Market Structure of the Chinese Equity Markets

Fordham Journal of Corporate & Financial Law - Article 3 Markets FORDHAM JOURNAL OF CORPORATE & FINANCIAL LAW MARKET STRUCTURE OF THE CHINESE EQUITY MARKETS Chengxi Yao* TABLE OF CONTENTS * Professor, Financial Regulation, Shantou University Business School, People’s Republic of China; Juris Doctor, Boston College Law School (1991); LLM with Distinction in Securities and Financial Regulation, Georgetown University Law Center (1997). The Author gratefully acknowledges the insightful review comments by Mr. Robert LD Colby, Chief Legal Officer of FINRA. The Author has benefitted from many conversations with Dr. Yi Liu of China Securities Regulatory Commission, and Dr. Linxiang Wu of the Shenzhen Stock Exchange. All views are Author’s own. The Author can be reached at . INTRODUCTION Founded at the end of 1990 for trading Renminbi-denominated Ashares and U.S. dollar-and Hong Kong dollar-denominated B-shares of Chinese issuers, the Shanghai Stock Exchange (“SHSE”) was ranked by the World Federation of Exchanges as No. 4, and the Shenzhen Stock Exchange (“SZSE”) No. 5, of the world’s top ten exchanges, measured by equity share trading value in 2012.1 In 2001, China became a WTO member. A year later, China opened up its domestic A-shares market to Qualified Foreign Institutional Investors or QFIIs—in an interesting role switch with its Bshares market, which was designed exclusively for foreign investors but was reoriented to Chinese individuals. In 2005, China effected an Ashares Reform, consolidating the hitherto tradable-versus-nontradable, segmented A-shares market into a unitary, all tradable A-shares market. At the end of 2011, China officially lifted its ban on margin trading and short selling in A-shares (while the ban remains for B-shares), provided that the government be the sole securities lender to the borrowing 1. See World Federation of Exchanges, 2012 WFE Market Highlights, 6, 9 ( 2013 ), available at http://www.world-exchanges.org/files/statistics/pdf/ 2012%20WFE%20Market%20Highlights_0.pdf. 2013] securities industry and the sole securities borrower to the securities lending investors. Beginning 2003 and 2004, respectively, in addition to their public auction market segments, the Shanghai Stock Exchange and the Shenzhen Stock Exchange each started the operation of an ATS-style block trading system on the exchange, with direct access restricted to exchange members and Chinese institutional investors. In 2006, combining the concept of the “Silicon Valley” with the concept of the “OTCBB,” China started a Zhong-Guan-Cun Brokerage System for agency trading in non-publicly issued shares of private, entrepreneurial companies from Beijing’s high-tech hub, the Zhong-Guan-Cun Park. In January 2013, the Zhong-Guan-Cun Brokerage System graduated into a new Beijing-based NEEQ, which is to function as a market making system trading securities of non-listed public companies, signifying the Chinese securities industry’s entrée onto a hitherto untraversed land. The Beijing-based NEEQ, the Shanghai Stock Exchange, and the Shenzhen Stock Exchange complete the market structure of China’s equity markets. Initiating and guiding China’s economic reform during the 1980s1990s, China’s economic reform architect Deng Xiaoping stated: “The fundamental difference between socialism and capitalism does not lie in more planning or more market. . . . Planning and market are both economic tools.” “Planning and market that serve socialism are socialist; planning and market that serve capitalism are capitalist.” 2 Reviewing the market structure of China’s equity markets, one ponders whether the secondary market in China is such an economic tool. 2. See DENG XIAOPING, 3 SELECTED WORKS OF DENG XIAOPING, 203, 373 (Beijing: People’s Publ’g House, 1993). Cf. LARRY HARRIS, TRADING AND EXCHANGES—MARKET MICROSTRUCTURE FOR PRACTITIONERS, 214 (2003) (“Many economists and political scientists study when and how governments should intervene in economies. They also consider the often unrelated issues of why governments intervene in markets.”). I. THE LISTED EQUITIES MARKETS A. TRANSFORMATION OF A SEGMENTED SHARES STRUCTURE 1. The A-Shares Reform: Moving to a Unitary Structure Prior to the 2005 reform, the secondary market structure in China for a Renminbi-denominated A-share issuer was designed as follows:  The State shares and State-owned legal person shares, which composed two-thirds of the total shares of a listed A-share issuer, were non-tradable pursuant to the government’s selfimposed restraint;  The employee shares were prohibited from trading;  The public shares, which composed less than one-third of the total shares of a listed issuer, were traded on the Shanghai or Shenzhen stock exchange.3 Based on summarized statistics for all A-share issuers listed on the Shanghai and Shenzhen stock exchanges, of a listed issuer’s net assets recorded on its book on June 30, 2005, 37.37% were attributable to the face-value of th (...truncated)