A share market in Shanghai and Shenzhen. This prompted Chinese companies to rush to market in order to benefit from the spike in liquidity. 2007 marked an important milestone – Hong Kong, Shanghai, and Shenzhen raised more capital from IPOs than the combination of NYSE and NASDAQ or any other significant financial hub. The fact that these are developing markets is an important driver – many of China’s largest companies are still going through the process of getting listed. As a result, China’s share of mega IPOs has climbed, accounting for 25% of top 20 IPOs in 2007 and 20% in 2008, compared to 10% and 15% respectively for US markets. This trend is likely to continue,

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with Agricultural Bank of China, one of China’s largest four banks, likely to be listed in the next 12 months. The surge in activity in China has coincided with concerns among American public officials that New York may be losing its edge as a global financial hub. This prompted the commissioning of the Bloomberg-Schumer McKinsey report in 2006. In particular, it highlighted concerns that the Sarbanes-Oxley Act passed in 2002 has made US markets less desirable to foreign companies looking at cross-listing given the additional burden and costs entailed by its requirements. Data from McKinsey shows that the proportion of foreign companies listing in NYSE/NASDAQ has declined since 2002. Incidentally, the McKinsey report, largely aimed at the competitive threat from London, devoted little attention to the Chinese equity markets. If the report had to be released today, more than a passing reference would need to be made to China. At the peak of the markets in 2007, exuberant Chinese equity markets and rushed listings fed on each other. By the beginning of 2008, more...
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