July 9, 2015 / 12:00 PM / 4 years ago

Reform in relegation zone after Beijing's own goals

* Beijing’s stated goal is to liberalise its capital markets

* Has intervened heavily in markets to arrest stock crash

* IPOs have been suspended, brokers made to buy stocks

* Hong Kong bourse also hit as conduit for China opening

* Investors fear political contingency always trumps reform

By Pete Sweeney and Michelle Price

SHANGHAI/HONG KONG, July 9 (Reuters) - China was taking great strides in liberalising its financial infrastructure until its stock market crash began last month, but Beijing’s attempts to arrest the rout have torpedoed one after another of its reform goals.

As China loosened up its command economy, its leaders wanted to encourage foreign capital, internationalise its currency and free markets to allocate capital more efficiently than has been achieved by state-controlled banks and government oversight.

Its 2013 commitment to give markets a “decisive” role in pricing assets now looks thin after unprecedented intervention in the operation of its stock markets, which have tumbled 30 percent since mid-June.

“The most likely result of these desperate attempts to restore credibility is, in fact, a deterioration in the credibility of the government’s commitment to reforms and its ability to execute them,” wrote Andrew Batson, analyst at Gavekal Dragonomics in Beijing.

The first item on the agenda for its securities regulator in a presentation in March was to reform the IPO process, by which companies raise capital by floating on the stock exchange.

That goal was a casualty of Beijing’s weekend blitz of policy measures; it instructed companies to drop their flotation plans, since IPOs suck liquidity from the system and compete with existing stocks for capital.

China’s aim to make its financial sector stronger and more efficient also came unstuck; brokerages, which oil the wheels of the market and were looking to expand the services and products they provide to clients, were conscripted to help Beijing bend the market to its will.

They were obliged to pledge 5 percent of their assets - 120 billion yuan ($19 billion) - to buy stocks.

That not only overrides Beijing’s wish to let markets set prices, but also strips the brokers of cash they had earmarked for overseas expansion, which in turn would have helped President Xi Jinping’s project to make China’s financial services industry a global player.


The drive to get more overseas capital into China’s markets is also among the walking wounded. Hong Kong’s bourse, a key conduit for foreign cash into China since the November launch of a scheme to connect it with its Shanghai counterpart, has also been brought low by the market turmoil.

The Hang Seng index has tumbled 16 percent since an April peak, and the bourse’s own stock, Hong Kong Exchanges & Clearing, has fallen more than twice that.

HKEx management has talked up the potential of other China-related projects, including a Shenzhen Connect, bond connect, commodities connect, and related futures products, but these now look likely to gather moss.

“They find themselves at the centre of this sell-off primarily because of concern of a sharp drop in volumes and the likelihood of further China market reform schemes being put on ice,” said one investor in HKEx stock.


China has also been lobbying index compiler MSCI to include China stocks in its main emerging markets index, which could bring in a flood of cash from foreign institutions and index tracking funds and help Xi’s goal of internationalising the yuan currency.

As recently as June 9, MSCI deferred inclusion pending further progress on market accessibility, saying China’s current cross-border stock investment schemes needed to be more predictable, transparent, and consistent. It also said major international investors “are eager for further liberalization” of China’s share markets.

Accessibility and liberalisation have both gone abruptly into reverse in the past week. On Thursday, China banned investors holding more than 5 percent of a stock from selling for six months. And that’s assuming they could sell in the first place, as nearly half of all China’s shares have suspended trading to duck out of the market turmoil.

Other measures restricting the use of short-selling, futures and derivatives to hedge positions - tools that many foreign investors would expect to have at their disposal - have also dealt a blow to the cause of liberalisation.

The China Securities Regulatory Commission did not respond to requests for comment.

MSCI requires financial reforms to be irreversible, but in China many were jettisoned when markets didn’t follow the script.

“(Such steps) no doubt will deepen foreign investors’ concerns,” said Qing Chen, Executive Director, Gold Mountains Asset Management Ltd.

It also makes domestic investors nervous about the underlying strength of capital markets.

“A healthy market shouldn’t require government intervention,” said Mrs Zhang, 50, a retail investor who declined to give her full name because she works at a state-owned company. ($1 = 6.2087 Chinese yuan renminbi)

Additional reporting by Umesh Desai, Saikat Chatterjee and Lawrence White; Writing by Will Waterman; Editing by Ian Geoghegan

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