Contents · market: Balance between improving efficiency and preventing risks 336 5.1.4 Outlook 345...

v

Contents

List of Figures ix

List of Tables xiv

Preface xvii

Notes on Contributors xx

1 Review of China’s Stock Market from 2002 to 2014 1 Ping Li 1.1 A brief review of the development of China’s stock

market from 2002 to 2014 3 1.2 Major events in China’s stock market in the last decade 6 1.2.1 Development of securities margin trading 6 1.2.2 Bringing forth the stock index futures 10 1.2.3 The split-share structure reform 13 1.2.4 Analysis of the bubbles from 2006 to 2007 16 1.2.5 Development of institutional investors 18 1.2.6 Development of equity investment 26 1.2.7 Bringing forth the refinancing business 30 1.2.8 Emergence and fall of warrants 32 1.2.9 Investing China’s housing provident funds in

the A-share market 35 References 38

2 Market-Oriented Reform of China’s IPO System and Information Disclosure Regulations 39

Chen Su and Jing Yu 2.1 The journey of market-oriented reform of the IPO system 40 2.1.1 Evolution of China’s IPO regulatory system 40 2.1.2 Evolution of China’s IPO procedures 44 2.1.3 Evolution of China’s IPO pricing methods 49 2.1.4 Market and law-oriented reform of the IPO system 54 2.2 Empirical study: influence of market-oriented evolution

of IPO system on pricing efficiency 57 2.2.1 Theoretical analyses 58 2.2.2 Data description and methodology 61 2.2.3 Case study and analyses of IPO underpricing 69 2.2.4 Case study and analyses of long-term returns for IPOs 74 2.2.5 Conclusions 83

Copyrighted material – 9781137391094


vi Contents

2.3 Regulation of IPO information disclosure 84 2.3.1 Regulatory systems guiding information

disclosure of listed companies in China 84 2.3.2 Problems of regulation of IPO information disclosure 90 2.3.3 Measures of enhancing regulation on information

disclosure 96 Appendix: Sector distribution of the 1351 enterprises listed in

China, 1992–2007 101 References 103

3 Institutional Investors in Chinese Stock Markets 106 Yuwei Sun, Zheng Zheng and Huiyan Dong 3.1 Introduction 106 3.2 Overview of institutional investors of different types 107 3.2.1 Public offering of securities investment fund 108 3.2.2 Sunshine private funds 111 3.2.3 Qualified foreign institutional investors 116 3.2.4 Broker asset management businesses 120 3.2.5 Broker proprietary trading 125 3.2.6 Insurance company and insurance funds 131 3.2.7 Trust company 138 3.2.8 Pension fund 143 3.2.9 Finance companies 149 3.2.10 Enterprise annuities 152 3.2.11 Private equity 153 3.3 Structural analysis of institutional investors 159 3.3.1 A structural analysis of investors in the SSE 160 3.3.2 Shareholding conditions by institutional investors 165 3.4 Problems with institutional investors: analysis of

model cases 168 3.4.1 Insider trading 169 3.4.2 Frequent financial irregularities; the legal

framework needs continual improvement 170 3.4.3 The construction of an information disclosure

system needs to be enforced 175 3.4.4 Product quality is different and scales are

differentiated 177 3.4.5 New hidden risks in innovations of finance 178 3.5 The development tendency of institutional investors in

China 180 3.5.1 Integration of institutional investors 181 3.5.2 The Matthew Effect and the development of

institutional investors 182 3.5.3 The professionalization of institutional investors 182



Contents vii

3.5.4 Marketization of institutional investors 183References 185

4 Characteristics of Different Styles and Sectors in China’s Stock Market 187

Wen Long, DingMu Cao, Wenning Yang and Tongyuan Shen 4.1 Characteristics of different styles in China’s stock market 187 4.1.1 Overall performance of the stock market from the

perspective of style indices 188 4.1.2 Characteristics of investors’ behavior from the

perspective of style indices 192 4.1 Brief summary 204 4.2 Characteristics of different sectors in China’s stock market 206 4.2.1 Overall distribution of different sectors 208 4.2.2 Research on the development status of

representative sectors 211 4.3 Construction and operation of sector indices 294 4.3.1 Constituents selection 294 4.3.2 Indices calculation 295 4.3.3 Examples for sector indices 298 Summary 310 References 312

5 Development and Problems of Stock Index Futures and Margin Trading and Short Selling in China 313

Zhou Zhou 5.1 Development and problems of the CSI 300 stock

index futures 313 5.1.1 Background and performance of the CSI 300

stock index futures 313 5.1.2 Functions of the CSI 300 stock index futures market 319 5.1.3 Main problems in the CSI 300 stock index futures

market: Balance between improving efficiency and preventing risks 336

5.1.4 Outlook 345 5.2 Development and problems of margin trading and

short selling in China 346 5.2.1 Brief introduction to and institutional

arrangements for margin trading and short selling 347 5.2.2 Status quo and problems of China’s margin

trading and short selling business 355 5.2.3 Outlook 363 5.3 Relationship between stock index futures and

margin trading and short selling 364



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5.3.1 Differences in short mechanisms between stock index futures and margin trading and short selling 365

5.3.2 Connections between stock index futures and margin trading and short selling 365

References 366

6 Development, Problems and Suggestions for China’s GEM 368 Manhong Liu and Jipei Wang 6.1 Development of China’s GEM 368 6.1.1 Overview of the GEMs 369 6.1.2 Features of China’s GEM 371 6.1.3 GEM, the main board market, and the

SME board market 374 6.1.4 GEM and venture capital 375 6.1.5 Review of the GEM’s decade of development 377 6.1.6 The influence of the creation of China’s GEM 380 6.1.7 Experiences in the creation of China’s GEM 383 6.2 Comparative analysis of international GEMs 384 6.2.1 Development of international GEMs 385 6.2.2 Establishment and operations model of

international GEMs 387 6.2.3 Comparison of the operations mechanism of

Chinese and foreign GEMs 388 6.2.4 Experiences from the NASDAQ for China’s GEM 392 6.3 Status quo of the operation of China’s GEM 393 6.3.1 Three years’ operation of China’s GEM since its

launch 393 6.3.2 Achievements made since the launch of

China’s GEM 398 6.3.3 Prospects for China’s GEM 401 6.4 Deficiencies in China’s GEM and policy suggestions 402 6.4.1 Deficiencies in China’s GEM 402 6.4.2 Notable problems in the development of

