MNI INTERVIEW: China To Strengthen Stock Market Oversight

China will likely increase stock market regulation, such as tighter IPO rules and strengthened law enforcement, to create a fairer trading environment and restore investor confidence, which could push A-shares up 50%, a policy advisor told MNI in an interview.

Pointing to the Shanghai Composite Index (SCI)’s underperformance, which has hovered at about 3,000 since 2007, Lin Yixiang, chairman at TX Investment Consulting and former vice president at the Securities Association of China, said trading irregularities – such as insider trading, market manipulation and fraudulent IPOs – had undermined the market.

Lin also frequently participates in China Securities Regulatory Commission (CSRC) advisory meetings and helped draft the country’s securities law and investment fund law.

The average price-to-earnings ratio of companies listed on the Shanghai Stock Exchange’s main board is 10-11 times, less than half of Western counterparts, he added, noting investor sentiment will lift if authorities plug loopholes. “China's stock market may have room for a 50% rise with valuation approaching its [western] counterparts’ level,” he estimated, adding valuation will also depend on profitability and development.

INVESTMENT-ORIENTED MARKET

Future market development must focus on investor protection and increased returns, Lin stressed, noting companies can raise more funds when investors make money.

Authorities should make financial fraud a priority, he said, noting improper IPOs and refinancingsmay cause significant capital outflow and involve serious interest transfer and corruption. (See MNI: China Should Limit IPOs, Boost Growth To Lift Stock Market) Those found falsifying information should face severe civil and criminal penalties, while intermediaries must bear joint liability, Lin argued.

The number of IPO terminations between January and February this year increased about 15% over the same period in 2023 to 54, following greater CSRC scrutiny.

SKIN IN THE GAME

Authorities must also prevent major shareholders from liquidating shares at high prices after listing, a significant “fake IPO” red flag, Lin continued. The holding should tie to the interests of secondary market investors and selling only allowed once the stock trades no lower than initial levels, he suggested, adding the sale price should also increase according to the length of the holding.

Major shareholders must also commit to owning the shares for a certain period to avoid inflating IPOs and explain their reduction to the market in advance, Lin added.

The CSRC suspended restricted share lendingin late January and prohibited brokerages from engaging in new securities refinancing on Feb 6 to curb short-selling, immediately driving the SCI 3.23% higher to 2789.49. Previously, some “strategic” investors offered restricted shares used short-selling to circumvent the 12-month sales ban.

CSRC Chairman Wu Qing, who took office in early February, recently vowed to keep fraudulent operators out of the capital market. (See MNI: China Needs To Make Delisting Companies Easier - Advisors)

STABILISATION FUND

Lin also called on authorities to establish a CNY5-10 trillion, central bank-funded and independently operated financial stabilisation fund to allow capital markets to channel base money and drive the economy. However, he admitted the establishment of such a fund, which represented the monetisation of fiscal policy, would require the People’s Bank of China to alter its existing monetary policy and theory, an unlikely near-term scenario.

China’s current equity market value is about CNY80 trillion, but freely-traded market value falls to about CNY30 trillion when state-owned and some private companies’ required shareholdings are excluded, making CNY5-10 trillion enough to impact the market.

Lin said the fund would boost market confidence, attract a large amount of institutional funds and deter malicious short-selling, but will likely not directly fuel higher CPI due to the country’s excess production capacity. It will, however, amplify the wealth effect, he said.

“Consumers and businesses will naturally increase spending and investment with expectations improved, and feed into economic growth,” Lin argued.

China has experienced inflation via higher asset prices, particularly home prices, over the past two decades, but the drawn-out property downturn has kept money in the financial system, Lin explained, noting capital markets should take over the role of allocating resources for economic activity.