Shanghai bourse gains global size, not status

SHANGHAI (Reuters) - China's rescue of its stock market last month was a spectacular success, boosting the main Shanghai index by more than a fifth in two weeks. But it marked a larger failure.

By slashing the stock trading tax -- raised less than a year earlier to curb excessive speculation -- and imposing curbs on the sale of large blocks of shares, regulators effectively acknowledged that Shanghai could not function as a free market.

Massive growth in the past two years has catapulted the Shanghai Stock Exchange into the ranks of the world's biggest markets. But it remains a sideshow for most international investors, and a poor indicator of the value of Chinese firms.

"Shanghai can no longer be ignored by its global counterparts, at least in terms of size," said economist Jin Dehuan at the Shanghai Securities and Futures Institute.

"But its development involves strong policy intervention by the government, it's still far from being a free market, and it's not an accurate barometer of China's economy. Its growth into a real, global stock market will take many years."

Since regulators lifted a ban on initial public offerings of shares in mid-2006 and began encouraging top Chinese firms to list domestically, the Shanghai exchange's capitalization has ballooned more than sixfold to about $2.9 trillion, making it Asia's second biggest stock market after Tokyo.

EXPANSION

The expansion has achieved one key policy goal: making the market an important source of funding for firms, thus helping to cut their reliance on bank loans. Since mid-2006, nearly 40 major firms have raised some $86 billion through IPOs in Shanghai.

Previously, China's biggest companies such as China Mobile had mostly listed in Hong Kong.

But growth has been much less impressive in other ways.

A licensing and quota system has limited legal foreign investment in Shanghai stocks to an estimated 1 percent of capitalization.

China resumed issuing fresh quotas in March, but monetary authorities' determination to curb potentially destabilizing flows of funds into the country means foreign investment in the exchange is expected to continue rising only very slowly.

While that helps insulate Shanghai from turmoil in global markets, it also means long-term foreign investors will not for the foreseeable future have enough influence in Shanghai to counterbalance wild speculation by domestic investors.

China's capital controls are also likely to slow the listing in Shanghai of foreign firms. Authorities have said they want to see such listings, but negotiating the mechanics among various Chinese regulators will be extremely complex.

NYSE Euronext Inc CEO Duncan Niederauer told the Reuters Exchanges and Trading Summit in New York this week that a growing number of U.S. companies wanted to list in Shanghai, and that his exchange was working with Chinese authorities on the feasibility.

Speculative trade has caused severe swings in Shanghai stocks.

The index soared sixfold between mid-2005 and last October as millions of inexperienced investors poured into the market for the first time, valuing some stocks at several times levels they would command overseas. The index then plunged 51 percent before the government intervened last month.

SPECULATION

There are now signs that Chinese investors, who are restricted in what they can invest offshore, are becoming more mature.

Despite the market's rebound in the past two weeks, the average premium of Shanghai-listed A shares over Hong-listed H shares of Chinese firms has stayed near 40 percent, well down from its peak of 113 percent in January.

The exchange is clearly trying to prevent a resurgence of the excessively speculative trade which led to the market's crash.

When shares in Zijin Mining Group more than tripled from their IPO price on their first day of trade last month, the exchange prompted a sharp pull-back in the stock by suspending trade in it for half an hour -- its first such intervention in a major listing since IPOs resumed in 2006.

But even if the demand side of the market becomes more rational, the supply side may remain a worry for some time.

Huge numbers of shares will become freely tradable through next year as lock-up periods related to IPOs and reform of the state's shareholdings expire. Follow-on share issues by some big firms also threaten to destabilise the supply/demand balance.

Ping An Insurance contributed to the market's crash in January by announcing a vague plan for a $22 billion equity offer -- one of the world's biggest equity sales -- without specifying clearly how it would use the money.

Although the mass of individual shareholders and fund managers opposed the plan, Ping An was able to win shareholder approval for it because public shareholders still hold only a tiny fraction of its equity, as is the case for most big firms. Most large shareholders are government-related firms.

A speculative investor base, big supplies of new equity and minority shareholders' difficulty in protecting their interests may prompt regulators to continue intervening heavily in the market for years to control wide swings in stock prices.

"Shanghai will likely remain a policy-directed market for years to come," says analyst Ren Chengde at Galaxy Securities. "Investors are still immature and regulators are still learning."

(For summit blog: summitnotebook.reuters.com/)

(For more on the Reuters Exchanges and Trading Summit, see

(Editing by Edmund Klamann, Andrew Torchia, Lincoln Feast)