China’s GEM 404 6.4.3 Suggestions 407 Appendix: Mr. Cheng Siwei and China’s GEM 411 References 412

Index 415



1

1Review of China’s Stock Market from 2002 to 2014Ping Li

The history of China’s securities exchange can be dated back to the early 20th century, with the first-ever stock in China issued by the China Merchant Steam Navigation Company (established in 1893). In 1914, the Beiyang government enacted the securities transaction law and, in June 1918, founded the first securities exchange in China: The Beijing Stock Exchange. The Shanghai Huashang Stock Exchange followed in 1920. China thus entered the era of stock exchanges during the period of the Republic of China. Being highly lucrative, a number of trust companies and exchanges were set up nationwide, but after the First World War the stock exchange and trust companies began to exploit each other, giving rise to rampant stock speculation. However, trends reversed relatively quickly. As foreign private capital flowed into China and the central bank tightened the money supply, stock prices slumped sharply and many exchanges and trust companies collapsed. The ‘unrest of trust companies and exchanges’ of 1921 began.

The stock market of New China was established after the reform and open-ing-up, according to the instruction of Deng Xiaoping. In December 1990, the Shanghai Stock Exchange (SSE) was set up, marking the beginning of New China’s securities market. In June 1991, the new Shenzhen Stock Exchange (SZSE) followed. Then, in October 1992, both the Securities Committee of the State Council and the China Securities Regulatory Commission (CSRC ) were established. At the same time, stock issuance was expanded to the whole country and a nationwide securities market was born in China. Over the past two decades, China’s stock market has made significant strides forward. Since the establishment of the SSE and SZSE, China’s capital market has been in operation for over two decades. After experiencing so much in such a short period, the stock market is now approaching a new era. Parallel to the stock market’s development, China’s enterprises have also experienced their ups and downs.

On December 19, 1990, in Pujiang Restaurant (a European-style old building on the west bank of the Huangpu River), the SSE’s opening gong



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was struck for the first time: The curtain of China’s capital market was thus raised. When compared with Wall Street, which has dominated the global financial market for over a century, the newly-established SSE was rather insignificant. It initially boasted only eight listed companies, 25 members, 30,000 investors and a market value of CNY1.234 billion.

The history of China’s stock market in the past two decades is one of continuous innovation, expansion, development and regulation . Since the establishment of the first exchange, many ‘firsts’ have followed on the Shanghai market: The first B-share of Electro Vacuum B, the first open-ended fund of HuaAn Innovation, and the first Exchange Traded Funds (ETF) of the Shanghai 50 ETF. With the development of the stock market, the variety of products on China’s capital market increased and began to link with other mature markets. Shortly after the stock market was established, the central government launched pilot projects and the SZSE tightly grasped this opportunity to incubate new avenues for development, strengthening its awareness of service and striving to achieve ‘growth with standardization and standardization in growth’. Distinct from the growth models and paths of traditional exchanges, the SZSE made innovations and improvements in the maintenance, organization and development of its market. It succeeded in escaping the constraints of a regional market and contributed to the perfecting of China’s securities market system and its technological infra-structure. In this way, the SZSE gradually grew, standardized, and became a national securities market.

Further, the SZSE has continued its efforts and become the ‘experimental plot’ for setting up the growth enterprises market (GEM) in China’s secur-ities market. Following the principles of ‘innovation, supervision, service and cultivation’, it courageously assumed responsibilities and risks to pioneer an effective set of measures for systematically cultivating small- and medium-size enterprises. This has included transaction regulation mechanisms (like suspension), supervising the market, educating investors, and regulating the governance practices of listed companies, the sponsor system , and the securities issuance system.

In April 2005, the CSRC released the Notice on the Trial Implementation of Measures on Full Circulation Reform for Listed Companies and Related Questions. On May 11 of the same year, one of the first four pilot companies, Sany Group (a listed company on the SSE), revealed its reform plan and sub-sequently saw its plan passed by a large-margin of its shareholders. This symbolized the beginning of a ‘full circulation era in China.’ During the past two decades, the stock market has played an important role in accel-erating the formation of capital in China, spreading market risks, broad-ening financing channels, and optimizing resource allocation. It has also helped push forward the rapid growth of the real economy, conducive to the overall sustainable, stable and healthy socio-economic development of China.



Review of China’s Stock Market from 2002 to 2014 3

1.1 A brief review of the development of China’s stock market from 2002 to 2014

As the reform and opening-up deepened and was pushed by domestic demand spurred by economic growth, in December 1990 the SSE and SZSE were established. They represented the first-ever attempt to build a capitalist market under a socialist system. China’s stock market has, after two decades of development, accomplished major achievements. In October 2007, the total market value of China’s stock market (including Hong Kong stocks) amounted to USD$673 million. This surpassed that of the EURONEXT, NASTAKE, Tokyo Stock Exchange and London Stock Exchange, and was second only to that of the New York Stock Exchange. By this time, most of the core state-owned and holding enterprises had gone public and the incremental effect of capital from state assets was prom-inent. The national economy had more vitality, with increasing influence and control. Private enterprises had become prominent, accounting for over 80 percent of listed companies on the small and medium-sized enter-prises (SME) market and the GEM, promoting the establishment of a modern enterprise system according to the standards of a public company. Further, many innovation-oriented and technology-oriented companies representing the future direction of the economy excelled in the capital market and vigorously propelled both industrial restructuring and techno-logical innovation.

In the last decade, China’s stock market has progressed rapidly, with many impressive accomplishments. A brief review of these follows.

The year of 2004 – The opening of the SME market: A breakthrough in (1) building a multi-layered market.

