China’s WTO Entry and Its Financial Market Reforms

FIMA Research Center, University of Hawai'i

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China’s WTO Entry and Its Financial Market Reforms

Rosita P. Chang, Crystal Xiaobei Chen, Rosita P. Chang, Crystal Xiaobei Chen, S. Ghon RheeS. Ghon Rhee

College of Business AdministrationCollege of Business AdministrationUniversity of Hawai’iUniversity of Hawai’i

International Symposium on Industrial Development and International Symposium on Industrial Development and Enterprise Reforms in ChinaEnterprise Reforms in China

August 18-20, 2001, Nanchang, Jiangxi, ChinaAugust 18-20, 2001, Nanchang, Jiangxi, China


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Quick Summary of the Equity Market (I) a.a. Listed CompaniesListed Companies 10881088

All A-sharesAll A-shares 1,060 1,060All B-sharesAll B-shares 114114A-share onlyA-share only 955955B-share onlyB-share only 28 28Both A- and B-sharesBoth A- and B-shares 86 86b.b. HK-listed companiesHK-listed companies 52 52 H-share onlyH-share only 33 33A- and H-shareA- and H-share 19 19

c.c. NY-listed companiesNY-listed companies 12 12 d.d. Securities companiesSecurities companies 100 100


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Quick Summary of the Equity Market (II) e. Market Capitalization $581 billion e. Market Capitalization $581 billion

or 54% of GDPor 54% of GDP Tradable Tradable 33%33%Nontradable Nontradable 67%67%

All A-sharesAll A-shares 98.68% 98.68%All B-sharesAll B-shares 1.32% 1.32%

Shanghai Stock ExchangeShanghai Stock Exchange 56%56%Shenzhen Stock ExchangeShenzhen Stock Exchange 44%44%f.f. Market TurnoverMarket Turnover378%378%g.g. Investor AccountsInvestor Accounts 58.01 million58.01 million


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Shanghai vs. Shenzhen Stock Exchanges

ShanghaiShanghai ShenzhenShenzhenNo. of MembersNo. of Members 305 305 326 326 No. of Listed CompaniesNo. of Listed Companies 572 572 514 514No. of Listed Stocks 614No. of Listed Stocks 614 560 560

A-sharesA-shares 559 559 451 451B-sharesB-shares 55 55 59 59

Market Capitalization ($bn)Market Capitalization ($bn) $325.35$325.35 $255.64 $255.64 TradableTradable 32% 32% 36% 36%NontradableNontradable 68% 68% 64% 64%

Market TurnoverMarket Turnover 370% 370% 387% 387%A-sharesA-shares 381% 381% 396% 396%B-sharesB-shares 103% 103% 89% 89%


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Weak Links in Financial Markets 1. Market Fragmentation: 1. Market Fragmentation: Different Types of EquityDifferent Types of Equity SharesShares

2.2. Market Fragmentation: Market Fragmentation: Different Types of BondDifferent Types of Bond InstrumentsInstruments

3. Market Fragmentation: 3. Market Fragmentation: Trading of Bond Trading of Bond Instruments Instruments

4. Underdeveloped Financial Derivatives Markets4. Underdeveloped Financial Derivatives Markets

5. Ailing State-Banking Sector5. Ailing State-Banking Sector


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Market Fragmentation:Different Types of Equity Shares

Summary Statistics:Summary Statistics:

P/E ratioP/E ratio RemarksRemarksA-sharesA-shares 40-50 40-50B-sharesB-shares 4-54-5 Over 10% of Over 10% of

listed listed companies but less companies but less

than 1.5% of market than 1.5% of market cap.cap.

H-sharesH-shares 8-12 8-12


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Market Fragmentation: Different Types of Equity Shares

Problems: Problems: a.a. Distorted price discoveryDistorted price discovery b.b. Price speculation Price speculation Shenzhen B-shares: 210% (1Shenzhen B-shares: 210% (1stst 5 months of 2001) 5 months of 2001)Shanghai B-shares: 160%Shanghai B-shares: 160%Hong Kong H-shares: 53%Hong Kong H-shares: 53% c.c. Illegal capital flows Illegal capital flows

Correctional Measures:Correctional Measures: a.a. Allowed companies with B- and H-shares to issue Allowed companies with B- and H-shares to issue A-shares without going through the extensive IPO process A-shares without going through the extensive IPO process (July 2000)(July 2000)

b.b. Allowed local Chinese (with FX exchange accounts) to buy Allowed local Chinese (with FX exchange accounts) to buy B-shares (Feb 2001)B-shares (Feb 2001)


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Market Fragmentation: Different Types of Equity Shares

c. Beginning in June 2001, local investors who opened c. Beginning in June 2001, local investors who opened foreign currency accounts were allowed to invest in B- foreign currency accounts were allowed to invest in B- sharesshares d. Silent on foreigners’ investment in China as the B-d. Silent on foreigners’ investment in China as the B-shares became available to domestic investorsshares became available to domestic investors e.e. In June 2001, the government announced a In June 2001, the government announced a sweeping crackdown on illegal foreign-exchange sweeping crackdown on illegal foreign-exchange dealings: “hot money” into Hong Kongdealings: “hot money” into Hong Kong

