Key Problems and Challenges of China’s MONEY and SECURITIES market

China’s Economy In Transformation / Presentation 06

Money Market

money market
a place for short term borrowing and lending specializes in debt securities that mature in less than one year

treasury notes treasury bills bankers’ acceptance certificates of deposit repurchase agreement (repo) commercial paper

1980

Short Term

Long Term

State of Disorder

realizing investment in prohibited areas

securities and real estate market

inflation and bubble economy

central bank reform package

1996

Unified national interbank funding market

16
headquarters of commercial banks

RMB 587.2 billion
total trading volume

2006

RMB 39 trillion
total trading volume

interbank credit borrowing & lending bond repos spot bond transactions

703
market players in interbank borrowing & lending

6439
market players in interbank bond market

Problems

Inadequate market tools
underdeveloped treasury bond market lack of treasury bills with maturity less than 1 year inactive commercial paper market

fragmented market

Different interest rates and trading rules Low liquidity of the market between regional and national market

Challenges

Interest Rates Liberalization

% : Adjustment to balance supply and demand for money

Interest Rate

Ms % MD

Loanable Funds

Interest Rate

M2 M1 %1 MD

Loanable Funds

Interest Rate

M2 M1
1

%1 MD

Loanable Funds

Interest Rate

M2 M1
2

%2 %1

1

MD

Loanable Funds

Interest Rate

3

M2 M1
2

%2 %1

1

MD

Loanable Funds

China People’s Bank of China stipulates the commercial banks’ benchmark deposit and lending rates of all maturities, with a certain degree of flexibility

Interbank rates normally serve as an important benchmarks for setting interest rates for other financial products Ultimate goal: Allow commercial banks to decide all their commercial rates in accordance with markets forces

Central Bank Paper

RMB

FX Market
Foreign Currency Purchase

Central Bank Paper

Money Market
Liquidity Absorption

RMB

FX Market
Foreign Currency Purchase

Central Bank Paper

Money Market
Liquidity Absorption

Capital Market

capital market
market for securities where companies and government can raise long terms funds

Stock Exchange

Shares Unit Trust Bond

3 share markets & 3 types of shares

Shanghai Stock Exchange Shenzhen Stock Exchange Hong Kong Stock Exchange

A Shares priced in RMB locals + QFII *

B Shares priced in USD / HKD locals and foreigners

* QFII : Qualified Foreign Institutional Investor System

Number of domestically listed PRC companies 1996 - 2005

1504
listed companies in Aug 2007

23.55 trillion
market capitalization

8 trillion
tradable market capitalization

60% increase
compared to August 2003

Problems

Underdeveloped corporate bond market

" China’s captial market only has one leg at the moment " "... hope to see smooth development of the corporate bond market"
Mandy Wang, Chief Executive of China International Fund Management, of which JPMorgan Chase owns 49 %

A mass of regulations Interest rate limitation Government control on listing

Inappropriate positioning of stock market

China Construction Bank listing on 25/9/07

“...A-share listing is politically driven It's not a business decision CCB has no urgent need for fresh capital”

Paddy Ran, analyst at Nomura International (HK)

To please the citizens Develop Shanghai as regional financial center

39%
CCB H-shares in 3 months time

Over-speculation and bubble formation

7 ‘SINS’ In China’s Captial Market
China Securities Regulatory Commission Chairman Shang Fu Lin

7 ‘SINS’ In China’s Captial Market
China Securities Regulatory Commission Chairman Shang Fu Lin

Immoral for stock dealers to lure students investing their live saving into stocks

7 ‘SINS’ In China’s Captial Market
China Securities Regulatory Commission Chairman Shang Fu Lin

Immoral for stock dealers to lure students investing their live saving into stocks Stock prices of companies with poor performance still shot up

7 ‘SINS’ In China’s Captial Market
China Securities Regulatory Commission Chairman Shang Fu Lin

Immoral for stock dealers to lure students investing their live saving into stocks Stock prices of companies with poor performance still shot up

Share prices of new listed stock ran up too much

7 ‘SINS’ In China’s Captial Market
China Securities Regulatory Commission Chairman Shang Fu Lin

Immoral for stock dealers to lure students investing their live saving into stocks Stock prices of companies with poor performance still shot up

Share prices of new listed stock ran up too much Insider trading and manipulation Intentionally destroy evidence

7 ‘SINS’ In China’s Captial Market
China Securities Regulatory Commission Chairman Shang Fu Lin

Immoral for stock dealers to lure students investing their live saving into stocks Stock prices of companies with poor performance still shot up

Share prices of new listed stock ran up too much Insider trading and manipulation Intentionally destroy evidence

1/ 2/ 3/ 4/

Companies Restructure ‘Rubbish’ asset injection Speculation Rise stop board

7 ‘SINS’ In China’s Captial Market
China Securities Regulatory Commission Chairman Shang Fu Lin

Immoral for stock dealers to lure students investing their live saving into stocks Stock prices of companies with poor performance still shot up Fraud in rise of newly open accounts in A shares

Share prices of new listed stock ran up too much Insider trading and manipulation Intentionally destroy evidence

1/ 2/ 3/ 4/

Companies Restructure ‘Rubbish’ asset injection Speculation Rise stop board

7 ‘SINS’ In China’s Captial Market
China Securities Regulatory Commission Chairman Shang Fu Lin