On June 25, 2004, the first batch of eight new firms listed, marking the for-mation of the SME stock market. This was not only the start of the GEM but also a major step in building a multi-layer capital market in China.

The SME stock market was the first step in establishing the GEM. Its success laid a strong foundation for the latter. Since the establishment of the GEM, it has been described as a business incubator for high-growth com-panies shouldered with great expectations from the market. On October 30, 2009, the GEM was formally put into place and subsequently developed rapidly. After four years, on October 30, 2013, the number of listed com-panies in the GEM had increased from an initial 28 to 355. From the outset, the government has maintained reform and innovation in the market. The GEM has also generated a ‘rich road’, giving rise to the emergence of mul-tiple billionaires and large numbers of millionaires. However, upheavals in the GEM have also resulted in market instability.



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The year of 2007 – The incident of ‘5.30’: The raising of the stamp duty (2) and the stock market crash.

The year 2007 was memorable for China’s stock market, as Chinese inves-tors pumped large amounts of money into the market. The SSE Composite Index rose 97 percent year-on-year, making it the best performing stock index in the world. This irrational phenomenon drew worldwide attention to China’s stock market.

In 2007, China’s capital markets were experiencing a bull market, ending a prior long, torturous bear market. At the end of 2006, the average price of listed stocks was around CNY5, but within four years this average had risen to CNY12; stocks under CNY5 no longer existed. In April 2007, the stock index of the SSE and SZSE increased by 30 percent, and, from January to April 2007 the increase at one point reached over 80 percent. Under these conditions, the Ministry of Finance (MOF) announced a new policy on the late evening of May 29, 2007. The MOF raised the stamp duty for stock transaction from 1 percent to 3 percent. Since this decision (or at least the announcement) was made late at night, most media outlets, such as newspa-pers, could not immediately publish the news. Instead, news of the decision was released through broadcasts and TV the following morning. The stock market responded to the news promptly. When the two exchanges opened on May 30 (the following day), the stock index began to slump significantly. Within one day, the SSE Composite Index fell 281 points (6.5 percent). Countless stocks on both exchanges went limit down and a market value of CNY4253.2 billion evaporated, trapping many investors. More frighteningly, this initial reaction was just the beginning. Over the following few trading days, the stock market crash continued in both Shanghai and Shenzhen.

The market was incensed by the sudden action of the MOF. Since the decision was announced at midnight, it was called ‘the cock’s crow at mid-night’. Strangely, before the official release, an MOF official had stated through the media that there was no such plan to raise the stamp duty. In fact, however, at that time the MOF had submitted the plan to the State Council for approval (which came two days after submission). It was because of this false signal from an MOF official that investors dismissed the rumor of a stamp duty hike. This dismissal further encouraged rampant growth in the SSE Composite Index. The inconsistency in policy signals, and the painful market reaction, made the MOF, as a responsible government body, the target of public criticism.

The bull market was finally stricken and reversed. The prolonged market slump made the government realize that the overuse of administrative controls would be detrimental to the market. In the beginning of June 2007, the CSRC adopted a mild policy with the aid of the media. A press conference was formerly scheduled on 5 June to publicly punish some commercial bank for infringing regulation s on offering loans to securities companies.




However, the night before the official announcement, the media was tipped that this action had been cancelled. This indicated that the government was unwilling to give another shock to the market. It also represented the warming climate toward market sentiments at the policy level. It was not until this moment that the stock market crash halted, after the Shanghai market had dropped thousands of points.

The incident of ‘5.30’ was seminal in the history of China’s stock market. It revealed many problems. On the one hand, the government lacked appro-priate approaches to administration of the stock market. On the other hand, the incident showed that China’s capital market was extremely unstable and speculative, falling into long bear market periods and rapidly reversing into bull markets.

From October 2007 to October 29, 2008, the SSE Composite Index slumped sharply from an unprecedented 6,124 points to a much more modest 1,665 points. Within one year, a market value of over CNY20 trillion had evapo-rated, echoing the saying that ‘the higher one climbs, the deeper one falls’.

The year of 2008 – The impact from the United States’ Subprime Crisis: (3) A moderate bull market turned into a bear market.

In January 2008, influenced by the Subprime Crisis, major financing insti-tutions in the US suffered from severe losses, badly damaging investor confidence. On January 15, Citibank announced it had suffered a loss of USD$9.83 billion in the fourth quarter of 2007 (the highest quarterly loss since in its history). On January 16, JP Morgan revealed that its net income for the fourth quarter had been reduced by 34 percent to USD$2.97 billion. And on the following day, Merrill Lynch declared its fourth quarter losses at USD$10 billion – again the highest quarterly losses in its history. The Subprime Crisis also resulted in major bank layoffs. Influenced by the Subprime Crisis and the related US stock market crash, global stock exchange indexes (including China’s) also declined sharply. On January 15, 2008, the SSE Index fell below 5000 points (a loss of 5.14 percent), beginning a new round of bear market moments and ending the era of the frenzy bull market in A-shares.

The year of 2010 – CNY460 billion: A historical record in new initial (4) public offering (IPO) financing.

In the SME stock market, Hepalink issued its new stock at the price of CN148 – a record issuing price in the history of China’s A-share market. This not only provided the Li couple (the actual controllers of the company) with assets of over CNY40 billion but also convinced Goldman Sachs of the huge profits generated by investments in China. Hepalink’s value had multi-plied by 90 times within three years. In fact, Hepalink was not an isolated



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case. Among the new IPOs in 2010, the ‘three highs’ (high issuance price, high earnings multiple and high excessive financing) phenomenon kept cropping up.

According to WIND Information, among the more than 300 companies which have listed or issued new stocks since 2010, 31 of them had issuing prices over CNY50. Indeed, Hepalink was not the only company that issued new stock at a price above CNY100. By-Health Corporation also issued in the GEM at CNY110. High issuance prices have made excessive financing quite common. The scale of financing since 2010 has struck a record in China’s A-share market with a value of CNY460 billion. Starting from 2006, new IPO financing began to exceed CNY100 billion and, when the stock market climbed in 2007, giant companies like Sinopec Group, China Shenhua, and China Construction Bank all rode the tide of the A-share market with total financing of CNY446.9 billion in that year (setting a world record). Surprisingly, three years later when there were few similar firms seeking listing, this record was still easily broken. Therefore, the primary task of regulators has been to curb the ‘three highs’ in the IPO market.

