Credit Relationship Matters
Owing to the concentration of pre-initial public offering (IPO) disclosures by more than 120 companies starting from April, the Shanghai and Shenzhen stock exchanges fell after a round of rises triggered by the preferred stock pilot, and now the Shanghai Stock Exchange is once again lingering around the 2,000-point mark.
Rough calculations suggest that over 1 trillion yuan ($160 billion) in stock value in the A-share market has evaporated due to expectations for the restart of IPOs. What's behind the panic? In my opinion, the point is whether or not the financial products and instruments invented by the developed world can be grafted to the Chinese market, where implicit government guarantee is overwhelming.
Generally speaking, finance means the risk pricing of credibility. Therefore, different credit relationships yield different financial products, segments and instruments. The divergences in the structure of financial markets among countries historically arose from their varied credit bases, which are comprised of commitments made by enterprises, individuals and governments. These commitments are not only molded by economic conditions and social circumstances, but also have to do with cultural traits, political and legal institutions, personalities and ideologies.
Credit can be classified into personalized and impersonalized categories. Credit in European countries and the United States is impersonalized, which is the result of long-term market evolution, and ensured by a complete set of sophisticated laws and a rational judicial system. But credit in China is now backed by implicit government guarantee. That explains why some modern financial products and instruments can't thrive in the Chinese market. It's safe to say that credit in China's financial market has been counting heavily on implicit government guarantee since the reform and opening-up policy was adopted 35 years ago.
The ongoing financial reform will be fraught with uncertainties if China blindly attempts to transplant modern financial products and instruments from the developed world into its own field. Now, the financial reform tends to transform the current bank-dominated financial system into a securities-led one, in the hope of increasing the long-term fund supply and developing a multi-layer capital market. In government documents, such an intention always takes the form of a pursuit of more direct financing, which has posed the most severe problem that the Shanghai and Shenzhen stock exchanges have yet confronted.
In reality, the government's implicit guarantee has filtered into the fabric of the entire financial market. Under such circumstances, investors always prefer to pursue high-risk options, and let society carry the risk for them. In this way, over speculation seems inevitable. Moreover, the rigid timetable for financial restructuring will do little good for the prosperity of the capital market.
During the IPO suspension, which lasted over one year, supervisors tried extremely hard to carry out reforms on the issuing system. Particularly after the Third Plenary Session of the 18th Central Committee of the Communist Party of China held last November, the China Securities Regulatory Commission launched an array of major institutional reform measures, many of which were unprecedented.
Nonetheless, when the A-share IPO market was restarted at the beginning of this year, problems kept popping up. The reform, which was originally designed to curb problems like high offering prices, high price-earnings ratios and excessive fund raising, has turned out to be a failure, because the renovated issuing system only added insult to injury, not to mention eliminating the surge of money encirclement.
It has been indicated that alien financial products and instruments can survive and thrive in the Chinese market only when new credit relationships are established.
The Shanghai and Shenzhen stock exchanges have been sparing no efforts in eradicating over-speculation by practicing the "T+1" trading system (shares can't be sold on the same day they are bought), imposing price limits and launching financial derivative instruments. However, companies that are applying for listing can always find a way to maximize their private gain through speculative activities.
Indeed, it tends to be the rule that the market makes progress along with the improvement of supervision. But the implicit government guarantee tends to make it easier for those who are closer to power to rake in more money. That's why small investors quite often turn out to be the victims of market fluctuations.
To ensure the long-term viability of the IPO reform, the financial market should be based on China's existing credit relationships. The country, instead of blindly copying Western practices, should try to develop its capital market according to its own conditions. In addition, the government should take measures to phase out those derivatives which don't have a leg to stand on in the Chinese market.
This is an edited excerpt of an article by Yi Xianrong, a research fellow with the Institute of Finance and Banking at the Chinese Academy of Social Sciences, published in Shanghai Securities News
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