Recommendations: Recommendations: No. 1: Eliminate different types of shares No. 1: Eliminate different types of shares No. 2: Cross-list all Hong Kong, Shanghai andNo. 2: Cross-list all Hong Kong, Shanghai and

Shenzhen-listed stocksShenzhen-listed stocks


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Market Fragmentation: Different Types of Bond Instruments

Summary StatisticsSummary Statistics Unit: Billion Yuan Unit: Billion YuanTypesTypes Issued (2000)Issued (2000) Outstanding (2000)Outstanding (2000)T-bondsT-bonds 465.7 465.7 1,367.4 1,367.4F-bonds F-bonds 164.5 164.5 738.3 738.3E-bondsE-bonds 8.3 8.3 86.2 86.2

Problems: Problems: a.a. Differential interest rate control: Differential interest rate control: i. E-bond yield can not exceed savings i. E-bond yield can not exceed savings interest rate by interest rate by 40% 40% ii. 20% withholding tax only on E-bondsii. 20% withholding tax only on E-bondsb. Short-term end of Treasury issues are missingb. Short-term end of Treasury issues are missingc.c. Banks are major players while individuals Banks are major players while individuals are major are major investorsinvestors


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Market Fragmentation: Different Types of Bond Instruments

Recommendations:Recommendations:

No. 1: Consolidate F-bonds into Treasury No. 1: Consolidate F-bonds into Treasury securities to create a bigger, deeper securities to create a bigger, deeper government bond marketgovernment bond marketNo. 2: Convert the E-bonds market into a No. 2: Convert the E-bonds market into a corporate bond market corporate bond market No. 2:No. 2: Eliminate interest rate control Eliminate interest rate control No. 3:No. 3: Create balanced term structure interest Create balanced term structure interest rates for benchmark interest ratesrates for benchmark interest rates


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Market Fragmentation: Trading of Bond Instruments (I)

Current StatusCurrent Status

Interbank Bond Market trades: T- and F-bondsInterbank Bond Market trades: T- and F-bondsOrganized Exchanges trade: T- and E-bonds Organized Exchanges trade: T- and E-bonds

TotalTotal ShanghaiShanghai ShenzhenShenzhenNumberNumber 46 46 25 16 25 16T-bondsT-bonds 31 15 11 31 15 11 T-bond cashT-bond cash 14 14 7 7 7 7 T-bond repurchase 17 8 9T-bond repurchase 17 8 9E-bondsE-bonds 15 15 10 10 5 5


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Market Fragmentation: Trading of Bond Instruments (II)

TotalTotal ShanghaiShanghai ShenzhenShenzhenVolume ($ billion)Volume ($ billion) $230.98 $204.12 $26.86$230.98 $204.12 $26.86T-bondsT-bonds $228.23 $203.01 $228.23 $203.01 $25.21 $25.21T-bond cashT-bond cash 22% 22% 22% 22% 24% 24%T-bond repurchase 78% 78% 76%T-bond repurchase 78% 78% 76%E-bondsE-bonds $2.75 $1.11 $2.75 $1.11 $1.65 $1.65

ProblemsProblemsa.a. Intense competition is lacking on primary market Intense competition is lacking on primary marketb.b. Banks are dominant in the interbank bond market, Banks are dominant in the interbank bond market, while individuals are dominant in the exchange while individuals are dominant in the exchange market marketc.c. Secondary market suffers from illiquidity Secondary market suffers from illiquidity


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Market Fragmentation: Trading of Bond Instruments (III)RecommendationsRecommendations

No. 1: No. 1: Develop a primary dealer system for Treasury Develop a primary dealer system for Treasury securities (including F-bonds)securities (including F-bonds)No. 2:No. 2: Utilize the bank-dominant interbank bond Utilize the bank-dominant interbank bond market for the People’s Bank of China’s open market market for the People’s Bank of China’s open market operationsoperations

No. 3:No. 3: Develop an OTC market network along with Develop an OTC market network along with interdealer interdealer broker system for secondary market broker system for secondary market trading of bond trading of bond instruments to absorb instruments to absorb exchange trading of exchange trading of bonds as well as T-bond bonds as well as T-bond repurchaserepurchase

No. 4: No. 4: Allow Shanghai and Shenzhen exchanges toAllow Shanghai and Shenzhen exchanges toconcentrate on equity and equity derivatives concentrate on equity and equity derivatives productsproducts


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Underdeveloped Financial Derivatives Markets (I)

Current StatusCurrent Statusa.a. Financial derivative markets were banned Financial derivative markets were banned (interest rate futures, equity (interest rate futures, equity index futures & index futures & options, bond futures) since 1995)options, bond futures) since 1995)

b.b. Three Commodity Futures Exchanges in Three Commodity Futures Exchanges in OperationOperationi.i. Dalian (soybean, doubo, barley)Dalian (soybean, doubo, barley)ii.ii. Shanghai (copper, aluminum, rubber) Shanghai (copper, aluminum, rubber) iii.iii. Zhengzhou (wheat, green & red beans, peanut)Zhengzhou (wheat, green & red beans, peanut)