1.2 Major events in China’s stock market in the last decade

In addition, China’s stock market has also undergone some major reforms in the past decade. Since 2000, propelled by the government, China’s modern stock market has achieved some fruitful developments, such as building a platform for transactions and establishing rules of operation. Comprehensively speaking, the following milestones were of great signifi-cance: Securities margin trading , stock index futures, the reform of non-tradable shares, the economic bubble s from 2006 to 2007, social security funds, venture capital (VC) and refinancing .

1.2.1 Development of securities margin trading

‘Securities margin trading ‘, also known as ‘securities credit transactions’ or margin trading, refers to the process where investors provide collateral to qualified securities companies to obtain capital for purchasing securities (financing transactions) or obtain securities for resale (margin transaction). It is either offered by securities brokers to investors or by financial institu-tions to securities brokers. Globally, securities margin trading is a basic form of the credit trading system.

On March 30, 2010, the SSE and SZSE separately released a notice that, from March 31, 2010, the securities margin trading system would be imple-mented and the exchanges would begin to receive applications from pilot members. This formally launched the securities margin trading business (Liu and Li, 2007).

In overseas securities markets, securities margin trading is mature and has been conducted for years, laying the foundation for the realization of the




securities market’s basic functions. Based on the financial system and credit conditions in different capital market s, various models of securities margin trading are used. These can be boiled down to three categories: The market-ization model (represented by the United States), the centralized trading model (represented by Japan), and the dual-track model (represent by China Taiwan).

The marketization model is mainly applied in developed and mature financial markets, like the United States. There are no professional financing institutions for credit trading in this model. Instead, credit is offered by the securities companies directly to investors. When the capital or stock is inad-equate, it can be obtained in the financial market through financing or secured borrowing.

The centralized trading model is mainly applied in Japan and South Korea. In order to better regulate the capital and stock volume in and out of the securities market, this model uses a specialized securities financing company. The regulatory objective is achieved through offering a refi-nancing service while the trading activities in the securities market can also be effectively administrated.

The dual-track model is mainly applied in China Taiwan. This model differentiates between companies with and without a license for secur-ities margin trading . Licensed companies can directly engage in securities margin trading and then carry out refinancing through financial secur-ities institutions. Unlicensed companies can only work as agents, applying to financial securities institutions, which can offer the securities margin trading service on their behalf.

1.2.1.1 The origin and development of securities margin trading in China

China’s capital market has achieved rapid growth since its establishment. With the continuing perfection of legislation related to securities, the legal basis was created for securities companies to engage in a securities margin trading pilot.

China has begun to carry out exploration and preparation for the launch of securities margin trading business since 2005. On October 27, 2005, at the eighteenth session of the Standing Committee of the tenth National People’s Congress, the newly revised Securities Law was enacted, which stipulated that companies could offer the service of securities margin trading to clients. This means that the securities margin trading in the Chinese stock market gets lifted. Subsequently, in order to meet the startup of the pilot securities margin trading business, the CSRC issued a series of laws and regulation s: On June 30, 2006, the CSRC released the Regulations on Pilot Program of Margin Trading Business of Securities Companies (taking effect on August 1, 2006) and on August 21, it released the Detailed Implementation Rules on the Pilot Program of Margin Trading Business. On April 23, 2008, the government released the Regulations on Supervision and Administration on



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Securities Companies, which stipulated in detail the relating issues of the margin trading business of securities companies.

Under the bedding and lead of the system of relevant laws and regulation s, on October 5, 2008, the CSRC announced the launch of the pilot program of securities margin trading . Then, Citic Securities, Everbright Securities, Orient Securities and eleven other securities companies carried out the entire network test for securities margin trading business and successfully passed, which means that China has had the conditions for securities margin trading. On October 31, 2008, the CSRC released the Interim Regulations on Examination and Approval of the Business Scope of Securities Companies, which took effect as of December 1. It carried out detailed provisions on how to apply for securities margin trading business.

On January 8, 2010, the State Council in principal consented to launch the pilot program of securities margin trading , marking the actual commence-ment of this business. Then, on March 19, 2010, the CSRC announced six pilot securities companies as the first batch to engage in margin trading. Guotai Junan, Guosen Securities, Citic Securities, Everbright Securities, Wide Hair Negotiable Securities and Haitong Securities began to try out securities margin trading business. On March 30, 2010, the SSE and the SZSE officially sent out notices to six pilot securities companies that they would begin to receive applications for margin trading business from March 31, 2010. Securities margin trading business thus entered the stage of market operations. From then on China’s A-share market formally firewalled with the ‘unilateral city’, and began to enter into a new era of ‘bilateral city’.

The first batch of pilot brokerage had a good performance, and secur-ities margin trading has made steady development. With the continuous expansion of the scale, on July 6, 2011, the second batch of approved brokers began the second try. On October 28, 2011, the CSRC issued the Refinancing Business Supervision and Management of the Trial Method and the decision on modifying the Pilot Securities Lending and Borrowing Business of Securities Companies Management Method. This marked the securities margin trading business turning into a regular business instead of being a pilot. In order to further improve the system of margin trading, the decision adjusted the access conditions for the business and magnified the range of business applications, which made more securities companies eligible to carry out the business. On November 25, 2011, the CSRC prom-ulgated the Implementing Rules for the SSE Margin Trading. By the end of December 31, 2012, according to the statistics, there were 74 securities companies engaged in margin trading business and the number of investor credit securities accounts reached over 500 thousand.

1.2.1.2 The significance and impact of introducing securities margin trading

Securities margin trading has injected new vitality into China’s capital market.




