Given a new mission

China’s stock markets are tasked with driving the transformation toward direct finance

In December 1990, the Shanghai Stock Exchange was officially unveiled, and the Shenzhen Stock Exchange also started trial operation. Thirty years on, China’s capital markets have undergone major changes in their functions. Initially, they were meant mainly to help Stateowned enterprises in financial difficulties get funding. Later, they financed the expansion of promising businesses for the most part. In the next 10 years, they are tasked with a new mission, which is to drive the transformation toward direct finance.

Direct finance is where investment banks play a leading role, which indicates equity financing for businesses; while indirect finance is where commercial banks call the shots, which means debt financing for businesses. China used to rely mainly on indirect finance, with the proportion of direct finance far lower than that of developed countries. Since the Chinese government laid more emphasis on indirect finance, commercial banks gained predominance in China’s financial market and businesses got liquidity mainly through bank loans. Statistics show that over the past five years, China recorded 38.9 trillion yuan ($6.02 trillion) in direct finance, accounting for only 32 percent of the increment in total financing, while direct finance in the United States accounted for more than 80 percent of its total financing. China’s central government officials have remarked on multiple occasions that direct financing will be given more prominence.

Capital markets constitute an important part of direct finance. In traditional lending markets, big businesses have more say and collateral, which makes it easier for them to get funding. In the capital markets, investors’ future expectations affect stock prices, so promising companies are more likely to succeed in raising capital. That is why capital markets represent the future. Many great businesses were born in mature capidisorderly tal markets. Moreover, capital markets also serve the real economy. According to the latest data in 2020, commercial banks account for about half of the profits of all listed companies in China, raking in huge financial profits from issuing loans. It is urgent that more profits should go to the manufacturing sector. Capital markets can direct more money to up-and-coming high-tech businesses. To this end, the Shanghai Stock Exchange Science and Technology Innovation Board was established in November 2018.

Well functioning capital markets can also prevent disorderly expansion of capital. When capital expands disorderly, big companies forge alliances, squeezing out small companies, and undermining innovation. To promote economic recovery, the governments of Japan and the Republic of Korea steered businesses toward mergers and acquisitions to boost their international competitiveness. This delivered rapid industrialization and economic growth but gave rise to zaibatsu and chaebol, large business conglomerates that monopolize the market. The Central Economic Work Conference held in Beijing in December made clear that preventing the expansion of capital, and opposing unfair competition in the market is one of the eight priorities for economic work this year.

At present, there are still many unresolved problems plaguing China’s capital markets. Listed companies are the backbone of the stock markets. Compared with other countries, the controlling shareholder of listed companies in China generally hold a lot more shares, often more than 50 percent in newly listed companies, with the whole company being controlled by individuals or families. It costs very little for initial shareholders to own shares. When the share prices rise, major shareholders sell their shares for profit. It is recommended that the major shareholder should hold no more than 35 percent of a listed company’s shares so that he/ she would lose absolute control over the company if he/ she reduces holding. Another problem facing China’s capital markets is that the punishment on information disclosure is not strict enough. For example, KDX was fined only 600,000 yuan for falsifying 11.9 billion yuan in profit in 2019, while Enron was fined $500 million for falsifying $600 million in profit in 2001. China’s capital market reform in 2020 highlighted registrationbased IPOs and delisting. So far, less than 150 companies in China have been delisted. Only 3.5 percent of A-share companies have been delisted, while the number is 14 percent in Hong Kong and 46 percent in the US.

The capital markets will play an important role in China’s new development pattern. The current international environment is full of uncertainties and there is still downward pressure on the economy. Mindful of medium and longterm economic growth, China has put forward the concept of a new dual circulation development paradigm, with the domestic circulation as the mainstay and domestic and international circulations reinforcing each other. During this process, China’s capital markets will play a role both at home and abroad. In international competition, capital markets will become a major battlefield for big-power politics. During the COVID-19 pandemic, the US has adopted many policies to revitalize its stock markets for economic recovery. In China, stock markets act as a barometer reflecting actual economic development. With the pandemic being largely brought under control and economic activities returning to normal, China has become the only major economy in the world with positive economic growth in 2020. The International Monetary Fund released its China Economic Assessment and Outlook Report on Jan 8, saying that the Chinese economy is expected to grow by 1.9 percent in 2020 and 7.9 percent in 2021. Both regulators and investors expect China’s capital markets to perform better in the future.

Liu Biao is a research fellow with the Capital Finance Institute at China University of Political Science and Law. Liu Jipeng is dean of the Capital Finance Institute at China University of Political Science and Law. The authors contributed this article to China Watch, a think tank powered by China Daily. The views do not necessarily reflect those of China Daily.

LUO JIE / CHINA DAILY