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Underdeveloped Financial Derivatives Markets (II)

Current StatusCurrent Status c.c. Trading Volume (2000): $194.29 billionTrading Volume (2000): $194.29 billionAgricultural ProductsAgricultural Products 64%64%Metal ProductsMetal Products 36%36%

DalienDalien 49%49% ShanghaiShanghai 41%41%ZhengzhouZhengzhou 10%10%

ProblemsProblemsa.a. Risk-hedging is impossible for institutional investors Risk-hedging is impossible for institutional investorsb.b. Liquidity of Underlying cash markets suffers Liquidity of Underlying cash markets suffers

Agricultural Products

64%

Metal Products

36% Dalien49%

Shanghai41%

Zhengzhou10%


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Underdeveloped Financial Derivatives Markets (III)

RecommendationsRecommendations

a.a. Introduce financial derivatives products (equity index Introduce financial derivatives products (equity index futures and options) immediately futures and options) immediately

b.b. Introduce short-term interest futures and long-term Introduce short-term interest futures and long-term bond futures as soon as interest rates control is liftedbond futures as soon as interest rates control is lifted

c.c. Allow Shanghai and Shenzhen Stock Exchanges to Allow Shanghai and Shenzhen Stock Exchanges to manage financial derivatives products rather than manage financial derivatives products rather than creating new derivative exchangescreating new derivative exchanges


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Ailing State-Banking Sector (I) Current StatusCurrent Statusa. Big 4 state banks hold 75% of banking assets and 60% of bank a. Big 4 state banks hold 75% of banking assets and 60% of bank

depositsdepositsAgricultural Bank of ChinaAgricultural Bank of ChinaBank of ChinaBank of ChinaConstruction Bank of ChinaConstruction Bank of ChinaIndustrial and Commerce Bank of ChinaIndustrial and Commerce Bank of China

b. NPL Ratio = 40% of combined assets b. NPL Ratio = 40% of combined assets (Official estimate is about 25%)(Official estimate is about 25%)i. Bank of China’s recent Announcement in May 2001: 28.8%i. Bank of China’s recent Announcement in May 2001: 28.8% ii. MOF issued Rmb270 bn ($32.6 billion) of special bonds inii. MOF issued Rmb270 bn ($32.6 billion) of special bonds in

1998 to recapitalize the four state-banks which transferred1998 to recapitalize the four state-banks which transferred Rmb1,400 billion (or $169 billion) to AMCs.Rmb1,400 billion (or $169 billion) to AMCs.


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Ailing State-Banking Sector (II) Current StatusCurrent Status c.c. Poor Profitability: ROA=0.19% Poor Profitability: ROA=0.19%

i.i. Interest receivable treated as income until loans areInterest receivable treated as income until loans aredeclared default declared default ii.ii. Loan-loss provision is subject to 1% of outstandingLoan-loss provision is subject to 1% of outstandingloan regardless of loan qualityloan regardless of loan quality

d.d. AMCs are not a viable solution in China AMCs are not a viable solution in China i.i. No or No or virtually illiquid markets for real assetsvirtually illiquid markets for real assetsii.ii. How can you sell SOEs?How can you sell SOEs?iii.iii. Approximately 60% of new loans (extended after Approximately 60% of new loans (extended after NPLs NPLs were transferred to AMCs) still go to cash-were transferred to AMCs) still go to cash- strapped SOEs in strapped SOEs in the form of working capitalthe form of working capitaliv.iv. No legal framework is in place to facilitate sale of No legal framework is in place to facilitate sale of AMC AMC assets to foreign investorsassets to foreign investors


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Ailing State-Banking Sector (III) RecommendationRecommendation

List 4 state banks as well as other public sectorList 4 state banks as well as other public sectorsector banks on local and international exchangessector banks on local and international exchanges. .

a. Will relieve the central government of its fiscal burdena. Will relieve the central government of its fiscal burden

b. Will improve Corporate governance: b. Will improve Corporate governance: Transparency and Financial DisclosureTransparency and Financial Disclosure

c. Will promote accountability of bank management c. Will promote accountability of bank management d.d. Will encourage commercial operationsWill encourage commercial operations


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Ailing State-Banking Sector (IV) Three Banks have been listed in China to raise aThree Banks have been listed in China to raise a total of Rmb 106 (or $12.8 billion)total of Rmb 106 (or $12.8 billion)

Pudong Development Bank:Pudong Development Bank: Rmb 49 billionRmb 49 billion

Minsheng Bank:Minsheng Bank: Rmb 29 billionRmb 29 billion

Shenzhen Development Bank:Shenzhen Development Bank: Rmb 28billionRmb 28billion

Bank of China’s Hong Kong Operation (in 2001?)Bank of China’s Hong Kong Operation (in 2001?)


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Mahalo for You Attention!

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China’s WTO Entry and Its Financial Market Reforms