The impact on the market(1) Adding liquidity to the securities market(i)

After the outbreak of the Subprime Crisis, China’s securities market was in turmoil. Capital was flowing out of the country, draining adequate liquidity from the market. Margin trading enhances the effectiveness of capital and increases transaction volume, thus adding liquidity to the market. Before its implementation, experts expected that a fully-formed margin trading business would increase the transaction volume of the securities market by at least 20 percent. The CSRC also suggested that, after implementation of margin trading, China’s A-share market would absorb new capital with a value of about CNY900 billion. In addition, through securities margin trading, capital can circulate freely between the capital and money markets, as well the real economy. Margin trading offers a financing platform between banks and the securities market. Since bank liquidity is relatively high, the stock market can absorb the liquidity accumulated in banks and the real economy. This better enables integration of the stock market and financial market (Xue, 2007).

Improving the price discovery mechanism(ii)

Securities margin trading benefits not only individual investors, but also the market as a whole. On the one hand, margin trading lowers investors’ risk through hedging. With margin trading, investors are no longer caught in a unilateral market situation resulting from short sale s. Instead, investors can use margin trading and spot trading in combination to lower the market’s systematic risks and stabilize stock prices. On the other hand, margin trading aids the price discovery mechanism, to some extent approximating the real price of stocks based on the behavior of both informed and unin-formed dealers. Consequently, China’s introduction of securities margin trading not only facilitated more accurate securities prices but also was a major move in developing a mature capital market .

Laying the foundation for stock index(iii) futures trading

On the one hand, compared with stock index futures, securities margin trading was less risky and its operation could familiarize and equip investors with short selling in stock index futures. On the other hand, as securities margin trading met the demands of timely spot trading, investors could jointly employ both spot trading and futures trading to achieve reverse arbi-trage . Therefore, securities margin trading laid a good foundation for stock index futures trading.



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Impact on securities brokers(2)

Securities margin trading was a new area and its introduction certainly benefited market intermediaries (mainly securities brokers). Through margin trading, securities brokers could earn interest on margins as well as commissions. It was estimated by one securities broker that ‘the interest rate was about or slightly higher than that of a one-year loan. Conservatively, the profit margin for securities margin trading would exceed 6 percent.’ Thus the major profit for securities brokers was the interest margin. In add-ition, because of a securities guarantee in the margin trading business, this income was almost risk-free. Margin trading also increased the frequency of transactions, further adding to brokers’ profits via commissions.

Impact on investors(3)

Financial trading and margin trading are completely different operations. Financial trading refers to the activity of investors purchasing stocks with cash (typical when the market is going up) and profiting through the appre-ciation of stocks. Margin trading, in contrast, refers to investors selling stocks to gain cash when the market falls, and then buying back stocks at lower prices to close their position. The key difference is that, in financial trading, investors profit when the market rises, while in margin trading investors may profit even when the market falls. The establishment of this two-way transaction mechanism could effectively curb the speculative momentum in the one-way market and better maintain market stability. Margin trading would also offer investors better methods to seek profit and avoid risk.

1.2.2 Bringing forth the stock index futures

Stock index futures refer to a standardized futures contract in which two parties agree to transact a stock index at a preset level on a certain day in the future. China’s stock index futures were formally traded on exchanges starting from April 16, 2010, with the CSI 300 index futures contract as the only available product. We first look at the background of the emergence of stock index futures in China.

1.2.2.1 International economic climate

As the Subprime Crisis broke out in 2008, the global economy experienced serious shocks. In 2009, measures were taken to deal with this situation. With the formulation and implementation of the proactive fiscal and mon-etary policies, the economy began to recover. In the United States, the economy had its first full year growth after the crisis in 2010, gradually returning to normal, but still plagued by unemployment, real estate market issues, and debt burdens. In the Euro zone, economic growth further slowed down and the risk of deflation rose. The emerging markets took the lead in




the recovery – China and India especially. Then the outbreak of the Greek government debt crisis led to the European sovereign debt crisis. Judging by the global economic climate, sustainable recovery was a long way off.

1.2.2.2 Domestic economic climate

The year 2010 was strenuous for China and the prevalent macroeconomic pol-icies were biased towards tapping into the economy’s innate dynamism for eco-nomic growth. Therefore, it was necessary to consider the potential impacts of a series of macroeconomic policies and judge whether they could both adjust the industrial structure and maintain steady economic growth. Statistics showed that inflation in the first five months of 2012 was quite serious.

Under the specific conditions of China’s market, the government’s pol-icies in 2010 became a major public concern – especially the heavily antici-pated withdrawal policy and a successive set of restructuring policies. The withdrawal policy severely damaged the cyclical stocks in the first quarter, which led to the market falling sharply. In contrast, stimulated by the restruc-turing policies, small and medium concept stocks in regional, newly-rising industries became the market focus, and most of them rose. The govern-ment’s hard-handed tactics in the real estate market led to sharp declines for exposed firms in the stock market. Also, with housing prices actually falling in some regions, the real estate market fell into a recession. In addition, the pilot program of securities margin trading was formally launched in China on March 31, 2010.

Under these conditions, CSI 300 index futures contracts began to be for-mally traded on China’s exchanges, starting from April 16, 2010. The first contracts were for May, June, September and December.

1.2.2.3 The pros and cons of the introduction of stock index futures in China

In any market, stock index futures have the following three economic func-tions: Price discovery; curbing the stock market from violent ups and downs; and adding liquidity to the market.

There were different opinions on the introduction of stock index futures and its impact on the market gradually deepened. When the CSI 300 index futures began to be traded, the stock market was coincidentally adjusting, which attracted significant attention from all market participants. Since stock index futures were introduced in a market recession, some blamed the recession on the futures contracts themselves (Wu, 2006). In fact, though, there are other casual factors. On the one hand, the rising inflation and the public’s expectation of interest rate raises made stock investors unable to correctly judge the stock market trend. On the other hand, the gov-ernment diverted its macroeconomic policy agenda towards suppressing the real estate market, resulting in its recession. Further, turmoil in overseas markets like the Greece sovereign debt crisis had some effect on China’s



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stock market. What is more, examining its trading in 2010, the market of stock index futures was small-scale, with only about 20,000 investors and a daily capital volume of less than CNY3 billion. When compared with the stock market’s overall 140 million accounts and market value of CNY1.3 billion, it was almost of no significance. Futures contracts were unlikely to exert substantial influence, let alone pull down the entire A-share market. Indeed, investors of the stock index futures mainly constituted commodity futures investors – there were only a few securities investors – and thus it was impossible for these investors to drain significant capital from the A-share market. Thus, the stock market adjustment was barely influenced by the stock index futures. It was unreasonable to regard futures as the ‘culprit’ for the recession just because of a timing coincidence.