Immoral for stock dealers to lure students investing their live saving into stocks Stock prices of companies with poor performance still shot up Fraud in rise of newly open accounts in A shares

Share prices of new listed stock ran up too much Insider trading and manipulation Intentionally destroy evidence

1/ 2/ 3/ 4/

Companies Restructure ‘Rubbish’ asset injection Speculation Rise stop board

Misleading descriptions of financial products

"The valuation of China Eastern is too high and the company is still loss-making, so it would take time to reflect synergies and other benefits from the deal," said an analyst with a European investment bank

Wealth Effect

P/E Ratio : Price per share / Earning per share

14
p/E ratio of U.S equity market

20
p/E ratio of developed markets

59.17
p/E ratio of Shanghai Composite Index
August 2007

68.99
p/E ratio of Shenzhen Component Index
August 2007

RISE

DROP

Clearly, something is wrong

Strengthen Corporate Governance Market Liberalization Delisting and Listing Regulations Share Reform

“...sustaining growth requires deepening China’s capital markets. It is not likely that the current bank-based system will be able to meet China’s needs for diversified, dynamic and competitive financial intermediation. The short-term challenge is managing the fallout from a stock market bubble. For the longterm, Chinese policy-makers might also consider further liberalizing capital markets by lifting restrictions on foreign and domestic private firms and developing new asset classes, especially corporate and municipal debt. Innovative new players, such as private equity firms, are particularly needed to inject competition and dynamism into China’s capital markets...”

“...sustaining growth requires deepening China’s capital markets. It is not likely that the current bank-based system will be able to meet China’s needs for diversified, dynamic and competitive financial intermediation. The short-term challenge is managing the fallout from a stock market bubble. For the longterm, Chinese policy-makers might also consider further liberalizing capital markets by lifting restrictions on foreign and domestic private firms and developing new asset classes, especially corporate and municipal debt. Innovative new players, such as private equity firms, are particularly needed to inject competition and dynamism into China’s capital markets...”

“...sustaining growth requires deepening China’s capital markets. It is not likely that the current bank-based system will be able to meet China’s needs for diversified, dynamic and competitive financial diversified intermediation. The short-term challenge is managing the fallout from a stock market bubble. For the longterm, Chinese policy-makers might also consider further liberalizing capital markets by lifting restrictions on foreign and domestic private firms and developing new asset classes, especially corporate and municipal debt. Innovative new players, such as private equity firms, are particularly needed to inject competition and dynamism into China’s capital markets...”

“...sustaining growth requires deepening China’s capital markets. It is not likely that the current bank-based system will be able to meet China’s needs for diversified, dynamic and competitive financial diversified intermediation. The short-term challenge is managing the fallout from a stock market bubble For the longbubble. term, Chinese policy-makers might also consider further liberalizing capital markets by lifting restrictions on foreign and domestic private firms and developing new asset classes, especially corporate and municipal debt. Innovative new players, such as private equity firms, are particularly needed to inject competition and dynamism into China’s capital markets...”

“...sustaining growth requires deepening China’s capital markets. It is not likely that the current bank-based system will be able to meet China’s needs for diversified, dynamic and competitive financial diversified intermediation. The short-term challenge is managing the fallout from a stock market bubble For the longbubble. term, Chinese policy-makers might also consider further liberalizing capital markets by lifting restrictions on foreign and domestic private firms and developing new asset classes, especially corporate and municipal debt. Innovative new players, such as private equity firms, are particularly needed to inject competition and dynamism into China’s capital markets...”

“...sustaining growth requires deepening China’s capital markets. It is not likely that the current bank-based system will be able to meet China’s needs for diversified, dynamic and competitive financial diversified intermediation. The short-term challenge is managing the fallout from a stock market bubble For the longbubble. term, Chinese policy-makers might also consider further liberalizing capital markets by lifting restrictions on foreign and domestic private firms and developing new asset classes, especially corporate and municipal debt and municipal debt. Innovative new players, such as private equity firms, are particularly needed to inject competition and dynamism into China’s capital markets...”

“...sustaining growth requires deepening China’s capital markets. It is not likely that the current bank-based system will be able to meet China’s needs for diversified, dynamic and competitive financial diversified intermediation. The short-term challenge is managing the fallout from a stock market bubble For the longbubble. term, Chinese policy-makers might also consider further liberalizing capital markets by lifting restrictions on foreign and domestic private firms and developing new asset classes, especially corporate and municipal debt and municipal debt. Innovative new players, such as private equity firms are firms, particularly needed to inject competition and dynamism into China’s capital markets...”

The Outlook for China’s Capital Market

1) What is the outlook for China's capital markets? Where are the greatest opportunities and risks? 2) What role do foreign investors play in the growth of China's capital markets? 3) How will China's stock exchanges continue to attract top companies to list domestically? What are the implications for foreign stock exchanges? Discussion Leader Fang Xinghai, Deputy Director-General, Office for Financial Services, Shanghai Municipal Government, PRC Fred Zuliu Hu , Managing Director, Goldman Sachs (Asia), Hong Kong SAR Shang Fulin, Chairman, China Securities Regulatory Commission, People's Republic of China Martin Wolf, Associate Editor and Chief Economics Commentator, Financial Times, United Kingdom Levin Zhu, Chief Executive Officer, China International Capital Corporation, People's Republic of China Moderated by Bernard Lo, Presenter, Bloomberg News, Hong Kong SAR

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