In November 2013, the 18th Central Committee of the Chinese Communist Party (CCP) held its Third Plenum in Beijing, during which it endorsed a package of economic reform tasks that included the restructuring of financial markets and the prioritization of direct financing through stock markets instead of traditional indirect financing in the form of bank loans. A year later, the Shanghai and Shenzhen Composite Indexes of China’s A-shares started to experience sharp increases despite flagging economic fundamentals, which was followed later on by an unprecedented stock rout in the summer of 2015 that led to draconian anti-graft investigations into officials and executives in China’s financial sectors, with at least eight officials in the China Securities Regulatory Commission (CSRC) being detained by the authorities.
Among those that were detained by the CCP Central Commission for Disciplinary Inspection (CCDI) and the Chinese police were the CSRC Vice Chairman Yao Gang and Assistant Chairman Zhang Yujun, General Manager Cheng Boming of the CITIC Securities Company, a leading full-service investment bank in China that reportedly had good connections with the CSRC, and Xu Xiang, the legendary manager of Zexi Investment, one of China’s most successful hedge funds. The CCDI has dispatched inspection teams to various financial organisations since September 2015, including the People’s Bank of China (PBOC, China’s central bank), the CSRC, the China Insurance Regulatory Commission (CIRC), the China Banking Regulatory Commission (CBRC), two stock exchange bourses (Shanghai and Shenzhen), and five major state-owned banks (Bank of China, Agricultural Development Bank of China, Industrial and Commercial Bank of China, China Construction Bank, and Bank of Communication). The PBOC, CSRC, CIRC and CBRC, often abbreviated as “one bank and three commissions” (yihang sanhui), constitute China’s regulatory system over the country’s financial activities at the central level. As a result, a large number of officials and executives from these securities groups, banks, insurance companies, investment companies and other financial organisations have been placed under investigation. The central leadership has demonstrated its determination to root out rampant financial corruption.
However, the Chinese authorities have failed to achieve the goal of reducing market volatility and boosting investors’ confidence in the stock market. The stock market turbulence continued in 2016, including steep plunges of A-share stock indexes that triggered the newly-installed market-wide circuit breakers twice in just one week. On those two trading days, circuit-breakers halted trading in China’s stock market after the blue-chip index fell by 7 percent. Some blamed the new system of circuit-breakers for inducing panic among traders who rushed to sell before the daily 7 percent limit closed the market, but even after the system of circuit-breakers was suspended by the regulators, stock market turbulence continued till very recently.
The volatility has been blamed on the immaturity of the Chinese stock market, which is dominated by false disclosures, insider trading, and retail investors. The central authorities intensified the crackdown on insider trading and market manipulation, with anti-corruption investigations going on in financial sectors. As a result, a large number of officials and executives from these securities groups, banks, insurance companies, investment companies and other financial organisations have been placed under investigation (see Table 1). The central government has demonstrated its determination to root out rampant financial corruption and thus lower the volatility of the stock market.
Table 1. Key Financial Officials and Executives Under Investigation since 2015
Source: Compiled by the author based on information from the CCDI website http://www.ccdi.gov.cn/special/jdbg3/zyhgjjj/
The fight against financial corruption may have implications for China’s ongoing economic restructuring. The long-suppressed stock market has been deemed by the new leadership since 2012 as a strategically important way to redistribute financial resources and cut overreliance on bank credit. Direct financing through stock markets was encouraged by the Third Plenum in 2013, which planned to turn the current approval-based system of initial public offerings (IPOs) into a “registration-based” one in the stock market.
China will increasingly face financial constraints to achieving sustainable economic growth in the future (Lardy, 1998, p. 187). Given the huge need for investment resources, and the small scope for further increases in the savings rate and senior-age revenue, the only option will be to reform the state-owned banks and state-owned enterprises (Long and Sagari, 1991, p. 431). Financial reform in China is more complicated than in most developing countries because it involves not only financial liberalisation, but also the reshaping of the structure and functions of the financial system. As China speeds up its financial liberalization, its weakness in financial regulation and supervision has become more obvious, with rampant insider trading and rent-seeking hurting the interests of ordinary investors. More professionals are needed to tackle the financial crimes.
Mainly by recruiting professionals, the CSRC has attempted to improve the professionalism of its staff and enhance regulation. Officials hired by securities companies often have rich experience and connections to the capital market. Nevertheless, CSRC officials are highly sought after by state-owned and state-controlled financial companies. The regulators-turned-executives no doubt will use their connections, knowledge, and experience to profit from the securities trading business. The conflicting roles of regulators and their regulated subjects could undermine the principle of fairness in the securities market (Fu, 2010, p. 105).
The ups and downs of the Chinese stock market have highlighted the urgency of reforming China’s financial system. Anti-corruption investigations alone will not be sufficient to solve the problem. In August 2013, the State Council announced plans to establish the central bank-led supervision coordination and inter-department joint conference system to provide financial supervision. However, in practice, all these mechanisms failed to perform their functions. China’s 13th Five-year Plan proposed to reform and improve the financial supervision framework to adapt to the development of a modern financial market through the establishment of a more effective coordinated supervision mechanism. On January 13, 2016, the State Council established the Financial Affairs Bureau (originally the sixth department of the economic bureau of the State Council). The new bureau was to take charge of the administrative coordination of the “One Bank and Three Commissions”. However, there is still a long way to go before China can establish a mature and effective intra-agency mechanism on financial supervision, and thus lower the volatility of its stock markets.
Lardy, N. (1998). China’s Unfinished Economic Revolution. Washington, DC: Brookings Institution Press.
Long, M. and Sagari, S. (1991). Financial reform in European economies in transition. In P. Marer and S. Zecchni (eds.), The Transition to a Market Economy, vol. 2. Paris: OECD.
Fu, J. (2010). Corporate Disclosure and Corporate Governance in China. Kluwer Law International.