1.2.2.4 The positive impact of the introduction of stock index futures

The introduction of stock index futures marked a major step for China’s capital market on the path of reform and development. It not only helped cultivate and improve the capital market overall, but also raised its capacity to serve the national economy. The introduction of futures was the inev-itable result of the innovation and development of China’s capital market.

With two decades of development, China’s capital market(1) had built up noticeable scale and capacity. However, before introducing securities margin trading , it had lacked a short selling mechanism, which encour-aged one-way bets in the stock market, supported financial bubble s, and steered the market toward a crash. These systematic issues could be addressed with stock index futures.As a basic risk management tool, stock index(2) futures have the basic func-tion of hedging to avoid risks.

The introduction of stock index futures enabled investors to effectively avoid systematic risks in the stock market, improve the efficiency of asset allocation and invigorate the securities market. Whether the stock market was going up or going down, it became possible to profit. The high sys-tematic risk and volatility of the stock index was the prominent charac-teristic of China’s stock market; portfolio diversification alone could not dissipate such risks.

There were many advantages to introducing the stock index futures business. It could add variety to investment instruments, provide effective risk management tools to institutional investors , add liquidity to the market, promote long-term portfolio investment and rational transactions, improve capital effectiveness, and reduce transaction costs (Wang, 2000). It could also help cultivate institutional investors’ creativity and boost the stock market’s sophistication. As for private investors, it enriched their investment options and further ingrained the idea of value investment. What is more, it was a




tool both for underwriters in the primary market and majority investors in the secondary market to hedge risks and secure income.

Promoting reasonable volatility(3) in stock prices and serving as an eco-nomic barometer.

In the past many institutional investors lacked effective risk control mech-anisms. As a result, they could only employ insider information to profit from short-term speculation, which led to the abnormal volatility in the stock market. The stock index futures business offers a better alternative by collecting information from all sources and making the spot stock market increasingly transparent. If the price differences between the spot and futures markets widen, there will be a sharp increase in arbitrage between the two markets. This responsiveness prevents extreme fluctuations in stock prices.

1.2.2.5 The negative impact of the introduction of stock index futures

As a financial derivatives product, stock index futures trading can mitigate the systematic risks of the securities market. However, as an investment instrument, it can also generate other risks. The transaction volume of stock index futures is very large and its practice in various countries has demonstrated that, because of capital leverage, its speculative nature can greatly increase investment risk. Strategic, institutional games which were formerly conducted only in the spot market can now extend to the futures market as well. Thus risk hedging becomes a mainstream form of market investment. However, at present, small and medium investors make up the majority of investors in China’s stock market. Their capability to hedge risks is limited. With the importance of risk hedging increasing, and the risks of not hedging necessarily rising as well, the incomes of smaller market inves-tors could be threatened. Thus futures contracts can potentially harm the steady development of the market.

1.2.3 The split-share structure reform

The reform of non-tradable shares refers to the reform of stocks which were frozen by regulators from being traded (non-tradable stocks). In contrast to listed, publicly-issued stocks (tradable stocks) held by private investors, non-tradable stocks were held by state shareholders and were issued prior to public issuance . This distinction between tradable and non-tradable stocks was a unique phenomenon in China’s stock market. Due to the difference between tradable stocks and non-tradable stocks, there are stocks with different rights, and with different prices. The arising of the non-tradable shares’ problems is inseparable from China’s special historical background and the road of reform and opening-up.

As a historical legacy, the existence of the problem of non-tradable stocks not only increases the transaction costs but also leads to a low efficiency of



14 Ping Li

resource allocation. On April 29, 2005, the CSRC released the Notice on the Pilot Program of the Split-share Structure Reform of Listed Companies and Other Issues, announcing the launch of a pilot to reform the non-tradable shares.

1.2.3.1 The origin and development of the split-share structure reform

Since being established, China’s stock market had begun to implement the offering idea that ‘part of the stocks are listing and circulation, some stocks are not tradable’ to solve the problem of the circulation of state-owned stocks. Therefore, the phenomenon of non-tradable stocks was formed.

The non-tradable shares, left over by history, had many defects. It constrained the normal development of China’s capital market and hindered reform of the management system of state-owned assets. When new stocks went public, problems concerning this issue piled up and its negative impacts became increasingly obvious (Wu, 2006).

In an attempt to solve the financing problem for state-owned enterprises (SOE s), the government tried to liquidate state-owned shares, but this made the non-tradable shares a real problem. From the second half of 1998 to the first half of 1999, in order to meet the capital needs of SOE reform and further improve the social insurance mechanism, the government began to cut down its shareholding. On November 29, 1999, the government formally put forward the pilot plan of transferring state-owned stocks, and soon 10 pilot enterprises were decided and made known to the public. However, because the market did not match the expectations and implementation of the programs, the pilot was turned off. In order to continue to implement this idea, the government released the Interim Measures on the Administration of Reducing State-owned Shares to Collect Social Security Funds on June 12, 2001, and the scheme of reducing state-owned shares was formally launched. But it didn’t work well, and the scheme was a shock to the stock market, which began to decline from its historical peak of 2,245.43. On October 23, 2001, the reduction scheme was then suspended. The news made all stocks on the SSE hit limit-up by a rising degree of 9.86 percent. On June 24, 2002, as the scheme was announced a failure, the government signaled the end of the selling of state-owned shares, which once again led to the limit-up of stocks at the SSE, with an average rise of 9.25 percent. Finally, the reduction of state-owned shares ended up in failure.

