China’s stock market needs new regulatory framework
The stark contrast between China’s sagging A shares and still-resilient US stocks, both clouded by the China-US trade row, should be a wake-up call against just paying lip service to restore investor confidence in mainland stocks.
An essential solution for fragile mainland shares would be to reconfigure an existing regulatory framework that has yet to effectively identify and address risks in an equity market ready to celebrate its 28th anniversary. Even more importantly, such efforts, supposedly determined by the market and ruled by the law, are envisioned to be part of a broader drive to rein in systemic financial risks as the nation holds to financial deregulation.
It’s been three months since US President Donald Trump’s announcement on March 22 suggesting broader tariffs of up to $60 billion annually on Chinese imports, which arbitrarily pulled the world’s two largest economies into a trade war. The ongoing stalemate, created by the mercurial Trump administration and hanging over the China-US economic relationship, comes across as an external constraint weighing down Chinese mainland stocks.
As of market close on Tuesday, the flagship Shanghai Composite Index had shed nearly 13 percent since the March 22 announcement. From a year-to-date intraday high of 3,587.03 points on January 29, the keenly watched Shanghai index had dropped 20 percent, technically marking a bear market.
The two other major indexes – the Shenzhen Component Index and the tech-heavy ChiNext Index – have followed the same trend.
Adding to investor woes, China’s central bank announcement over the weekend to cut reserve requirements by 50 basis points for some banks, which will free up funds totaling 700 billion yuan ($107.09 billion), failed to shore up the mainland stock market on Monday. Contrary to many people’s expectations, property and bank shares that were supposed to get a boost from the targeted reserve cut suffered a big decline Monday.
By comparison, the Dow Jones Industrial Average remains above its March 22 level, although it had fallen by more than 8 percent from a peak of 26,616.71 points on January 26 by the close of the market on Monday.
Especially worth noting is that the tech-focused NASDAQ has delivered a superb performance this year, touching a new record intraday high of 7,806.60 points on June 20.
The numbers speak for themselves. It is fair to say that the US stock market is a barometer of the country’s economy, while China’s economy seems to be working with a mismatched equity market.
An additional 1.1 million investors jumped on the A-share bandwagon in May, bringing the total number to 139.58 million by the end of May, pursuant to the latest data from the China Securities Depository and Clearing Corporation. This suggests nearly one-tenth of the country’s population is participating directly in the stock market.
The domination of retail investors in the country, many of whom make investment decisions based on things they hear through the grapevine or recommendations by key opinion leaders spread through social media platforms, means that the A-share market is by its very essence less immune to external shocks.
That said, it would be unfair to blame millions of retail investors for the market downturn. Without a readily available mechanism to allow average investors to short the stock market, they can only benefit from an upturn.
While home purchases in the country have proved enviably profitable over the years, rewarding early birds heftily in bigger cities, the past three months have been shown to be a stretch of suffering dating back to the summer of 2015 for a large number of average investors.
Efforts made so far to lure investors from across the border, notably the gradual inclusion of A shares into the MSCI Emerging Markets Index, which aims to introduce overseas institutional investors to the market, cannot change the structure of the market overnight. Along with moves to restructure the market over a long period of time, it’s more urgent to renovate the existing regulatory framework, which in some instances fails to uncover hidden pitfalls that could cause a series of side effects and adverse events. The recent correction in many small-cap firms found to have endorsed a heavy portion of their stocks as collateral for loans is actually a warning about how dangerous a vicious cycle of market downturns and a plunge in pledged shares could be.
With nearly 140 million people participating in stock investment, it is advisable that authorities put more constraints on stock-based loans by particularly large shareholders in small-cap firms, among other down-to-earth actions to create a genuinely level playing field for those hoping to enjoy the yields of rapidly growing Chinese companies.
Only in this way can the country’s massive number of retail investors be guided toward sophisticated stock investing, which would then justify the attractiveness of A shares for foreign retail investors who have recently been allowed to invest in mainland shares.
That being the case, efforts to avoid systemic risk, which now primarily means concerns over yuan weakness, would be a wider move in line with the country’s financial opening-up.