Then, in November 2003, the concept of ‘split-share structure’ was offi-cially defined by the then chairman of the CSRC, Shang Fulin. He pointed out that the problems of split-share structure should be solved, but at the same time we the legitimate rights and interests of investors must be safe-guarded, and the interests of public stockholders must be protected. After this, the regulator also realized that in order to solve the Chinese market’s special problems of split-share structure, they must proceed from the higher level. They should protect the public rights and interests of investors, so as to make sure the securities market could develop healthily and stably.




To promote the reform and development of the capital market , the issue of non-tradable shares was seen as a major piece of institutional reform and became a matter of great urgency. On January 31, 2004, Some Opinions of the State Council on Promoting the Reform, Opening and Steady Growth of Capital Market was released, which explicitly aimed ‘to proactively and prudently solve the non-tradable shares issue’. Then, in order to solve the problem of split-share structure better, led by the securities and futures commission, the State-owned Assets Supervision and Administration Commission of the State Council (SASAC), the Ministry of Finance and other ministries estab-lished a focus group to make sure the problem could be carefully studied.

All aspects of the positive efforts brought good news for China’s securities market. On April 29, 2005, the CSRC released the Notice on the Pilot Program of the Split-share Structure Reform of Listed Companies and other issues, indicating the launch of the pilot work of the split-share structure reform. On May 10, 2005, the first pilot program was launched at four listed companies, including Sany, and on June 20 another pilot program was carried out at 42 listed com-panies including China Yangzte Power Co., Ltd. In September 2005, the split-share structure reform was implemented in an all-round way, requiring share conversions worth 60 percent of the market value of listed companies to be completed within a short period of time. The stock market fell down to around 1,000 points and then gradually rose up above 1,200 points.

But due to the discrepancy between the market’s expectations and the implementation plan, the pilot project was closed. To keep on working on this idea, on June 12, 2001 the Interim Measures on the Administration of Reducing State-own Shares to Collect Social Security Funds was released. But due to the same reason, it was called off on October 22 of the same year.

The resolution of the non-tradable shares issue was of great significance – perhaps even on the scale of China’s establishing a securities market. It could be considered the most important reform measure in China’s secur-ities market to date. As pilot companies brought out more and more pilot programs, the market gradually accepted and recognized the reform, indi-cating a good start for the split-share structure reform : The principles, measures and stipulations of reform were recognizable. One renowned insider commented that the non-tradable shares issue was like the Sword of Damocles suspended above China’s securities market – only by falling down could it change into a plow. Apparently, with the launch of the reform of non-tradable shares, this ‘sword’ had melted.

1.2.3.2 The effect of the split-share structure reform

Through implementing thoroughly the policies of the reform of non-tradable shares, China adapted well to the new development in its capital market s.

The reform laid a good foundation for the full utilization of capital market instruments and the promotion of companies’ development. On the one hand,



415

Index

approval system, 40, 57, 60, 61, 69, 70, 72arbitrage, 9, 13, 113, 128, 129, 168, 179,

180, 316, 319, 322, 334, 335, 342, 346, 365

bubble, 6, 12, 16, 17, 33, 58, 140, 159, 193, 201, 205, 378, 384, 386, 387, 388, 404

capital market, 1, 2, 3, 4, 5, 7, 8, 9, 12, 14, 15, 29, 30, 84, 95, 106, 107, 110, 111, 115, 116, 117, 119, 121, 125, 130, 131, 134, 135, 136, 138, 139, 140, 145, 147, 149, 151, 153, 154, 158, 159, 168, 169, 170, 176, 177, 178, 180, 181, 182, 184, 268, 334, 341, 345, 346, 368, 369, 370, 371, 372, 373, 375, 379, 380, 381, 382, 383, 384, 386, 388, 392, 398, 399, 400, 401, 402, 403, 404, 405, 406, 409, 410, 412

cash settlement, 32China Securities Finance Corporation,

30, 354circuit breakers, 322, 337, 339, 340collateral, 6, 100, 347, 351, 352, 354,

355, 363CSI300, 190, 206CSRC, 1, 2, 4, 9, 14, 30, 33, 36, 38, 40,

41, 42, 43, 44, 46, 47, 48, 49, 51, 52, 53, 54, 55, 57, 60, 62, 68, 85, 87, 88, 89, 90, 91, 92, 93, 94, 101, 106, 109, 114, 117, 118, 119, 120, 122, 123, 124, 126, 128, 133, 153, 169, 171, 176, 177, 179, 276, 313, 345, 46, 354, 371, 378, 379, 380, 390, 398, 406

delisting system, 100, 374, 400, 407, 409delivery, 86, 151, 314, 315derivatives, 13, 32, 34, 87, 106, 113, 128,

131, 175, 182, 293, 313, 333, 334, 335, 345

equity investment, 20, 26, 27, 28, 29Exchange Traded Funds, 2, 319, 351

financial futures, 313, 314, 365financials, 210, 273, 280, 311

GARCH, 269, 279, 290, 291, 324, 325, 326, 341

growth enterprise market, 2, 62, 368, 369, 371, 382, 383, 387, 388, 392, 398, 401, 409, 410

health care, 234, 236, 237, 238, 282, 395hedge, 13, 22, 114, 314, 316, 321, 334,

335, 340, 341, 346high-tech enterprises, 369, 375, 376,

381, 388, 410housing provident fund, 35, 36, 37

incentives, 42, 184, 361independent innovation, 368, 373, 375,

379, 402, 405index constituents, 189, 352information disclosure, 23, 24, 28, 39,

43, 54, 55, 56, 57, 84, 86, 87, 88, 89, 90, 94, 95, 97, 113, 114, 169, 173, 175, 176, 177, 345, 369, 370, 371, 372, 374, 400, 402, 403, 409, 410

information services, 210, 211, 238, 239, 240, 246, 247, 252, 255, 256, 257, 258, 311, 375

initial margin, 340, 341, 351, 365Initial Public Offerings (IPO), 5, 6, 27,

28, 39, 40, 42, 43, 44, 48, 49, 50, 52, 53, 54, 55, 56, 57, 58, 59, 60, 61, 63, 64, 65, 66, 67, 68, 69, 70, 71, 72, 73, 74, 77, 78, 79, 80, 81, 82, 83, 84, 87, 88, 90, 99, 101, 153, 158, 159, 321, 380, 386, 393, 394, 395, 396, 397, 398, 405, 406, 407

inquiry pricing, 52institutional investors, 12, 13, 18, 19, 27,

29, 47, 48, 52, 57, 60, 106, 107, 108, 109, 111, 114, 116, 117, 118, 119, 121, 151, 159, 160, 161, 162, 165, 166, 167, 168, 169, 170, 180, 181, 182, 183, 184, 342, 343, 345, 346, 385, 395, 408, 409



416 Index

insurance company, 107, 117, 131, 133, 135, 136

investors’ behavior, 188, 192, 193, 311issuance, 1, 2, 6, 13, 18, 35, 39, 40, 41,

42, 43, 44, 45, 46, 47, 48, 49, 50, 52, 54, 55, 56, 57, 60, 61, 62, 63, 67, 68, 70, 88, 90, 92, 95, 114, 122, 321, 353, 371, 374, 376, 384, 385, 389, 397, 403, 404

large-trader reporting system, 342long-term underperformance, 64, 67, 74

machinery, 102, 258, 259, 260, 261, 262, 263, 264, 265, 266, 268, 269, 270, 271

main board, 92, 247, 368, 369, 370, 371, 372, 373, 374, 375, 376, 378, 379, 382, 385, 387, 388, 389, 398, 399, 401, 402, 406, 408, 409, 410

maintenance margin, 341, 349, 351, 352, 355

margin purchase, 352, 355, 358margin trading, 6, 7, 8, 9, 10, 11, 12, 30,

31, 32, 314, 347, 348, 349, 350, 351, 352, 353, 355, 356, 358, 361, 362, 363, 364, 365

margin trading and short selling, 346, 347, 348, 349, 350, 351, 352, 353, 354, 355, 356, 357, 358, 359, 361, 363, 364, 365, 366

market economy, 17, 109, 138, 196, 283, 284, 372, 383

market-oriented reform, 39mutual funds, 22

Non-Public Offer Fund, 106NPC Standing Committee, 106

operational characteristics, 311outstanding contracts, 314

pension fund, 19, 21, 28, 31, 32, 37, 143, 145, 146, 147, 149, 152, 153

position limit, 342, 345price limit, 315, 337, 338, 339, 340, 345pricing methods, 39, 49, 51private equity, 27, 29, 106, 111, 153,

155, 156, 395, 399Private Fund, 107, 111, 113, 114, 115,

169

profitability, 54, 58, 85, 149, 153, 159, 162, 163, 212, 216, 258, 273, 282, 283, 287, 299, 303, 305, 387, 392, 400

real estate, 10, 11, 16, 17, 33, 131, 132, 133, 139, 140, 155, 157, 158, 171, 172, 208, 209, 210, 212, 272, 283, 292, 303, 311, 358

refinancing, 6, 7, 30, 31, 32, 348, 349, 353, 354, 358, 361, 362, 363, 364

regulation, 2, 4, 7, 8, 18, 21, 23, 24, 25, 30, 34, 35, 37, 40, 44, 48, 55, 56, 84, 85, 87, 88, 90, 97, 98, 109, 114, 118, 119, 122, 123, 124, 126, 128, 131, 133, 141, 148, 149, 150, 152, 157, 169, 170, 171, 173, 174, 175, 176, 206, 257, 258, 311, 341, 342, 346, 349, 350, 351, 365, 384, 403, 406, 407

representative sector, 187risk-return, 191, 192, 310

sector indices, 187, 206, 221, 222Shanghai Composite Index, 268Shenzhen Composite Index, 268short sale, 9, 348, 352, 358, 366SME board, 370, 371, 375, 377, 378, 379,

382, 383, 388, 389, 393, 398, 399, 400, 406, 409, 412

SOE, 14, 370split share structure reform, 13, 14,

15, 205sponsor system, 2, 40, 60SSF, 19, 20startup companies, 370, 402, 409, 410,

412State Council, 1, 4, 8, 15, 18, 19, 20, 36,

40, 42, 45, 60, 109, 119, 133, 140, 237, 238, 285, 313, 347, 378, 379

stock index, 4, 6, 9, 10, 11, 12, 13, 79, 119, 130, 212, 239, 272, 313, 314, 316, 317, 319, 321, 322, 324, 325, 326, 327, 328, 329, 332, 333, 334, 335, 336, 339, 341, 342, 343, 345, 346, 364, 365, 386

stock index futures, 6, 9, 10, 11, 12, 13, 130, 313, 314, 315, 316, 318, 319, 320, 321, 322, 325, 327, 329, 332, 333, 336, 337, 364, 365, 366

stock liquidity, 194, 408Style Indices, 188, 189, 192, 193subprime crisis, 5, 9, 10, 292, 368, 370, 373



Index 417

trust company, 106, 107, 111, 113, 120, 138, 139, 141

underpricing, 39, 53, 54, 58, 59, 60, 63, 68, 70, 71, 74, 83

underwriter reputation, 58, 59, 60, 67, 70, 71, 74, 79, 83

valuation, 32, 55, 84, 106, 114, 117, 119, 142, 159, 172, 177, 198, 271, 350, 395, 402, 404, 408

venture capital, 6, 28, 109, 135, 368, 369, 372, 375, 376, 377, 378, 379, 380, 381, 383, 384, 397, 398, 399, 400, 402, 403, 405, 406, 409, 411, 412

volatility, 12, 13, 17, 32, 35, 111, 130, 190, 221, 230, 231, 232, 246, 250, 251, 252, 253, 269, 276, 279, 280, 291, 302, 304, 309, 321, 322, 324, 325, 327, 328, 329, 330, 331, 332, 333, 336, 340, 341

warrant, 32, 33, 34, 35, 44, 45, 112, 352



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